The Biggest Market Crash Since 2020, What Next?

This episode dissects the unexpected market turbulence since early 2024, revealing why macro analysts Quinn and Felix turned cautious and what the interplay of policy, liquidity, and global trade means for Crypto AI investors navigating heightened volatility.

Revisiting the Early 2024 Bearish Call

• Quinn explains his shift to a bearish stance around the start of 2024, despite prevailing bullish sentiment fueled by anticipated Fed rate cuts and the Trump election. He highlights that aggressive Fed cuts in late 2023, while powering asset prices to highs, were perhaps unnecessary and occurred alongside already elevated valuations. Quinn argues the market overlooked that the liquidity tailwinds (like Fed facilities and government spending) were ending, while new administration policies (deficit reduction, trade reorientation, immigration cuts) presented near-term growth headwinds.
• Key Insight: Quinn emphasizes the market misjudged the timing of policy impacts, stating, "all those progrowth, pro business, positive market things have been put in the back pocket to sort of pain before pleasure type of idea."
• Strategic Implication: Investors should critically assess the sequencing of policy initiatives rather than assuming immediate pro-growth effects, especially when valuations are high.

Felix's Complementary Analysis: Economic Slowdown and Fed Policy

• Felix shares his parallel concerns from late 2023, focusing on an emerging economic slowdown coinciding with a hawkish Fed pivot. He notes the Fed shifted from proactively addressing potential labor market weakness to being intentionally reactive and slow. Felix points to the drying up of COVID-era state and local government fiscal spending (a key growth driver) as a major factor, alongside other deteriorating economic indicators.
• Context: The "fiscal cliff" Felix mentions refers to the point where stimulus funds provided to state/local governments were projected to run out, removing a significant support for economic activity, particularly government hiring.
• Strategic Implication: The combination of organic economic slowdown and a deliberately passive Fed created significant tension, especially against euphoric market expectations (like overly optimistic Bitcoin reserve predictions), signaling a potential mismatch ripe for correction.

Market Expectations vs. Reality: The Role of Pricing

• The discussion highlights the critical role of market pricing and expectations, referencing Howard Marks. Even with potentially positive developments (like a pro-crypto administration), the key question is what's already priced in. Quinn notes that equity forward P/E ratios were at 2021 highs, coupled with extremely high forward earnings growth expectations comparable to the post-tax-cut Trump era.
• Technical Term: Forward Price-to-Earnings (P/E) Ratio: A valuation metric comparing a company's current share price to its expected earnings per share over the next 12 months. High ratios suggest high growth expectations are priced in.
• Key Insight: "It's when things are priced to perfection, it doesn't take much to derail markets." This underscores the vulnerability created by peak valuations and optimistic assumptions.

Portfolio Repositioning and Time Horizon

• Quinn explains their fund's patient approach entering the year, taking small, high-reward shots (like gold, dip-buying for reversions, pair trades like short ETH/long BTC) rather than large directional bets, acknowledging a potential multi-month topping process. Felix stresses the importance for investors to define their time horizon before major events, distinguishing between trading (reacting quickly) and investing (weathering storms or hedging).
• Actionable Insight: Clearly define if you are trading or investing. This dictates your reaction function during volatile events like "Liberation Day," preventing impulsive decisions based on short-term noise.

Decoding "Liberation Day": Tariff Impacts and Market Reactions

• Felix recounts the market reaction to the "Liberation Day" tariff announcements. Initial optimism based on a perceived 10% flat rate quickly reversed as analysis revealed a much higher effective rate (around 30%). This triggered a rapid sell-off, particularly as large institutional players (multi-strat pods) were forced to deleverage.
• Context: "Liberation Day" refers to the day the Trump administration announced significant new tariffs, primarily targeting China. The "effective tariff rate" considers the weighted average impact across all affected goods.
• Strategic Implication: Policy announcements can have immediate, drastic market impacts. Nimble investors who can quickly assess the true implications (beyond initial headlines) may gain an edge over slower institutional capital.

Cross-Asset Correlations and Deleveraging Dynamics

• Felix details the shifting market dynamics post-Liberation Day. Initially (pre-Thursday), classic flight-to-safety saw bonds rally and the dollar fall. However, on Friday/Monday, correlations shifted: the dollar rallied while most assets (gold, US equities, global equities) sold off simultaneously. This indicated forced selling and margin calls hitting large, leveraged funds ("pod shop capitulation").
• Technical Term: Multi-Strat Pod Shops: Large hedge funds structured with multiple independent teams ("pods") running different trading strategies, often employing significant leverage. Deleveraging by these funds can cause correlated sell-offs across unrelated assets.
• Key Insight: Observing cross-asset correlations can signal why markets are moving – distinguishing between fundamental shifts and technically driven liquidations (like margin calls).

Shifting Capital Flows and Bond Market Focus

• Following the initial deleveraging, Felix notes a surprising reversal: capital appeared to leave the US, evidenced by a significant bond market sell-off (yields rising) and a weakening US Dollar Index (Dixie). This contrasts with the typical flight-to-safety into the dollar during crises and raises questions about confidence in US assets amidst the new policy landscape.
• Context: The US Dollar Index (DXY or Dixie) measures the value of the US dollar against a basket of foreign currencies. A falling Dixie indicates dollar weakness.
• Strategic Implication: Investors should monitor capital flows (via bond yields and the dollar) closely, as sustained outflows could signal deeper concerns about US fiscal sustainability or policy direction, impacting all risk assets including crypto.

Understanding the Administration's Long-Term Strategy (Bessant's View)

• Quinn emphasizes understanding the administration's underlying goals, particularly citing advisor Scott Bessant. He argues the administration is willing to endure short-term market pain to achieve long-term objectives like balancing the budget (seen as growth-negative initially), reshoring critical supply chains away from China, and addressing the potential China/Taiwan geopolitical threat.
• Key Insight: Quinn suggests the administration's actions, while disruptive, are part of a calculated strategy. "They were willing to take the medicine and endure pain in risk asset markets to achieve what they deem to be more important long-term sustainability goals."
• Actionable Insight: Look beyond surface-level policy noise and analyze the stated long-term strategic goals of policymakers (like Bessant) to better anticipate market direction.

Scenario Planning: Bullish, Bearish, and Base Cases for 2024

• Bullish: A gradual, "lock step" implementation of deficit reduction alongside pro-growth measures (tax extensions, deregulation like energy) to balance impacts and calm markets.
• Bearish: An aggressive, front-loaded implementation of painful policies ("tear the band-aid off quickly"), potentially tipping the economy too far negative before pro-growth measures kick in. This risks a deeper downturn requiring larger, inflationary stimulus later.
• Base Case (Optimal): A range-bound, choppy market for the year, avoiding extremes of recession or inflationary overheating – a "controlled burn" with risks of becoming uncontrolled.

Geopolitical Risks: The China/Taiwan Factor

• The discussion touches upon the significant geopolitical risk of a potential China move on Taiwan, which produces the vast majority of essential semiconductors. Felix connects this to the tariff strategy, suggesting the administration needs Western allies aligned to effectively isolate China economically (preventing trade rerouting) if confrontation escalates.
• Context: Taiwan Semiconductor Manufacturing Company (TSMC) dominates advanced chip manufacturing, making Taiwan a critical node in global tech supply chains. Disruption would be catastrophic.
• Strategic Implication: The China/Taiwan situation represents an extreme tail risk. While difficult to predict, investors should consider its potential impact and factor it into risk management and cash allocation strategies.

Bond Market Stress: Leverage, Liquidity, and Systemic Risk

• Felix highlights the significant leverage built up in the US Treasury market, particularly via the "basis trade" used by hedge funds. He draws a parallel to the UK's Liz Truss crisis, where fiscal concerns caused the bond market to "go on strike," forcing central bank intervention (Quantitative Easing). The risk is that current US policies could similarly erode bond market confidence.
• Technical Term: Basis Trade: A hedge fund strategy exploiting small price differences between Treasury bonds and their corresponding futures contracts, often involving high leverage. Unwinding this trade can cause volatility.
• Technical Term: Quantitative Easing (QE): A monetary policy tool where a central bank purchases government bonds or other securities from the market to increase the money supply and lower interest rates.
• Key Insight: The stability of the highly leveraged Treasury market is crucial. Loss of confidence could trigger forced selling and potentially necessitate Fed intervention, impacting all assets.

Explaining the Recent Bond Yield Spike

• Felix attributes the recent spike in bond yields (counterintuitive if recession fears rise) primarily to technical factors: the unwinding of leveraged trades (like the basis trade) and potentially some speculation about foreign central bank selling (which he discounts). The concern is that a technical catalyst could lead to a fundamental acceleration if confidence erodes.
• Actionable Insight: Monitor Treasury market functioning and leverage indicators, as technical dislocations can precede or exacerbate fundamental shifts.

Hedging Extreme Scenarios: Cash and Strategic Positioning

• The conversation explores how to position for extreme tail risks like a Taiwan conflict. Quinn references Scott Bessant's "MG7 problem" comment, interpreting it as a warning about overconcentration in mega-cap tech stocks (like the Mag 7) which would be highly vulnerable. He suggests positioning longs in sectors potentially resilient or benefiting from conflict/reshoring (defense, commodities, energy, critical industrials), similar to Buffett's shift from Apple to Occidental. Holding cash is also emphasized as the ultimate hedge.
• Key Insight: Diversification beyond market-cap leaders and into sectors aligned with potential geopolitical or policy shifts (reshoring, defense) can offer resilience. Cash provides crucial optionality.

Identifying Fed Intervention Triggers: Market Plumbing Indicators

• Felix clarifies that the Fed prioritizes financial plumbing stability over equity market levels. He points to specific indicators they watch:
• SOFR-IORB Spread: The difference between the Secured Overnight Financing Rate (SOFR) and the Interest on Reserve Balances (IORB). When SOFR approaches or exceeds IORB outside of quarter-ends, it signals stress in crucial funding markets. Felix notes this happened recently.
• Treasury Market Liquidity: Specifically, the functioning of the "off-the-run" Treasury market (older, less liquid bonds). Seizures here (like in March 2020) are a major red flag.
• High Yield Credit Spreads: Widening spreads indicate stress in the corporate debt market.
• Actionable Insight: Crypto AI investors should monitor these specific plumbing indicators (SOFR-IORB, off-the-run liquidity, credit spreads) rather than just equity indices to anticipate potential Fed intervention, which often involves liquidity injections beneficial to risk assets like crypto.

Navigating Market Commentary: Key Voices and Perspectives

• The speakers discuss who they listen to. Quinn highlights valuable independent analysts on Twitter (Andy Constan, Joseph Wang, Warren Pies) for diverse opinions beyond bank research, while emphasizing Bessant and Hasset for policy insights. He cautions that figures like Jamie Dimon often "talk their book" (promote their own positions), though their views are still data points. Felix notes Dimon's concerns align with the banking system's vulnerability to rising bond yields.
• Strategic Implication: Triangulate information from various sources (official policy advisors, independent analysts, institutional figures), but be critical of potential biases (like banks benefiting from lower yields).

Dissecting Tariff Objectives: Interest Rates vs. Global Trade Realignment

• The discussion clarifies the primary goals of the tariffs. Both Quinn and Felix agree the main objective is not primarily to lower interest rates (as suggested by Chamath Palihapitiya), but rather strategic: realigning global trade, isolating China, potentially generating revenue for tax cuts, and reshoring critical industries. Lowering deficits (via spending cuts like "Doge") and deregulation are seen as the key levers for sustainably lowering bond yields.
• Context: "Doge" likely refers to the "Debt Overhang Growth Enhancement Act" or similar deficit-reduction proposals discussed by the administration.
• Key Insight: Tariffs are primarily a tool for strategic trade/geopolitical goals, potentially inflationary in the short term, while deficit control and deregulation are aimed at lowering borrowing costs.

Crypto Outlook Amidst Macro Uncertainty

• Quinn expects elevated volatility (VIX staying in high teens/20s) for the rest of the year. He notes Bitcoin's recent relative strength against equities, potentially linked to gold's strength and Bitcoin's nature as a "50/50 NASDAQ goldish combo." He's become more bullish on Bitcoin since the start of the year, seeing a strong case for authorities needing to intervene in markets, which often benefits Bitcoin.
• Key Insight: Bitcoin may benefit if macro instability forces central bank or government intervention (liquidity injections), potentially outperforming traditional equities in such scenarios.

Quinn's Take: Bitcoin Dominance and Risk Expression

• Quinn remains cautious on most altcoins, believing they are often still overvalued fundamentally and that the trend of increasing Bitcoin dominance will continue. He suggests that for investors seeking leveraged Bitcoin exposure, directly levering Bitcoin (cautiously) might offer better risk-reward than chasing high-beta altcoins, which often have disproportionately larger downside.
• Actionable Insight: When considering altcoins, rigorously assess their fundamental value proposition relative to Bitcoin and their historical downside volatility, rather than simply chasing beta.

Felix's Take: Bitcoin as a Macro Hedge vs. Tech Innovation Plays

• Felix sees significant Bitcoin upside primarily as a bet on the failure of current administration policies – leading to higher deficits, loss of bond market confidence, and eventual QE. Conversely, he believes the technological innovation side of crypto (stablecoins, infrastructure improvements facilitated by deregulation) will do well regardless of the macro outcome, driven by the administration's pro-crypto stance and focus on productivity-led growth.
• Strategic Implication: Investors can potentially structure their crypto portfolio to capture both narratives: Bitcoin as a hedge against policy failure/instability, and specific crypto assets (e.g., stablecoin infrastructure, AI-related crypto projects) as bets on deregulation and technological progress.

Expressing Crypto Views: Vehicles and Considerations

• The conversation touches on the expanding ways to gain crypto exposure (ETFs, public equities like COIN/HOOD, direct ownership). Felix notes the potential for the "MicroStrategy premium" (scarcity value driving up prices of public crypto proxies) to diminish as more accessible options like ETFs become available, potentially compressing multiples for stocks like Coinbase.
• Actionable Insight: Consider the evolving landscape of crypto investment vehicles. The availability of ETFs may reduce the valuation premium previously enjoyed by public equities like COIN or MSTR.

The Bitcoin Dichotomy: Macro Hedge or Risk Asset?

• Santi raises the recurring debate: is Bitcoin truly a macro hedge or just another risk asset correlated to liquidity (M2 money supply)? While acknowledging Bitcoin's historical correlation to risk assets and liquidity, the potential for it to act as an "escape hatch" in a severe crisis remains a factor, justifying a portfolio allocation ("get off zero"). The key tension is balancing long-term tech optimism (AI, crypto) with near-term macro risks and the need for cash.
• M2: A measure of the money supply that includes cash, checking deposits, and easily convertible near money. Often correlated with asset price inflation.

Strategic Portfolio Allocation: Balancing Defense and Offense

• Felix proposes a sample allocation: 30% Gold, 20% Equities (SPX Index), 20% Bitcoin, and 30% "High Beta Technological Optimist Trade" (representing AI, crypto innovation). He sizes gold higher due to lower volatility (beta). Quinn emphasizes cash's value but notes its recent purchasing power decline due to dollar weakness. He suggests looking for income sources outside sovereign bonds (due to rising global cost of capital), like high-dividend energy MLPs or lower-volatility equities, and focusing longs on sectors benefiting from reshoring.
• Technical Term: MLP (Master Limited Partnership): A type of publicly traded entity, often in the energy sector, known for distributing a significant portion of its income to investors.
• Actionable Insight: Portfolio construction should balance defensive assets (cash, gold, potentially resilient equities) with growth assets (Bitcoin, tech/AI/crypto innovation plays), adjusting allocations based on risk tolerance, time horizon, and assessment of macro conditions. Volatility (beta) should inform position sizing.

The Challenge of Long Volatility Strategies

• The difficulty of implementing effective long volatility ("long vol") strategies is discussed. While desirable (as most portfolios are implicitly short volatility), simply buying VIX calls or puts is often inefficient due to options pricing. Finding positive carry long vol strategies is the "golden goose" but extremely difficult. Quinn reiterates that cash is the most reliable hedge during sharp downturns.
• Key Insight: Directly hedging via options requires expertise and can be costly due to time decay (theta). Cash remains the simplest and most effective buffer against unexpected volatility.

Deep Dive: The Future of Coinbase (COIN)

• Quinn expresses a bearish view on Coinbase, arguing increased competition (from Robinhood, traditional finance entering crypto) will erode its high fees (e.g., retail trading, staking margins). He sees the opening up of the regulatory landscape as a negative for incumbents who benefited from previous barriers to entry. He also questions the outlook for crypto trading volumes.
• Strategic Implication: Increased competition and fee compression are significant headwinds for established crypto exchanges like Coinbase. Investors should assess the sustainability of their current business models and fee structures.

Robinhood (HOOD) as a Contrasting Play

• Both Felix and Quinn indicate a preference for Robinhood (HOOD) over Coinbase recently. Felix notes HOOD's potential advantage in attracting retail flow and potentially lower fee structures. He suggests Coinbase's potential acquisition of Deribit (the dominant crypto options exchange) could be a saving grace by adding a moat in a complex market segment, but even then, competition from traditional finance options platforms will be fierce.
• Key Insight: Competition is intensifying across crypto services (trading, staking, custody). Platforms diversifying revenue streams or establishing strong moats (like potentially in derivatives) may fare better than pure-play spot exchanges facing fee pressure.

Conclusion

• The discussion highlights heightened market volatility driven by significant policy shifts and fragile economic conditions. Crypto AI investors must prioritize understanding these macro drivers, manage risk through strategic allocation across asset types (including cash), and closely monitor financial plumbing indicators and geopolitical developments for signs of instability or intervention.