Market and Crypto Outlook H1 2024

Team Halogen
December 1, 2023

Executive Summary

As we head into early 2024, our analysis points to a potentially favourable market environment, with either Goldilocks or reflationary conditions prevailing and easier financial conditions. We expect the Federal Reserve to be on hold, with peak inflation and rates likely behind us. However, it’s important for investors to brace for volatility, influenced by economic slowdowns and higher-for-longer rates, alongside potential impacts from geopolitical tensions and the upcoming US Presidential Election. 

Locally, we foresee a period of inaction on local interest rates, avoiding disruption of economic growth. The Malaysian Ringgit (MYR) may see mild appreciation under favourable conditions, though it might not outperform regional peers and foreign investment options. Local bonds could appreciate with increased international investment, but Malaysia’s international diplomatic decisions and geopolitical uncertainties suggest diversifying away from exclusive investments in MYR. Investors are advised to consider a balanced and cautiously diversified approach in their portfolios.

In the cryptocurrency space, we think the likely scenario for Bitcoin (BTC) is ‘buy the rumour, sell the fact’, on the back of any approval for spot Bitcoin ETFs in the US. The market could remain volatile due to speculative positioning, yet is underpinned by structural tailwinds that provide longer term support for BTC. Ether (ETH), in comparison, shows more upside potential than BTC at current levels. We caution that the outlook is vulnerable to sentiment shifts, especially if the current spot Bitcoin ETF applications face rejection, thus significantly impacting market dynamics. Investors in the crypto space should remain agile and responsive to these evolving trends. 

Introduction

2023 was another volatile year for global markets, with events like the fall of Silicon Valley Bank and Credit Suisse, fears of US fiscal indiscipline pushing long end treasury yields above 5%, and the eruption of conflict between Israel and Palestine. Locally, the Ringgit hit a 25 year low of RM4.80 to the US Dollar and domestic assets were also pressured by the external environment. Overall, it was another tough year to be an investor.

There were bright spots here and there though. Peak inflation in the US (and perhaps globally) looks to be behind us, undoing the damage from the spike in treasury yields and allowing US equities to rally hard into the year end. The potential for spot Bitcoin ETFs being listed in the US has also caused a lot of hype in the cryptocurrency space, helping Bitcoin be one of the best performing major assets this year at over 125% return as of November 2023.

But what next? While the environment still looks challenging, we at Halogen think there are opportunities to be taken advantage of, at least in the first half. We’ve covered our early thoughts on that in our Nov 23 webinar, but would like to pen them down here and expand on them, for those who prefer the written word. We also include some new information in our views. Lastly, we also talk a bit more about the frameworks we use which hopefully you, the reader, would find useful.

This post is more about our views and interpretations from available data sources, and how we would like to position ourselves around their implied outcomes.

The Global Macro Outlook

The global macro outlook is of utmost importance to navigating financial markets, especially that of the United States of America. As the world’s largest economy with the richest datasets, and also the largest, most open capital market in the world, US economic factors and policies drive huge flows worldwide across multiple asset classes. This is a natural starting point for any form of investment analysis, be it in local or foreign markets.

We start with an assessment of US growth and inflation outlooks. From there, we can form a baseline expectation on what assets will perform well using a quadrant model. The quadrant is built with year-on-year change in growth on one axis, and YoY change in inflation on the other. The quarterly figures are then mapped to their respective points via the usual scatterplot method.

Popularised by Bridgewater’s Ray Dalio and his All Weather Portfolio, the theory is that certain asset classes and sectors perform better in different economic quadrants. For instance, energy and commodities tend to outperform during quadrants of accelerating growth and inflation, while bonds and the Dollar tend to do well in periods of deflation (decelerating growth and inflation).

Of course, a simple model like this is far from enough to navigate the complexities of global markets, and these data are backward looking. Hence, we also take a look at other pertinent angles such as the monetary policy outlook and sentiment data. 

US Economy

Growth and Inflation Outlook

Source: Federal Reserve

Multiple sources anticipate a cooling of the US economy in 2024. The Federal Reserve’s official forecast states that GDP growth will drop from 2.1% to 2023 to 1.5% in 2024, while Personal Consumption Expenditure, and especially Core PCE, will tumble by 0.8% and 1.1% respectively. While the deceleration might seem concerning on the surface, the path to get there and the context in which it takes place matters.

Source: J.P. Morgan forecasts

Looking at the quarterly breakdown provided by JPMorgan, we see that while the quarterly numbers decelerate, 1Q24 still implies a YoY change for growth that is positive, owing to base effects. Likewise, inflation could see a minor pickup on a quarterly YoY basis. Both only look to decelerate meaningfully in the 2nd quarter of the year. In that regard, the first quarter of next year could be one which rewards risk taking, being either a Goldilocks or a reflationary type of environment, before subsequently decelerating into the second quarter.

Labor Market Dynamics: A Closer Look

Source: Bloomberg

What about the labour market, a key market that policy makers are watching? A running theme in 2023 was that so long as employment conditions remained strong, the US Federal Reserve could continue to raise interest rates and keep them higher for longer. A possible explanation for why hiring remained strong in the US despite poor sentiment and rising inflation was posited by Alex Gurevich, founder and CIO of HonTe Investments. The outperformance of the US economy, particularly in the services sector, allowed for companies to prioritise sales - and the easiest way to do that was actually to hire people. Starting from 2021, when real wages were deeply negative, companies went on hiring sprees, and this momentum could still continue into this year.

Recent Non-Farm Payroll (NFP) figures initially suggest robust job additions, despite signs of lower consumer spending. However, subsequent downward revisions point to a possible overstatement of labour market strength, and this is also reflected in the Household Survey data, which showed a sharp drop in Employment Change for October.

This data series bears watching closely. A sharper downturn in hiring could shift the narrative from easing financial conditions to concerns over the economy. In which case, defensive positions would be more warranted, and duration sensitive positions like bonds will likely outperform.

The Federal Reserve's Policy Conundrum

Source: CME Group

In light of the recent CPI and employment data, we can pretty much conclude that the Fed is done hiking. Nick Timiraos from the Wall Street Journal has publicly stated as much on the X (formerly Twitter) platform, and he’s widely regarded as the Fed’s official mouthpiece for policy guidance.

Amid these dynamics, the Federal Reserve faces a conundrum. Hawkish FOMC messaging suggests a commitment to higher interest rates, yet market sentiment leans towards an imminent pivot, potentially halting hikes or reducing rates by May 2024. Nearly half of market participants expect rates between 4.75% and 5.00%. Sell side research teams expect between 3 to 4 rate cuts for the year.

The data does indeed support the view that peak rates are behind us, and if job revisions lower continue at this current pace, there is indeed a risk that the economy is softer than what official estimates portray. In that event, the market will be right that the Fed will indeed need to pivot and reduce rates preemptively. Pershing Capital’s Bill Ackman, who publicly sparked this year’s rise in yields from 4.50% to 5%, is now on record saying he expects the Fed to reduce rates in the first quarter of the year. 

The irony is that as the market continues to fight the Fed on its stance, it sets up an environment of looser financial conditions - higher equity prices and lower borrowing rates, based on treasury bond yields. This indirectly stimulates the economy and potentially causes inflation to accelerate once again, at which point the Fed is forced to step up its hawkishness and induce volatility into asset prices again.

On balance, we think the Fed must continue to sound hawkish, but a lot of that rhetoric will just be sabre rattling as they cannot flinch in the face of market expectations. While there might be instances where the market will be spooked, the repricing of higher for longer will likely not gain momentum in the face of slowing economic data. 

Source: Bank of America Global Fund Manager Survey

Bank of America runs a monthly survey of global fund managers, asking them a series of questions from their stance of the current environment and what the risks are, to how heavily they are invested (and many others). The research is then shared in their publications, which helps provide a sanity check to participants and, more importantly, the current view of fund managers to everyone else. 

Fund managers, often seen as market sentiment barometers, have shown notable bearishness for most of 2023 (understandably so when faced with 100 year old banks collapsing i.e. Credit Suisse in March). However, a recent uptick suggests a shift towards optimism, potentially leading to money managers deploying their cash reserves into investments. 

Source: Bank of America Global Fund Manager Survey

The surveyed expectations for the global economy over the next 12 months further underscore this cautious optimism. A majority of fund managers predict a 'soft' or 'no landing' scenario, suggesting that the underlying drivers of the global economy are strong enough to withstand the headwinds caused by higher interest rates. This consensus points to an expectation of manageable economic conditions rather than a full-blown recession.

Nevertheless, there has not been a good track record of predicting a soft landing in the past as demonstrated in this chart:

Source: NBER and Bloomberg

Despite the relatively short time frame of around 30 years, during this period recessions generally follow a spike in interest in soft landings. On top of that, soft landings are rare.

Source: Bloomberg

There’s only been one since the 1980s and that happened in 1995. 

Past experience may not translate well in a post-Covid world and perhaps this time is different. We would just caution on writing off a “hard landing” or a recession completely. 

Knowing what the ‘wisdom of the crowds’ says is important in positioning. It allows us to determine whether to follow the crowd, or go against them. Sentiment based indicators are typically contrarian in nature, hence Warren Buffet’s famous quote: “to be fearful when others are greedy and to be greedy only when others are fearful.” 

Given the base from which we have started from, we think that there is scope for fund managers to continue deploying cash, in anticipation of a Santa rally. Into Q1, fund managers typically start putting cash to work early in the year, which might prolong any such move higher.

Seasonality: The Presidential Election Impact

Source: Halogen Capital, Yahoo Finance

2024 is an election year for the US. Incumbent President Joe Biden will be up against the Republican party’s candidate, which may or may not be former President Donald Trump, whom he defeated in the 2020 elections. Elections typically introduce some form of uncertainty into financial markets, and this year’s presidential election should be no different.

With some historical data dating back to 1927, we took a look at seasonal performance of the SPX 500 during election years only vs. the long term average. While the average path of yearly returns has been positive, we note that historically, US markets tend to experience an outsized uplift in returns in the middle of the year, leading up to the election. 

During his time as US President, Donald Trump considered the performance of the US stock market as a barometer for his approval ratings, with public references to the performance of the stock market during official speeches. While he might have emphasised it a lot during his tenure, it’s without a doubt that the stock market’s performance influences support for the incumbent president. Policy making will likely shift to try and prop up stock market performance.

China

China’s Economic Shift

Source: Bloomberg

The Chinese narrative going into the end of the year is in stark contrast to the start of 2023. The China reopening trade provided a huge lift to global markets, but petered out when the flows were smaller in magnitude, following which the China property crisis started to unfold. The latter’s impact on the Chinese narrative has turned into a huge drag.

The recent economic data from China paints a picture of a transitional period for the country's economy. The analysis reveals a tangible weakening in consumer spending, particularly in sectors such as recreation and transportation, as highlighted by the October readings from the QuantCube indicator. Given the pivotal role of consumer expenditure in driving economic growth, this softening suggests potential headwinds for China's overall economic recovery.

Source: Bloomberg

The recent economic data also reveals a weakening in consumer spending, particularly in recreation and transportation. This softening, alongside declining foreign direct investment (FDI) for the first time since 1998, highlights a broader trend of deglobalization. This pullback poses risks to global supply chain cost structures and may introduce long-term inflation because of the move away from the ideal comparative advantage [1].

Source: Bloomberg

China's export sector, once a growth engine, shows deceleration signs due to various factors, including deglobalisation, slower global economic growth and tighter monetary policy.

Geopolitics

War

Geopolitical tensions have been a key risk since 2022, starting with the Russia-Ukraine war. That conflict is still ongoing, but as markets are wont to do, the sentiment surrounding the conflict gets normalised and trading behaviour returns to ‘business as usual’. However, escalation of geopolitical tensions is actually the one risk that derails any and all forecasts, hence we would take some time to address our reaction functions to these risks.

The eruption of war between Israel and Palestine came out of left field in November. The initial reaction of the market was solidly risk-off, especially with the threat of a key shipping passage in the Straits of Hormuz being choked off. Luckily, that did not come to pass, and the conflict has since simmered down into a slow burn. Unfortunately, there’s no end in sight to what is increasingly seen as genocide by the global media.

Unlike the proxy war in Ukraine, Western powers want neither the conflict to escalate, nor to get too involved in it. Besides trying to support a war on two fronts, the US is particularly beholden to the Jewish electorate, given how 2024 is an election year. Studies have found that the Jewish vote can be the deciding factor in who becomes the president.

Where things could get dicey, is if the other Muslim aligned countries in the Middle East start to become heavily involved. Thus far, the IDF has been surgical in its retaliation, but as the death toll mounts and public outrage grows, there may be mounting pressure for external intervention. At that point, we’d see what amounts to typical risk aversion once again. We see that as a slim possibility right now, but nevertheless feel compelled to point it out and prepare a defensive reaction.

US-China Relations

Did Joe Biden literally call Xi Jingping a dictator on live television? Yes, he did indeed, in remarks to the press after their meeting at this year’s APEC summit. As should be expected by American media though, those headlines excluded a lot of context. In totality, the US President was cognizant of the cultural differences between the US and China, stating that over there it has a significantly different meaning and role.

In fact, since the Middle East conflict, one could say that the tension between the US and China has eased significantly. One could see this in the bilateral meetings that took place between the two powers. Envoys from both countries were personally met by the sitting presidents themselves during their respective visits recently, when typically their direct level equivalent would be sufficient. 

The US still wishes to restrict the export of high-value technology to China, and it’s unlikely to change the status quo on Trump-era trade tariffs. Still, a stance of mutual tolerance should be sufficient to allow China to clean house internally.

Key Points for the Macro Outlook 

Taking into consideration all of the above, we can distil that information into the following action points:

  • We anticipate conditions to be either Goldilocks or reflationary, both of which are typically positive for markets (at least in a loosening policy regime)
  • Barring an exogenous shock, peak inflation and hence peak rates should be behind us. The Fed is done hiking 
  • Some volatility in rates and hence risky assets could be expected on two fronts - the slowing of the economy weighing on asset prices, juxtaposed with the possibility of a Fed pivot in the face of those conditions
  • The market is still playing chicken with the Fed, which may introduce further volatility as the Fed initially pushes back against those expectations
  • US Presidential Election cycles tend to support US equity prices
  • Geopolitical tensions have potential to significantly disrupt otherwise favourable market conditions, and one should have a defensive action at the ready
  • On balance, we are cautiously optimistic on the outlook going into year end and into Q1 of 2024, and reckon it is better to allocate to risky asset positions than cash
  • However, we caution that should the data continue to worsen, the narrative will start turning from ‘the Fed is easing’ to ‘the economy is worsening’. While bonds will likely see some pick up either way, this will be the superior position in these conditions

The Malaysia Economic Outlook

2023 was a gloomy one for Malaysians. Despite headline inflation under control locally (thanks mainly to fuel subsidies), the rising cost of living was felt everywhere. Malaysian Government Securities bond yields continued to track US Treasury yields higher, and our currency hit a 25 year low vs. the US Dollar at RM4.80 in Oct 2023 (and an all time low against the Singapore Dollar at RM3.51 as of late Nov 2023).

As a relatively open and export driven economy, Malaysia is greatly affected by external factors and flows. Nonetheless, domestic demand is also a large enough driver, such that policy makers must strike a careful balance when guiding the country’s economy. While we can still apply a quadrant framework to local growth and inflation metrics, the global macro quadrant drivers can and often do supersede those locally.

Malaysia's Economy

Balancing Growth Amidst Global Uncertainties

Source: Bank Negara Malaysia

The economic outlook for Malaysia, as projected by Bank Negara Malaysia, suggests a growth rate ranging between 4% to 5% for the current year. A closer analysis of the quarterly figures paints a nuanced picture. The first quarter saw a robust growth of 5.6%, followed by a significant slowdown in the second quarter to 2.9%, and a slight improvement in the third quarter at 3.3%. This trajectory indicates a mixed economic performance across the quarters.

To achieve a growth rate close to the upper end of the projected range, specifically around 5%, Malaysia would require an exceptionally strong performance in the fourth quarter. Given the current trends and underlying factors, this appears to be an optimistic scenario rather than the base case.

Source: Department of Statistics Malaysia

On the positive side, the domestic factors supporting Malaysia’s growth are noteworthy. The labour market is showing signs of recovery, nearing pre-pandemic levels of employment. This rebound in employment is crucial as it underpins consumer spending and overall domestic economic activity.

Additionally, the continued investment in transport mega-projects highlights the government's commitment to long-term infrastructure development, which is typically associated with boosting productivity and economic growth.

The outlook is tempered by external headwinds. Slower global growth could dampen export demand, impacting Malaysia's trade-dependent economy. Furthermore, the graphic indicates a concern over slower commodities, which could refer to either a price decline or a reduction in commodity export volumes. Given Malaysia's status as an exporter of commodities like palm oil and petroleum, reduced commodity performance can significantly impact its trade balance and GDP growth.

Malaysia’s Inflation Outlook 

Source: Department of Statistics Malaysia

The inflation outlook for Malaysia shows a complex interplay between domestic policy measures and external economic factors. The headline inflation, which includes all items that consumers spend on, has been trending lower, aligning with broader external economic trends. This downtrend reflects the impact of global market conditions on Malaysia's economy. However, the expectation for inflation is about 3% in 2023, which suggests a moderate level of price increases for consumers.

A closer examination of the inflation components reveals that core inflation, which strips out volatile items like food and energy, has been relatively stable. This stability in core inflation is indicative of underlying economic conditions that are less susceptible to external shocks, such as global commodity price fluctuations.

The outlook is not without its challenges. The implementation of new taxes and a rationalisation of subsidies are expected to potentially reverse the current trend in 2024. These policy changes could lead to higher costs for goods and services, thus pushing inflation higher. Such policy-induced inflation can be particularly challenging to manage, as it does not stem from supply and demand dynamics but from changes in government fiscal policy.

Steady Monetary Policy and Interest Rates

Source: Bank Negara Malaysia

The rates outlook for Malaysia, as indicated by the policy stance of Bank Negara Malaysia (BNM), points to a period of monetary stability. BNM has maintained the key overnight policy rate at 3% as of November, suggesting a cautious approach to interest rate adjustments amidst a complex economic backdrop.

BNM appears unlikely to increase rates in the first half of 2024, possibly due to a cautious external growth environment. This hesitation could stem from concerns about global economic trends and their potential impact on Malaysia's growth prospects. The stability in interest rates could also reflect a balanced view of inflationary pressures. While inflation has been steady, with slowing growth on one side and cost-push factors, such as new taxes and gradual subsidy removal, on the other, BNM may be adopting a wait-and-see approach before making any rate adjustments.

The bond market reflects this cautious sentiment with Malaysian bond yields remaining low compared to foreign counterparts, indicating limited upside for yields. This could suggest that investors expect the current monetary policy to continue, with low interest rates supporting government borrowing but offering modest returns for bond investors.

The Malaysian Ringgit in the Global Economic Theatre

A key theme for the past 2 years has been USD strength globally. Currency strength has many driving narratives, ranging from risk aversion (safe haven currencies strengthen) to rising global growth (high beta currencies outperform). If there were one key reason for this though, it would be due to interest rate differentials between the Dollar and other global currencies. Classical economics teaches that the currency with a higher interest rate will outperform the one with a lower interest rate. Traders refer to this trade as the carry trade.

This was indeed the narrative that helped the Dollar strengthen so drastically in the last 2 years. The Fed was on an aggressive hiking path while many other countries could not afford to match them hike for rate hike. And this indeed likely explains a huge part of the Ringgit’s weakness in the last two years. 

At this year’s low in Ringgit, there were calls for BNM to hike the OPR to defend our currency. In our view, this would have been a mistake. Interest rate hikes would not solve the problem locally, and their effectiveness would depend highly on context. Plenty of other central banks, from the Bank of England to the Bank of Canada, attempted to match the Fed’s pace of rate hikes - during that cycle, their currencies continued their downtrends against the Dollar despite these efforts.

Source: Halogen Capital

Our framework to analysing currencies is to understand how drivers and narratives influence flows into and out of that currency. For the Ringgit in particular, foreign portfolio flows are a critical driver. They come in large, chunky sizes, they are subject to rules-based allocation and de-risking strategies, and they can be the result of herd-like behaviour amongst fund managers, all of which means the magnitude and persistence of directional flows are significant.

Source: Bank Negara Malaysia

The data on non-resident holdings of Malaysian Government Bonds showcases the extent to which foreign investors participate in the Malaysian bond market. A substantial portion of these bonds is held by asset management companies, central banks, and pension funds, reflecting a diverse international interest in Malaysia’s debt instruments. An unnecessary rate hike, at the time when the Ringgit was at its low, would serve to exacerbate the losses on these bond holdings. This could have caused further pressure on both local bonds and our currency, as investors cut their losses and exit the country.

Given the potential turn in the global outlook, we think that the Malaysian Ringgit is poised to recover in line with regional peers. Some local research houses expect a recovery back to RM4.40 vs. the Dollar. 

Unfortunately, we lack a local catalyst (aside from valuations and positioning) that would allow us to outperform them. There also exist certain risks that could make us less attractive now to foreign portfolio managers, such as the recent hardline stance over the current conflict in the Middle East. As such, we would prefer to ensure our investment holdings have some exposure to currency diversification.

Key Points for Malaysia’s Economic Outlook 

In summary:

  • We expect inaction on local interest rates in the near term, avoiding potential economic disruptions from aggressive monetary policies.
  • The Ringgit shows potential for a mild appreciation under favourable global conditions, though likely to underperform vs. regional peers and foreign investment vehicles
  • There are prospects for appreciation in local bonds, contingent on increased international investment.
  • Malaysia's international diplomatic positions could affect its attractiveness to certain investor segments.
  • Given the uncertainties in Malaysia's geopolitical decisions and external economic influences, diversification from exclusive holdings in MYR is advised for investors.

Crypto’s Outlook

Who would have thought that Bitcoin would be 2023’s best performing major asset to date? BTC is up nearly 125% on a year-to-date basis, rising from a mere $16,500 to trade around $38,000 at the time of writing in end Nov 2023. Despite the setback the industry faced after the fall of FTX in November 2022, 2023 has been the year crypto started to see more mainstream adoption.

Cryptocurrencies were seen as a hedge against the traditional banking sector during the fall of Silicon Valley Bank and Credit Suisse in March 2023. The sector rallied while fears of contagion roiled financial markets. The regulatory overhang in the space started to clear up as well, with the SEC suffering legal defeats in several landmark cases vs. industry names like Ripple and Grayscale, plus a fresh start after the recent plea deal between Binance and the US DOJ.

But most importantly, this is the year where the potential for mainstream institutional adoption begins, starting with the filing of spot Bitcoin and Ether ETFs by large asset managers like BlackRock and Fidelity in mid 2023. That news kicked off a huge wave of positive sentiment, and has been responsible for most of the rally in crypto during the second half.

Where do we go from here? Given the amount of focus on Bitcoin and Ethereum currently, we will restrict our focus to these two. As it stands, there are many factors to consider for these two alone when positioning ourselves for the first half ahead. We’ll take a look at these factors individually first before coming up with a more comprehensive view.

The Regulatory Landscape

In terms of regulatory overhang, 2023 helped clear some of that away from crypto space. Starting with the SEC’s loss in its case vs. Ripple Labs, the ruling that XRP is not a security when transacted via programmatic channels (i.e. exchanges) might be controversial, but sets a huge precedent going forward for the remaining tokens on the SEC’s list of potential securities. 

The SEC has also been denied its request to appeal that decision. While a trial date for the Ripple vs. SEC case is set for 24 April 2024, the market anticipates that the outcome is a mere settlement to be paid by Ripple Labs for its sales to institutional investors, which are deemed as unregistered securities. We would continue to watch that space for any surprises, but for now the regulatory clarity in that area is appreciated.

The recent bombshell that Binance CEO Changpeng Zhao had accepted a plea deal with the US DOJ, and also stepped down as CEO of Binance, initially hit market sentiment negatively. After the wave of selling was done though, the market figured that this helped provide certainty that Binance would collapse under punitive DOJ sanctions, resulting in contagion throughout the cryptoverse. JPMorgan analysts have also agreed that this development is positive for crypto as a whole.

Binance is still the world’s leading crypto exchange by volume, but we could see a shift away from that as crypto players shun the exchange in place of either more regulated venues, or more opaque ones. After all, the plea deal opens Binance up to a huge amount of scrutiny by US officials. We would expect that US dealing volume shifts to more acceptable names like Coinbase, despite the exchange still facing its own suit vs. the SEC.

Bitcoin (BTC)

US Spot Bitcoin ETF: A Potential Game Changer

We first need to navigate the news and reactions surrounding the much anticipated approval of a spot Bitcoin ETF in the US. The ball is in the SEC’s court. Under the current rules, the SEC can delay making a final decision up to 4 times, with about 90 days in between each delay. At this time of writing, the market’s focus is on the third deadline, coming up roughly around the middle of January next year. Given the number of applications and how close the deadlines are, there is also an expectation that the SEC will approve (or reject) all applications simultaneously.

Source: Bitwise Asset Management

Does a spot ETF really change the game for crypto? After all, there are currently spot ETFs (notably Canada’s Purpose Bitcoin ETF) or other similar funds (like the Halogen Shariah Bitcoin Fund) which exist worldwide. There are even ETFs which invest via CME Bitcoin Futures, which is enough to give one exposure to the price movements of Bitcoin. Investors aren’t exactly rushing into these products wholesale (though of course we argue that they should).

In context though, the US financial market and its base of active participants is many times the size of any comparable market globally. Furthermore, for a deflationary asset like Bitcoin, the actual impact of locking up lots of circulating supply via a spot ETF is something that a Bitcoin Futures ETF could never achieve.

In the longer term, yes we do think that a spot ETF in the US is a game changer for the industry. While the current price action and sentiment might be extreme and volatile, this is one of several structural tailwinds that help support Bitcoin in the long run. Flows might take at least 6 months to materialise in earnest once approvals are out of the way, but we’d expect sophisticated crypto native players to buy into meaningful retracements before that.

The market currently attributes a very high probability towards the SEC eventually approving some, if not all, of the outstanding applications. Bloomberg has reportedly assigned a 90% probability of this going through. We also note reports stating that Blackrock continues to be in constant communication with the SEC in an attempt to improve its chances for an approval. 

There also seems to be a huge anticipation for an approval to come by the 3rd deadline in January 2024. Be warned; the SEC is not obligated to do so. Another delay likely introduces some more downside volatility into the price, but will likely be shrugged off by the market after the initial selldown.

On-Chain Data: Indications of Tightening Supply

Source: Glassnode

The crypto market is arguably one where deeper and more meaningful data analysis can be performed. In traditional finance, transaction level data is hidden behind centralised institutions who control access to that information. In crypto markets though, real time transaction data is freely available if one knows how to access and read the blockchain’s distributed ledger. We refer to this data as on-chain data, and it provides deep insight into the flows in crypto markets. 

A key observation from the data, provided by Glassnode (an on-chain data aggregator), is the divergence between readily liquid supply and illiquid supply. The liquid supply, represented by orange and red lines in the chart, has been consistently declining throughout the year. This trend indicates a decrease in the amount of Bitcoin readily available for trading or selling on the market.

Conversely, the illiquid supply, which signifies Bitcoin held by long-term investors (often in wallets labelled as cold storage), has been steadily increasing. This trend became particularly pronounced following the lows in June and July, marking a sharp uptick in long-term holdings and a significant decline in liquid supply.

Two major anticipated events could be driving this behaviour:

  1. ETF Approval: Investors may be holding onto their Bitcoin in expectation of an exchange-traded fund (ETF) approval, which they believe could lead to a surge in demand and higher prices.
  1. Anticipated Halving: The Bitcoin Halving is a structural phenomenon in Bitcoin’s algorithm that halves the block rewards to miners at set intervals (every 210,000 blocks mined, approximately every 4 years). It essentially halves the rate of new supply in a steady and predictable manner, and the next halving is scheduled to occur in April 2024. The community likes to point out that Bitcoin’s bull and bear cycles fit very closely with the halving, and that the event is bullish for the token.

Overall, we agree that the supply and demand picture for Bitcoin is very positive for further price appreciation. The halving helps provide a structural tailwind for Bitcoin, but please do not buy Bitcoin just because of this narrative. Many other factors still play a role in determining the evolution of Bitcoin’s price.

Additionally, we've conducted a comparative study here that demonstrates how including even a small allocation of Bitcoin in your portfolio can result in substantial outperformance compared to a traditional 60/40 portfolio.

Understanding the Market through Perpetual Swaps

Source: Coinalyze

Real time data on derivative-based positioning is also more readily available in the crypto space compared to traditional finance. Crypto derivatives, typically in the form of perpetual swaps, can have an outsized impact on short term price movements. This is because the asset class is traditionally associated with excessive risk taking and leverage, thus being more susceptible to large liquidations and cascades of de-risking.

Today, we point out that Bitcoin’s recent price gains in November have seen a corresponding surge in open interest (OI) for Bitcoin derivatives. Open interest refers to the total value of derivative contracts which are currently open i.e. live in Bitcoin. Given the correlation between open interest and price, we can reasonably assume that traders are predominantly long Bitcoin via futures, chasing the move higher. 

The level of OI is roughly similar to that of August. The end of August saw a massive deleveraging exercise, plunging Bitcoin from $31,000 to $25,000 in a liquidation cascade. We also see other periods of similar price action, where sharp selling and price weakness was accompanied by a reduction in OI.

Despite the plunges in OI as time passes, the spot price of Bitcoin continues to make higher lows. In that sense, an increasing proportion of the price action is being driven by spot buyers, which we saw earlier via on-chain metrics. Taken together, we can conclude that while another derivative position cleansing can drive prices sharply lower, the price support base should now be higher, which is overall supportive of the market.

Key Resistance and Support Levels

Notably, Bitcoin is contending with resistance levels at $40,000, $42,000, and $48,000. The $40,000 mark is a psychological barrier, owing to what is well-known as round number bias. The $42,000 price point, colloquially tied to internet meme culture, may offer a less conventional resistance level, while the $48,000 level is underscored by its standing as a previous interim high in 2022.

In the near term, $35,000 was a key breakout point in the last two months, which should now serve as immediate support. If the hype continues, we anticipate that the market would likely attempt to buy any dips in the $31,000 to $32,000 regions, making any move down a slow grind. Major price support levels are then observed at $30,000 and $25,000, acting as potential floors (also nice round numbers, but where the market saw strong volumes and key developments). 

Ether (ETH)

Early In The Cycle

An interesting aspect of Ether's market dynamics is its relationship with Bitcoin (BTC) performance. Often, altcoins such as ETH tend to follow the trend set by Bitcoin, considering BTC's dominance and established market presence. For most of the year, ETH has been heavily correlated with Bitcoin’s price movements, but has lagged behind in magnitude. Understandably so; all the hype has been about Bitcoin and institutional adoption lately.

Early in November though, Blackrock started the process for the filing of a spot Ether ETF as well. While the news was bullish for the market as a whole, this was the one moment recently where ETH outperformed BTC. 

Since the start of its ETF narrative cycle in June, BTC is up nearly 52%, while ETH is only up ~26%. Even if we discount the popularity of ETH and its slightly inferior tokenomics compared to BTC (no finite supply, deflationary nature dependent on network activity), we could still see a 15 - 20% upside from here. Especially given that ETH is now attempting to break above the $2,150 resistance level towards the end of 2023. Such a move opens up potential for much higher prices, with $2,600 being the next level to target from a technical perspective.

As the first mover, the Bitcoin ETF approval process understandably takes more time to go through. But an approval paves the way for a much easier listing of spot Ether ETFs, especially given that the initial Blackrock application has not included more complex features like ETH staking. In that regard, we can expect the cycle to be much more compressed, but that does also mean it can be inherently more volatile.

Our Anticipated Playbook

Make no mistake, there is A LOT of hype surrounding the potential approval of spot Bitcoin ETFs. While there are underlying fundamental dynamics that help support price, the recent activity has been undoubtedly speculative. And it’s not just crypto native traders that are involved - recent reports show that open interest for Bitcoin futures on the Chicago Mercantile Exchange, the go-to marketplace for large institutions, has actually exceeded that of Binance. Hedge funds and other smart-money type institutions might have been late to the party, but they are now here, and in large sizes.

With a market already this well positioned, we think it’s likely that we see the classic ‘buy the rumour, sell the fact’ type of price action. An announcement by the SEC that it approves the outstanding applications, whenever that happens, will be met by a spike in the price of Bitcoin as momentum traders try to get on the bandwagon. We anticipate that, if the current resistance levels hold, Bitcoin will handily break $40,000 and could go to $42,000.

However, the already well positioned traders who were early will then sell into this buying flow. Potentially, this results in a quick liquidation cascade and drives prices lower. From there though, we anticipate that dips back to $30,000 might be bought by spot traders who see longer term value, and have patiently waited for better levels to enter once again.

Source: TradingView

Additionally, we also think that these traders will then rotate into buying ETH instead. Given ETH’s relative valuation to BTC currently (expressed via ETH/BTC) and the potential upside that it still has, the speculative interest will shift towards ETH instead.

Lastly, we note that a lot of this hinges on a successful ETF application. As market participants, we must always manage the downside risk to the current view: what if the SEC instead rejects all applications?

While the response could be contextual, the obvious outcome is that a large wave of selling would be unleashed across all crypto pairs. While supply issues might play a role in stemming some of the paint, we expect a very deep retracement to take place, perhaps back to the $25,000 levels. The only way to hedge against that would be to buy some Bitcoin puts as a portfolio hedge.

Key Points for the Crypto Outlook

While there was a lot of data to get through, we can summarise our crypto outlook into a few key points

  • We expect ‘buy the rumour, sell the fact’ price action in BTC
  • While the current market is susceptible to volatility due to speculative positioning, structural tailwinds exist that are bullish for Bitcoin in the long term
  • At current levels, there is likely more upside for ETH vs. BTC
  • The current outlook is at risk of sentiment turning hugely negative on the rejection of existing spot Bitcoin ETF applications

Conclusion

From here till to the first quarter of 2024, we expect conditions to be conducive for risk taking, in both traditional finance and cryptocurrency markets. The reasons for such are more structural in nature, as opposed to any real strength in economic fundamentals. Nonetheless, these opportunities are there for the taking, and it would be a mistake not to take advantage of them if they avail themselves.

We do caution that downside risks remain to the global macro outlook, especially into the second quarter. Positions that might do well in a wider variety of outcomes, like long US treasury bonds and curve steepeners, could be considered superior to being long outright market beta.

In the crypto space, the narrative could quickly take a turn for the worse too, especially in a market positioned so one-sidedly. We look to navigate this space nimbly, with an emphasis on prudent and disciplined risk management. 

On balance, we continue to seek opportunities for risk taking, but are careful to anticipate risks to the downside.

We wish you a successful investing journey to start 2024. All the best!

We also have the video presentation available for your convenience.

Footnotes:

[1] Comparative Advantage in this context refers to a nation being able to produce goods or services at a lower opportunity cost compared to other nations.

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Disclaimer: The information, analysis, and viewpoints presented here are intended solely for general informational purposes and should not be construed as personalised advice or recommendations for any specific individual or entity. For personalised investment decisions, individual investors are advised to consult their licensed financial professional advisor. The opinions expressed by the Manager are based on certain assumptions or prevailing market conditions, and they are subject to change without prior notice. This material is being distributed for informational purposes only and should not be regarded as investment advice or an endorsement of any particular security, strategy, or investment product. While the information provided herein may include data or opinions from sources believed to be reliable, its accuracy and completeness are not guaranteed. Reproduction of any part of this material in any form or reference to it in other publications is strictly prohibited without the express written permission from Halogen Capital Sdn Bhd. Halogen Capital Sdn Bhd and its employees assume no liability regarding the use of this material or its contents.

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Team Halogen
December 1, 2023