Market Commentary
Market Commentary: Whispers
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Tuesday, July 19, 2022

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The markets’ shrug off accelerating inflation provided reason for positivity, with whispers of an Ethereum Merge date leading to big ether outperformance on the week.

Key Takeaways:

  • Broader markets shrugged off the 9.1% headline CPI print for the month of June, perhaps as participants take note of declining commodity prices, interest rates, and breakevens since mid-June
  • Last week, ether outperformed on whispers of a Merge date, highlighting the asset’s higher-beta nature versus bitcoin
  • Bitcoin has rallied 17.7% since the peak in inflation expectations, illustrating its ability to bounce when macro conditions warrant
  • Correlations to traditional equities have declined from their highs and digital assets remain diversifiers to traditional portfolios

THE BIRD'S EYE VIEW

Some signs of positivity were illustrated last week as the market shrugged off the highly anticipated headline CPI report for the month of June, which illustrated yet another acceleration in U.S. inflation with 9.1% growth from a year ago.

Despite a new four-decade high in headline CPI, digital assets and equities rallied off their weekly lows, perhaps as market participants took note of real-time indicators such as the declines in commodity prices, yields, and breakeven rates since mid-June.

Friday’s economic data also provided reason for positivity, with equities breaking a four-day losing streak following the morning data. Retail sales highlighted the strength of the US consumer, while the University of Michigan survey illustrated improving sentiment (51.1 vs. 50 prior) and a decline in inflation expectations (1yr ahead inflation 5.2% vs. 5.3% prior, 5-10yr 2.8% vs. 3.1% prior).

This data resulted in a strong second half of the week for bitcoin and ether, with the two rallying 10.6% and 33.5% from Wednesday’s lows. On the week, bitcoin was flat (-0.2%), while ether gained 14.2% as the S&P 500 and the Nasdaq declined -0.9% and -1.6%, respectively.  

This gain from the lows on Wednesday (low of $18,918 for bitcoin and $1,006 for ether) illustrates to us that in this environment, lower inflation expectations are beneficial for digital assets, as this can bring a resurgence in risk-appetite.

This resurgence has been illustrated in our tantrum table on page three: the growth and tech heavy Nasdaq Composite is up 7.6% from its lows, while high-beta and small-cap growth have rallied 5.9% and 9.1% in the same period. Bitcoin and ether are up 17.7% and 48.9% from the lows placed on June 18th  

In other news, some of the dust has settled with the overleveraged bunch, as Celsius has now filed for Chapter 11 (restructuring) bankruptcy protection. This comes alongside Voyager Digital’s Chapter 11 filing and 3AC’s Chapter 15 (liquidation) filing. While the recovery process and ultimate solution may take some time, this progress and a lack of new bad news since has certainly provided some reassurance for digital asset investors and traders.

Bitcoin closed the week at $20,931, showing four weeks of support since the capitulatory low of $17,785 on June 18th, while ether closed at $1,334 versus its closing low of $903 on the same day. Strong weekend performance followed through on Monday, with bitcoin and ether closing at $21,488 and $1,471, respectively.

UPDATE ON THE MERGE

Ether rallied throughout the weekend as an Ethereum core developer offered a tentative target date for the long-awaited transition to proof-of-stake, which is now penciled in for September 19th.


In short, “stakers” post collateral, vote to approve transactions, and receive rewards for doing so. Key benefits of Ethereum’s Merge include:

  • ~99% less energy use than proof-of-work, making Ethereum ESG-friendly
  • Improved scalability as transactions are approved without complex equations
  • Reductions in new issuance and a potential deflationary supply with EIP-1559’s buyback
  • Staked ether (in hot validators) receive staking rewards as a form of cash-flow and income

While the Merge introduces some execution risk, the result will be a significant improvement to Ethereum if successful.

These whispers of a tentative merge date provided reason for a significant rally in ether last week, with the asset up 14.2% in the week and 33.5% just from Wednesday’s lows.

This illustrates the high-beta nature of ether vs. bitcoin; while ether underperformed on the downside (max drawdown of -81.2 vs. bitcoin’s -73.7%), it has outperformed on the upside (up 48.9% from the lows vs. 17.7%, as of Sunday’s close.)

CRYPTO RALLIES AS INFLATION EXPECTATIONS EASE

While many question whether bitcoin is a price inflation hedge, recent events illustrate that in today’s environment, it’s likely better for inflation to decline, rather than to rise.

As we find, inflation expectations likely peaked in mid-June with commodities, yields, breakeven rates, and Fed expectations having declined quite rapidly since.

Crude, wheat, and copper futures have fallen -21%, -29%, and -29% since early June. On Friday, the University of Michigan’s survey reported a decline in inflation expectations, with consumers expecting one-year ahead inflation to be 5.2% vs. 5.3% prior, and five-to-ten years ahead to be 2.8% vs. 3.1% prior. Fed Fund futures are now pricing in a 3.5% policy rate by February of 2023, down from the 3.9% expected on June 14th.

To the right, we illustrate short-term breakeven rates, with the important 1-year breakeven declining from 5.5% on June 13th to now 3.6% by the end of last week.

Despite 191 basis points of lower inflation expectations, bitcoin has rallied 17.7% from the lows on June 18th. Bitcoin and digital assets do not need inflation to rally.

CORRELATIONS DECLINE,  CRYPTO STILL DIVERSIFIES

We often discuss the old-adage “when volatility rises, correlations go to one” as an example of why bitcoin and ether have traded in-line with traditional equities in these tumultuous times.

Important to note, however, is that while correlations have risen, both bitcoin and ether remain less correlated to the S&P 500 than other major equity indices and sectors.

For example, while bitcoin and ether’s 90D correlation to the S&P 500 reached a maximum of 0.71 and 0.73 on May 12th, these correlations are still less than the S&P 500’s correlation to global equities (0.97) or the Information Technology sector (0.97).

So, despite the rise in correlations, a trim of equities for digital asset exposure certainly diversifies traditional portfolios.

With different long-term drivers of returns and many periods of negative correlations in the past, we’re eager to see how today’s relationships evolve over time. For now, bitcoin and ether’s correlations have begun to decline, with correlations to the S&P 500 of 0.62 and 0.60.

Click here to download full report. As always, please reach out with any questions or comments.

Stay tuned,

Joseph Orsini, CFA
Vice President of Research

DISCLOSURES
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.
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About Eaglebrook Advisors
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