The Year Ahead for Markets

The Year Ahead for Markets is the final report of our Year Ahead series. It provides our top-down view of the biggest macro and market trends we’re focused on as we close the book on 2022 and look to the new year. We highly recommend reading all of the other sector Year Ahead reports to get a much deeper understanding of the most critical trends impacting individual sectors and the teams and protocols building the future of this industry.

The Year Ahead for NFTs | Gaming | DeFi | Infrastructure

A Tale of Two Halves – The Great Reset

2022 was The Great Reset for crypto. Overly hyped trends and mass speculation pushed the crypto market far out over its skis by the end of 2021, so this year’s washout was a necessary reset. Sizable corrections are healthy for long-term secular uptrends.

The last three years have been a tale of two halves.

The plot of act I was the culmination of policy responses to the post-COVID flash recession — massive stimulus programs were the stars of the show.

“The giant backstops put in place by such policies turned markets around almost on a dime, and were a key catalyst in propelling asset prices to new all-time highs. Financial conditions eased, risk appetite returned, and BTC and crypto assets were huge beneficiaries of this environment, which saw global liquidity expand at one of the fastest rates on record.”             

– Why Bitcoin is Behaving Like It Should (January 2022)

Act II was the fall of the market’s shining white knight as our story’s hero turned into its biggest villain. All the tailwinds that propelled asset prices to new highs reversed course, and 2022 was the polar opposite of the previous 12 months — something we warned of a year ago:

“Several macro tailwinds that helped propel BTC and crypto assets to new highs over the last 12-18 months have reversed course; the shift away from excess liquidity and accommodative monetary conditions is a structural headwind we’ve highlighted in recent months, which now appears to be coming to a head.”

This leads us to an important theme we’ve been harping on since our earliest days — crypto is macro.

What’s happening in macro has a direct impact on the crypto market, as we’ve seen not just over the last two years, but arguably the better part of the last few price cycles. We’ll get into that shortly, but first let’s get a quick sense of the current state of the crypto market.

State of the Crypto Market

The sharp drawdown in crypto asset prices this year has many wondering when the pain will subside. General interest in many of the most prominent crypto themes of the last few years has died down considerably over the last 6-9 months.

Unsurprisingly, interest tends to pick up during bull markets and wane in bear markets.

BTC is trading right in the range of its previous 2017 peak and its summer 2019 retest, an area many consider to be a pocket of vulnerability as we head into 2023.

BTC is down ~76% from its prior all-time high. For context, the price of BTC fell ~85% from peak-to-trough in each of the last two major bear markets. History never repeats itself, but this year’s drawdown mirrors that of 2017-2018 in many ways.

ETH saw an even larger drawdown during the 2017-2018 cycle, falling 93% from peak-to-trough. ETH’s peak drawdown this year was 82% back in June — it’s currently trading ~76% off its prior ATH as well.

Interestingly, BTC and ETH peaked in November 2021, unlike the rest of the crypto market which peaked earlier in the year back in May 2021, as measured by the S&P Crypto BDM Ex-MegaCap Index. The broader crypto market has experienced an even sharper ~82% price drawdown from its all-time high.

If the market were to mimic the same peak-to-trough drawdown of last cycle (~93%), the total market cap for the broader market would have to fall another ~60% from here (though that’s not our base case).

Correlations between crypto and traditional asset classes have been very tight over the last 12 months, and for good reason. Intramarket correlations within crypto have also remained elevated this year, which has led to widespread weakness across every major sector.

Bitcoin is now trading roughly two standard deviations below its long-term trend.

Prior cycle bottoms were marked by a sizable selloff that pushed BTC into oversold territory on its 14-month RSI and a test of its 200-week MA, which historically served as strong support for price to find a floor. We saw these same conditions play out this past summer, and BTC has been largely rangebound since.

Past performance is not indicative of future results. But if this cycle follows the general path of those before it, one would expect to see markets consolidate into Q1 2023 before forming a clear bottoming pattern. This accumulation period in H1 2023 would be a welcoming setup for the crypto market to move into its next bull cycle. We would add that this is dependent on a reversal in the key macro headwinds that have weighed on risk assets throughout 2022.

Key Theme #1: Liquidity Still Runs the World

For those who haven’t read our “Liquidity Runs the World” report, we highly recommend it as a precursor for the topics discussed below.

We noted at the turn of last year that a sustained downtrend in global liquidity was the biggest risk to crypto markets heading into 2022.

“Bitcoin is one of the purest plays on fiat currency debasement. It also happens to be one of the most leveraged bets on global liquidity; when liquidity is abundant and expanding, BTC and crypto assets tend to outperform; when liquidity tightens, they struggle.”

Global liquidity is the most powerful force in macro, which is why it’s our first key theme and one which we believe will have a significant market impact in 2023.

Global liquidity cycles have a strong correlation with changes in the business cycle.

And the business cycle drives changes in asset prices.

Therefore, trends in global liquidity influence the direction of markets. They drive fluctuations in global equities…

And have a strong impact on the largest equity market in the world.

They even influence the direction of the crypto market.

And not just mega caps like BTC and ETH…

Global liquidity’s influence on crypto asset prices also affects capital flows into (and out of) crypto funds.

One caveat is that M2 is not an all-encompassing measure of global liquidity (see our prior report Liquidity Runs The World for a more in-depth discussion on these points), but it serves as a decent proxy. It tracks trends in major central bank balance sheets…

…and the relationship with markets, including crypto, is striking.

Liquidity cycles aren’t new — we’ve seen their power before. Global liquidity growth slowed considerably back in 2018 as financial conditions became more restrictive. The result was a sizable correction in risk assets and a prolonged bear market for the most speculative long-duration assets (like crypto). We saw a similar dynamic play out over the last 12 months, though on an even greater scale.

Global liquidity cycles drive changes in asset prices. They influence the direction of global equity markets. They drive fluctuations in bond yields and credit spreads. They even have a substantial impact on the crypto market, which is why a reversal in global liquidity is one of — if not the most — important catalysts for a renewed bull market.

It also looks like this liquidity cycle is approaching another inflection point.

Global Liquidity – The Reversal We Need

There are early signs that a reversal in global liquidity is upon us. Here’s an updated chart from CrossBorder Capital that shows the early signs of a potential bottom in this current cycle:

“The cycle moves in 5-6 year waves and is currently just starting to turn higher from its mid-2022 lows. Global liquidity leads financial markets by some 6-12 months and economies by around 12-18 months…it shows that we are at ‘maximum tightness’” – CrossBorder Capital

Our good friend Raoul Pal also has a great chart showing how the business cycle tends to lead liquidity reversals as well.

“…but the business cycle leads liquidity, and the ISM (shown inverted here) is forecasting significant economic weakness ahead, and thus liquidity is on the cusp of turning to offset falling growth…” – Raoul Pal, GMI

The two biggest contributors to global liquidity are the US and China. The world’s second largest economy has grown to be a liquidity powerhouse over the last 15 years.

Households in the US and China also make up nearly half of the world’s personal wealth.

After months of stern rhetoric, pressure is starting to mount on China as its economy sputters. Policymakers are warming up to the idea of supportive initiatives aimed at promoting growth as the country continues to grapple with significant headwinds (some of which are self-induced, e.g., zero-COVID).

The focus in China is shifting, and reopening its economy is now top of mind to combat its weakening growth outlook. The PBOC has already asked banks to “stabilize” lending to property developers, a critical sector for China’s economy, who’ve struggled to claw their way out of a year-long slump that’s left many companies cash-strapped and facing greater insolvency risk. The PBOC recently cut required reserves for banks for the second time this year — the latest of which is estimated to free up ~$70B of liquidity — and will likely take further action to prop up growth (especially as the rapid spread of COVID infections impact a growing percentage of its workforce).

China’s credit impulse has turned higher in recent months too.

Positive net changes in China’s credit impulse tend to lead to reversals in global M2 growth.

In recent years, they’ve also led trend reversals for the US dollar (which would be a very welcoming sign for markets).

Global liquidity cycles have an inverse relationship with the dollar, making them a key trend to monitor given our past warnings that a strong USD remains o