Week by numbers
Last week has seen a sharp downward trend in the cryptocurrency market. The price of the largest cryptocurrency, Bitcoin, fell by about six percent. The price of the second-largest cryptocurrency, Ether, dropped by around eleven percent, as did the total market value of other cryptocurrencies (excluding the largest stablecoins).
As Bitcoin’s price held its ground slightly better than the rest of the market, Bitcoin dominance increased by just over a percent during the week. On the others hand, ETH/BTC ratio dropped by more than five percent during the week.
Among the tokens of the Kvarn X trading service, the following ones managed to stay in green during the downward week: Tron’s TRX (+2%), XDC (+2%), and Aptos’s APT token (+0.4%). On the other hand, the biggest price drops were by Starknet’s STRK token (-27%), Arweave’s AR token (-23%), and NEAR Protocol’s NEAR (-21%).
Market Commentary
The crypto market rally, which began two weeks ago following the U.S. Federal Reserve's announcement of a 50 basis point interest rate cut, reached its local top over the weekend. The reversal was not entirely surprising, as the preceding rise was quite sharp, which can be seen in the Relative Strength Index moving into overbought territory.
As the rally hit a momentary overheating over the weekend, market sentiment quickly cooled with rising geopolitical tensions in the Middle East. This combination triggered a steep price drop on Tuesday, wiping out most of the gains following the interest rate cut.
Bitcoin made a so-called “higher low” from September (around $53,000, compared to the August low of $49,000). Our primary assumption is that this budding long-term upward trend should continue, and within this, the shorter-term downward move would not go below $53,000. However, we also do not see reasons to expect an immediate reversal of the downward trend. We will keep on closely monitoring the situation and return to it in our upcoming Pulse newsletters.
Market risk appetite still declining?
In our May 10, 2024, we titled our Kvarn Pulse newsletter “Risk appetite declining?”
In that newsletter, we presented a hypothesis that the long-standing rise in market risk appetite and the particularly good performance of high-risk asset classes might be coming to an, at least temporary, end.
We concluded our analysis with the following:
“If our three interpretations are correct, it would point to a situation where the market's willingness to take risks would be slowly declining. The highest-risk Bitcoin would have already started to weaken compared to the lower-risk ones. If the hypothesis is correct, next we would see the Nasdaq index begin to weaken against the S&P 500 index. After this, or at the same time, we would also see the S&P 500 index turn down.”
Our May newsletter was strongly forward-looking, as at the time of writing, risk-on assets were still, at least in dollar terms, experiencing quite strong upward momentum.
About five months later, it is a good moment to assess how this hypothesis has fared.
We will start by examining the largest cryptocurrency, Bitcoin. Our hypothesis regarding Bitcoin was: “The highest-risk Bitcoin would have already started to weaken compared to the lower-risk ones”
A few weeks after our newsletter was published, Bitcoin's price, which had been on a 1.5-year upward trend, saw its 100-day moving average turn downward, and it has been heading down since.
When comparing Bitcoin’s relative valuation to the technology stock benchmark, the Nasdaq 100 index (NDX), the reversal has been even sharper. It appears that at least in terms of cryptocurrencies, the market's risk appetite indeed turned from an uptrend to downtrend during late spring and early summer.
Next, we will compare the valuation of technology stocks (NDX) against the broader stock index S&P 500 (SPX). Technology stocks are often seen as higher-risk investments relative to the broader index, so these ratios could be assumed to indicate market risk appetite.
In this comparison, we can see that the NDX/SPX ratio reached one more significant peak in July after May. After that, the ratio turned sharply downward and has spent the last ten weeks below its 100-day moving average. The U.S. Federal Reserve’s announcement of an interest rate cut of 0.50 percentage points two weeks ago has not yet brought a clear reversal to this trend, but has so far only resulted in a new “lower high” compared to the August peak.
Our original hypothesis regarding the NDX index included: “next we would see the Nasdaq index begin to weaken against the S&P 500 index” It seems that this portion of our hypothesis has been realized.
Thirdly, we will examine the final part of our hypothesis, which stated: “After this, or at the same time, we would also see the S&P 500 index turn down.”
The S&P 500 index recently made its all-time high last week, so it obviously has not yet turned downward.
However, we can notice that the speed of the SPX index's increase has clearly slowed down. This is evident, for example, in the following graph depicting weekly price development, where the Relative Strength Index (RSI) shows “bearish divergence.” The RSI has also been making lower highs and lower lows since July and has not been able to rise above its 14-week moving average (the yellow line).
We cannot definitively say that any of these observations indicate that a downturn in the S&P 500 index is inevitable or even likely. However, we want note that if the S&P 500 index was about to turn, its development before the turn would likely look something like this. If we compare the price development of the last few months to the price peak of 2021, the similarities, at least in terms of the Relative Strength Index, seem striking.
We still emphasize that this does not mean that a reversal in the stock market is necessarily imminent. However, in our view, the slowdown in the price increase has made that scenario somewhat more plausible.
Why should this matter?
For a reader who follows purely the cryptocurrency market and less macroeconomics, it might be unclear why one should interpret the relationships between stock indices and their RSI readings with such precision. Did we not just see a new “higher high” from Bitcoin, and don’t the recently initiated interest rate cuts mean more liquidity, and haven’t the years following Bitcoin halvings traditionally been strong years for crypto prices?
All of the above is true. However, we encourage you to consider the matter from this perspective as well:
The S&P 500 index represents, from a risk appetite perspective, the “last bastion” of the investment markets, into which capital withdraws from higher-risk assets as risk appetite decreases. Its rise is a necessary condition for the performance of higher-risk investments, but by no means sufficient condition. The fact that the S&P 500 is performing better than the Nasdaq 100 or Bitcoin’s price is, in our view, a quite strong signal of “risk-off” sentiment. A downturn in the S&P 500 index would indicate a total “risk-off” state in the markets, where significant downward corrections would be seen in the valuations of higher-risk investments (both in dollar terms and relative valuations).
We therefore are prone to consider the accelerating rise of the S&P 500 index a prerequisite for the possibility of favorable price development in higher-risk investments such as cryptocurrencies. For illustrative purposes, we would like to point out that since the peak of the cryptocurrency market in March, the S&P 500 index has still risen about 10%, or about 20% on an annualized basis.
Compared to historical returns, a 20% annual gains in stock market would be considered excellent. However, it currently, somewhat peculiarly, indicatin a slowing pace of rise, which seems to not have been sufficient to maintain the price increases in cryptocurrencies.
In summary, we state:
1. The hypothesis we presented in May regarding the turning of market risk appetite appears to have materialized thus far.
2. If one wishes to draw conclusions about the future outlook of the cryptocurrency market based on stock market developments, we think it is essential to understand that a simple upward trend in stocks is unlikely to be sufficient for a rise in the cryptocurrency market. In addition to an SPX going up, upward movement is also needed in the NDX/SPX ratio, and preferably an acceleration of stock indices' rise.
3. None of the above is intended as a prediction of the future. The purpose is merely to express that since May, the market's risk appetite seems to have been declining. A change to this state of affairs could naturally happen at any time.
We will continue to interpret the market's risk appetite in future Pulse newsletters and keep you updated, so stay tuned!
The material contained in the Kvarn Pulse is produced solely for the purpose of marketing communication. Any information conveyed through Kvarn Pulse should not be construed as an offer or an invitation to make any purchase or sale decisions, or as an encouragement to make investment decisions about any investment object. Copying or borrowing the content of the newsletter without Kvarn's express permission is prohibited. The information presented in the newsletter pertains to the situation prevailing at the time of writing, and the information may or may not have changed. Kvarn Capital Oy does not guarantee the accuracy or completeness of the information contained in the newsletter or referred to in the newsletter.
