Did Anyone Get The License Plate Of That Crypto Exchange?

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.

Prepper Mindset

This post is inspired by the following Tweet;

I think I've been espousing this idea forever but I like the way Daniel articulated it. Your plans won't get derailed by things going right, plans get derailed by negative surprises. 

One negative surprise that shouldn't be a surprise if it happened was if the Feds do something radical with Social Security. That Social Security has issues is not new. For many years, younger people have been responding to polls that they don't expect Social Security to be there for them. The possibility of a 23% haircut sometime in the mid 2030's has been looming out there for a while and lately there have been a lot of pro Democrat/anti Republican political ads saying the GOP wants to "put it on the chopping block." Here's an article from Marketwatch that says the Repubs "really are talking openly" about making changes.

This post is not going down a political rabbit hole on this. The objective here is think about preparing ourselves in case it does get altered somehow. No one is worse off if this is just political theater but plenty of people stand to be adversely affected if, I say if, there are big changes made. How vulnerable are you to that and what can you do to protect against that outcome. 

To me, the simplest way to overcome this is to work longer. Working longer does not have to mean staying in a job you are desperate to leave, working for a boss you can't stand, perpetually navigating bureaucratic nonsense. 

At some age, maybe as early as 50 or maybe 60 or so you might get to a point where you've maybe saved enough for retirement or you're very close to your number such that you may not have to save any more money and at the same time maybe you've paid off your mortgage. In that scenario, it seems like it would be reasonable to downshift into something you would enjoy much more even if it paid a lot less. 

With the right type of planning and ground work I think it would be reasonable to figure a way to work half the time for maybe 2/3rds of your full time pay. Here's a relevant success story I heard about today that is fire department related. One of our volunteers is a retired city firefighter from down in the Phoenix area. He affiliates with us so that he can go out on large wildfires as a Medical Unit Leader (MEDL). We were talking this morning and he said he'd been out for 45 days this summer as a MEDL and even though that was fewer days than 2021 he still made about as much money in 45 days as he did from his department salary before he retired. While there is kind of a long runway to that outcome, it's not insanely long by any means. 

Now is the time to plant those seeds to see what grows for your future. I have some understanding of fire service opportunities as a function of volunteering so those examples are easy for me to cite. You probably have examples from your life that you could pursue and line your ducks up now for down the road even if it takes a lot of planning. A lot of planning is good, it is your future and no one will care more about your future, about your outcome more than you. 

Extending this out a little further, Barron's took a look at the current state of the Secure 2.0 Retirement Bill. There's a lot in there about catch up contributions and how 401k plans would be offered to employees but for purposes of this post, the most relevant is the bump in age to 75 for having to take required minimum distributions from traditional IRA accounts. 

Someone wants to retire from their primary career at 62. As noted above they are pretty much on target, not way ahead or way behind, their house is paid off and they are in good shape. This person has a lot of optionality. How reasonable is it to find a way to monetize one of their interests to be able to cover the bills (mostly insurances and utilities) and have a little left over for some fun? I think that's doable. Yes, you might have to pay your dues for awhile ahead of time, that's ok, especially if we're talking about something that interests you. 

Can this 62 year old then delay Social Security until 70, letting it grow to max out, take it then in case this part time gig is no longer feasible at that age? Then at 75 they start taking from their IRA, or sooner if they need. 

Who knows what cuts in Social Security might look like, or how people would be impacted. Someone who is today 65 might be impacted differently than someone who is today 45 or 50. The scenario I'm laying out might insulate against a cut to Social Security if you can make an income from something you enjoy to an older age, you delay taking from your accounts such that maybe your money only needs to last for 25 years not 35 years.

For anyone not where they want to be physically for improved optionality, this idea gets scoffed at or dismissed but I am telling you there is a lot that is reversible or can be improved but it is up to individuals to do this for themselves. Start lifting weights and reduce your carbohydrate consumption. Some people are hesitant to lift weights because they think they'd be using too light of weight and be embarrassed. That is pure ego, no one cares how much or how little you're using. There is no downside whatsoever to starting to exercise and eating less sugar. 

Regret Waiting To Happen

There has been discussion in the last couple of days in articles and Tweets trying to look at some of the drawbacks with bond funds beyond the obvious and what might be described as an exploration about what to use instead of bonds, like the types of alternatives we've been looking at for a long time here. 

We've probably talked 100 times about the extent to which bond funds can drop in price. Cullen Roche compares that to holding individual bonds which despite the possible decline in price, holders will get their 100 cents on the dollar back at maturity so clients tend to worry less than with bond funds which have no par value to return to. Concern about bond fund fluctuations could lead to bad behaviors is Cullen's main point.  

Rodrigo Gordillo, one of the managers of the Rational/ReSolve Adaptive Asset Allocation Fund (RDMIX/RDMAX) Tweeted that he was at a conference where participants explored the current macro threats but didn't seem to have ideas about how build portfolios that might better weather the current market event. Regardless of what you think about RDMIX, the fund is certainly on the cutting edge of portfolio construction and probably well situated to make that critique of a panel of macro strategists. 

AQR of course manages a suite of alternative strategy mutual funds. Its Honcho, Cliff Asness Tweeted out a good article from Bloomberg about several types of alts that should offer protection but haven't really done so. Asness took the opportunity to mention how well trend following (managed futures is a type of trend following strategy). Of course AQR has a managed futures fund which after a long run during the bull market for equities were it lagged by a lot, is absolutely killing it this year.  

The Bloomberg article hit on funds that buy put options one way or another having not really given too much protection. The article cited the nature of this bear market having been slow as opposed to a fast crash as a reason. Also certain VIX products have underwhelmed too. I would add some VIX funds have done ok though. 

Buying puts is absolutely a valid strategy. It turns out some the funds that buy puts haven't worked out on this go around but long puts is valid, just not infallible. Managed futures is absolutely a valid strategy. It turns out some of the funds that run managed futures have worked out very well this go around, it is a valid strategy but it too is not infallible. There are plenty of alternative funds that are valid, some have worked out very well this time, some have not. The next market event the opposite could happen. Maybe funds that buy puts will be huge winners and managed futures will disappoint. I have no idea which is why you diversify your diversifiers.

Eric Balchunas Tweeted out about how much new AUM has gone into managed futures this year. The strategy is getting a lot of attention because it is doing well. There are some who will tell you to put 15, 20, even 25% into managed futures. This behavior repeats, we've talked about it before. Something does fantastically well and then experts tell us to go heavy. I've made this point before, this event will end and when stocks start to do well again, it is likely that managed futures will get left behind.

Allocating a small portion of a portfolio to holdings that usually go the opposite direction of the stock market makes for good diversification. Putting 1/4 of a portfolio into one strategy that usually goes the opposite direction of the stock market is regret waiting to happen. One sequence of going down in a bull market for stocks followed by not "working" in the subsequent bear market would be a deep hole to dig out from.