In the two-year crypto bull market, BTC has risen by a maximum of 20 times; after the half-year rotation, BTC has fallen by 70% from its relative high.
Everything has a cycle, and the cycle of financial asset investment is very obvious. The price of traditional venture capital market fluctuates like a pendulum. After a big rise, there must be a big fall, and after a big fall, there must be a big rise. The price swings between these two extremes. The process is the investment cycle.
Due to its special industrial attributes, the cycle logic of cryptocurrency has a somewhat unique narrative. We will analyze it from three dimensions:
1. Technological attributes – technological development, optimization of productivity and production relations;
2. Commodity attributes – supply and demand relationship, supply and demand imbalance caused by BTC halving;
3. Financial attributes – the direction of liquidity, which is currently highly related to the traditional risk financial market, so it is greatly affected by the Fed’s monetary policy, interest rates + balance sheet and other macro liquidity factors.
Since 2018, the correlation between the trend of encrypted assets and the US stock index has exceeded 80%, and its financial attributes have become the dominant factor in its price impact. This article will make an in-depth study of the financial attribute cycle of encrypted assets.
1. Merrill Lynch Clock
The Merrill Lynch clock is a model representative for analyzing fundamental cycles, and it is also one of the common tools for locating market cycle stages. It links economic cycles with asset and industry rotations to guide asset allocation.
Merrill Lynch divides the economic cycle into four stages using the high and low macro indicators of economic growth rate (GDP) and inflation rate (CPI):
Figure 1: Merrill Lynch Clock
- The classic boom-bust economic cycle starts at the bottom left and progresses clockwise in four stages, divided into four stages: reflation, recovery, overheat, and stagflation.
- In a complete cycle, the best performing (best reward/risk) asset is different at each stage, and if the cycle starts with a reflation stage, bonds, stocks, commodities, and cash, in turn, realise better than other assets in the process. The results of the backtest show that although each economic cycle has different characteristics, there are certain commonalities, and investors can use these commonalities to improve returns.
Figure 2: Map of assets corresponding to the Merrill Lynch cycle
- Challenges of Merrill Lynch in practice. In the real process, not every cycle will rotate in sequence; even if it rotates in sequence, it is difficult to judge the dwell time, especially in a recession, due to the Fed’s policy adjustment, the bottom and the reversal may occur quickly – big cycle and small cycles. At the same time, not all capital markets respond in a timely manner to the macro economy, such as A shares, such as the crypto market.
- The most important thing is that the trend of assets gradually deviates from the economic fundamentals, and the mapping relationship between the economic cycle and the financial cycle is broken. For example, after March 2020, it is not a period of economic recovery, but risk assets have risen; for example, after the 2008 financial crisis, the trend of major global assets did not fully follow the asset rotation model of the Merrill Lynch clock, and there was a wave of equity and debt in the US financial market. Bull pattern; at the same time, commodities began to enter a slow downward channel, even if the US economy from recovery to a strong stage, the commodity market is still bleak.
In addition, in the economic cycle, the currency cycle will follow the economic cycle to change, and the currency cycle will react to the economic cycle. For example, the Federal Reserve will adjust the currency cycle accordingly according to the situation of the US economy. In addition, there are industry cycles and business cycles, macro cycles that are more important to the fundamental cycle, and the three come and go and interact with each other.
2. Analysis cycle
Combined with the Merrill Lynch clock, according to the past price trends of different assets at different stages, we can see the following states from the financial attribute cycle of encrypted assets:
- Easing cycle: start rate cut → start QE → stop rate cut;
- Tightening cycle: The Fed turns hawk → starts taper → keeps raising interest rates → starts QT → stops raising interest rates after raising interest rates several times, and the interest rate hike cycle ends.
Figure 3: Asset performance at different stages of the cycle
The corresponding reactions of US stocks and encrypted assets:
- Loose cycle: it starts to rise, the market accepts more risks, the risk premium decreases, and bubbles appear in extreme cases;
- The first stage of the tightening cycle: the valuation is destroyed, the stock price falls, and it is manifested as a financial crisis. The tightening pushes up 10-year Treasury yields, which directly leads to a rise in risk-free rates, triggering a rebalancing of portfolios from risky assets to risk-free or low-risk assets.
Figure 4: Interest rates and U.S. stock volatility at different stages
- The second stage of the tightening cycle: killing fundamentals, corporate bankruptcy, and economic crisis. In the later period of interest rate hike, under the influence of interest rate increase and QT, economic recession is expected, 10y2y interest rate spread continues to invert, and in extreme cases, a great recession or even economic collapse occurs.
Figure 5: Spreads and U.S. stock volatility at different stages
- Taper, interest rate hikes and QT do not necessarily bring risk assets down immediately, the key is the impact of the scale and speed of tightening on liquidity.
III. The current stage
Judging from the current market situation, inflation remains high, GDP appreciation rate slows down, and the market is in a stage of stagflation.
In addition, U.S. new home sales data and consumer business data show a slight recession, the U.S. economy is declining faster than inflation, and there is a high probability that a recession will follow. The next step is to see whether the depth of the recession will exceed the adjustment range of previous cycles (such as the financial crisis in 2008), and whether it will last for a long time (such as the Internet bubble in 2000).
Figure 6: SPX has fallen three times since 2000
As can be seen from Figure 6, the market decline brought about by the Internet bubble in 2000 lasted for 29 months, and SPX fell from $1,500 to a minimum of $770. Three years of lamentation are still in my ears; in 2008, the subprime mortgage crisis SPX fell from It took only 16 months for the $1,550 to drop to a minimum of $670.
Figure 7: Data analysis of SPX in the economic crisis in the past 20 years
If we predict that stagflation in 2022 will inevitably lead to a recession and then trigger a full-blown economic crisis, neither the length of the decline nor the magnitude of the decline is in place, so it is still in the early stages of an economic crisis.
4. Post-situation judgment
Judging by the current situation, U.S. stocks will also face a big sell-off. According to past rules, it may be the July/August earnings season, or the November/December earnings season, but the Fed may adjust its policy in time, so the September FOMC meeting Crucially, the crisis may not last long and is expected by the end of 2022.
Generally speaking, U.S. stocks fall in two stages, but this time is different. The complex internal and external environment makes the Fed in a dilemma. This time the decline of the stock market may come out of three stages:
- The first stage is caused by fear of inflation;
- The second stage is the rise in US bond interest rates to kill valuations;
- The third stage will be the economic recession killing the fundamentals;
However, we believe that the third stage has not really arrived, because the liquidity premium of US stocks in the past ten years has been very high, and the real value return has not yet been realized, and the liquidity risk and credit risk have not been fully released (US high yield bonds OAS is only half way through to price in credit event scenarios).
Of course, it is highly probable that inflation will drop in the second half of the year. As long as oil prices do not rise sharply, there is a high probability that commodities will fall. At the same time, U.S. companies have already started to cut hiring after their earnings forecasts have been lowered, labor costs will fall passively, and housing sales have also declined. But there is also the possibility of a worse situation, the Fed has no room to adjust when recession expectations occur; if inflation is slow to come down (such as 6% in the second half of the year), then there may be a big recession, and the duration will be longer Therefore, September is a key trend judgment time point.
Recently, the market has been turbulent, Luna sacrifice, Celsius run, and three arrows liquidation, all of which are epitomized. No individual force can escape the coercion of the big economic cycle, and the same is true of encrypted assets. At a time when the financial attributes of encrypted assets have become dominant, it is more and more important to grasp the cycle of their financial attributes.
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/binary-research-exploring-the-financial-attribute-cycle-of-crypto-assets/
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