Market Commentary
Market Commentary: Conviction Tested
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January 11, 2022

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Key Takeaways:

  • After a strong 2021 in which bitcoin and ether rallied 59.8% and 399.1%, the two are down 8.7% and 13.5% YTD.
  • Fed hikes don’t derail bull markets; in fact, bitcoin’s advance to $20k in 2017 occurred in a rising rate environment. 
  • BTC’s highs in November coincide with highs in the Nasdaq 100, SC Growth, and Momentum, to name a few.
  • Despite the pullback, realized volatility remains muted, a sign of overall maturation of digital assets.

The Focus

A rough start of the year for bitcoin and digital assets. After a strong 2021 with bitcoin up 59.8% and ether rallying 399.1%, the two are down 8.7% and 13.5%, respectively.

The culprit for the move lower thus far seems to stem from a hawkish tilt in the minutes of the Fed’s December meeting. While the market rallied following the announcement on December 15th, further details into the conversations of voting members sparked worries that “some participants” recommend a hike immediately upon the conclusion of QE (planned for ~March), and even a run-off of the balance sheet (no longer reinvest proceeds) at the very same time. Given that December Q&A session with Fed Chair Jerome Powell did not mention this conversation, markets quickly turned risk-off: naturally, bitcoin, ether, and digital assets declined alongside equities and particularly tech as both rates and the DXY index moved higher.

Nonetheless, the conversation remains the same: Can the Fed hike 3-4x in 2022 in these highly uncertain times? Is this peak hawkishness, or will the Fed really take the opportunity to refuel the toolkit given four-decade high inflation? If so, how will bitcoin and digital assets perform in either environment? Will risk rally on indications of less hikes than expected? These are the questions investors ask.

As we know, debate over the Federal Reserve’s next moves last in perpetuity: as time progresses, investors always find new reason to worry. This year, it’s how digital assets will perform during monetary “tightening.”

For now, we remind investors that long-term secular drivers remain in play – digitalization, technology, network effects, and long-term monetary inflation are likely to overcome today’s short-term blips and concerns in macro sentiment.

Bitcoin and ether tend to test the conviction of long-term investors – we’ve seen in the past, those with the highest conviction have so far been rewarded.

Fed Hikes Don’t Derail Bull Markets

Much of the crypto community is concerned of the Federal Reserve hiking interest rates and what this may mean for risk assets. What we find, in the most recent past, is that Fed hikes don’t derail bull markets. In fact, risk-assets rallied in the previous two hike cycles. Bull markets seem to end upon the realization of new, significant economic concerns, rather than the act of raising rates themselves. In the past, we’ve seen:

  1. The Fed hiked 17 times, 25 basis points each in the period of June 2004 to June 2006, and then cut 50bps in September 2007: SPX rallied 34% in this time. Concerns over MBS, eventually leading to the GFC, then derailed the bull market. BTC was not yet invented in this period.
  2. The Fed hiked 25bps in Dec ‘15, Dec’ 16, 3x in ’17, and 4x in ’18 before cutting 25bps in July ‘19: SPX rallied 46% in this time, BTC/USD rallied 2200%, including the parabolic advance to $20,000 in December of 2017. A weakening economy due to trade wars and a new pandemic then derailed sentiment towards risk assets.

Highs Coincide With Other Risk-Assets

As investors in bitcoin and digital assets, we hope to understand how the asset class is expected to perform in various market environments. With underperformance in momentum, small caps, and large cap tech given the markets significant focus on the Fed’s process of normalization, bitcoin and ether are in similar company with their risky friends within equities. We point out many of these assets highlighted below have higher volatilities than the broader S&P 500 Index, and we illustrate recent highs and drawdowns since to put bitcoin and ether’s move in perspective.

Realized Volatility Shows Trends Towards Maturation

Even with bitcoin and ether’s pullback from their highs, realized volatility has remained muted, and continues to show signs of maturation and institutionalization of these two assets. We can see both lower highs and lower lows in volatility trends, a positive sign for investors looking to hold digital assets within portfolios. Continued decreases in volatility should allow for higher allocations in the future as digital assets would contribute less to portfolio risk at lower volatilities.

Click here for the full PDF. As always, please reach out with any questions or comments.

Stay tuned,

Joseph Orsini, CFA
Director of Research

Investment advisory and management services are provided by Eaglebrook Advisors, Inc., a registered investment advisor. Information presented is for educational purposes only. Past performance is no indication of future results. Please see our Form ADV Disclosures and Privacy Policy in our website.
Price Volatility of Digital Assets – A principal risk in trading Digital Assets is the rapid fluctuation of market price. High price volatility undermines Digital Assets’ role as a medium of exchange as consumers or retailers are much less likely to accept them as a form of payment. The value of client portfolios relates in part to the value of the Digital Assets held in the client portfolio and fluctuations in the price of Digital Assets could adversely affect the value of a client’s portfolio. There is no guarantee that a client will be able to achieve a better than average market price for Digital Assets or will purchase Digital Assets at the most favorable price available. The price of Digital Assets achieved by a client may be affected generally by a wide variety of complex and difficult to predict factors such as Digital Asset supply and demand; rewards and transaction fees for the recording of transactions on the blockchain; availability and access to Digital Asset service providers (such as payment processors), exchanges, miners or other Digital Asset users and market participants; perceived or actual Digital Asset network or Digital Asset security vulnerability; inflation levels; fiscal policy; interest rates; and political, natural and economic events.
Digital Asset Service Providers – Several companies and financial institutions provide services related to the buying, selling, payment processing and storing of virtual currency (i.e., banks, accountants, exchanges, digital wallet providers, and payment processors). However, there is no assurance that the virtual currency market, or the service providers necessary to accommodate it, will continue to support Digital Assets, continue in existence or grow. Further, there is no assurance that the availability of and access to virtual currency service providers will not be negatively affected by government regulation or supply and demand of Digital Assets. Accordingly, companies or financial institutions that currently support virtual currency may not do so in the future.
Custody of Digital Assets – Under the Advisers Act, SEC registered investment advisers are required to hold securities with “qualified custodians,” among other requirements. Certain Digital Assets may be deemed to be securities. Currently, many of the companies providing Digital Assets custodial services fall outside of the SEC’s definition of “qualified custodian”, and many long-standing, prominent qualified custodians do not provide custodial services for Digital Assets or otherwise provide such services only with respect to a limited number of actively traded Digital Assets. Accordingly, clients may use non- qualified custodians to hold all or a portion of their Digital Assets.
Government Oversight of Digital Assets – The regulatory schemes—both foreign and domestic—possibly affecting Digital Assets or a Digital Asset network may not be fully developed and subject to change. It is possible that any jurisdiction may, in the near or distant future, adopt laws, regulations, policies or rules directly or indirectly affecting a Digital Asset network, generally, or restricting the right to acquire, own, hold, sell, convert, trade, or use Digital Assets, or to exchange Digital Assets for either fiat currency or other virtual currency. It is also possible that government authorities may take direct or indirect investigative or prosecutorial action related to, among other things, the use, ownership or transfer of Digital Assets, resulting in a change to its value or to the development of a Digital Asset.

About Eaglebrook Advisors
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