Market Goes ‘Full Bitcoin’
What the “heck” was that?
This past week seemed to be the story of Christmas coming early. Earlier this week the markets surged higher on hopes that “Ole’ St. Tax Cuts” would soon be here. But that dream seemed to be short-lived on Friday, at least at the open, as General Mike Flynn seems to embody the “Grinch” trying to steal Christmas.
But at the end of it all, not much actually changed. Well, except for the fact that volatility not only made an appearance as stock prices swung wildly in both directions, but also in Treasury rates. As expectations of tax reform grew, rates spiked higher but then sank just as quickly as fears of turmoil in the Administration sent money into the safety of bonds.
As shown above, despite all of the “sound of fury” the S&P advanced 1.53% for the week while rates, not surprisingly as money rotated from “safety” to “risk,” ticked up from 2.3% to 2.4%. However, while volatility finished week only up mildly, intra-week we saw volatility jump to nearly 15 before settling back at 11.
The sharp advance, as the market went all “bitcoin,” pushed well into 3-standard deviation territory above the longer-term moving average with overbought conditions pushing extremes. While the backdrop remains decidedly bullish, the sharp moved higher has all the earmarks of an exhaustion move which suggests some profit-taking cool things off over the next couple of weeks.
While the market is extremely overbought, the bullish trends remain intact. Furthermore, the month of December tends to bullish for equities which keeps portfolios allocated towards equity risk currently.
With the tax bill now out of the Senate, the real work begins as the House bill and Senate bill will go to conference to work out the rather substantial differences between the two bills. With neither bill even remotely approaching a “fiscally conservative” that will actually lead to stronger economic or reduced debts and deficits, it is a huge windfall for corporations.
This, of course, raises the question as to how much of the “tax cuts” are already priced into the markets.
One thing to be cautious of is the possibility this could well be a “buy the rumor, sell the news” event as we move into the New Year. As I stated last week, I see two potential outcomes:
- A tax bill clears Congress reducing taxes which leads to tax-related selling by money manager to lock in gains at a lower tax rate that will not have to be paid until 2019, or;
- The tax bill fails, a still likely scenario, which leads to tax-related selling by money manager to lock in gains on which taxes will not have to be paid until 2019,
Let me repeat from the last newsletter:
“As I see how December plays out, I will be seriously looking at adding a short-hedge to portfolios before year end. I will keep you apprised.”
This weekend, I am traveling to Florida to give a presentation on the markets and will be joined by some of my friends like Chris Martenson and Nomi Prins. It promises to be fun and I will fill you in on any great insights next week.
The Bitcoin Ramp – Is It Sustainable?
by Michael Lebowitz, CFA
The explosive rise of Bitcoin (BTC) has taken the investing world by storm, and for good reason. Over the past six months alone BTC has quadrupled in value. Since 2012, it has risen over 200,000%. To put that into context, had one invested 10k in 2012 they would be worth over $20 million today. The graph below shows the meteoric rise.
There are predominantly two camps with strong opinions on what the future holds for BTC. One generally believes it to be the currency of the future while the second camp thinks BTC is another financial bubble. Given BTC’s increasing popularity we thought it would be helpful to present these two competing perspectives and then offer our own assessment.
Believers in BTC claim it is quickly becoming a widely accepted global currency. To better understand their view let’s see how BTC meets the definition of a currency, both as a means of transacting (money) as well as a store of value.
Money: money is anything that two parties can agree is acceptable in exchange for goods and services. For example, if I pay you a case of beer to mow my lawn, the beer, in this instance, is money. However, for “money” to be widely accepted, the masses must ascribe similar value to it. While there is an increasing number of vendors accepting BTC, it is nearly impossible to use BTC to meet your everyday needs. Further, the value, or price of money, needs to be relatively stable to be effective. If a dollar bill bought you a case of beer today, but only a single bottle tomorrow and a keg the following week, few consumer or vendors would trust the dollar’s value. BTC’s value can fluctuate 5-10% on an hourly basis
Store of value: a store of value is something that allows one to save money and retain its value. When we save money we want comfort in knowing the money we earned can buy us the same amount of goods and services tomorrow that it can buy today. Again, the extreme volatility of the price of BTC makes it difficult to project how much purchasing power a BTC will buy you in the future. All currencies fluctuate but typically nowhere near the degree we are witnessing in BTC.
If the extreme price movements of BTC subside it is possible that BTC can serve as a widely accepted currency and the believers could be correct.
A second camp believes BTC is a financial bubble. The chart below compares BTC to other recent investment fads.
You will notice in all instances above the bubbles rise steadily in price before transitioning to an exponential increase prior to collapse. Often, in the so-called euphoric phase, prices go well beyond the point most investors think is reasonable. In this respect, BTC is following the path of prior bubbles.
Bubbles are not solely defined by price movements, but more importantly by a lack of supporting fundamental value. If you subscribe to the value of BTC as does the first camp, the rapid increase in price may well be justified. If you believe there is no value, BTC is showing the classic pattern of most bubbles.
We believe BTC can rise even further from current levels. That said, we question whether it has any meaningful fundamental value. In the textbook on sound investing, Security Analysis, Benjamin Graham, and David Dodd define investing as follows:
“An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.”
Based on this very clear definition of terms, there is no way to classify BTC as anything other than speculation. Furthermore, while we agree with those in camp one that BTC might one day be universally accepted as money and a reliable store of value, we have one major problem with which to contend.
To help you grasp our issue, consider that an investor who bought Bitcoin a few years ago and sold it today would have accumulated a remarkable gain. Even better, unlike a capital gain on stocks, bonds, real estate and all other financial assets, that profit is tax-free.
Now ask yourself, how long will the government allow investors to avoid paying taxes on gains in BTC? Further, will the U.S. government, or any other government, cede control of its currency and ultimately the economy? We expand on this concept below from a primer we wrote on cryptocurrencies- Salt, Wampum, Benjamins – Is Bitcoin next?
The preamble to the U.S. Constitution states the purpose of the Federal government is to:
“…form a more perfect union, establish justice, insure domestic tranquility, provide for the common defense, promote the general welfare, and secure the blessings of liberty to ourselves and our posterity.”
In other words, the government’s role is to protect the freedoms and liberties of its citizens. If the government has no ability to fund itself and is unable to provide defense and law enforcement it cannot uphold the Constitution. More precisely – the sovereignty of any nation, regardless of its form of government, rests upon the strength and integrity of its currency.
There may still be gains ahead for BTC, but the volatility of its price and still low adoption as a means of transacting pose obvious problems. The bigger risk, however, is given government incentives to impose taxes on the public and manage economic activity, the speculative value currently being ascribed to BTC does not seem durable and is therefore unlikely to survive.
Here’s What Works For Me
by Doug Kass
“And I said to myself, ‘This is the business we have chosen.’” –Hyman Roth, “The Godfather”
To me, stock price deception is seen with more frequency today than in any time in modern investment history.
Our markets, influenced by massive central bank liquidity and dominated by passive strategies (ETFs, risk parity, and volatility trending), not only are inhibiting price discovery but also are artificially influencing price action — “buyers live higher and sellers live lower” — to both the upside and downside.
In some measure, this is reducing the authenticity and validity of stock prices and charts and is hurting the value of technical analysis, which may be basing its decisions, in part, on artificial patterns/prices/data. On the other hand, it benefits those who view the market without emotion and who are willing to buy extreme weakness and sell extreme strength.
Yesterday underscored the reasons why and how I look at stocks. I would emphasize, again, that I do not have a concession on the process and I recognize that others have different approaches that provide good investment returns.
But I have a logic in my approach and Wednesday’s bifurcated action and its selective and often extreme volatility underscores some of these principles that I have adopted over the last four decades and provides some additional lessons:
* Avoid Volatile and Unpredictable Stocks — It’s Gambling: In the last two days, Riot Blockchain Inc. (RIOT) has had a range from about $12 to $25. There has been no news to account for that volatility and random action.Other collateral bitcoin plays such as Social Reality Inc. (SRAX) and Xunlei Ltd. (XNET) have had similarly large trading ranges. No specific company news there, either. Given my risk profile, I never will trade in these stocks. Others believe differently and believe they successfully can skate on this thin ice, but I will stick to my risk appetite, and I believe all but a few professionals may be kidding themselves in rationalizing these stocks “tradeability.” This also explains my reluctance to trade bitcoin, which had a trading range yesterday of $9,290 to $11,377 — again, on no news.
* No Matter What the Charts Say, I Prefer to View Every Trade/Investment Based on an Assessment of Reward vs. Risk — Seize Those Opportunities: The dynamic of an upside/downside calculation and determining discounts or premiums to intrinsic value form the basis for my trading and investment decisions. Recently, I successfully traded two retail stocks, Macy’s Inc. (M) and Dillard’s Inc. (DDS) , on this basis. Consider Twitter Inc. (TWTR) , which at $22 a share looked technically solid. Nevertheless, I sold off a large portion of my position between $22 and $22.50 recently based on an assessment of a less-favorable upside/downside ratio. Others bought based on an improving chart. Both I and they are likely comfortable with our decisions, but the purpose of this missive is to further explain my tenets and methodology.
* There Are Many Great Charts That Lie at the Bottom of the Sea: Though one or two days don’t make a market, the artificiality of the markets may be underscored by two stocks yesterday — Micron Technology Inc. (MU) and Square Inc. (SQ) . Both recently looked fantastic technically. Embraced by many a talking head in the business media, both have been schmeissed in recent sessions. Like the Nasdaq 100 ((QQQ) was down $3 yesterday), they all looked good on the charts until they didn’t, and all provided little indication to prepare traders for the reversals. At times like these, it is increasingly dangerous to buy stocks on breakouts. Buying calls on these stocks moves one further to the end of the risk curve. This strategy may work well for some time in a trending market, but a swift directional change can evaporate profits and eviscerate a portfolio. Again, such a strategy should be limited to professionals, and even that body of traders may suffer from a steady diet of options activity, as academic studies show.
* Do Not Underestimate the Impact of Price Momentum Strategies on Individual Stocks and Sectors: Over the last month, technology, especially of a FANG kind, has soared and other areas such as retail have collapsed. The possible artificiality of both moves was evident in the reversals this week and yesterday. Amazon.com Inc. (AMZN) , as an example, was down by more than $45 on no news yesterday. Retail stocks such as M and DDS rose by 10% on Wednesday and 20% in the last week, also on no news. This may underscore (1) the reduced value of analyzing stocks on price technically, and (2) that opportunities are provided for those who are emotionless and have a sense of intrinsic values and legitimate upside/downside calculations.
* A Diversified Portfolio Is a Preferable Course: Jim “El Capitan” Cramer detailed the value of this approach late yesterday in a well-thought-out column, “‘Am I Diversified?’ May Be Boring, but It Can Help Avoid the Pain.” Please reread it. As a matter of course, and as most are now aware, I keep my individual stock positions as a low percentage of my total overall portfolio and often have 40 to 50 portfolio names. I am always diversified in position size (typically at about 2% to 3% each) and in sector exposure (limited to 15% of the portfolio). Recognize that when a trader or investor is only buying “good” charts, that is not being diversified. Rather, it is part of a process that leads to a binary outcome that may end badly given the likely artificiality of prices.
The artificiality of stock prices has accelerated in recent years with the domination of passive investment strategies.
I will not trade/invest in stocks solely on the basis that they “look good” on the charts in this sort of setting, which is dominated by influences that create an under-appreciated degree of price deception.
For these reasons and others I will not buy breakouts and sell breakdowns; this may be the wrong approach in the environment we are now in.
Rather, an approach to buying value and breakdowns and selling seemingly irrationally based prices and breakouts is my investment cup of tea based on the fundamental and dynamic assessment of intrinsic values relative to the current prices.
Others disagree and I respect their ability to navigate differently. I am not taking a shot at their approaches; rather, I am saying what serves me well and what may serve the majority of conservative risk-based investors and traders well.
This is how I am handling the markets these days, and, frankly, will forever.
And … buckle up.