As the Coronavirus continues to hammer the global economy, sharemarkets are booming and fund managers are having trouble finding a home for all the cash - it’s a scenario that only bodes well for Bitcoin says Wall Strategies founder Kehan Zhou.
Looking at the share market today, it is increasingly clear that the gap between the economy and the market continues to widen. While the Coronavirus crisis worsens in the US, the stock market has closed the second quarter of 2020 with its best performance in over 20 years.
Along with stocks, the Bitcoin price today has long recovered from its low in March. The Bitcoin price surge over $11,000 in July and the clear economic challenges ahead keep investors wondering “is Bitcoin a good investment now” or have they already missed their window? While the BTC price will remain volatile in the short-term, investors should focus on its long-term outlook. In this article I will examine the three macroeconomic drivers that will not only boost the Bitcoin price in 2021 – but will also push it further into mainstream adoption.
COVID has forced the Federal Reserve into a corner. Out of desperation to save the economy, the Fed has been furiously handing out free money by buying government bonds through Quantitative Easing (QE). What’s remarkable about the new QE program is the sheer speed at which assets are bought. To put things into perspective, after the 2008 recession, the Fed purchased over $4 trillion of assets over the course of six years, an amount that at the time was considered controversial. However, since the pandemic started three months ago, the Fed has bought nearly another 3 trillion dollars of assets, consequently pouring almost the same amount of money into the economy in a matter of weeks as it did over six years following the GFC.
With the 3 trillion dollar bond purchase, the Fed prevented an economic disaster by throwing money into the economy. But this victory comes at a cost. The downside of the aggressive QE program is sustained inflation in the long-run. The overflowing money and credit will work its way through the economy and push up prices. Regular people and bondholders will ultimately have to pay the price, when cash and bonds devalue. The inflationary pressure is also here to stay. Most bonds bought by the Fed have a maturity of five years or more, which means the free money will remain in the economy long after the pandemic. The US is not the only country with an aggressive QE program. Japan and the EU also reinstated QE in March. So we are looking at a global increase in inflationary pressure caused by aggressive monetary policies from central banks.
Bitcoin as an inflation shelter
For Bitcoin investors, inflation has always been more friend than a foe. Bitcoin is an inflation-proof asset and the inflationary pressure should boost the Bitcoin price in 2021 – primarily through two mechanisms.
Bitcoin is priced against fiat currencies. As inflation erodes the value of base currencies such as USD and JPY, BTC will become more valuable in comparison.
Bitcoin’s fixed supply. The deflationary nature of Bitcoin will attract new investors looking for an inflation shelter. The demand for deflationary assets may create a another Bitcoin price surge as fiat currencies devaluate.
The central banks are not the only ones facing an uncharted territory. Wall Street has a strange conundrum. Hedge fund managers and individual investors are holding a record level of cash and struggling to deploy their capital in the stock and bond market.
Artificially inflated stock market
The recent divergence between stock prices and the economic reality signals that stocks are overvalued. In the past decade after the Great Recession, the US equity market broke record after record with the longest growth period of 128 months. Despite Coronavirus crippling the US economy, the stock market has been propped up by the Fed. One-third of the S&P 500 companies have withdrawn their earnings guidance and many are cutting dividends. Yet the stock market has nearly recovered to its pre-COVID high. The lofty valuation and shaky economic reality do not present a good risk-reward ratio for investors. As a result, more people are sidelining their cash from the equity market.
Bleak return in the bond market
In a normal market, high stock prices are often accompanied by high bond yields. The inverse relationship between bond prices and stocks gives investors the opportunity to move into fixed-income when stocks are overheating. However, it is not the case now. Aggressive bond buying programs have kept bond returns extremely low. Additionally, the flight to safety during the pandemic pushed treasury yields to their lowest levels and they have never recovered. With the 10-year Treasury Note yielding just 0.673% per year, no wonder investors are steering away from bonds.
The hunt for alternative assets
The elevated price levels for stocks and bonds create an opportunity for Bitcoin to attract new funds and investors. When fund managers can’t reach their performance targets with equities and bonds, they look for other asset classes to boost their portfolios.
The problem with elevated asset levels is that the risk-reward ratio is unattractive. While Bitcoin has high volatility, the risk is justified by its high growth potential that is missing in bonds and stocks. When we compare the performance of BTC and the S&P 500 ETF – SPY, we can see that the performance of Bitcoin overshadows that of the equity market. At time of writing, the Bitcoin price is up 23%, while SPY is down 4.19% since the beginning of the year.
In fact, the elevated asset prices have already driven more money into Bitcoins. In 2019, crypto hedge funds doubled their assets under management (AUM) (PWC, May 2020). Given the low-yield environment, we can expect more money to flowing into Bitcoin and thus push the BTC price higher in 2021.
The Coronavirus outbreak has recently ended the US’s 128-month economic expansion. We are officially entering the contraction phase of the business cycle. During a contraction, business profits decline. Companies must reduce their headcounts to cut costs and some of them will file for bankruptcy. Unfortunately, high-profile bankruptcies have already started to roll in, including JC Penny, Hertz, and Chinos. As more companies suffer from low profitability, we can expect more Chapter 11 filings in 2021.
Hedging against a recession
In a recession, safe-haven assets outperform other investments as people flee to safety. While Bitcoin is not fully a safe-haven asset like gold or silver yet, it, by design, is a hedge against the mainstream economy. Independent of the central bank, Bitcoin tends to outperform when people lose faith in the economy and the Fed. Unlike the 2008 Great Recession, the Fed’s ability to save the day does not inspire confidence. The interest rate is already at the zero-bound and the Fed’s balance sheet is already heavy. With inflationary pressure, inflated asset prices, and an economic contraction, more investors will begin to see Bitcoin as an attractive investment option, which is likely to boost the Bitcoin price in 2021 and beyond.
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