Translation: BitMEX founder Arthur Hayes: Have we hit the bottom? How to judge the timing to buy at the bottom

BitMEX co-founder Arthur Hayes released a new article today, August 26th, titled "Bottomless." The first half of the article consists of narrative content he enjoys, telling stories about people's emotions before and after a major market drop. The second half of the article contains more in-depth perspectives. Here is a summary. For any uncertainties, please refer to the original text.

Have We Bottomed Yet?

After a 30% drop from the all-time high, Arthur Hayes stated that he had written a bearish essay where he mentioned he had rotated his positions into Bitcoin, Ethereum, and some shitcoins that he truly believed in. He wrote these analyses based on logical arguments, not to help people time the market, but to challenge your views and help you grow as a trader/investor.

He believes that the crypto capital markets are the last free financial markets on Earth. All other major asset classes and the intermediaries that help people trade these financial products have become political targets for governments and their central bank heads.

"When a measure becomes a target, it ceases to be a good measure." — Goodhart's Law.

Arthur Hayes mentioned that stocks, fixed income, and currency markets are influenced by the largesse of central banks and "too big to fail" banks. This means they can run infinite leverage using taxpayers' money, resulting in rampant money printing and inflation. The balance sheets of these banks are used to keep asset prices fixed at artificially low levels, which benefits the wealthy as financial asset ownership is highly concentrated in the top 10% or 1% of citizens in every society.

"Crypto operates completely outside the traditional financial system, and has therefore found a market clearing level before stocks or bonds." Cryptocurrencies are now a true asset class, traded by commoners like us, global hedge fund masters, and a few sell-side banks. Cryptocurrencies, as the last truly functioning free financial market, will find a clearing price for the current macroeconomic environment before all other assets.

Based on these beliefs, Arthur Hayes noted that the crypto market saw a big drop in the first three weeks of the year, while the U.S. stock indices are still only slightly below their all-time highs. He thinks that the stock market has not yet entered a true bear market, but the crypto market has experienced capital destruction, indicating that holders of these stock indices will be affected by the Fed's tightening policies in the short term.

Arthur Hayes mentioned that if Bitcoin falls below thirty thousand, and Ethereum drops to two thousand dollars, he would be tempted. Hence, he wanted to write this article discussing how to determine the timing to buy the dip.

One Scenario Where the Fed Might Change Its Mind: Corporate Bonds

Arthur Hayes believes that even though the Fed has a mandate to control inflation, politically it is required to hike rates. However, it never fully commits to policies and will change its mind if significant financial changes occur.

The question is: Can the Fed publicly change its restrictive monetary policy before the March meeting? Currently, people are expecting a rate hike to 0.25%.

Here are three scenarios where the Fed might change its course:

1. The S&P 500 and/or Nasdaq 100 indices drop at least 30% from their all-time highs. The S&P 500 index is at 3,357 points, and the Nasdaq 100 index is at 11,601 points.
2. An error occurs in the U.S. Treasury/Currency markets.
3. Investment-grade/high-yield corporate bond spreads widen significantly.

He has talked about the importance of the first two points on the U.S. and global economic models in the past, as the Fed is likely to restart money printing if an error occurs. He wants to address the corporate credit sector here, mainly because everyone believes the Fed solved this issue when they nationalized the market in March 2020.

The Fed nationalized the U.S. corporate bond market by supporting all BBB and above bonds, and indicating that they could buy ETFs holding high-yield credits, such as junk bonds like HYG. The two charts below show how nationalization lowered credit default swap spreads. CDS spreads can illustrate how much interest companies in a specific rating category must pay to issue bonds.

High Yield Spreads CDX HY CDSI GEN 5Y CORP

Investment Grade Spreads CDX IG CDSI GEN 5Y CORP

Facing an unknown pandemic severity, the market offered high-interest rates to corporate borrowers (red part has changed), but the Fed did not agree with the market's incorrect interest rate levels, hence nationalizing the market through unlimited money printing. While it maintained easy borrowing conditions for large corporations, small businesses suffered as they could not access institutional credit markets and went bust. The market only recently started to recover from this turmoil.

Arthur Hayes mentioned that if the Fed tightens, how will it ensure continued support for corporate bond issuers? This means the Fed buying or threatening to buy all eligible corporate bonds for support. Since the market has sensed a change, yields have started to slightly break higher.

Could Corporate Bonds' Problems Change the Tide?

Arthur Hayes stated that this is a problem because in 2022, approximately $3.3242 trillion worth of U.S. non-financial corporate bonds will mature. Companies must repay investors with their available cash or issue new bonds to pay off the old ones. Based on issuance statistics from 2021, the amount of debt that needs to be rolled over accounts for 17% of the total for the year.

Very few companies have pricing power to offset the adverse effects of wage and commodity inflation; profit margins and earnings must contract. Therefore, as inflation continues to ravage the U.S. and the world, the free cash flows available to repay bondholders will decrease. If the Fed does not actively suppress spreads by expanding its balance sheet, the market will demand higher rates for new bond issuances.

The nightmare scenario for the Fed is if the market anticipates tightening monetary conditions early and demands increasingly higher rates for corporate bond issuances. If companies cannot raise funds, they will cut back on operations, leading to politically untimely unemployment.

Arthur Hayes believes that inflation does not necessarily cause unemployment, but if companies cannot bear the high rates demanded by the market, it will lead to unemployment.

“I believe politically, a 7% unemployment rate is worse than 7% inflation.” Arthur Hayes stated. If the credit market messes up, the Fed and politicians will have to choose between more goods and wage inflation or unemployment.

Arthur Hayes believes in betting on a return to loose monetary policy, which is beneficial for the crypto market. He also mentioned that markets change rapidly, and if the market perceives that the Fed will not support corporate bonds, spreads will widen quickly.

The game is not waiting for the Fed to publicly announce a change of heart but using the signals provided by these indices as signs of an impending shift. Cryptocurrencies will respond to these signals and trade higher before the Fed publicly changes its policy.

Arthur Hayes points out that the timing is not to wait for the Fed to announce a change but to judge the tide using the signals provided. Cryptocurrencies will receive these signals and move higher before the Fed publicly changes its policy.

He identified resistance levels at: Bitcoin $28,500, Ethereum $1,700. And it's not considered a bottom until these levels are retested; massive liquidations will occur between Bitcoin $20,000–$28,500 and Ethereum $1,300–$1,700. $20,000 is the Bitcoin high in 2017, and $1,400 is the Ethereum high in 2018.

Arthur Hayes mentioned that markets never have a perfect script. Things are more sensitive until the previous low in the trend channel is clearly tested, and you can observe more data: open interest on leveraged trading platforms, net inflows of stablecoins to exchanges, growth in the asset under management of exchange products, levels of implied and realized volatility, etc.

Positive Notes

Arthur Hayes believes that people may dream of the Fed immediately turning on the money printing faucet as Bitcoin and Ethereum maintain their current trend channel bottoms. However, he is certain this will not happen. Therefore, people must think more flexibly about which signals can inject confidence to buy more.

He thinks that even though the market has been continuously sliding recently, traditional markets have not been truly extinguished. With price action, as a participant in the crypto market for many years, he knows that sell-offs come in waves. Last weekend was brutal, but it has not dampened the spirits of those who are bullish on the market.

He tells people that technically, prices are determined by the marginal seller. If institutional bonds and stocks are hurt, they will not hesitate to unload the relatively small amount of cryptocurrencies they hold. They have not started selling yet because the negative news of the crypto market drop in mainstream financial media is not enough to affect them. He believes that once the S&P 500 and Nasdaq indices continue to decline in the first quarter, the time when the stock market and the crypto market are highly correlated is approaching.