Crypto Mania Dumpster Fire Is Setting the Stage for the Mother of All Bubbles
The Ivory Hill RiskSIGNAL is still red and we are sitting on roughly 76% cash (since January) for our noninstitutional clients.Value stocks are outperforming growth stocks by a wide margin.The FTX crypto crash is telling us how big this bubble actually is.Fundamentals are telling us this bear market rally could still have legs but don't expect it to last.We are still far from a bottom.
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Crypto Mania Dumpster Fire Is Setting The Stage for the Mother of All Bubbles
The market's response to last week's CPI report, which showed that core inflation seems to be slowing down, was very positive. Keep in mind that one data point does not necessarily indicate a trend, and the Fed has been very blunt that it will not stop raising rates until inflation is in check. The trend is decisively down, and we will be patient and let the market tell us when to buy and when to re-enter the market.
The Ivory Hill RiskSIGNAL is still red, and we are sitting on roughly 76% cash for our noninstitutional clients.
As I wrote in my last report, our signals told us lower volatility was expected, implying the market was due for a rally, and that's exactly what happened. The S&P 500 rallied 7% in eight trading days.
BUT in the same period of time, gold rallied 8%. Traders normally flee to gold during times of uncertainty or during periods of high volatility, so why would gold be rallying along with the stock markets if volatility was down and stocks were up?
Let’s ask that question from a different point of view. Let’s say that gold is a hedge against inflation. It’s not, but for the sake of this post, let’s assume some traders would buy gold as a hedge against inflation before the inflation report. The inflation report showed that inflation went down, so that doesn’t make sense. But why would investors buy gold when stocks are clearly a better choice?
This question is easy to answer: traders are rapidly covering their short positions. Short covering is the process of buying back securities that have been borrowed so that an open short position can be closed at a profit or loss. It requires purchasing the same security that was initially sold short, and handing back the shares initially borrowed for the short sale. This type of transaction is referred to as a "buy to cover."
Gold is still clearly in a bearish downward trend along with the market, but what happens when traders start covering both stocks and bonds? Well, we are seeing it right now with the "everything rally."
Asset class selection is crucial:
The Vanguard Value ETF (VTV) is down 3.72% this year while the comparable Growth ETF (VUG) is down more than 28%, which underscores just how important investment style selection and individual sector allocations have become. Boring value stocks are outperforming growth stocks this year.
If you have been following the horror movie/comedy show that is FTX, Sam Bankman-Fried and the crypto space in general, I want to explain to you how this dumpster-fire is a scaled-down version of a broader macroeconomic trend that some are calling "The Mother of All Bubbles."
That bubble appears to be bursting.
For those of you who are not up to speed on this situation:
FTX is a crypto exchange just like Coinbase, Binance, and Gemini. The FTX exchange, which used to be one of the largest in the world, filed for bankruptcy last week, and its CEO and founder also quit. Hours later, the trading firm said there had been “unauthorized access” and that funds had disappeared. Analysts say hundreds of millions of dollars may have vanished.
On Friday, FTX filed for Chapter 11. CEO Sam Bankman Fried resigned. Billions of customer assets are caught up in the crypto exchange’s epic mismanagement.
The pre-collapse mania has been supported by a long list of carnival barkers. That list includes Michael Saylor, Raoul Pal, Anthony Scaramucci, and a rotating cast of clowns on CNBC. They convinced millions of uneducated investors that crypto was their only hope. Since the climax of this insanity, more than $2 trillion in crypto market cap has been erased.
What's happening today in crypto is not symptomatic or even pointing to a potential bottom.
Think about this for a minute. People have invested a lot of their hard-earned capital into crypto, and then this happens after this entire space has crashed. Can you imagine?
If you invested $1,000,000 in Bitcoin at its peak in November of 2021, you only have $250,000 in your account today. Bitcoin is down 75%.
This situation is beyond out of control. To quote one of my marine colleagues, the crypto space is FUBAR.
About this time last year, Elon Musk was pushing Dogecoin. It literally started as a joke.
Here's another example. I was scrolling through my Instagram feed this morning and came across this targeted ad. This is advertising the benefits of trading crypto futures with 150X leverage!
When you invest or trade with leverage, you use borrowed money to improve your trading position beyond what you could do with just your cash on hand. Through margin trading, which borrows money from the broker, you can use leverage with a broker account.
Do any of you want to mortgage your house to buy cryptocurrency? For a lot of people, that isn't too far off from what they did. They took out debt to buy crypto and then lost it at an accelerated rate when they got margin called. When you get your margin called, you either need to put more money in your account or you need to sell your position down to the minimum amount. Typically, margin calls result in increased selling.
If you are trading anything at 150X leverage, that means you are getting 150X the gains while also taking 150X the losses. Think this space has finally gotten out of control?
There is more leverage in the crypto space than there is actual cryptocurrency! To my point, the entire market (including stocks) is just one big leveraged trade that is being margin called.
Overconfidence leads to leverage. Increased leverage has led to every single major market crash in history.
Here's how this plays out in the broader market: margin calls trigger increased selling, increased selling turns into oversold markets, and oversold markets turn into major market crashes.
This is not an indication that the bottom has been reached. This is most likely a sign of what's to come in the global capital markets.
Here's a quick recap:
$2 trillion in crypto market cap … GONE
$10 trillion in aggregate equity market cap ... GONE
We do not own any crypto right now, and when we did, it was in an ETF, and we were quick to take profits.
REALITY CHECK: If you've been following Ivory Hill, you know that our proprietary quant-based indicator flipped red in January when we moved our clients to 60%-70% cash.
To read the rest of this analysis, click below...
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Outperformance is achieved through the avoidance of major market crashes.
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Kurt S. Altrichter, CRPS®
Fiduciary Advisor | President
8400 Normandale Lake Blvd, Suite 920, Bloomington, MN 55437