VegaX Flash News Report: April 2022 Market Outlook
VegaX Holdings highlights current economic dynamics that are driving market movements globally. Learn more about what is happening in currently in the economy, how that affects the market, and what that means for Bitcoin and the crypto market. This edition covers April 2022.
April 2022 — What’s Driving the Crypto Markets?
Last week, the crypto market suffered from one of the harshest sell-off events of this year. Crypto funds have seen significant outflows as investors liquidated about $134 million worth of their Bitcoin and Ethereum funds, as reported by CoinShares.
Investors worldwide are overwhelmed with a myriad of macroeconomic and geopolitical events unfolding around them. The conflict between Russia and Ukraine sends economic shockwaves far and beyond, raising energy, food, and commodity prices. Fears of record inflation and a potential recession loom over the market.
The following rundown will attempt to demystify the intertwined web of macroeconomic factors that are driving markets and help crypto investors devise the optimal strategy to safeguard their purchasing power during such trying times.
What’s propelling the markets?
Inflated economy, inflated fears-
The inflation in the US hit a record high of 8.5% over the year at the end of March. This is the highest inflation ever recorded since 1981. The latest Consumer Price Index (CPI), which measures the price of a basket of goods and services like energy(fuel), food, rent, and commodities rose by 7.9% through February, this is the fastest pace of inflation in the past 40 years. The soaring gas prices as a result of the supply shock from sanctions on Russia have been a major contributor to this trend. Gas prices have gone up by 18.3% and food by 8.8% year over year.
The situation in developing countries with limited resources is far worse than in the US. When people are forced to allocate a larger portion of their income to basic necessities, they are left with a thinner appetite for what they deem as speculative assets like equity and crypto.
Tax is right around the corner.
The tax deadline in countries like the US, UK, Europe, and Australia for the year ending on December 31st is near. 2021 was a great year for the stock market, NFTs, and digital assets in general. Retail investors made handsome returns in crypto last year, unlike previous years, when only institutions profited the most. The COVID-19 tax deadline in the US was extended to May 18, 2021 last year, but remains April 18, 2022 for this year. Investors seem to be cashing out their crypto investments to file their income taxes. Similar kind of sell-off happened last year during the taxation week.
The infamous yield curve
The yield curve is a simple plot that showcases the relative yields of two interest rates over time. Economists worldwide compare the relative yields of the 10-year and the 2-year treasury bonds to determine the health of the economy. Under normal circumstances, the yield of bonds with a later maturity is higher, owing to a greater risk assumed for a longer exposure.
So what happens during times of economic uncertainty? Typically, when the Fed starts to raise interest rates, the yield on short-term bonds tends to rise disproportionately than yields on long-term bonds. The curve finally flips when the short-term bond yields go higher than the latter.
The yield curve flipped last week — generally, this is an indication of bearish market sentiment and the potential for recession. With the fears of a decreased economic activity due to recession, it is natural for investors to get attracted to risk-off investments like bonds.
Tech stocks and crypto
Investors who understand the digital asset industry’s value proposition tend to have a long-term investment horizon, generally speaking. So why the recent panic-selling?
There is an evident correlation between the trading patterns of tech stocks by traditional investors in the equity market and BTC (which can be assumed as a reliable proxy for the broader crypto market). Both are being perceived as a version of risk-on assets in their respective environments.
Tech equities, and other risk-on assets, typically perform better in low-interest-rate environments where access to capital is “cheap” and, as such, investors seek opportunities that yield higher returns than fixed-income vehicles, like bonds. Tech stocks are typically accompanied by higher PE ratios and stretched valuations. This is a partial reason why they are the first ones to fall prey to rising interest rates.
While digital assets are not subject to PE ratios and valuations, the correlation between them suggests a similar perception of stretched valuations in the short term.
The NDX is an index of the 100 largest companies listed on the Nasdaq exchange — 7 out of the top 10 securities are tech stocks, and the tech industry makes up ~60% of the index’s weight.
The following charts illustrate NDX’s 10, 30, and 90-day correlations with BTC.
Correlation is statistical metric that ranges between (-1) — (+1). A perfectly negative correlation means that the instruments move exactly opposite to each other, while perfectly positive correlations suggest they move in perfect tandem. The 10-day correlation is significant (0.599), and the medium-term 30 and 90 correlations are trending in that same direction.
How does all this play out?
The number of variables influencing the market today is unprecedented. Predicting what is going to happen in speculative markets like equity and digital assets at this moment is like predicting the flow of wind in the next hour, which although theoretically possible if every little variable is accounted for, is a tremendous task. Our job however gets easier when we widen our scope to longer timeframes.
Inflation:
Rising inflation affects the purchasing power of investors, which in turn affects their saving and investment patterns directly. The fed has set plans to pace up the rate of interest rate hikes to 50 basis points for the coming months.
Investors who are in the market for the short term are at greater exposure to inflation. Rising interest rates make risk-off assets like treasury bonds lucrative against speculative assets like crypto and equity and could be deemed as a safer alternative to safeguard purchasing power.
Investors with the luxury to stay invested in the long term have less to worry about. Both equity and digital assets have comfortably outpaced inflation historically, in the long term.
An inverted yield curve is not necessarily bearish for the market-
The yield curve, however efficient in predicting the impending recession, has not necessarily translated to falling asset prices. Historically, the flip of the yield curve has corresponded with a rally in the stock market, followed by a drop within 6–12 months of the flip, when the recession actually unfolds.
While this may be true for stocks, there is a lack of enough data to comment on the correlation between the yield curve and digital assets, as they have only been around since 2009. However, this data talks more about investors’ behavior with risk-on assets than stocks specifically, a trait common between stocks and digital assets.
A lesson from tech stocks:
A pessimistic macroeconomic outlook like rising inflation, worsening global liquidity, and falling economic growth (due to price run-ups in commodities) are not favorable to tech stocks. If the correlation between tech stocks and digital assets is believed to hold, if not get stronger, the crypto industry is likely to bottom out before big tech, but should also recover ahead of risk-on equities.
What short-term traders deem as risky or speculative is also perceived as undervalued by ones with a wider horizon. It is crucial for investors to weigh their appetite for risk and be decisive about where they park their money.
Q2 Conclusion thus far — In crypto we trust
Governments globally have seemingly had an unlimited supply of money, it’s just a matter of firing up the money printer whenever needed. That is why the purchasing power and returns from savings accounts have eroded at an astounding rate in the recent past.
The equity market is no exception to manipulation, the supply of equity is in the control of a handful of board members of a company, a position that has been used extensively to manipulate the market in the past.
The global economy has had many recessions and high inflationary periods in the past, but never in the past, existed any financial instrument whose supply and inflation were baked into its code and predictable down to the last penny.
Let’s look at BTC for instance- The supply of BTC has been capped at 21 million units. The rate of supply of new units is halved every four years. The circulating supply is sitting around 19 million units at the moment, about 90% of the maximum supply. Out of this, about 4 million BTC is assumed to be lost in dormant wallets, bringing down the effective supply to just 17 million. When you do the math, the last BTC will actually be mined in the year 2140.
The use cases and adoption of Bitcoin are growing exponentially every year. With less than 10% of the supply left to fill the ever-increasing appetite, its potential is seemingly limitless. This is why digital assets could emerge as the most significant instrument that protects the purchasing power of consumers worldwide.
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