Crypto Market: Navigating Key Hurdles In 2023 With A Silver Lining For The Long-Term Outlook
Summary
The recent gains made by risk-on assets, including cryptocurrencies and technology stocks, came to a halt in February after experiencing a strong recovery in January. This was due to less favorable macroeconomic conditions and the realization that monetary policy and the Federal Reserve still hold significant influence over the market and the corporate earnings are in contraction. Despite a significant increase in the value of cryptocurrencies and growth stocks over the past five weeks, with the Nasdaq (COMP.IND) and Bitcoin(BTC-USD)/ETH(ETH-USD) up 14% and 40% respectively, the relief rally exhaustion set in and came to a pause during the second week of February.
Despite facing challenges, the crypto market has demonstrated resilience amidst the 2023 turbulence, with the possibility of reaching a $10 Trillion valuation by 2030 still within sight.
Two key factors hindering a sustainable rebound for risk-on crypto assets in 2023
While various factors impact the crypto market, two primary factors limit sustainable and steady growth in the crypto market in 2023:
Overall, the equity market began its correction and reversal on February 2nd and 3rd, which was reflected in the declining prices of crypto and Bitcoin. This decline in BTC was further fueled by specific regulatory incidents such as the SEC settlement with Kraken on February 9th. Macroeconomic factors continue to play a major role in shaping the overall trend for crypto. It's worth noting that the US Dollar Index (DXY), often considered a barometer of the macro trend, has been ticking upward since February 2nd. This can limit the upward potential of Bitcoin and other cryptocurrencies. Despite this, Bitcoin has held above $21,400, which was the level prior to the large drop following the FTX incident. It remains to be seen if Bitcoin will continue to hold above or fall below this key psychological level.
Ongoing drain in liquidity and high terminal rate
To some degree, the recent rally in the market was fueled by an over-optimistic and irrational belief that the economy would experience a soft landing with little or no recession.?Fed Chairman Jerome Powell's less hawkish tone, and his advocacy of disinflation, has led to market excitement or premature optimism about a potential shift in the Fed's policies.This week, however, the market has begun to consider the actual data and outlook for the economy and company earnings.
The impact of monetary policy cannot be overlooked as the tightening cycle continues, with the Fed's balance sheet shrinking by $95B per month through quantitative tightening. This reduction in liquidity will place a cap on the forward price-to-earnings ratio of the S&P 500 (SP500), with the median forward P/E at 18.3, according to Yardeni research. Currently, the value is already above the median at 18.52. This means the S&P 500 is trading at an earnings per share of over $220, based on its current price level of approximately $4080. However, the Q4 earnings season for S&P 500 companies was underwhelming, with a decrease in the percentage of companies reporting positive earnings surprises and a lower magnitude of these surprises compared to historical averages, according to Factset. Despite this, the earnings decline for Q4 2022 has slightly improved from the previous week, but remains larger than the end of the quarter. If the S&P 500 reports a year-over-year decline in earnings for Q4, it will be the first such decline since Q3 2020.
According to the Federal Reserve's latest Dot-plot, the forecasted terminal rate of the Federal Funds Rate is expected to be close to 5% or higher in 2023. This is a significant increase compared to the 0.25% rate at the start of 2021, which could drastically increase the cost of capital for small to large businesses and lead to slower growth for companies and the economy as a whole.
S&P 500 and Nasdaq reached oversold level
From a technical perspective, the S&P 500 and Nasdaq both reached an oversold level on February 2nd following the announcement of the Federal Reserve's 25-basis-point interest rate hike. It is logical that the market began to decline.
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BTC Futures Open Interest volume is ticking up but the overall trend remains low
Open interest as a market indicator: Similar to the equity market, open interest serves as a key indicator for traders and investors to assess market trend direction, with higher open interest indicating higher liquidity and volume. In the crypto market, BTC open interest serves as a measurable metric for gauging the overall trend.
It's noteworthy to observe that the open interest in BTC has increased after reaching a low in November 2022, but it still remains at a relatively low level since June 2022, similar to the benchmark low seen in May 2021, both around $10B. This is also reflected in the options open interest, which currently falls in the range of $6-7B.
More broadly, The options open interest for the entire crypto market, encompassing all cryptocurrencies, remains at a low level below $25 billion, a 75% decrease from the 2021 average volume of $100 billion.
Key takeaway: BTC Shows Resilience Above the level of Pre-FTX Incident and BMSB
Despite the challenging macro environment and regulatory concerns, BTC is holding steady above the $21,400 level, which is the level prior to the significant drop caused by the FTX incident. It remains to be seen if Bitcoin will continue to hold above or fall below this key psychological level.
Additionally, the Bull Market Support Band (BMSB) is a strong indicator of bullish territory. The BMSB is formed by the 20-week Simple Moving Average (200w SMA) and 21-week Exponential Moving Average (21w EMA). BTC's price was below the band for the majority of 2022, indicating bearish territory. However, since the second week of January 2023, BTC has been trending above the BMSB, signaling a clear uptrend in bullish momentum.
While facing various challenges including the broader equity market, macroeconomic conditions, and regulatory scrutiny, the crypto market, driven by major cryptocurrencies like BTC and ETH, is holding up better than expected, especially given the past experiences with the credit bubble and fraudulent incidents. These incidents have caused a loss of over $100 billion in 2021 and have been compared to the Lehman Brothers financial crisis and Bernie Madoff fraud case. The recent price action and organic resilience in crypto assets suggests a positive long-term outlook beyond 2023, although investors should exercise caution as there may still be factors that impact the market and increase volatility.
Long-term investors should stay patient and acknowledge that the underlying blockchain and cryptocurrency infrastructure continues to progress despite the current market downturn and absence of speculative headlines in mainstream media. The potential of a $10 Trillion valuation by 2030 is still on the horizon.