by Dan Clarke & Jesse Knutson, Institutional Sales
DISCLAIMER; This post and its contents should in no way be considered investment advice.
Summary:
1. Crypto assets remain highly correlated to emerging markets & risk assets.
2. Crypto led decline in risk assets. Logical it could lead us out of the bottom.
3. We have some strategists starting to pick bottoms in equity markets.
4. EEM RSI is back at levels that match up with price bottoms since 2016.
5. Likely that a strong $ has been a big part of the reason for risk asset sell-off.
6. US dollar RSI & price divergence support a possible $ price reversal.
7. We are starting to see noise from Trump that questions $ strength appetite.
8. Seasonality of crypto as well as emerging markets, favor the upside.
After a crypto sell-off this morning, overall crypto market cap is down 6%~(Bitcoin-4.7%) vs overnight Nasdaq-4.4%, S&P-3.3% & the Emerging Market ETF EEM-3%~. This morning’s sell-off comes despite many hopes that price action in recent days had started to show crypto acting more resilient against broader financial assets (Which it had until this morning!). This twitter poll from Tuur overnight was a great indication of this improving sentiment (Or just the eternal optimism of people in crypto), whilst also potentially being a great example of the group stink or the maddening of the crowd!?
The reality as the below Bloomberg chart shows, is that Crypto is more correlated vs tradition risk assets now that it has been for more than a year. Rolling 120Day correlation of the MVIS CryptoCompare Digital Assets 10 Index (A modified market cap-weighted index which tracks the performance of the 10 largest and most liquid digital assets) with the Emerging Market ETF EEM is currently 0.899 and at its highest levels over that period.
The scatter correlation chart below lines up all the correlation points of the Digital Asset 10 Index with the Emerging Market ETF EEM over the last 2Yrs (254 points) & gives us a “bigger” overall feel of historical correlation (0.84) which is roughly in-line with the current rolling 120Day result. The R squared shows that historically over the last 2Yrs, 71% of price movement in EEM can be explained by moves in the top 10 crypto index (MVDA10).
What does this mean? Statistically speaking if crypto jumps, EEM will follow 71% of the time. So what next? The TradingView chart below shows EEM vs Bitcoin prior to this morning’s moves. Until today, Bitcoin (Blue line) had been showing signs of resilience vs emerging markets. The thinking being that given Bitcoin led the EEM correction at the beginning of the year, it could logically be leading in a year end bounce as well. This would be similar to how high beta cyclical stocks like DRAM typically lead a market sell-off & recovery at tops/bottoms vs say a large emerging market big cap stock like TSMC 2330 TT that typically lags at both tops & bottoms.
But as it stands after this morning’s sell-off in crypto, it appears both crypto and emerging markets are back to being super correlated. So now we have to decide if today’s crypto weakness is the last bear trap before a move higher into year end. If this is true and if the correlation holds, would probably imply that the overnight sell-off in emerging markets was in fact a capitulation or at least very close to being so.
RSI (Relative Strength Index) supportive of bounce in emerging markets.
Whilst RSI is not a good indicator to time tops/bottoms (tends to remain elevated/depressed for long periods of time in trending markets), Emerging market EEM RSI is now back near levels that line up well with bottoms in both early 2016 & late June 2018.
At the same time, as we wrote about earlier this week in the “The Bull Case For Bad Volume” ( The Bull Case for Bad Volume ) Bitcoin is entering a period where we typically see both a pick up in volume & a pick up in price (Makes sense as I think price typically leads volume in crypto). Its hard to ignore that Bitcoin has been up 4 of the previous 5 Octobers and 5 of the previous 5 Novembers. For EEM October is still the second best performing month of year on average over last 5Yrs +2.88% just behind +3.6% in March (See Bloomberg seasonality chart below).
What else do we have to support a bounce in risk assets (Bitcoin & EEM)?
A good place to start would probably be the US$. A large part of the weakness in emerging market assets is seen as the result of tightening US$ liquidity as the U.S slowly withdraws liquidity from the system injected in the aftermath of the global financial crisis. I just watched an amazing interview with Michael Howell on @realvision (Another must see video from these guys) who posted this chart to visualise where we are in this liquidity cycle. As you can see we are at the extremes of “Liquidity Tight” equating to extremes of “Risk-Off”.
As the below TradingView chart shows, this contraction of US$ liquidity has sent the US$ higher (As indicated by blue arrow) & emerging markets lower (As indicated by the red arrow). Therefore any s-term change in the US$ trend could likely support a bounce in emerging markets & crypto assuming the correlation holds.
Is there anything else technically that supports a reversal is the upwards move of the US$?
Whilst I am not a chartist (My background is in equity sales-trading which means at best I could describe myself as a jack of all trades & a master of none), a very common technical signal is the divergence between an asset’s price & it’s RSI (Relative Strength Index).
As described in Investopedia: “…an uptrend divergence occurs when a price makes a higher high but the RSI does not. When we see this divergence there is a higher probability of a price reversal..”
As we can see from this TradingView chart below, we currently have these precise dynamics playing out in US$ today.
Fundamentally is there anything to support a weaker US$?
I am not a macro strategist or an expert on U.S politics however one plausible scenario I recently heard that could lead to s-term US$ weakness, was the idea that post the U.S mid terms we may see Trump take a more conciliatory stance towards its trade partners & more importantly towards China after playing hard ball these last few months, essentially pandering to his base going into the elections.
Another possible indicator for a weaker US$ could be a pause in U.S rate hikes. Many commentators I follow still think we have at least one more hike, however overnight we had Trump say the federal reserve had gone “crazy” in reference to recent tightening. Whilst the Federal Reserve remains independent to the White House, these recent comments from Trump certainly serve to question the the administrations appetite for a stronger $.
Is anyone calling for a bottom yet?
The below tweet shows an exchange between Doug Kass & Crypto’s very own Tom Lee ( @fundstrat ) today. Whilst Doug highlights the risk of picking bottoms, Tom Lee remains an optimist into the weakness highlighting “markets have a massive wall of worry — markets climb a wall of worry”.
So as they so often say in markets “its often darkest before dawn” (Although whenever I use that I am told it’s not actually true!!).
DISCLAIMER; This post and its contents should in no way be considered investment advice. We may individually hold positions in some of the assets we discuss. Any projections, conclusions, analysis, views are to be considered hypothetical & for informational purposes only & not meant as recommendations for investment. Anyone considering an investment in crypto should only invest what they can afford to lose. You alone are responsible for evaluating the risks & merits of our content.
