Stocks Are Boring. The Triple Digit Returns Are In Bitcoin...?
If you experienced the housing market bubble 12 years ago or the tech bubble in the late 1990s, you’ll see similarities with bitcoin. I’ve seen speculators claim buying stocks to get an 8% return is silly when you can get higher returns and be part of the crypto ‘movement.’ The fact that an investment is considered a movement is a telltale sign this bubble has taken on a new life. The interesting psychological aspect of this is the trader who says he wants to be a part of the movement knows that you aren’t supposed to fall in love with an investment, but is doing it anyway. That’s why the important disciplines are tough to follow unless you’ve experienced bubbles pop yourself. Just like you can’t learn how to swim by reading about it, you can’t read about disciplines and become a great investor. The only way to become skeptical instead of giving in to FOMO is getting burned by following the crowd off the cliff.
I hate to show the chart below, which compares bitcoin to the tulip bubble in the 1600s, because I think bitcoin represents the start of a technological revolution and tulips are just flowers. The value of tulips went up 20 fold in one month in the 1600s. Bitcoin was slightly under $1,000 at the start of the year and now it’s at $16,500. It’s not certain if bitcoin has any value at all. Just like any other currency, it’s impossible to value. My only basis for saying bitcoin is a bubble that will likely have over a 50% crash after this speculation craze ends is the psychology of the speculators getting involved. They don’t know anything about cryptocurrencies. All they know is the price is going up. It’s amazing to see people get bored of the stock market when this has been a great year. Amazon’s 55% return this year just isn’t interesting enough for speculators seeking the rush that comes with betting.
Value It Based On Transactions?
The only real valuation techniques I see with bitcoin is comparing the price to the number of users or transactions. The chart below shows the price has increased faster than the number of transactions. The reality is this isn’t a great way to measure bitcoin because people are only making more transactions and getting involved with bitcoin because the price is increasing. If everything is reliant on price momentum, then this is a house of cards. For the past few years up until the beginning of this year, I used to do fundamental analysis on bitcoin, but now that doesn’t matter because it is a textbook bubble. The price momentum is fed off speculators telling other potential speculators to get involved because they are making so much money. This bubble has the potential to become massive because most people who have been in the crypto space are used to 20% declines. Most speculators won’t sell after it starts to fall; they will buy the dip. There needs to be enough people who need to take profits because the gains have gotten too high to justify taking more risk to cause the pyramid to implode.
The current market cap of all the cryptocurrencies is $450 billion. I mentioned a couple weeks ago how if the top 100 coins went to 0, it would be like a 1-2% drop in the S&P 500. Obviously, that’s not a big deal. I mentioned that if they rallied more, it would become a big deal. It’s starting to become a big deal as it rallies to amazing levels. I don’t have any additional statistical analysis to give, but you’d have to expect if it went to $1 trillion and then crashed that there would be some systemic issues especially after futures trading starts. If I was concerned about the systemic effects, I’d want it to crash soon because the bigger it gets, the bigger the negative impact will be after it crashes.
Stocks Haven’t Fallen In A While
Thursday was another solid day for the stock market. The S&P 500 was up 0.29% and the Russell 2000 was up 0.77%. The VIX was down 7.8% to 10.16. The action today is typical of a trading day in 2017. It’s amazing how so many records aren’t appealing to crypto speculators. They are enamored by the double digit gains which occur in minutes in alt coins. The S&P 500 streak without a correction has continued as the tax cut likely being passed means there aren’t any negative catalysts for the market left this year. The spending bill was also extended for a couple of weeks, kicking the can down the road. Ever since I named the few potential negatives facing the market in the next few months back in August, everything has gone in favor of the market. In fact, not much has gone wrong in the past 350 trading days. As you can see from the chart below, this is the third longest streak without a 5% correction in the S&P 500 since 1960. In a couple of weeks, it will be the longest without a 3% and 5% fall.
Obvious risks that jump out at me for the next 6 months are inflation picking up and tough earnings comparables. I don’t know if a weak year over year comparison is enough to cause a correction, but it should slow the rally down. Inflation would be welcomed at first, but then quickly disdained if it got to near 3%.
Conclusion
The excessive speculation in bitcoin and the alt coins is dominating the financial media. The stock market has had the 2nd quietest year ever and we’re approaching a seasonally quiet time. CNBC added a bitcoin ticker on the screen. This is anecdotal evidence that the crypto space is in a euphoric mode. The financial networks barely covered bitcoin before this year other than to discuss the illegal activity occurring through its use. Now that viewers are interested because it is going up fast, they are covering it.