This has been an incredible few days. The election was dramatic enough (don't worry, this post is not about politics) and then KABOOM, the tide went out on crypto exchange FTX and its founder Sam Bankman-Fried (SBF) who had emerged as sort of a white-knight, smartest guy in the room-type for having been involved with bailing out other crypto business, his involvement with politics and his charitable nature.
The demise of FTX and the evaporation of about $15 billion of SBF's wealth, a 94% decline for his net worth, seemed, from the outside looking in, to come in just a couple of days. I don't know the full precise nuance but it turns out the business leveraged its own token which trades as FTT, which led to SBF's hedge fund Alameda Research blowing up causing a spiral of the whole thing with reports about investors like Canadian pension funds and a GOAT quarterback being taken down in the mess, but we'll see how that all shakes out soon enough.
It also emerged yesterday that frienemy exchange Binance was going to rescue FTX. Today, Binance walked away from the deal.
You should really do your own research to learn in greater detail if you're interested but for me the takeaway is that this is a story about someone misusing leverage because they thought they were smarter than the system. Here's a good Twitter thread to learn more.
The news broke in the middle of the Tuesday stock market session and since that point the US equity market has pretty much gone straight down. Is this a systemic problem? Is this another Bear Stearns or Lehman Brothers? Crypto adds up to less than $1 trillion but it seems like it a little more of an island unto itself as opposed to the mortgage market which is not only bigger but enmeshed into the financial system. Various institutions have investments in the space but it is not clear to me yet how big this might be. It is weighing on markets but I would lean toward it not having anywhere near the impact of the Financial Crisis. We'll see if that turns out to be right or wrong.
What is your exposure to crypto? Do you have any? If so, how, where, how much? I've mentioned before that I took a small flier a while back, it went up a lot, I spread my exposure around a little more as different products became available and I'd guess that net net I took a little off the table around $50,000 on Bitcoin, on the way down. It's money I can afford to see go to zero, I am in for the asymmetric opportunity. I've been saying for ages, it either goes to a bazillion or it goes to zero and that I am in for whatever outcome. I did add a little more Bitcoin today in my wife's IRA.
It doesn't impact any other aspect of my financial life. Not my job, not my financial planning outcome, not my eventual Social Security payout, not whether people book our Airbnb, nothing. At the other end of the spectrum are the so called Bitcoin Maxis, the shills and touts who told people to mortgage their houses to buy Bitcoin when it was at much higher levels. People have leveraged assets, careers and reputations to Bitcoin and other cryptos. Where the outcome to this event is unknown, it is possible that the Maxis are in real trouble
Where equities are concerned, this seems like an external event that is driving prices in the short term. We'll see if it drives equities prices in the long term or not. This is all happening in the middle of a bear market for equities. If you believe in trying to hedge or otherwise manage downside volatility in the context we've been writing about all year then you already have that hedge exposure in your portfolio. In today's decline it looks like most of the hedge strategies are up today. So any hedge strategy that is up today is working for the day. I tend to think they work more often than not but look at the chart it is a handful of alternatives before the bear market started compared to the S&P 500.
The hedge strategies, the alts, were all far behind equities. Did you predict the bear market? Did you predict the crypto market meltdown? Have you predicted any of the market calamities that have occurred in your investing lifetime? Realistically, I think someone could predict one calamity in their lifetime maybe two if they were lucky. You might be able to assess when risks are higher than normal though, that seems plausible, position to protect against being right and then flip of the coin as to whether you'd be correct.
If we're not going to be able to reliably predict these events but you do want to maintain some sort of exposure to protect against large declines or manage portfolio volatility, then how comfortable can you be holding something that lags for extended periods or in the case of a couple of the lines charted, hold onto something that goes down over a multi-year period?
Can you do that? No wrong answer, can you sit on something that you believe will protect against a bear market even if it might go down the rest of the time?
You often hear that investing is about patience. Being patient is important to many aspects of participating in markets. If your largest allocation in your portfolio is to stocks, then you need to be patient as this downturn plays out. During the bull market, holding diversifiers required patience. If you have any crypto exposure you now need to be patient. Nothing can "work" all of the time but equities "work" most of the time and hopefully the other stuff "works" when you need it to work.
Regardless of the details from this event being different, the equity market's behavior is not. At some point, this event will end and when it does the stock market will then start to work its way back up and eventually make a new high. The only variable is how long that all takes which frustratingly is not knowable. Until then, stay calm and disciplined and realize the worst thing is not whatever the market might do but the worst thing would be succumbing to emotion with a panicked sale.
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