The Underlying Assets are Getting Squeezed
An interesting phenomenon has emerged in the last 3 or 4 months. It appears as if many of the core underlying investment assets of the economy are getting steadily killed in the markets. This is observable in FANG stocks (Facebook, Amazon, Netflix, and Google) as well as commodities like crude oil and iron ore.
Additionally, Bitcoin has continued to get hammered during this absolute beat down on the economy. Many pundits have come out and talked about how this is the “end of Bitcoin” or how this is Bitcoin finally finding its true value, but something far more important is at work here.
Deleveraging During the Credit Squeeze
For anyone who hasn’t been reading the news over the last several months, the actions of the Fed (and other central banks) have been under considerable analysis. The previous decade has seen some of the easiest money in the history of our economy. Easy money refers to the cost of borrowing. The lower the cost (interest rate), the easier the money is considered to be.
So as we start to see the credit markets change in a way that makes it a lot harder to borrow money, a credit crunch begins. This is when there is a shortage of credit (lending) and borrowers are forced to pay back parts of their loans, or at least not take out any new ones. And as a direct result, they can’t afford to maintain certain investment positions.
Their inability to maintain these positions means they need to sell off their holdings in the same way a short squeeze causes short sellers to need to buy back the security they were shorting. A credit crunch closes a lot of positions.
The economy-wide effect this is having is both predictable and scary, because we don’t know how far all these underlying assets are going to fall before they stabilize. In the mean time, there will be drastic political effects as a result. The policies of central banks have come under scrutiny in recent months thanks to comments by President Trump, and now that a tighter monetary policy is being put into play, we are going to see much lower dollar liquidity in the future.
Zooming in on Bitcoin
So with all of these assets “puking on themselves”, or deleveraging, we are seeing some interesting dynamics unfold. In Bitcoin, capitulation is occurring on both sides of the asset, which is exactly what is necessary to reverse this trend in the future.
You can see traders instinctively realize that the “dead cat bounce” that normally occurs as shorts get squeezed out in the $4k range is much more muted now. This is because many of the shorts have already closed their position. Longs are doing the same as they bought in at what they thought was the bottom, even as recent times have proven them to be mistaken.
This is going to work out as a good thing for Bitcoin in the long-term, as it could be the end of the massive downmarket it has experienced all year and a new time to shine. At the very least, it could create a good “bottom” for opportunistic buyers to hop in and average their costs down a bit.
Disclaimer: The author owns bitcoin, Ethereum and other cryptocurrencies. He holds investment positions in the coins, but does not engage in short-term or day-trading.
Featured image courtesy of Shutterstock.