Where is the bottom?
Breaking: US inflation hits 8.6%, the highest it’s been since December 1981
It is much harder to pinpoint a bottom than it is to identify where we are in a cycle. If you are investing on a multi-year time horizon, you’ll weather multiple cycles. So you benefit most from focusing on entry points, accumulating when valuations are attractive, and listening to the data.
What’s the data saying?
On chain indicators
In previous cycles, on chain indicators at current levels support adding exposure.
MVRV, a ratio of BTC's market cap to its realized cap, in the 1.25 to 1.5 range suggests the current bitcoin price is on average held at a modest premium to cost basis. Sell pressure tends to increase as holders take profits when MVRV is over 2, but MVRV at or below 1.25 is an attractive accumulation range.
The percent of bitcoin that hasn’t moved in over a year is at an all-time high, suggesting long term holders have been absorbing sell pressure created by short term holder capitulation.
Despite accumulation vibes from on chain indicators, a responsible degen must now also consider the impact of sustained macro headwinds — or worse, a major macro shock — given the high correlation of BTC and equities.
Macro headwinds
We all heard the fed’s money printer go brrrrr in 2020 as JPow dropped interest rates and held them close to zero through March 2022.
Unsurprisingly, this pushed the stock market valuations to levels we hadn’t seen since the dot com bubble, crypto to all-time highs, and inflation to levels last seen in the 1980’s.
Plus real inflation could be even higher. As one example, there is a strong case rising housing costs, which account for 30% of the overall index, are understated.
The federal reserve
The federal reserve now has two levers to reel in runaway inflation: interest rates and its balance sheet. A Messari macro report published in April showed fed fund rate futures suggest the market is pricing in a 74% chance of ten rate hikes by the end of 2022 — which hasn’t happened since the 1970s when annual inflation was in the teens leading up to the worst recession since the Great Depression.
In addition to raising rates, the fed announced it will runoff balance sheet assets (quantitative tightening) at the rate of $50B per month starting in June increasing to $95B per month in September. If the goal is to return the fed’s balance sheet to pre-pandemic levels, it would take 2-3 years to runoff $3-4 trillion at this rate, which is double the pace of the 2018 runoff that corresponded to a 20% sell-off in the S&P 500.
We have seen what happens in a rising rate environment. And the current scenario is rate hikes combined with aggressive quantitative tightening (QT). There is also no precedent for the current disconnect between rates and inflation.
National debt
Horizon Kinetics raised an important point in a recent memo. The debt to GDP ratio during the inflationary environment of the 1970s was in the low 30s. The latest debt to GDP ratio from end of year 2021 was 123%.
When the US national debt was $890 billion in 1980, a 1% interest rate increase cost the US Treasury an additional $8.9 billion incremental annual debt service. The current national debt is $30.5 trillion so a 1% interest rate increase would create $300 billion incremental annual debt service.
In addition to national debt, US citizens collectively have $89.5 trillion in debt and pay 3.76% annual interest, or $3.36 trillion. A 3% interest rate hike would push the total US interest expense over $6 trillion. In other words, a 3% interest rate hike would require 25% of a $24 trillion economy be devoted to servicing debt — assuming a recession doesn’t decrease the size of our economy.
The HK memo concluded:
The magnitude of today’s debt levels appears to greatly reduce the central bank’s monetary policy options. If inflation cannot be controlled by interest rate increases, perhaps it cannot be controlled. The alternative is to control inflation via the money supply, meaning actually reducing the money supply. The last time that was tried was during the Great Depression.
Crypto vs Inflation
Institutions aren’t expecting inflation to go away anytime soon. HK notes:
One of the most important elements in asset management in the coming decades will be finding inflation beneficiaries and business models that are protected from inflationary pressures.
We’ve seen crypto serve as a safe haven in emerging market countries experiencing currency devaluations such as Turkey where chainanalysis reports a significant relationship between lira devaluation and lira trading on cryptocurrency exchanges and Argentina which recorded the 10th highest rate of cryptocurrency adoption in the world.
We’ve also seen how inflation can affect asset class correlations, and Bitcoin didn’t exist the last time inflation averaged over 5% in the US:
The correlation between stocks and bonds has been negative since 2000 but prior to that period, the last time the correlation was negative was the 1950s. Why? That was the last period where inflation averaged under 2%.
Conclusion
Returning where we started this post, is this the bottom? Probably not.
[Breaking: US inflation hits 8.6%, the highest it’s been since December 1981]
Is this a good point in the cycle to accumulate exposure? Yes.
Are there any promising catalysts for crypto on the horizon? Yes.
Currency devaluation in the US drives demand for Bitcoin and other crypto assets as it has been in other countries // Crypto assets decouple as equity and bond correlations increase returning to levels last seen 20+ years ago when average inflation topped 5% // The merge heightens the appeal of Ethereum and other yield generating crypto assets // Game, NFT, and Defi projects funded during the last 24 months ship new products, onboard a fresh wave of people into the crypto ecosystem, and ignite the next rally.
nfa.