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What The Crypto Crash & Stock Market Plunge Have In Common

Only one thing matters in bubble markets: sentiment
Monday, February 5, 2018, 5:57 PM

Today saw Jerome Powell sworn into office as the new Chairman of the Federal Reserve, replacing Janet Yellen. Looking at the sea of red across Monday's financial markets, Mr. Powell is very likely *not* having the sort of first day on the job he was hoping for...

Also having a rough start to the week is anyone with a long stock position or a cryptocurrency portfolio.

The Dow Jones closed down over 1,200 points today, building off of Friday's plunge of 666 points. The relentless ascension of stock prices has suddenly jolted into reverse, delivering the biggest 2-day drop stocks have seen in years.

But that's nothing compared to the bloodletting we're seeing in the cryptocurrency space. The price of Bitcoin just broke below $7,000 moments ago, now nearly two-thirds lower from its $19,500 high reached in mid-December. Other coins, like Ripple, are seeing losses of closer to 80% over the same time period. That's a tremendous amount of carnage in such a short window of time.

And while stocks and cryptos are very different asset classes, the underlying force driving their price corrections is the same -- a change in sentiment.

Both markets had entered bubble territory (stocks much longer ago than the cryptos), and once they did, their continued price action became dependent on sentiment much more so than any underlying fundaments.

The Anatomy Of A Price Bubble

History is quite clear on how bubble markets behave.

On the way up, a virtuous cycle is created where quick, outsized gains become the rationale that attracts more capital into the market, driving prices up further and even faster. A mania ensues where everyone who missed out on the earlier gains jumps in to buy regardless of the price, desperate not to be left behind (this is called fear of missing out, or "FOMO").

This mania produces a last, magnificent spike in price -- called a "blow-off" top -- which is then immediately followed by an equally sharp reversal. The reversal occurs because there are simply no remaining new desperate investors left to sell to. The marginal buyer has suddenly switched from the "greater fool" to the increasingly cautious investor.

Those sitting on early gains and looking to cash out near the top start selling. They don't mind dropping the price a bit to get out. So the price continues downwards, spooking more and more folks to start selling what they have. Suddenly, the virtuous cycle that drove prices to their zenith has now metastasized into a vicious cycle of selling, driving prices lower and lower as panicking investors give up on their dreams of easy riches and increasingly scramble to limit their mounting losses.

In the end, the market price retraces nearly all of the gains made, leaving a small cadre of now-rich early investors who managed to get out near the top, and a large despondent pool of 'everyone else'.

We've seen this same compressed bell-curve shape in every major asset bubble in financial history:

Phases of an asset price bubble

And we're seeing it play out in real-time now in both stocks and cryptos.

The Bursting Crypto Bubble

It's amazing how fast asset price bubbles can pop.

Just a month ago, the Internet was replete with articles proclaiming the new age of cryptocurrencies. Every day, fresh stories were circulated of individuals and companies making overnight fortunes on their crypto bets, shaking their heads at all the rubes who simply "didn't get" why It's different this time.

Here at PeakProsperity.com the demand for educational content on cryptocurrencies from our audience rose to a loud crescendo.

We did our best to provide answers as factually as we could through articles and webinars, though we tried very hard not to be seen as encouraging folks to pile in wantonly. A big reason for this is we're more experienced than most in identifying what asset bubbles look like.

After all, we *are* the ones who produced Chapter 17 of the The Crash Course: Understanding Asset Bubbles:

To us, the run-up in the cryptocurrencies seen over 2017 had all the classic hallmarks of an asset price bubble -- irrespective of the blockchain's potential to unlock tremendous long-term economic value. Prices had simply risen way too far way too fast. Which is why we issued a cautionary warning in early December that concluded:

So, if you've been feeling like the loser who missed the Bitcoin party bus, you've likely done yourself a favor by not buying in over the past few weeks. It is highly, highly likely for the reasons mentioned above that a painful downwards price correction is imminent. One that will end in tears for all the recent FOMO-driven panic buyers.

And now that time has shown this warning to have been prescient in both its accuracy and timeliness, we can clearly see that Bitcoin is following the classic price trajectory of the asset price bubble curve. The chart below compares Bitcoin's current price to that of several of history's most notorious bubbles:

Chart of Bitcoin vs other historical asset price bubbles

This chart (which is from Feb 2, so it doesn't capture Bitcoin's further decline below $7k) shows that Bitcoin is now about 2/3 of its way through the bubble life-cycle, and about half-way through its fall from its apex.

Projecting from the paths of previous bubbles, we shouldn't be surprised if Bitcoin's price ends up somewhere in the vicinity of $2,500-$3,000 by the time the dust settles.

Did The Stock Market Bubble Just "Pop"?

Despite the extreme drop in the stock market over the past two days, any sort of material bubble retracement has yet to begin -- which should give you an appreciation of how overstretched its current valuation is.

Look at this chart of the S&P 500 index. Today's height dwarfs those of the previous two bubbles the index has experienced this century.

The period from 2017 on sure looks like the acceleration seen during a blow-off top. If indeed so, does the 6% drop we've just seen over the past two trading days signify the turning point has now arrived?

Crazily, the carnage we've seen in the stock market over the past two days is just barely visible in this chart. If indeed the top is in and we begin retracing the classic bubble curve, the absolute value of the losses that will ensue will be gargantuan.

If the S&P only retraces down to the HIGHS of its previous two bubbles (around 1,500), it would need to fall over 43% from where it just closed today. And history suggests a full retracement would put the index closer to 750-1,000 -- at least two-thirds lower than its current valuation.

How Spooked Is The Herd?

As a reminder, bubbles are psychological phenomena. They are created when perception clouds judgment to the point where it concludes "Fundamentals don't matter". 

And they don't. At least, not while the mania phase is playing out.

But once the last manic buyer (the "greatest" fool) has joined the party, there's no one left to dupe. And as the meteoric price increase stops and then reverses, the herd becomes increasingly skittish until a full-blown stampede occurs.

We've been watching that stampede happen in the crypto space over the past 4 weeks. We may have just seen it start in the stock markets.

How much farther may prices fall from here? And how quickly?

History gives us a good guide for estimating, as we've done above. But the actual trajectory will be determined by how spooked the herd is.

For a market that has known no fear for nearly eight years now, a little panic can quickly escalate to an out-of-control selling frenzy.

Want proof? We saw it late today in the complete collapse in XIV, the inverse-VIX (i.e. short volatility) ETN that has been one of Wall Street's most crowded trades of late. It lost over 90% of its value at the market close:

Chart of collapse of XIV ETF

The repercussions of this are going to send seismic shockwaves through the markets as a tsunami of margin calls erupts. A cascading wave of sell-orders that pushes the market further into the red at an accelerating pace from here is a real possibility that can not be dismissed at this point.

Those concerned about what may happen next should read our premium report Is This It? issued over the past weekend.

In it, we examine the congregating perfect storm of crash triggers -- rising interest rates, a fast-weakening dollar, a sudden return of volatility to the markets after a decade of absence, rising oil prices -- and calculate whether the S&P's sudden 6% rout is the start of a 2008-style market melt-down (or worse).

Make no mistake: these are sick, distorted, deformed and liquidity-addicted bubble markets. They've gotten entirely too dependent on continued largess from the central banks.

That is now ending.

After so many years of such extreme market manipulation finally gives way, the coming losses will be staggeringly enormous. 

The chief concern of any prudent investor right now should be: How do I avoid being collateral damage in the coming reckoning?

Click here to read 'Is This It?', Part 2 of this report (free executive summary, enrollment required for full access)

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24 Comments

cmartenson's picture
cmartenson
Status: Diamond Member (Offline)
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Posts: 5663
About Mr. Powell

Remember, the several times that I've had Axel Merk as the Off The Cuff guest, he has talked specifically about Mr Powell and how he differs from Yellen and Bernanke.

Most tellingly, the main question centers on his style and training which will lead him to move a bit slower during a crisis.  

Axel surfaced a key risk of a Powell-led Fed as being crisis paralysis.  Maybe not complete, maybe not too terribly bad, but slower than what a crisis needs to be averted.

What an interesting first day on the Job for Powell!  I'm looking forward to gathering more observations from Axel in the near future.

Snydeman's picture
Snydeman
Status: Gold Member (Online)
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Posts: 475
Yes, and

As I recall, one other problem with Mr. Powell is he is a lawyer type and not as well-versed in understanding these market dynamics, right?

Mark_BC's picture
Mark_BC
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Posts: 462
I'm going to suggest that

I'm going to suggest that this crash was entirely planned out and controlled. I haven't done any looking into the numbers yet but I'd guess patterns will emerge after analysis. Look for the famous 7.

I think that in this day when the NSA knows every byte of information you share and your whereabouts, the idea that the stock market is somehow out of their digital control is preposterous.

I'm also sure that the banks were on the short side of this... It went down, but not down far enough to do real damage. The Dow only retraced its steps back to mid Dec '17!!!!

dcm's picture
dcm
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Posts: 209
axel

this is what axel said Oct 20, 2017:

 

And then, there is Jay Powell. His name keeps popping up as a potential successor to Fed Chair Janet Yellen. Nominated by Obama, he is currently a member of the Federal Reserve Board of Governors. During the Obama years, he gave a speech in which he appeared open to break up banks. Now he is open to de-regulated them. He has never dissented at the FOMC. I do not question the integrity or intentions of Mr. Powell, but would like to point out he is a lawyer: with no offense intended to the profession, the task of a lawyer is to please their clients. Lawyers are advocates of the causes of their bosses. He is no economist. You don't need to be a Ph.D. economist to run the Fed (indeed Warsh is not a Ph.D. economist; neither was former Fed Chair Volcker, for example). Powell is known as a regulator, not as someone with views on interest rates. And as a Fed governor, that's exactly what it does.

The way the Fed is structured, there are regional Fed Presidents; there are governors, and then there's the Chair. The regional Fed Presidents are scattered throughout the country with their own research staff. The Chair has her staff. But the governors do not have a staff. Instead, they get presentations at the FOMC meetings. Currently there are a numerous vacancies (and there would be an additional one if Powell were to become Chair). The lawyers at those FOMC meetings have a reputation of simply being at awe at the presentation of the research staff, then sign off on whatever the Chair proposes. They are at awe because they have neither the education, understanding, nor the resources to get smart about how to proceed. 

Of course this doesn't mean an intelligent person like Mr. Powell cannot make monetary policy decisions. But to me, it suggests that leadership on monetary policy will come from elsewhere should Mr. Powell become Chair. Maybe there's a particularly prominent staff member at the Fed whose influence will rise. Or maybe the market will be in charge, with the Fed following what the market demands. Neither is necessarily bad. But I disagree strongly with those that say with a Powell Fed we would get continuity; if you read the few speeches Powell has given on monetary policy, they lack original content, but rehash the view presented by the Fed as a whole. 

Cynics will say a Powell Fed may be controllable by the White House. Possibly, although I don't doubt that Mr. Powell is independent enough to pursue his own path. Except that his own path is that of an administrator, a bank regulator. It's in that context that we might be facing a leadership vacuum when it comes to assertiveness where the bazooka will be directed going forward.

The best outcome should Mr. Powell become Fed Chair I see is that the Fed will become more boring. At worst, turmoil in financial markets could be amplified if the market cannot gauge where the all-important benchmark of risk is heading if there is a lack of intellectual leadership with regard to monetary policy.

Uncletommy's picture
Uncletommy
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Posts: 510
I hope I'm not becoming a tedious contributor

With interest rates headed higher, bond mechanisms fluttering, and an easy money history, what else should we expect? The very same mechanisms are at play now as they were in the "big correction" of 1929. This harkens back to CHS's observations of "productive profit" means. As financial gurus continue to wield their copious piles of financial tools for incremental gains totally disconnected from the common good, the rollercoaster will become even a more thrilling and stomach-churning ride. Mr. Powell's "too-litlle-too-late" tendencies (IMHO) may be the cure or death-knell for this market. Eventually the ride has to level out before the ride is over Keep your cash and powder dry! Just my opinion!

This is from November 2017. A good summation from Wolf Richter:
http://www.businessinsider.com/stock-market-margin-debt-2017-11

sand_puppy's picture
sand_puppy
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Sell Off Continues - 11 PM

Now, I have a handy futures screen to check on (thanks Chris).  ZH reports that the Sell-off continues.

  • Dow Futures Down Another 600+ 3.5%
  • NIKKEI (Japan) down 6.0%
  • Hong Kong (Hang Seng Index, HSI) down 4.9%
  • DAX (Germany) down 4.2%
  • Gold, and US Bonds are doing well.

Interestingly, the Chinese Shanghai Composite is Green.  I would love to know what that is about.

 

New_Life's picture
New_Life
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Posts: 257
Just a correction, apparently....

DJI's largest one day point fall is just part of a correction.

That's according to the BBC just now.......

http://www.bbc.co.uk/news/business-42957834

 

Looking forward to Chris'es take on that...

 

ps the Bubble Phases1.jpg linked at the top of this page keeps triggering my Anti virus...

cmartenson's picture
cmartenson
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Da PPT is in Da 家

That symbol in the title , is Japanese for house.

Check out this laughably out of sync series of stock futures:

The Bank of Japan (BoJ) is, with 99.99% certainty, the big buyer here that has bought and brought the Nikkei back into the green.

Heck, the BoJ was a key buyer of the Nikkei mainly during down days.  This is a well known and reported on fact.  They are  the 75% owner (and certainly more after today) of Japanese ETFs.

I figure that the BoJ will be the first test of what happens when a central banks finally fails.  How will the losses be distributed?  Is there any possible outcome besides destruction of the currency?

Or will it be a true deflationary implosion?

Either way the good people of Japan have had their economic and therefore physical future comprehensively and irretrievably ruined by their central bank.

But the big question is what does the BoJ do with trillions of yen losses on its equity holdings?  How will it account for those?  The answer has a direct bearing on everybody's future because the other central banks will be watching carefully.

 

Snydeman's picture
Snydeman
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Posts: 475
How important?

This feels like a very important and pivotal day. Every talking head on CNBC last night, save one, was jawboning about how "normal" this is, and how much it means nothing in the long run, and how this is a clear buying opportunity, and...

 

If today is another plunge of 400+ points, that might mark a psychological breaking point for average investors. I fully expect every Plunge Protection Team in the developed world to be very active today.

 

If there is a market recovery today, is it a Bull Trap or a real return to stellar markets? I know what the CNBC talking heads would say...

davefairtex's picture
davefairtex
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bond bear

Forces that are pushing bond prices lower aren't subject to jawboning by the folks at CNBC.

Fed is rolling off its balance sheet.  USG is doing more deficit spending.  This pushes bond prices lower, because supply is increasing.

Lower bond prices -> higher interest rates -> generally depress equity prices, at least according to the correlations I've seen.

These forces are not subject to jawboning as I pointed out earlier.

cmartenson's picture
cmartenson
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...If VIX products are broken...

One of  the key ways of manipulating these "'markets"" over the prior years has been through the use of VIX slamming.

Just buy a bunch of VIX ETF and ETN products and you can magically elevate the overlying cash markets.

But the VIX products are not just wounded, they are destroyed in several important cases.

I rather think that this method is now toast.

So they'll figure out something else next...I expect that plain old buying eminis hand over fist is the solution of choice here...a return to the old tried and true. 

But what if that signal is no longer all that effective in swaying the non-emotional algos?  What if the cash market is now untethered from an easily controlled leveraged tail-wags-the-dog VIX-like product?

That means there's more reversion to the mean underway.  It also means they've temporarily lost  control.

Fun times.

Snydeman's picture
Snydeman
Status: Gold Member (Online)
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Posts: 475
Well...

If stocks are for show but bonds are for dough, the question becomes how long the show goes on if so many institutional investors are losing so much dough, right? If I'm understanding things correctly, anyone holding Treasury bonds of a lower yield can either hold that paper to maturity (and lose out on current higher yields), or sell those bonds at a loss to then purchase higher-yielding bonds now. OR use current side-lined cash to buy the better yielding bonds now while holding the lesser bonds to maturity. BUT, again as I understand it, there's not a lot of liquidity out there right now.

 

Am I missing something?

cmartenson's picture
cmartenson
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VIX still working apparently

Man, they sure are good at what they do...

Massive VIX slam this morning:

Why do I say they are good?

Because not only is the VIX still useful for slamming the ""markets"" around, but they blocked little folks from taking any advantage from it, preserving all of the gains for themselves.

Lots of stories like these surfacing:

"Sorry for your losses (or lack of gains) sir.  Care to play again?"
 

Brunel's picture
Brunel
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Posts: 32
Perspective

The Dow drops 3% in one day and the world is aghast.  The Dow rose 25% (?) last year on 3% growth (if you're very optimistic) - and everyone thinks this is quite normal.

dcm's picture
dcm
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Posts: 209
shock and awe

"but they blocked little folks from taking any advantage from it, preserving all the gains for themselves"

I can't believe they'd do such a thing

Snydeman's picture
Snydeman
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Posts: 475
PPTs?

It seems they are out in force, as expected.

sand_puppy's picture
sand_puppy
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Posts: 1810
Nanex notes another trick to disrupt plunges

From ZH:

By all accounts, markets feel broken now, quickly and violently moving between gains and losses. At one point we went from -700 on the futures to a +400 in the opening minutes of trade. I would call that fuckery of extreme proportions. On top of that, Fidelity and other online brokerages have been down all morning, effectively stopping advisors and retail from accessing accounts to make adjustments. This is probably why markets ripped higher in the morning. There was no one there to sell because all of the fucking platforms were down.

 

And I like the imagery of this liquidity description device.

New_Life's picture
New_Life
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Posts: 257
cmartenson wrote: Man, they
cmartenson wrote:

Man, they sure are good at what they do...

Massive VIX slam this morning:

 

Why do I say they are good?

Because not only is the VIX still useful for slamming the ""markets"" around, but they blocked little folks from taking any advantage from it, preserving all of the gains for themselves.

Lots of stories like these surfacing:

 

"Sorry for your losses (or lack of gains) sir.  Care to play again?"

There's more than plenty volatility to share out and play with with over in the world of BTC & ETH. :-)

macro2682's picture
macro2682
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Crypto is different...

There is one aspect of the BTC bubble that is provably different from the chart Chris displayed.  The order of adoption is out of whack.  

We would expect 1.) Smart money, 2.) Institutional, 3.) Retail...

With BTC we got 1.) Nerds, 2.) Prepper Nerds, 3.) Traders...

 

Obviously nerds are smart by definition, but there was almost no adoption by traditional/financial “smart money”... Smart money mocked BTC the whole time sitting on the sidelines.  Institutional money had even less involvement, not even mentioning BTC for fear of embarrassment and industry shunning.

...And yet, the number one question asked of financial advisors in 2017 was regarding Bitcoin.  

If “smart money” and institutions DID go into BTC, widening the pool of retail investors willing to follow, the blow-off would have been orders of magnitude larger.

Does that mean we should expect another leg up?  ...Probably not for BTC.  But when another crypto comes out that has the blessing of the smart and institutional money, look out!  

 

dcm's picture
dcm
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Posts: 209
"online brokerages have been

"online brokerages have been down all morning, effectively stopping advisors and retail from accessing accounts"

...and I thought internet false flags and cyber war were just a play toy for the deep state(s) 

New_Life's picture
New_Life
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Posts: 257
Macro, yes its worth exploring the differences
macro2682 wrote:

There is one aspect of the BTC bubble that is provably different from the chart Chris displayed.  The order of adoption is out of whack.  

We would expect 1.) Smart money, 2.) Institutional, 3.) Retail...

With BTC we got 1.) Nerds, 2.) Prepper Nerds, 3.) Traders...

Obviously nerds are smart by definition, but there was almost no adoption by traditional/financial “smart money”... Smart money mocked BTC the whole time sitting on the sidelines.  Institutional money had even less involvement, not even mentioning BTC for fear of embarrassment and industry shunning.

...And yet, the number one question asked of financial advisors in 2017 was regarding Bitcoin.  

If “smart money” and institutions DID go into BTC, widening the pool of retail investors willing to follow, the blow-off would have been orders of magnitude larger.

Does that mean we should expect another leg up?  ...Probably not for BTC.  But when another crypto comes out that has the blessing of the smart and institutional money, look out!  

I've been considering this myself, I do think this is something worth exploring on here or on another relevant topic such as Adam's Crypto Carnage post...

I've just posted 2 charts on there for Crypto Total Market Cap showing a six month run up to their respective blow off tops in 2013 when it went up 16x to its peak, this time in a six month period it went up 8x to $800B.

How confidentially can we all agree and state that the Crypto market is dead forever, that it will quietly go away and wither and not go over a total market cap of $800B by the end of this year?

I'm not stating my case either way, just keen to hear thoughts and reasoning from others, there's new developments on the horizon that could easily increase the value of some of the good major coins and tokens.

My post with the chart comparison is here...

https://www.peakprosperity.com/comment/213464#comment-213464

New_Life's picture
New_Life
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Posts: 257
2018 Crypto Forecasts

1 Trillion Market Cap forecast for 2018.

https://cointelegraph.com/news/crypto-experts-predict-2018-bull-run-bitcoin-to-50k-overall-market-cap-to-1-trln

I have also seen forecasts suggesting Market Cap to increase by 25% to back above $500B by March.

Bytesmiths's picture
Bytesmiths
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Posts: 201
Snydeman wrote: anyone
Snydeman wrote:

anyone holding Treasury bonds of a lower yield can either hold that paper to maturity (and lose out on current higher yields), or sell those bonds…

I'm not certain if this holds for T-bills, but with munis, they can "call" the bond if they can float a replacement at a lower rate.

I recall holding some 5% munis, thinking, "Woa, I'll hold these 'til I die!" Then, one day, I saw a pile of cash unexpectly arrive in my bank account — the face value of bonds that were presently worth at least a 15% premium!

"Wha hoppen?" I cried, as I replaced them with bonds paying only 3.5%, losing both the 15% differential I would have had if I had sold them on the market, and the 1.5% extra income I'd been enjoying.

New_Life's picture
New_Life
Status: Gold Member (Offline)
Joined: Apr 18 2011
Posts: 257
Bubble still bursting
New_Life wrote:

1 Trillion Market Cap forecast for 2018.

https://cointelegraph.com/news/crypto-experts-predict-2018-bull-run-bitcoin-to-50k-overall-market-cap-to-1-trln

I have also seen forecasts suggesting Market Cap to increase by 25% to back above $500B by March.

Market Cap already north of $500B...

BTC still on a downtrend, but trying very hard to get bullish again, especially if it makes past $12,777 for a few days..  Regardless how it performs in the next month or two, I'm fairly sure it will remain a hot topic on here and elsewhere for the remainder of the year. 

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