So US markets have officially entered a bear market. The Fed has given the markets the 75 basis point hike it wanted. And the next shoe in crypto seems to be falling.

That’s a lot to unpack so let’s pull on each of those threads one at a time.

US markets enter a bear market

On Monday, 13 June 2022, the S&P 500 closed at 3,749.63, marking a drop of more than 20% from the all-time highs (ATH) of approximately 4,800 that the S&P 500 reached in early January 2022. For those in the markets, it seems like markets have already been in a bear market for a while now and this official drop below 20% is merely just making it official.

No one knows exactly what’s going to happen because markets are really just a reflection of the cumulative expectations of all the participants in it and these expectations change depending on the perception of the latest events and happenings in the news.

But if you expect history to rhyme, then it pays to look at what happened over the last bear markets. According to the stats compiled by Ben Carlson, the average peak-to-trough decline was 32.7% and lasted 351 days.

Now, the problem with stats like these is that the sample size is super small (only 13, if you include the current one that we’re in) and these averages are easily influenced by outliers. The biggest drop on the list is -56.8% and the longest bear market lasted 929 days. In case you’re wondering, those records belong to the Global Financial Crisis and Dot-com bear markets respectively.

Whether you think this bear will end up anything like those or more like the average bear really depends on whether the current fall in financial markets ends up infecting the economy in a larger way. Right now, it certainly doesn’t seem that way but in a couple of months, who knows?

The fall of crypto

(Update 17 June ’22: I found this great post by Amy Castor that gives a great overview of the various pieces to look out for in this space.)

While there have certainly been excesses in some parts of the financial markets (think Zoom, Pelaton, or ARKK), there can be no doubt that there have been excess in ALL parts of the crypto space. After the LUNA/TERRA debacle, the latest story making its way in the crypto-verse is about Celsius and Three Arrow Capital (3AC).

The irony of Celcius’s troubles is that despite trying to throw shade at the traditional banking system, Celcius is getting killed because it faces a classic bank run. And this happened because Celcius was doing all the things that a traditional bank wouldn’t have been able to do if there were regulators.

With the 3AC story, it appears that how they were making returns was to stake its capital to earn high yields (essentially locking in their capital for promised high returns). Under any circumstances, losing your own capital is one thing but with leverage, the fall in crypto prices meant that the value of its collateral decreased, causing lenders to require more capital otherwise its stake would have been liquidated, leading to even lower prices and more liquidations.

The big question now is whether the fallout in crypto will have major spillovers in the economy and financial markets. It’s one thing if Michael Saylor’s bitcoins go to zero. It’s another if Michael Saylor’s bitcoins going to zero causes a systemic failure in the financial markets.

Will this happen? Only time will tell.

The 75 bps hike

All of the above is stuff related to the financial markets. If losses in the financial markets or crypto-verse are just contained within those realms, then it’s not so bad. The thing is, inflation in the economy has turned out to be not so “transitory”.

The war in Ukraine and China’s continued zero-Covid policy has no doubt caused disruptions on the supply side. The other part of the equation is, of course, that demand for goods and services remains high.

Housing prices in the U.S. have been on a tear, as with prices in Singapore. Travel-related demand has come back in a more significant way as most of the world relaxes covid measures. More importantly, unemployment numbers have remained low across all major economies.

It appears that the story the Fed is hoping for is to cool demand off enough while the supply-side issues take time to get sorted out. The 75 bps hike is really about cooling off demand and hope that the war in Ukraine ends soon and/or that China manages to keep Covid in check so that their economy can also hum along.

Now, if US markets face another leg down, I think it will be because the Fed has tightened so much that something breaks. Now, it’s not the intention of the Fed to crash the economy but their first priority is going to be to get inflation under control. If they can do it while keeping job and profit losses to a minimum, that’s going to be a bonus.

Meanwhile, look to the credit markets for the next signs of stress. If credit markets remain fine, then this bear won’t be anywhere near as bad as the most recent two.