Dialogue with macroeconomic expert Tom Lee: The bull market rises like an elevator and descends like an escalator; significant corrections are usually associated with bull markets

Original Title: 《What's Next For Markets? Macro Expert Tom Lee》

Host: Ryan Sean Adams, Co-founder of Bankless

Compiled by: Shenchao TechFlow

Key Takeaways

In this episode of the podcast, we tackle a big question: has the bull market ended with the massive sell-off earlier this week? Our guest Tom Lee doesn't think so.

We aim to answer several key questions: Why did the market take a hit on August 5? Will there be more pain ahead?

Is the bull market really over? What is the likelihood of a recession? What are the arguments for bear and bull market scenarios? Finally, Tom's predictions for future prices.

Background Information

• Tom is the Head of Research at Funstrat and a commentator on CNBC. He recalls first meeting Tom in 2017 when Bitcoin and cryptocurrencies were not yet popular on Wall Street, and Tom was optimistic about cryptocurrencies.

Reasons for Market Decline

• During the conversation, Ryan raised the issue of the recent market decline, particularly the significant drop 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 in hiring, with only 114,000 new jobs added, marking a major miss in expectations since the pandemic. This raised investor concerns about a recession. Secondly, the Bank of Japan raised overnight rates, leading to volatility in the yen, further affecting market sentiment.

Other Contributing Factors

• In addition to the above factors, Ryan mentioned that tensions in the Middle East might have impacted the market. He noted that markets often experience sell-offs in the lead-up to war, followed by potential rebounds after conflict erupts.

• Tom acknowledged these factors, believing that the market's reaction to uncertainty is complex.

How Bad Is It?

• Ryan posed a question about the VIX index. He mentioned that the VIX index experienced severe fluctuations during the 2008 financial crisis and the 2020 COVID pandemic, and recent market events have shown similar spikes.

(Shenchao Note: The VIX index is a commonly used abbreviation for the Chicago Board Options Exchange Market Volatility Index, which measures the volatility of S&P 500 index options.)

• Tom analyzed this, pointing out that the VIX index had soared to 60, indicating extremely high expected volatility in the market.

• Tom explained the possible reasons for the rise in the VIX, including market uncertainty, investor panic, and a large number of margin calls. He mentioned that despite the market experiencing severe volatility, some high-net-worth individuals and institutions were actually buying during this period, while retail investors faced liquidations.

Potential Risks Ahead

Ryan asked if there would be large fund liquidations.

• Tom expressed his concerns. He mentioned that short-term volatility trading is a crowded strategy, and many investors may suffer losses during severe market fluctuations. He recalled that last year, during smaller volatility events, some large hedge funds had already faced failures, suggesting that there could be more market turmoil and potential fund liquidations in the coming days.

Is It Over?

When discussing the future of the market, Ryan presented a binary choice: Is this market volatility temporary, followed by a return to a bull market, or will there be more declines and fluctuations?

• Tom shared his view, suggesting that this volatility might be a "growth panic." He explained that if the trigger was the recent employment report or a retreat from speculative trading, these are temporary impacts.

Market Reaction

• Tom pointed out that while there was panic in the market, the credit market remained relatively stable, indicating that this volatility was primarily a panic in the stock market. Based on his experience at JPMorgan, the bond market usually leads the stock market, so if the stock market experiences such significant volatility while the bond market remains stable, it suggests that investors are seeking liquidity rather than a fundamental change in the market.

Future Expectations

Ryan asked what the fundamental assumptions would be if this is indeed a growth panic.

• Tom believes that the upcoming employment report will be crucial, especially the report released in September. He noted that although recent employment data has been inconsistent, some factors, such as extreme weather in Texas, may have impacted the employment data.

Likelihood of Recession

• Tom also mentioned a rule that since 1949, a 50 basis point rise in the unemployment rate typically indicates an impending recession. However, he pointed out that the effectiveness of this rule may be questioned due to the impact of the COVID pandemic on economic indicators. He believes that the market's performance in the coming months will depend on the economic data to be released, particularly the employment report.

What Happens Next?

Ryan asked what would happen if the economy does not enter a recession and the September employment data is strong.

• Tom believes that the Federal Reserve may begin to cut interest rates. He mentioned that while no one knows the Fed's decisions for certain, if the labor market slows down without entering a recession, the Fed will be forced to act.

Federal Reserve's Response

• Tom emphasized that the Fed's response will depend on the data, but the market has criticized the Fed's "data dependence," arguing that it causes the Fed's responses to always lag. Therefore, the market is calling for the Fed to adopt a more proactive policy. He mentioned that the Fed might cut rates in September and could potentially cut rates five times within the year.

Impact of Rate Cuts

• If the Fed does implement rate cuts, how will the market react? Tom pointed out that if the Fed's dot plot shows more rate cuts than expected, this could be interpreted by the market as support for the economy, thereby driving up the stock market and risk assets like cryptocurrencies. He noted that rate cuts would directly impact consumer loans, small business loans, and adjustable-rate mortgages, reducing borrowing costs and stimulating demand.

Potential for Economic Recovery

• Tom believes that the current economy faces high-cost issues, and rate cuts could alleviate this pressure, thereby reviving consumer demand. He pointed out that consumers still have room to borrow, so rate cuts could have a substantial catalytic effect on the economy.

Risks of Arbitrage Trading

Ryan raised a question about whether the Fed's rate cuts would exacerbate the risks of arbitrage trading, especially in the context of the yen and strong dollar, potentially worsening market conditions.

Fed's Focus

• Tom pointed out that the Fed does not want financial instability, but a 20% rise in the stock market is not their primary concern. He emphasized that the Fed is more concerned about misallocation of capital. If capital flows into the financial markets because companies are unwilling to make capital expenditures (Capex), then rate cuts could encourage capital to be reinvested in the real economy.

Environment for Corporate Investment

• He mentioned that many CEOs are reluctant to make capital expenditures in the current environment because investing does not seem wise amid the Fed's tightening policies, inflation concerns, and potential economic impacts. Thus, this environment actually poses a barrier to economic growth. At the same time, it also exacerbates the risks of arbitrage trading, as investors seek returns in a high-cost funding environment.

• Tom believes that the Fed's policies not only affect financial markets but also have profound implications for the real economy. Rate cuts could change corporate investment decisions, thereby impacting the overall economic recovery.

Cases of Economic Recession

Ryan asked Tom to present a counterpoint, suggesting that the current economy might be at the beginning of a recession, with a potentially more pessimistic outlook.

Expansion vs. Recession

• Tom emphasized that economic expansions do not end due to "aging," but typically because the Fed's policies are too tight. He believes that if the Fed maintains tight policies for too long, it could harm the economy. Additionally, the economy could also face recession due to external shocks.

Current Economic Weaknesses

• Tom pointed out that there are currently three areas showing signs of recession:

• Automotive Industry: Auto sales are declining, used car prices are plummeting, and automakers are raising prices due to "greedflation," leading to inventory buildup and increased delinquencies.

• Durable Goods: Consumer demand for durable goods like appliances is decreasing, partly due to high installment payments and credit card debt costs (such as 25% interest rates), making people reluctant to purchase new appliances.

• Real Estate Market: Housing activity is also in decline due to high mortgage costs and rising home prices. Although the reasons for rising home prices may relate to supply constraints, high prices and borrowing costs make home buying difficult.

Likelihood of Recession

• Tom believes that weakness in these three areas could indeed trigger a recession, especially in the durable goods and housing markets. Nevertheless, he holds a relatively optimistic view on the housing market, believing that there is still pent-up demand, and once the Fed begins to cut rates, mortgage rates may decrease, stimulating demand.

Impact of External Shocks

• Tom also mentioned that external shocks (such as significant fluctuations in oil prices) could lead to economic recession. If oil prices were to soar to $250 per barrel, household spending on gasoline would take up a larger proportion of their budgets, potentially triggering a recession.

• Despite the multiple challenges facing the economy, Tom believes that adjustments in the Fed's policies and potential market demand could still provide opportunities for economic recovery. The possibility of recession exists, but it is not irreversible.

Comparison with the Past

Ryan posed a question about whether the current economic growth panic is similar to other historical periods. He noted that observing the VIX index reveals fluctuations in 2008, 2000, and 2020, followed by many negative events in the market. He feels a sense of market fragility and tension, suggesting that the current situation is somewhat strange and may resemble the dot-com bubble era.

Tom's Perspective

• Tom stated that he has over 31 years of experience in observing the stock market and shared some insights. He pointed out:

• Bull Markets vs. Bear Markets: Bull markets are typically characterized by "taking the elevator up and the escalator down," with significant corrections usually associated with bull markets rather than bear markets. At the peak in 2000, the market showed signs of weakness, and as the market was about to peak, there was a "let me out" sell-off.

• Market Volatility: He noted that the current market correction occurred within just three days, and such panic selling is not uncommon in history. For example, the "panic" triggered by the Fed's rate hikes in 2018 and the rapid decline due to the pandemic in 2020 were both severe fluctuations within a short time frame.

• Speed of Market Rebound: The market in 2020 rebounded quickly after experiencing a rapid decline of about 45%, indicating that the market can recover swiftly in the face of significant shocks. Although there were concerns about the negative impacts on the economy at the time, the market had already bottomed out and rebounded six months before the vaccine rollout.

• Role of the Fed: Tom believes that the Fed can easily respond to the current market volatility, even taking action at the upcoming policy meeting. He pointed out that while the market has experienced a low-volatility phase, the current return of volatility may simply be a normal stage in the growth process of a bull market.

• Tom believes that the current market's fragility and volatility do not necessarily indicate an impending recession but rather that the bull market is undergoing adjustments and growth. He is confident that the Fed's policies can effectively address market volatility, and the market may stabilize in the future.

Why Tom Is Right

Ryan mentioned that Tom was bullish on Bitcoin back in 2017 and asked him about his views and reasoning at that time.

• Tom recalled his analysis of Bitcoin in 2017, highlighting his main points:

• Price Signals: Tom emphasized that their research approach treats price as a signal rather than simply judging whether an asset is in a bubble. They focus on whether price increases reflect a trend or phenomenon.

• Model Building: In 2017, they spent considerable time building a model to explain Bitcoin's price history. Through their research, they found two main variables that could explain most of Bitcoin's price fluctuations:

• Network Effects: The exponential benefits brought by the increase in the number of wallets, which is widely known, similar to Metcalfe's Law.

• Transaction Activity per Wallet: This is a secondary explanatory variable.

• Data Analysis: Tom pointed out that their model could explain 87% of the price increase of Bitcoin since 2010 or 2011. Based on this data, they predicted that if the number of wallets grew by 30% annually, Bitcoin's price would reach $25,000 by 2022.

• Understanding Traditional Markets: Tom stated that investors in traditional financial markets are often older individuals who may not understand how younger people drive the economy. He himself noticed the practicality of mobile phones when he was younger, even though many were skeptical at the time. He believes this resistance to new technology is also reflected in attitudes toward cryptocurrencies.

• Prejudice Against Cryptocurrencies: Tom believes that the traditional financial system holds a negative bias against cryptocurrencies, partly because cryptocurrencies pose a threat to the existing banking system. He thinks this bias still exists today.

• Tom's successful predictions stem from his deep understanding of market dynamics and keen insights into emerging technologies. Through data analysis and recognition of the economic driving force of younger generations, he solidified his bullish stance on Bitcoin. This forward-thinking mindset allowed him to seize opportunities in the early stages of cryptocurrency.

Current Assessment of Wall Street

Ryan raised a question about Wall Street's current attitude toward cryptocurrencies and asked Tom for his thoughts on this change.

• Here are Tom's main points:

• Market Changes: From 2017 to 2024, Wall Street has undergone significant changes regarding cryptocurrencies. Now there are Bitcoin and Ethereum ETFs, and financial giants like BlackRock's Larry Fink are beginning to discuss the benefits of Bitcoin and the potential for tokenization.

• Still in Early Stages: Despite the progress in the cryptocurrency market, Tom emphasized that six years is not a long time in the traditional financial world. Cryptocurrencies are still in their early stages, and the financial industry is gradually adopting new products and technologies.

• Analogy to the Telecom Industry: Tom used the history of the telecom industry to draw parallels with the development of cryptocurrencies. He noted that initially, the telecom industry relied heavily on landlines and long-distance calls, while wireless communication was relatively small in scale in 1999. However, as the number of mobile phone users increased, all communication innovations shifted to mobile devices. Similarly, financial product innovations may also occur on the blockchain.

• Conservatism in Banking: Tom pointed out that the banking industry still earns substantial profits from traditional businesses, leading to a lack of motivation for innovation. He believes the financial industry needs to innovate while ensuring safety to avoid fraud.

• Acceptance Among Young People: He mentioned that the adopters of electric vehicles are primarily young people, while traditional fuel vehicle consumers tend to be older. This trend is similar to the acceptance of cryptocurrencies, where younger individuals are more open to new technologies, while older investors often hold reservations about emerging technologies.

• Not Yet at the "Smartphone Moment": Although the price volatility of cryptocurrencies remains striking, the market has not yet reached the "smartphone moment," which is the stage of comprehensive innovation and application. Tom believes that the cryptocurrency industry needs more innovation to achieve broader applications in the future.

• Tom provided a profound analysis of Wall Street's current attitude toward cryptocurrencies, noting that while the market has made some progress, it is still in its early stages, and innovation and acceptance need to be enhanced. He emphasized the future potential of cryptocurrencies while also pointing out the challenges faced by the traditional financial industry during the transformation process.

BTC and ETH Price Predictions

When discussing cryptocurrency price predictions, Ryan asked Tom about the future trends of Bitcoin (BTC) and Ethereum (ETH).

• Here are Tom's main points:

Bitcoin Price Prediction:

• Tom noted that the recent sell-off and liquidations have had some impact on the market, but he remains optimistic about the performance of risk assets in the second half of the year, especially after the elections. He believes that the period from August to October may not be the best time for investment.

• If the S&P 500 index rises by 20% before the end of the year, Bitcoin could easily break through $100,000. He emphasized that Bitcoin's price fluctuations are not linear but exhibit stair-step growth.

• Tom mentioned that past research indicates that if you exclude the best 10 days of Bitcoin's performance each year, the overall return is nearly negative. This suggests that Bitcoin's gains are concentrated in just a few days.

Ethereum and Other Crypto Assets:

• Tom believes Ethereum is one of the core crypto assets, initially innovative due to smart contracts, and now has a stronger advantage due to its robust community support.

• He noted that Solana is also a crypto asset worth watching, as it similarly has a loyal and wealthy community behind it.

• Tom emphasized that the innovative potential of these crypto assets is still being explored, and the market may see more innovations in the future.

• Tom holds an optimistic view on the price predictions for Bitcoin and Ethereum, believing that the market has significant upside potential in the future. He highlighted the non-linear nature of Bitcoin's price fluctuations and pointed out that the community support for Ethereum and Solana is a crucial factor in their success. Overall, he is confident about the future of crypto assets, believing that innovation and development are ongoing.

Impact of Elections

When discussing the upcoming elections and their potential impact on the market, Ryan posed related questions to Tom.

• Here are Tom's main points:

Impact of Elections on the Market:

• Tom pointed out that elections have a significant impact on the market, as the issues people care about (such as abortion, transgender rights, family values, and ownership of cryptocurrencies) are emotionally connected to voters.

• He believes that regardless of which party wins, the short-term impact on stock market returns may not be substantial, but there will be significant differences in performance across different sectors.

Impact of Trump's Policies:

• Tom mentioned that Trump has a very positive stance on supporting Bitcoin, believing that the U.S. should not take an adversarial approach to Bitcoin.

• Trump advocates for deregulation and reducing regulatory interference for businesses, which would be a major boon for both small and large companies and could also promote merger and acquisition activities.

• He believes that Trump's policies could have a positive impact on the real estate sector, helping to protect commercial real estate.

Impact of Harris's Policies:

• If Vice President Harris wins, Tom believes this will be favorable for Silicon Valley, as she comes from California, which will benefit the performance of tech stocks (like FANG stocks).

Outlook for Small Caps:

• Tom emphasized that Trump's election would be very beneficial for small-cap stocks, as his policies would support the development of small businesses.

• Tom conducted an in-depth analysis of the upcoming elections and their impact on the market, pointing out that the policy orientations of different parties will significantly affect market performance, particularly regarding Bitcoin and small-cap stocks. He believes that regardless of the election outcome, investors should pay attention to potential changes across various industries to make informed investment decisions.