The crash in bitcoin is starting to look like something more than the minor setback like we’ve seen in the past few weeks. It has fallen  more than $6,000 from its peak at $19,661 which is highlighted in the chart below. I think this is a great thing for stock investors because it could mean the bubble could be over. If it’s over now, I don’t think the crash will cause many problems for the economy or stocks as the total cryptocurrency market cap peaked somewhere around $600 billion. This could be a premature obituary, but it’s important to recognize that there won’t be a plateau. When it starts to fall, it will crash like a rock. The price hasn’t been stable on the way up and it won’t be stable on the way down.

The bitcoin rally of 2017 will be written about in the financial history books because the size was unlike anything we’ve seen since the late 1990's tech bubble. There are people who don’t know much about finance putting a few hundred dollars in bitcoin because they heard about it going up. Socially, it’s unusual to see such actions take place because people aren’t realizing that the fact that they are putting money in it is a sign of a top. The stock market hasn’t had a 3% selloff this year and is up 20%, but this crypto craze makes stocks look like they are standing still.

Yield Curve Flattening

The top story of 2017 in the traditional markets was the lack of volatility. Next year’s top story will be the yield curve. The yield curve inverting is known as one of the best indicators for a recession. The moment it inverts, everyone in finance and in the financial press will be talking about it. Just it falling below its previous cycle low was enough to get everyone buzzing. There is pent up demand for a negative story as weird as that sounds. Since this will become the 2nd longest expansion since 1854 in 4 months, investors are waiting for the first shoe to drop. Even if the yield curve inverts in 2018, there’s a strong chance this becomes the longest expansion as there’s a delay between a yield curve inversion and a recession.

The chart below combines the top story of 2017 with the top story of 2018. Having such a low VIX is rare on its own. When you compare it to another variable, it will always look unprecedented. However, the chart below is still interesting with that caveat in mind. As you can see, usually when the yield curve flattens, it implies that volatility will fall. One point that this chart fails to differentiate is whether the vied curve is at the beginning or the end of the cycle. If the yield curve was at 62 basis coming out of an inversion, it would mean a recession either happened or is very close to happening. If it is before the inversion, the economy is likely fine for a couple more years.

The chart below is another interesting way to look at the yield curve. As you can see, the yield curve is much flatter than the gold to copper ratio indicates it should be. Charts like these will spring up next when the yield curve gets close to an inversion because bullish investors will try to invalidate what the yield curve is saying. While I think the copper to gold ratio is interesting, I don’t trust it at all. That’s because gold marches at its own beat. Sometimes gold does well during inflation and sometimes it doesn’t. There’s no rhyme or reason to gold’s action, so using it as an indicator is wrong in my opinion. It’s possible gold is in a secular downtrend. If it continues to fall, it wouldn’t mean the economy is suddenly booming. I think copper can rally next year because inflation will pick up as demand exceeds supply for most commodities. Inflation heating up is a warning sign for a recession so copper can go up, but it could still mean a recession is coming in 2019 or 2020. Therefore, I would call this chart interesting, but spurious.

ETFs Continue To Lead A Passive Revolution

I haven’t discussed the inflows into passive funds as much in the past few months, but it remains a big story this year as investors take their money out of active funds and buy index funds. As you can see in the chart below, the inflows into equity ETFs in October was a new record high. The critical point will be if these passive investors keep their money in stocks when times get tough. Frankly, I doubt they will. This money will pour out when there’s trouble just like what’s happening in bitcoin, except at a much slower pace.

Earnings Estimates

I’ve discussed that 2017 was an unusual year because earnings estimates didn’t fall that much. What’s more unusual is how well 2018 estimates have done so far. The chart below shows a complete picture of what I’ve been discussing. The only year since 2009 that had the final earnings result end up being higher than the initial estimate was 2011. The main reason why that happened is because the initial forecasts were made in the middle of 2009 right when the recession was ending. If you look at the two previous years, the bottom in estimates was right around that point. Since the 2018 estimates started coming out in late 2016, that situation isn’t the same. The tax cuts are what 2018 estimates are hanging onto. If they fall like the other years, expect 2018’s performance to not come close to the 20% gain seen in 2017. Heightened inflation increases input costs which pushes down margins and hurts earnings. Look for that to start impacting stocks in the second half of 2018. Fed rate hikes tightening financial conditions is also worrisome as increasing financing costs will also crimp margins.