Compiled and edited by TechFlow
Guest: Tom Lee, CNBC Crypto Expert
Moderator: Ryan Sean Adams, Co-founder of Bankless
Podcast source: Bankless
Original title: What’s Next For Markets? Macro Expert Tom Lee
Air Date: August 7, 2024
Summary of key points
In this podcast, we tackle the big question: With the massive sell-off earlier this week, is the bull market over? Our guest Tom Lee doesn’t think so.
We aim to answer several key questions: Why did markets take a hit on August 5? Is there more pain to come?
Is the bull market really over? What are the chances of a recession? What are the arguments for the bear and bull cases? Finally, here is Tom’s prediction for future prices.
Background Information
Tom is the head of research at Funstrat and a commentator on CNBC. He recalled that he first met Tom in 2017, when Bitcoin and cryptocurrencies were not yet popular on Wall Street, and Tom was optimistic about cryptocurrencies.
Reasons for the market decline
During the conversation, Ryan raised the issue of recent market declines, particularly the significant declines in Ethereum and Bitcoin.
Tom analyzed several key factors that led to market volatility. He pointed out that first, the U.S. employment report released last Friday showed a significant weakening of recruitment, with only 114,000 new jobs, which was the first major disappointment since the outbreak. This triggered investors' concerns about a recession. Second, the Bank of Japan raised its overnight interest rate, which led to fluctuations in the yen and further affected market sentiment.
Other influencing factors
In addition to the above factors, Ryan also mentioned that tensions in the Middle East may have had an impact on the market. He pointed out that the market usually sells off during tensions before a war, and may rebound after the conflict breaks out.
Tom acknowledges these factors and believes that the market’s response to uncertainty is complex.
How bad is this?
Ryan asked a question about the VIX index. He mentioned that the VIX index experienced sharp fluctuations during both the 2008 financial crisis and the 2020 COVID-19 pandemic, and that recent market events have shown similar spikes.
(Note from Shenchao: VIX is the abbreviation for the Chicago Board Options Exchange Volatility Index, a common indicator used to measure the volatility of S&P 500 index options.)
Tom analyzed this and pointed out that the VIX index had soared to 60, indicating that the market's expected volatility was very high.
Tom explained the possible reasons for the rise in VIX, including market uncertainty, investor panic, and massive margin calls. He mentioned that despite the market's dramatic volatility, some high-net-worth individuals and institutions were actually buying during this period, while retail investors faced liquidation.
Potential risks in the future
Ryan asked if there would be a situation where large funds were liquidated.
Tom expressed his concerns. He mentioned that short-term volatility trading is a crowded trading strategy and many investors may suffer losses when the market fluctuates violently. He recalled that some large hedge funds had already suffered failures during smaller fluctuations last year, suggesting that there may be more market turmoil and potential fund liquidation events in the coming days.
Is it over?
When discussing the future of the market, Ryan posed a binary choice: Will this market volatility be short-lived and the bull market will resume, or will there be more declines and volatility.
Tom expressed his opinion that this volatility could be a “growth scare.” He explained that if the trigger was the recent jobs report or a retreat from speculative trading in the market, these would be temporary effects.
Market reaction
Tom pointed out that although there was panic in the market, the credit market was relatively stable, which showed that this volatility was mainly a panic in the stock market. According to his experience at JPMorgan Chase, the bond market usually leads the stock market, so if the stock market fluctuates so much and the bond market remains stable, it means that investors are seeking liquidity rather than major changes in market fundamentals.
Future expectations
Ryan asked what the underlying assumptions were if this was indeed a growth scare.
Tom believes that the next employment reports will be key, especially the one released in September. He mentioned that although recent employment data has been inconsistent, some factors, such as extreme weather in Texas, may have had an impact on the employment data.
The possibility of a recession
Tom also mentioned a rule that since 1949, a 50 basis point increase in the unemployment rate usually means that a recession is imminent. However, he pointed out that the validity of this rule may be questioned due to the impact of the COVID-19 pandemic on economic indicators. He believes that the market performance in the coming months will depend on the upcoming economic data, especially the employment report.
What happens next?
Ryan asked what happens next if the economy is not in recession and September jobs data is strong.
Tom believes that the Fed may start to cut interest rates. He mentioned that although no one knows exactly what the Fed will decide, if the labor market slows down without entering a recession, the Fed will be forced to take action.
Fed's response
Tom emphasized that the Fed's response will depend on the data, but the market has criticized the Fed's "data dependence", believing that this makes the Fed's response always lag behind. Therefore, the market calls on the Fed to adopt a more forward-looking policy. He mentioned that the Fed may cut interest rates in September, and may even cut interest rates five times this year.
Impact of rate cuts
If the Fed does cut interest rates, how will the market react? Tom pointed out that if the Fed's dot plot shows that the number of rate cuts exceeds expectations, this may be interpreted by the market as support for the economy, which will in turn drive up the stock market and risky assets such as cryptocurrencies. He mentioned that the rate cut will have a direct impact on consumer loans, small business loans, and adjustable rate mortgages, which will reduce borrowing costs and stimulate demand.
Potential for economic recovery
Tom believes that the current economy is facing high costs, and interest rate cuts can alleviate this pressure, thereby reviving consumer demand. He pointed out that consumers still have room to borrow, so interest rate cuts may have a substantial catalytic effect in the economy.
Risks of Carry Trading
Ryan posed a question asking whether the Fed’s rate cuts could exacerbate the risk of carry trades, especially against the backdrop of a strong yen and dollar, and whether that could make market conditions worse.
Fed's focus
Tom pointed out that the Fed does not want financial instability, but a 20% stock market rise is not a major concern for the Fed. He emphasized that the Fed is more concerned about the misallocation of capital. If the reason for capital inflows into financial markets is that companies are unwilling to make capital expenditures (Capex), then interest rate cuts may prompt capital to be reinvested in the real economy.
Business investment environment
He mentioned that many CEOs are reluctant to make capital expenditures in the current environment because it is not wise to invest when the Fed is tightening policy and is worried about inflation and may affect the economy. Therefore, this environment actually poses an obstacle to economic growth. At the same time, it also exacerbates the risk of carry trades because investors will seek returns in a high-cost funding environment.
Tom believes that the Fed’s policies not only affect the financial market, but also have a profound impact on the real economy. A rate cut may change companies’ investment decisions, thus affecting the overall economic recovery.
The Case for a Recession
Ryan asked Tom to present a counter-argument that the current economy may be at the beginning of a recession and the future may be even bleaker.
Expansion and recession
Tom emphasized that economic expansions do not end because of "aging," but usually because the Fed's policy is too tight. He believes that if the Fed maintains a tight policy for too long, it may harm the economy. In addition, the economy may also decline due to external shocks.
Current economic weaknesses
Tom pointed out that there are three areas that are currently showing signs of decline:
Automotive: Car sales are languishing, used car prices are plunging, and automakers are hiking prices in a “greed inflation” that is leading to pent-up inventory and rising delinquent payments.
Durable goods: Consumer demand for durable goods such as home appliances has declined, partly because high installment and credit card debt costs (such as 25% interest rates) have made people reluctant to buy new appliances.
Housing market: Housing activity also fell into recession due to high mortgage costs and rising house prices. Although the reason for the rise in house prices may be related to tight supply, high house prices and high borrowing costs make it difficult to buy a house.
Possibility of a recession
Tom believes that weakness in these three areas does have the potential to trigger a recession, especially in durable consumer goods and the housing market. Nevertheless, he is relatively optimistic about the housing market, believing that there is still pent-up demand in the market and that once the Fed starts to cut interest rates, mortgage rates may fall, thereby stimulating demand.
Impact of external shocks
Tom also mentioned that external shocks, such as large fluctuations in oil prices, could also cause a recession. If oil prices spiked to $250 a barrel, households would spend a larger portion of their spending on gasoline, which could trigger a recession.
Despite the multiple challenges facing the economy, Tom believes that the Fed's policy adjustments and potential market demand may still provide opportunities for economic recovery. The possibility of a recession exists, but it is not irreversible.
Comparison with the past
Ryan raised a question asking whether the current economic growth panic is similar to other periods in history. He mentioned that when looking at the VIX index, you can see the fluctuations in 2008, 2000 and 2020, and the market has experienced many negative events afterwards. He feels the fragility and tension in the market and thinks that the current situation is a bit strange and may be similar to the Internet bubble period.
Tom's opinion
Tom said he has over 31 years of experience in stock market observation and shared some insights. He noted:
Bull vs. Bear Markets: Bull markets are usually “elevator up, escalator down” and large corrections are usually associated with bull markets, not bear markets. During the 2000 peak, the market showed weakness and just as the market was about to top, there was a “get me out” sell-off.
Market volatility: He mentioned that the current market correction occurred in just three days, and such panic selling is not uncommon in history. For example, the "panic" caused by the Fed's interest rate hike in 2018 and the rapid decline caused by the epidemic in 2020 were both violent fluctuations in a short period of time.
Speed of market rebound: The 2020 market rebounded quickly after a rapid decline of about 45%, demonstrating that markets can recover quickly in the face of major shocks. Despite concerns at the time about the negative impact on the economy, the market bottomed out six months before the vaccine was launched.
The Fed’s role: Tom believes that the Fed can easily handle the current market volatility, even if it takes action at the upcoming policy meeting. He noted that while the market has experienced a period of low volatility, the current return of volatility may just be a normal stage in the growth of the bull market.
Tom believes that the current market fragility and volatility do not mean that the economy will inevitably decline, but rather that the bull market is undergoing adjustments and growth. He believes that the Fed’s policies can effectively deal with market fluctuations, and the market may return to stability in the future.
Why Tom is right
Ryan mentioned that Tom was bullish on Bitcoin in 2017 and asked him about his views and basis at the time.
Tom recalled his analysis of Bitcoin in 2017. Here are his main points:
Price signals: Tom emphasized that their research method is to regard prices as signals, rather than simply judging whether a certain asset is in a bubble. They focus on whether the price increase reflects a certain trend or phenomenon.
Model building: In 2017, they spent a lot of time building a model to explain the price history of Bitcoin. Through research, they found that there are two main variables that can explain most of the fluctuations in Bitcoin prices:
Network effects: The exponential benefit of increasing the number of wallets is well known and is similar to Metcalfe’s Law.
Transaction activity per wallet: This is a secondary explanatory variable.
Data Analysis: Tom noted that their model was able to explain 87% of the increase in Bitcoin’s price since 2010 or 2011. Based on this data, they predicted that if the number of wallets grows by 30% per year, the price of Bitcoin will reach $25,000 in 2022.
Understanding of traditional markets: Tom said that investors in traditional financial markets tend to be older groups who may not understand how young people drive the economy. He himself noticed the practicality of mobile phones when he was young, although many people were skeptical of them at the time. He believes that this resistance to new technologies is also reflected in attitudes towards cryptocurrencies.
Bias against cryptocurrencies: Tom believes that the traditional financial system has a negative bias against cryptocurrencies, in part because they pose a threat to the existing banking system. He believes this bias still exists today.
Tom’s successful predictions stem from his deep understanding of market dynamics and keen insight into emerging technologies. He solidified his bullish stance on Bitcoin through data analysis and his recognition of the economic driving role of young people. This forward-looking way of thinking enabled him to seize opportunities in the early stages of cryptocurrency.
Wall Street Current Situation Assessment
Ryan brings up Wall Street's current attitude toward cryptocurrencies and asks Tom what he thinks of this change.
Here are Tom’s key points:
Market Changes: From 2017 to 2024, Wall Street experienced significant changes when it came to cryptocurrencies. Now that there are Bitcoin and Ethereum ETFs, financial giants like Blackstone’s Larry Fink are starting to talk about the merits of Bitcoin and the potential of tokenization.
Still in the early stages: Despite the progress made in the cryptocurrency market, Tom stressed that six years is not a long time in the traditional financial world. Cryptocurrency is still in its early stages, and the financial industry is gradually adopting new products and technologies.
Analogy to the telecommunications industry: Tom used the history of the telecommunications industry to analogize the development of cryptocurrency. He mentioned that initially the telecommunications industry relied mainly on landline and long-distance calls, while wireless communications were relatively small in 1999. But as the number of mobile phone users increased, all communication innovations shifted to mobile devices. Similarly, innovations in financial products may also be carried out on the blockchain.
Conservatism in the banking industry: Tom pointed out that the banking industry still makes huge profits from traditional businesses, so there is insufficient motivation for innovation. He believes that the financial industry needs to innovate under the premise of ensuring safety to avoid fraud.
Acceptance of young people: He mentioned that the adopters of electric vehicles are mainly young people, while consumers of traditional fuel vehicles tend to be older groups. This trend is similar to the acceptance of cryptocurrency, where young people are more likely to accept new technologies, while older investors tend to be reserved about emerging technologies.
Has not yet reached the “smartphone moment”: Although the price fluctuations of cryptocurrencies remain eye-catching, the market has not yet reached the “smartphone moment”, the stage of comprehensive innovation and application. Tom believes that the cryptocurrency industry needs more innovation to achieve wider application in the future.
Tom made an in-depth analysis of Wall Street’s current attitude towards cryptocurrencies, pointing out that although the market has made some progress, it is still in its early stages and innovation and acceptance still need to be improved. He used historical analogies from the telecommunications industry to emphasize the future potential of cryptocurrencies while also pointing out the challenges faced by the traditional financial industry in the process of transformation.
BTC and ETH Price Predictions
While discussing cryptocurrency price predictions, Ryan asked Tom about the future trends of Bitcoin (BTC) and Ethereum (ETH).
Here are Tom’s key points:
Bitcoin Price Prediction:
Tom pointed out that the recent sell-off and liquidation have had some impact on the market, but he is still optimistic about the performance of risk assets in the second half of the year, especially after the election. He believes that from August to October may not be the best time to invest.
If the S&P 500 index (SP 500) rises 20% by the end of the year, Bitcoin could easily break through $100,000. He stressed that Bitcoin’s price fluctuations are not linear, but rather present a step-by-step growth.
Tom mentioned that past studies have shown that if Bitcoin’s best 10 days each year are excluded, its overall return is almost negative. This shows that Bitcoin’s gains are mainly concentrated in a few days.
Ethereum and other crypto assets:
Tom believes that Ethereum is one of the core crypto assets, which was initially innovative due to smart contracts and now has an advantage due to its strong community support.
He mentioned Solana as a crypto asset worth paying attention to, also because of the loyal and wealthy community behind it.
Tom emphasized that the innovative potential of these crypto assets is still being explored and more innovations may appear in the market in the future.
Tom is optimistic about the price predictions for Bitcoin and Ethereum, believing that the market has a lot of room to rise in the future. He emphasized the non-linear nature of Bitcoin's price fluctuations and pointed out that the community support of Ethereum and Solana is an important factor in their success. Overall, he is confident about the future of crypto assets and believes that innovation and development are still continuing.
Election Impact
While discussing the upcoming election and its potential impact on the markets, Ryan asked Tom a question about it.
Here are Tom’s key points:
Election impact on the market:
Tom pointed out that the impact of elections on the market is significant because issues of concern (such as abortion, transgender rights, family values, and cryptocurrency ownership) are emotionally relevant to voters.
He believes that no matter which party wins, the impact on stock market returns in the short term may not be significant, but there will be big differences in performance in different sectors.
Trump's policy impact:
Tom mentioned that Trump’s stance in supporting Bitcoin is very positive and he believes that the United States should not be hostile to Bitcoin.
Trump advocates deregulation and less regulatory intervention in business, which would be a major boon to both small and large businesses and would also boost merger and acquisition activity.
He believes that Trump's policies could have a positive impact on the real estate industry and help protect commercial real estate.
Harris' policy impact:
If Vice President Harris wins, Tom thinks it will be Silicon Valley-friendly because she is from California, which will be good for the performance of tech stocks, such as the FANG stocks.
Outlook for small-cap stocks:
Tom emphasized that Trump’s election would be very beneficial to small-cap stocks because his policies would help small businesses grow.
Tom conducted an in-depth analysis of the upcoming election and its impact on the market, pointing out that the policy orientations of different parties will greatly affect the performance of the market, especially in terms of Bitcoin and small-cap stocks. He believes that regardless of the election results, investors should pay attention to potential changes in various industries in order to make wise investment decisions.
