Pulse of the Market - May 2022
One of the worst Nasdaq months on record was in April 2022 and all you hear is people saying "Sell everything it's all going to zero." Is sentiment really getting this bad? It definitely is for Luna..
Never Buy Stocks Again? It’s Panic at the Disco
Margin, which is the money borrowed from a broker to purchase an investment and is the difference between the total value of the investment and the loan amount, is basically a drug. Think of it as going to casino, and asking them to borrow money to go play craps. When the shooter is hot and you are making money hand over fist, it’s great. When the shooter craps out 3,4,5 times or more in a row, the casino forces you to pay them back, with interest.
Just like between 2001-2004, or 2008-2010, when sentiment changes dramatically, it really doesn’t matter how well a company is performing or how “cheap” a company is on valuation. When people and funds decide it’s time to “sell everything” and “never buy stocks again” then they will sell.
When I warned back in August 2021 about leverage in the market reaching a historical peak, I made that point because it was getting fairly obvious there would be a rush to the exit at some point (even though I had no idea when).
At some point the big players: reckless hedge funds, family offices (aka Bill Hwang), etc had to de-lever and pay back their debt. But this time, they couldn’t do it in an orderly manner since the Federal Reserve forced their hand due to raising the fed funds rate, which caused interest rates to rise at a historic pace. As such, you saw these type of collapses in “safe tech stocks” given hedge funds had to force sell, or liquidate, to pay back margin:
Facebook, Netflix, and Amazon all being force liquidated:
Now that we are back at historic margin levels, we are approaching the pink shaded area, where max risk-reward levels are revealed. Back in August 2021, I warned about margin at the literal peak. Looks like history has repeated itself as literally everyone on margin has been completely wipeout, including the reckless hedge funds that pretend to be market experts…
When sentiment gets this bad, literally almost as bad as 2009 per the graph below, you either see massive opportunity or you don’t. It really depends on your time horizon and what you are willing to endure because as the market goes lower, it’s safer to add, not when the market is at historic levels….
Lastly, I thought this chart was really interesting. It shows how every rally is sold and every dip is bought, which creates zero follow through for the markets, compared all the way back to 1932….
The Black Swan of Crypto: The “Stable Coin” Collapse
You’ve probably heard of a “stable coin” that CNBC kept calling a stock, that collapsed after it depegged from $1. I will try to explain how this collapse happened:
Terra Luna ($LUNA) was, using past tense now since it literally is zero at this point, a layer 1 blockchain. The chain was created by Do Kwon, an eccentric Korean founder , who if you just watched 5 minutes of an interview, like one here, you could tell he was a moron, to say it lightly.
Several people in the space saw the massive risk of an “algorithmic stable coin” and called it outright like Nevin Freeman back in 2020 here:
Here’s a great analogy on how this happened. I think you should all read this to get a better picture. It was a similar method of attack as what George Soros did with the British Pound.
As a synopsis, the attacker borrowed 100k Bitcoin $BTC (that’s a ton of BTC), which is a short position in the crypto market. Their short position was bought by Do Kwon, Terra Luna’s founder, and $UST to use as collateral for the stable coin. To start the attack, the attacker built a large $1B position in $UST then starts to dump it to drain the liquidity of the stable coin. To defend the peg, the team behind $UST starts to sell their BTC reserves to try to hold up the $UST $1 peg. This created a feedback loop where Luna was selling $BTC while the attacker was selling $UST. The peg started to fail, lowering to 95 cents and then others started to realize the floor was going to collapse under them and pulled their money out of $UST.
Eventually, to try defend the $1 peg, Luna sold all their $BTC, allowing BTC to flash crash to $26,000 or so, and had to start minting trillions in $LUNA tokens, which collapsed $LUNA from $120 to zero in days.
Could this have been prevented? Yes, all you had to do is not create Anchor protocol, the lending protocol Luna was using to provide 20% APY for $UST holders, and instead actually use dollars as collateral for your stable coin (like $USDC, $USDT, and other actual stable coins).
Here is my favorite meme out of this whole fiasco. If you know the show, you will get this one:
And if you want to listen to podcast that explains this episode well here is one from Bankless
Bear Market Confirmed: Feeling the Top
When I wrote this in November 2021, I could feel things getting insane and started to take chips off the table. Now that we are in a bear market, looking back at these types of things is great hindsight. Next time I see things like this I will sell more. It’s a great learning lesson. For context, November 2021 was the literal top of the NASDAQ ($QQQ) until the rapid decline. Lesson: When you are feeling FOMO wait for it to go away then reconsider…
We will see how inflation responds but even in May 2021 when I called the rise of inflation being a huge issue, I didn’t think the FED could f’up this bad…..
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