🥛 The market is sick. The economy isn’t (yet?) 🤒

🥛 The market is sick. The economy isn’t (yet?) 🤒

Leverage wash-out drives market dip.

GM. This is Milk Road, the newsletter that’s not here to say “we told you so” but, like, low-key, we’ve been saying to watch out for a few weeks now.

Here’s what we’ve got for you today:

• ✍️ Bears take a big bite of markets.

• 🎙️ The Milk Road Show: Bitcoin Is Compressing… And a VIOLENT Move Could Be Next.

• 🍪 Plasma x Stripe.

BEARS TAKE A BIG BITE OF MARKETS

First of all, don’t panic.

I think it’s mostly just leverage coming out of the market. But let’s take a closer look at the big picture.

Our Milk Road Macro Index reading fell from -0.93 to -1.51 this week. That pushes it deeper into RISK-OFF. The guidance here is not to add exposure to risk assets. But there’s some nuance to that we’ll get to later.

All of the drop in the headline index reading came from one place. Market momentum fell from -0.68 to -1.26. The economy side of the dashboard barely moved at all, but in case you somehow haven’t noticed, the market puked hard.

In other words, the economy is holding up, and the markets aren’t.

It’s not just the U.S. either. Korea, Turkey, Indonesia, and many others have all had severe sell-offs. China’s stock market is in its tenth consecutive week of downward movement.

So, what’s driving this global market downturn?

Last week’s two big questions got answered, and both went the wrong way:

1. The “fear gauge” gap closed the ugly way. The VIX measures how nervous stock traders are. The MOVE does the same for bonds. Bonds had been nervous while stocks stayed calm. That gap could have closed with bonds settling down. Instead, stocks caught up to the panic, and the VIX jumped from 14.84 to 19.99 as equity markets finally priced in what bonds had been warning about.

Last Thursday, the VIX was even higher:

2. Inflation didn’t cooperate. September CPI showed a second straight +0.3% monthly core reading. That knocked out the shaky floor we flagged last time and made a December Fed hike a near-certainty. Our financial conditions reading (roughly, how easy it is to borrow money and take risk) worsened from -0.79 to -1.38.

Inflation heating up is the bad news that the market had been nervous about. This print seems to have confirmed their concerns in the short term.

Markets got hit from every direction at once

• Growth signals collapsed: Stress around AI-related debt spread through the tech supply chain. It hit credit spreads, sector rotation, and shipping all at the same time.

• Breadth fell to -1.02: Weak breadth is something we’ve been writing about for a while and hoping to see improve. Instead of spreading out to more stocks, money hid in energy and consumer staples, the safe, boring corners of the market.

How can it get any worse?

This is the part to watch closely.

The IMF warned that circular AI infrastructure debt could spread into a broader credit contagion. That debt is the web of AI companies financing each other’s buildouts. If it unravels, market stress starts dragging the real economy down with it.

So, it seems that the market is still worried, and there isn’t a clear end to this for the moment.

THE ECONOMY IS “BEARLY” HANGING ON

The good news is that the economy pillar is still standing. Jobless claims look especially strong.

The bad news is that the cushion is getting thinner. The inflation direction moved from -0.10 to +0.00, so the six-month trend of cooling inflation is officially over.

If we get a third hot monthly core inflation print in a row, the inflation reading flips positive. Inflation heating up and moves to fight it could cool down the economy that has been “running hot” this whole time. That could end up with a stagflationary scenario. Or a recession. Or worse.

What could turn this around?

All eyes are on the October 27–28 FOMC meeting. Markets now price in an 84% chance of a December hike. The Fed may hold in October. In fact, the market expects them to. But the market also confidently expects them to hike again in December. So, some capital will likely stay cautious to avoid having to “fight the Fed.”

The one thing that would really help is a signal from the Fed that inflation hasn’t yet cleared the bar for a December hike. That would give the MOVE room to fall for real and start easing the pressure on financial conditions.

The other way out is for AI credit stress to be contained before it spreads into the broader high-yield (junk bond) market. Without either one, I don’t see an easy path from here back to RISK-ON territory for risk assets.

Bottom line: The economy is hanging in there, but markets are in rough shape. The big risk now is that the market’s problems spread to the economy.

But, John, if the macro setup is so firmly RISK-OFF, why are you still so bullish on crypto?

Well, slow down there. Let me explain.

WHAT DOES THIS MEAN FOR CRYPTO?

With all that macro gloom, you’d expect crypto to be getting hit hard. It isn’t. So, wtf is going on?

Crypto is holding up well, and here’s why I think that is.

This sell-off is mostly coming from a leverage unwind, and the leverage is in stocks.

A big chunk of this market downturn is hedge funds and other players who have been way overleveraged, unwinding some of their positions and facing liquidations. They borrowed money to make bigger bets, and now they’re selling positions to pay that money back.

The key detail is what they’re selling. These funds were loaded up on AI stocks, memory chip stocks, and equities in general, not crypto and digital assets.

When a fund has to de-lever, it sells what it owns. Most of them don’t own much crypto right now, so the forced selling is landing on stocks instead. In a liquidation scenario, an account with cross-margin leverage may be forced to sell any crypto it has, and I think some of that has contributed to the slowdown in the crypto rally. However, overall, the leverage has been in AI, so the unwind is putting sell pressure on equities, not crypto.

Also, in case you forgot, crypto already did its suffering.

Crypto is coming out of a very long bear market and reverting to the mean on Bitcoin price levels. It isn’t stretched or overheated. It isn’t way overvalued by almost any metric. It has mostly settled back to an average point.

That matters because there isn’t much capital heavily levered long on Bitcoin or crypto right now. Less leverage means less forced selling, and less forced selling means less room to fall.

So, despite the macro headwinds driving AI stocks down, crypto is just ranging, and Bitcoin is still over $80K (knock on wood) at the time of writing.

The fundamentals are pulling capital back into crypto

While stocks deal with their leverage problem, some strong fundamental drivers are bringing capital and attention back to digital assets:

• Tokenization: bringing real-world assets onto the blockchain, where they can trade around the clock.

• Real value accrual: tokens that pay off for holders through buybacks and revenue capture. When the protocol makes money, token holders benefit.

• Privacy tokens: renewed interest in assets built around financial privacy.

• Regulatory support: The SEC and CFTC have been rolling out the red carpet for the whole digital assets industry.

My two satoshis

I don’t expect Bitcoin and crypto to break out to new highs until some of these macro headwinds clear. A hawkish Fed and spreading AI credit stress are hard for any risk asset to fight through.

Even so, crypto looks like it has more strength and less downside than other risk assets right now. The leverage unwind is coming out of AI equities and memory equities, not Bitcoin and digital assets. This could change, but this is how it’s played out for the last few weeks.

Macro is risk-off, and crypto probably won’t run until that changes. But this storm is mostly hitting stocks, and crypto is in a much better spot to ride it out.

What am I doing? Well, if you want to see how I and the other Milk Road PRO Analysts are handling this in our portfolios, you can join Milk Road PRO today for just a buck.

In the meantime, stay safe, stay educated, and stay bullish! (Although, again, to be clear, the macro outlook right now is bearish lol.)

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*this is sponsored content.