Bitcoin Is Skyrocketing
The biggest story of the day, which was on most investors’ minds, was the rally in bitcoin. The fact that this was such a major story even though most people in finance don’t have a large stake in the currency shows how remarkable the rally has been. As you can see from the chart below, bitcoin has rallied from $8,000 to near $10,000 in a few days. The cryptocurrency space now has a $300 billion market cap. If you were to have an equal weight portfolio with 60% stocks and 40% bonds, where cryptocurrencies were a percentage of your equity portfolio based on their market cap, the weighting of the whole industry in a diversified portfolio would be less than 1%. It’s interesting to see how such vociferous debate is occurring on something that is a small fish in the big currency sea. The reasons for such heated debate are the following: many speculators have a large portion of their portfolio in the space, many investors have sharply divergent views on the industry (some think the cryptocurrencies will go to zero and some think they can’t go down), and crypto industry experts claim these currencies will completely replace traditional finance.
Because bitcoin and the other cryptocurrencies like ethereum have had such a quick rally, there is an expectation that the speculation will cool off, potentially leading to a crash in the prices. This makes some wonder what the domino effects could be if a crash occurs. If all the top 100 cryptocurrencies went to zero, it would be the same as a 1.3% drop in the S&P 500. This means the industry still likely isn’t big enough to cause any aftereffects if it crashes. If it continues to rise exponentially, it can start to become big enough where domino effects will occur in the event of a crash. The fact that it is still small, might imply there is more room to run in the next few months. $300 billion is smaller than some of the bigger tech companies that saw exponential increases in their stock prices in the 1990s. The 1990s tech bubble is the best comparison to this situation as euphoria starts to reach illogical levels. Personally, I wasn’t involved in finance in the 1990s, but what most finance professionals can tell you now is that they are fielding questions about the crypto space from friends and family who aren’t in the industry. That’s a telltale sign a bubble is forming.
In terms of fundamental analysis, the speculation in bitcoin is bringing more people into the industry which is good. Talent flows to money; developers are incentivized to improve the system because a lot of their wealth has become tied up in the crypto space as the price has appreciated rapidly. On the other hand, if speculators are trading or holding the cryptocurrencies instead of spending them, that defeats the purpose of them being currencies. Being used as currencies and as protection against fiat value declines are more sustainable reasons to have the currency than pure speculation. When the price crashes, a lot of the interest will wane especially from retail investors. Personally, I know people who have invested in bitcoin without knowing what it is. This type of awareness isn’t viable. It would be great to see people learning about it before putting money to work, but the rapid price appreciation gives speculators a sense of urgency which doesn’t allow them to read about it for a few months before dipping their toe in the water.
Q4 Earnings Look Great
I discussed the latest earnings update in my last article, but didn’t mention all the details. As you can see from the chart below, the earnings estimates for Q4 have been steady which is good news as this is the time in the quarter they usually fall. According to FactSet, Q4 earnings are expected to grow 10.0% and revenues are expected to grow 6.3%. Now let’s look at some of the numbers from S&P Dow Jones. The latest blended estimate for operating margins is 10.22% which would be a record. 97.43% of firms have reported earnings with 72.15% beating estimates and only 19.51% of firms missing them. This will be a quarterly record for as reported earnings and operating earnings. The trailing 12 month S&P 500 as reported earnings are $107.23 which means the PE ratio of the market is 24.26. The Shiller PE of the market is 31.56 which means it is coming very close to the peak of the 1920s bubble. 66.5% of firms have beat their sales estimates. Sales were up 6.00% year over year and were up 2.43% quarter over quarter. I stated a few months ago that this quarter would need to have impressive sales results to keep up the earnings growth pace. If it wasn’t for the hurricanes, the overall results would have been consistent with the first half of the year.
Financial Conditions Are Very Easy
As we wind down the year, one of the aspects I will be focused on into next year is the inflation rate. If it continues to accelerate higher, the Fed will be forced to raise rates more than twice next year. The final increase of this year will occur in 15 days. Even with two rate hikes this year and a third being priced in, the financial conditions have eased as you can see in the chart below. With the yield curve getting closer to showing an inversion and the Fed continuing to raise rates next year, I’ll be looking to see if the financial conditions begin to show cracks. While I’m not expecting a recession next year, I do expect some weakness in the financial conditions which could squeeze economic growth. Bringing this article full circle, one of the reasons why I think the cryptocurrencies have risen so much this year is because of the excess liquidity in the system brought about by the fact that financial conditions have been very easy. It will be interesting to see if bitcoin and the alt-currencies start to correct when the financial conditions show stress.
