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This year investors must balance near-term risks with long-term opportunities; while uncertainty within the industry remains, valuations and history illustrate the attractive opportunity presented for investors.
- 2023 will be a year in which digital asset participants must balance near-term risks with long-term opportunities
- Despite headlines, macro conditions have improved on the margin, supporting a rally in equities; digital assets may finally participate, should contagion risk move to the rear-view mirror
- We discuss the portfolio impact of responsible digital asset allocations through the tough year and highlight bitcoin’s attractive valuation, still below 1 on the MVRV multiple
The first week of the new year started off with a bang as digital assets finally participated in an equity rally: bitcoin and ether gained 2.1% and 5.6%, while the S&P 500 and Nasdaq gained 1.4% and 1.0%, respectively.
While a nice start to the year is certainly welcomed, market participants are hesitant to trust any gains. Of course, rampant inflation, the Fed’s miscommunication, and historically tough market performance has left a sour taste in the mouth of investors that have experienced the market rollover after every rally that took place in 2022.
As a result, the years-long mantra of “buy the dip” has quickly turned to “sell the rip” with the new perception that markets offer more “danger than opportunity” even for long-term investors.
But for centuries, capital markets have been an avenue for opportunity. Risks are always present, but success often comes with buying quality assets and waiting long periods of time. In history, dollar-cost averaging and remaining patient has provided investors with a means to accumulate assets, particularly when taking advantage of market weakness.
But just one year and another digital asset drawdown has investors hesitant and feeling as if there is “no rush” to rebalance or re-allocate to their digital asset exposures.
Sure – this asset class is more volatile than equities, which may be hard to stomach. But rebalancing – no matter the asset – benefits from volatility.
In this regard, digital assets investors must now “balance” near-term risks with long-term opportunities. Near-term, contagion concerns remain forefront, and this uncertainty is rather justified. But the question remains, are there actually more dominos to fall, and if so, does this lead to forced selling pressure?
While these near-term contagion risks are rather binary, under the surface, the macro environment has improved - supporting the almost three-month rally seen in equities since mid-October. Factors that are also relevant for digital assets:
- The growing likelihood of a cyclical peak in yields, with the 10yr placing a high of 4.24% on 10/24, now 3.56% by Sunday’s close
- The growing likelihood of a cyclical peak in the DXY Index, which has fallen 9.0% from a peak of 114.1 on 9/27 to now 103.9 by Sunday’s close (see our deep dive on bitcoin vs. the dollar found here);
- The growing certainty around the Fed’s process of normalization, with expectations that have remained the same since October (5 – 5.25% is just 50-75 bps higher than the current upper bound of 4.5%)
- The recent strength in gold’s rally, reaching an 8-month high, serving as a potential hint towards upcoming Fed dovishness
- Continued disinflation, with 3-month annualized US CPI at 3.7% y/y (Thursday’s print can further support disinflationary trends, with an m/m est. of -0.1%)
- A resilient US economy that has yet to crack, and in particular, the strong labor market with a 3.5% unemployment rate
And as such, equities have rallied in response to these improving conditions. S&P 500 earnings are the next nearest hurdle, which begins later this week, while a soft versus hard landing remains “up in the air.”
For digital assets, the near-term risk is contagion, while the long-term opportunity is the attractive valuation presented following yet another historical drawdown.
On page 2, we discuss the importance of responsible position sizing and highlight the continued attractiveness of bitcoin’s valuation as a long-term asymmetric opportunity.
The Importance of Position Sizing
For perspective, we offer a contribution report that illustrates digital assets’ impact on portfolio performance after a meaningful, event-driven decline.
While negative crypto performance impacted portfolios to the downside, responsible position sizing (we recommend anywhere from 1-6%) led to relatively minor differences in performance when compared to the larger impact of stocks and bonds. While an 80% MSCI ACWI and 20% Barclays AGG portfolio declined approximately 17.2% in the year, bitcoin and ether exposure with a:
- A small 2% market-cap position resulted in portfolio performance of -18.2%, a difference of ~100bps
- A base-case 4% market-cap position resulted in portfolio performance of -19.2%, a difference of ~200bps
- A large 6% market-cap position resulted in portfolio performance of -20.2%, a difference of ~300bps
For those that rebalanced on the first day of Q3, position size remains underweight the target, with a 2% position now ~1.9%. For those that haven’t rebalanced, this position is now just 1.4% of total portfolio holdings.
Active investors should consider including digital assets in their portfolio rebalance after last year’s performance, in an effort to maintain investment discipline.
The Long-Term Opportunity
As investors look to balance near-term contagion risks with long-term opportunities, we again point to bitcoin’s valuation.
As we see, an MVRV multiple around 1x has been a strong entry point for long-term investors as it represents a price that is at or even below the on-chain “fair value.”
The tough 2022 year has now offered an attractive valuation of 0.86x, with Sunday’s closing price of $16,957 compared to the $19,725 on-chain cost basis.
Consider that MVRV multiples have reached 3, 4, and even 5 at market tops, with December 2017 (4.9x), April 2021 (4.0x), and November 2021 (2.8x) as recent examples.
Near-term contagion risks versus long-term, asymmetric opportunities.
Click here to download full report. As always, please reach out with any questions or comments.
Joseph Orsini, CFA, CMT
Vice President of Research
Investment advisory and management services are provided by Eaglebrook Advisors, Inc., a registered investment advisor. Information presented is for educational purposes only and should not be construed as providing investment advice. Past performance is no indication of future results. Investing in digital currency comes with significant risk of loss that a client should be prepared to bear, including, but not limited to, volatile market price swings or flash crashes, market manipulation, economic, regulatory, technical, and cybersecurity risks. In addition, digital currency markets and exchanges are not regulated with the same controls or customer protections available in equity, option, futures, or foreign exchange investing. Eaglebrook does not offer tax advice. Neither consultations nor information published by Eaglebrook should be construed as offering or providing tax advice.
Volatility Risk: Digital currency is a speculative and volatile investment asset. Investors should be prepared for volatile market swings and prolonged bear markets. Digital currency can have higher volatility than other traditional investments such as stocks and bonds and market movements can be difficult to predict.
Economic Risk: The economic risk associated with digital currency is in the lack of widespread or continuing digital currency adoption. The market and investors could decide that digital currency should not be valued at the current market capitalization due to a variety of factors.
Regulatory Risk: Digital currency could be banned or highly regulated by governments that would deter investors from buying or holding digital currency.
Technical Risk: Digital currency is a dynamic network with a codebase that is updated to add new security and functionality features. The updated code that is merged by the core developers could potentially have an error that threatens the security or functionality of the digital currency network.
Cybersecurity Risk: Digital currency exchanges and wallets have been hacked and digital currency has been stolen in the past. This is a potential risk that clients must be comfortable with when investing and holding digital currency. Theft is less likely when holding digital currency at a qualified custodian in offline systems (cold storage) with institutional security and controls.
The indexes presented are unmanaged portfolios of specified securities and the performance shown is gross of fees which do not reflect any initial or ongoing expenses. Indexes cannot be invested in directly. Returns for digital assets may differ significantly from the returns of indexes which hold securities. Returns are for the time periods shown.
There are significant limitations in the comparison of cryptocurrencies, notably Bitcoin, to fiat currencies and therefore the comparison of Bitcoin to fiat currencies in the presentation above is for presentation and discussion purposes and does not imply that Bitcoin is comparable to fiat currencies. The information presented should not be relied upon as a recommendation to invest in Bitcoin or any cryptocurrency and should not serve as an indication of the future value of Bitcoin.
Fiat currency is issued and backed by a government and is largely stable and controlled. Through legitimate monetary policy, central banks determine the amount of money in circulation and when to increase or decrease the supply, which in part affects the value and price of fiat currency.
Cryptocurrency, on the other hand, is decentralized by nature and does not have a central authority governing it. The price of cryptocurrencies is determined by several external factors may including, but not limited to: supply and demand, investors’ expectations with respect to the rate of inflation, interest rates, currency exchange rates or future regulatory measures (if any) that restrict the trading of a cryptocurrency or the use of a cryptocurrency as a form of payment. Values of cryptocurrencies have historically been highly volatile, experiencing periods of rapid price increase as well as decline.
There is no assurance that a crypto currency will maintain its long-term value in terms of purchasing power in the future, or that acceptance of Bitcoin payments by mainstream retail merchants and commercial businesses will continue to grow. Bitcoin and other cryptocurrencies are not endorsed or guaranteed by any government, are not FDIC or SIPC insured, are very volatile, and involve a high degree of risk. Consumer protection and securities laws do not regulate cryptocurrencies to the same degree as traditional brokerage and investment products.
BGN, Bloomberg Generic Price: A real-time composite based on quotes from multiple contributors that provides a market indication of where assets are priced. BGN uses both executable and indicative pricing, depending on the type of quotes available in the marketplace at the time of pricing. This methodology is used for bitcoin and ether.
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