Stock markets have always been cyclical, swinging in an endless series of bulls and bears. Each successive phase of these cycles is inevitable, like winter following summer. As it seems this extended bull cycle is coming to a close, investors might turn to cryptoassets to protect their wealth.
Traders get caught up in the excitement of bull markets and push stock prices far higher than their fundamentals can support. The ensuing bear markets are necessary to eliminate unsustainable valuation excesses, leading stock prices lower until profits catch up.
Longest Bull Cycle
The current bull cycle following the 2008-2009 financial crisis has expanded significantly, largely due to the low-interest-rate environment maintained by the Federal Reserve (Fed). This makes it the second-biggest and longest bullish cycle in US history, fueled by the quantitative easing policy of the Fed to print money over the last several years.
Policymakers that steer these methodologies believe that actively encouraging higher asset prices increases the confidence of consumers and businesses. As people spend more, the further it helps the economy to expand.
However, such policies create several consequences aside from wealth effects. Encouraging spending with consistent inflation also creates asset bubbles. When the bubble inevitably bursts, corporations will start cutting expenses, unemployment will surge, and an economic recession will likely ensue.
Share Buybacks with Cheap Money?
Effectively, ultra-loose monetary policies keep the cost of credit exceptionally low for an extended period of time. Experts argue that the catalyst for the looming recession will be the excessive use of cheap credit for share buybacks by corporations.
Generally, a share buyback is a signal of confidence in the company’s potential to reach its targets and pushes valuations of the stock higher. Moreover, when shares are taken off the market, earnings per share (EPS) increase, even if the company isn’t experiencing organic growth.
As the mismatch between the valuation and its underlying value exceeds a critical point, a sell-off is expected to trigger a wealth effect reversal. The more acute pain point in the current economy is that the Fed has its hands tied when it comes to managing a bubble burst, as interest rates are already low.
This will most likely see investors lose most of their gains made during the past years. The severity of the wealth effect reversal will define the severity of the next recession.
Cryptocurrencies as an Asset Class
As a potential recession unfolds, investors will look to make up for the losses incurred during the bubble burst. Traditional asset classes have demonstrated real returns in the low-single digits over the past years, which are not likely to be sufficient to attract investors straight away.
Cryptoassets are the new emerging asset class that, as experts argue, has a skewed risk-reward profile. Cryptocurrencies remain volatile and viewed as a risky investment, but the potential return on investment is unmatched.
This could work to offset the losses of an asset bubble pop in the current economy much quicker. Simply by devoting a small portion of a portfolio into Bitcoin (BTC), a currency that isn’t reliant on monetary policies from a handful of persons, investors could put themselves in a better position in the case of a recession.
What do you think of having a small exposure to the cryptoasset class during a recession? Share your opinions in the comments below!
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