A Permanent Plateau: Crypto Bubbles

Tom Macpherson

 

You think your facts are more valuable than my feelings. I’m tired of being told facts. Sometimes facts just don’t matter. Sometimes facts are not facts”.

  • Bobbie Sanders, (Inaugural Attendee)

One attendee said, “I think stock picking abilities are overrated. I’ve beaten the stock market for something like 6 years in a row. People in index funds are driving a VW while I’m in a Porsche”. When asked how his returns fared versus the S&P500 Index, the investor said he really didn’t track numbers like that.

  • Shaun Rodriguez

The view from the top of bull markets is remarkably like that from the top of the Matterhorn. What begins in a slow ascent at the base becomes a near vertical cliff for the last quarter. Sitting at the apex one might be inclined to puff up a little bit about one’s climbing abilities. One things climbers will tell you on a regular basis is that disaster usually happens when you lose that sense of risk. Studies show that 60-70% of accidents happen to climbers on the way down not on the way up. It’s often referred to as “hikers’ letdown”[1]. While the view from the top is great, the danger lies in getting cocky at the height of the climb.

Market Bubbles

I bring all this up because many investors are sitting smugly on top of their own investment Matterhorn – serenely looking down at those numbers that seem so small down below. If we follow our hiker’s advice, now is the time to utilize the most caution and avoid the 1000-foot fall into a market crevasse. Put another way, Ieyasu Tokugawa always said that after a victory one must tighten the helmet strap.

The funny things about market bubbles is that you can’t put your finger on exactly when they start. It’s even difficult to tell if you are in one at a given moment. Knowing you have been in one is a heckuva of a lot clearer. But I would suggest that in the later stages of a bubble there are some events that take place that really aren’t seen in less exuberant times. For instance:

  • At the height of the Japanese asset bubble in 1989, the value of the land underneath the Imperial Palace in Tokyo (roughly 280 acres) was worth the same as the entire acreage of California (roughly 100,000,000 acres).
  • Near the height of the technology bubble in 1999, there were 457 IPOs of which nearly 80% were technology companies. Of those, 117 doubled in price on their first day of trading.
  • In 1999, thirty of the top 50 stocks (by market size) on the Nasdaq exchange had prices that reflected estimated growth to be 35% for the next 50 years.
  • Three weeks before the crash of 1929, Yale economist Irving Fisher proclaimed that “stock prices have reached what looks like a permanently high plateau.”

Cryptocurrencies: The Symptom or the Disease?

We all generally look back and wonder how we couldn’t see the bubble at the time. With 20/20 hindsight it looks so obvious. But we shouldn’t be so smug as to think we can’t be fooled again. Take a look at some recent news surrounding cryptocurrencies.

  • Ripple (which owns XRP, a digital currency) rose to nearly $4 per share. This made its majority shareholder and CEO Chris Larsen’s net worth jump to roughly $60 billion, placing him number four on the Forbes list of the 500 richest Americans. The vast majority of this wealth has been generated over a period of roughly 180 days.
  • SkyPeople Juice International, a company that makes – wait for it, juice – renamed itself Future Fintech Group and saw its stock jump by 280%.
  • Not to be outdone, Long Island Ice Tea company changed its name to Long Blockchain and saw its share price jump by 600%. More than 15 million shares changed hands the day the name change was announced, compared with average daily volume of about 170,00 shares over the prior three months.
  • CNBC reports an ever-increasing number of people are utilizing debt to purchase cryptocurrencies. In an interview Josh Fairfield says “People are maxing out their credit cards because they think it’s going to make them a lot of money,” said Fairfield. “They’ve been right enough that people are now making ever more risky investments in cryptocurrencies.”
  • Software developer Rishab Hegde launched a cryptocurrency he called Ponzicoin. The company described its offering as “the world’s first legitimate Ponzi scheme” and encouraged people to buy and then “shill this coin heavily to your family and friends like a fucking sociopath”. Owners of the company had to shut the site down after “things got crazy out of hand”.

Watching the cryptocurrency craze sweep over Wall Street, Ben Carson wrote on his wonderful blog A Wealth of Common Sense, “Hundreds of billions of dollars in a currency have been created basically out of thin air over the past few months. This doesn’t seem normal.”

 Indeed. It definitely doesn’t seem normal. Most of the aforementioned events lead me believe there is a great deal more speculation than investing in cryptocurrencies. But I’m not sure it stops there. With the major indices trading (by some measures) at levels not seen since the mid-1920s, one has to think long and hard whether stocks are currently in a bubble or not.  Only one thing is certain: A surfeit of confidence creates bubbles, and the sudden loss of confidence pricks them – where the bubbles are in cryptocurrencies, stocks, or tulip bulbs. David Preiser says “Until 2008, people thought debt problems were confined to specific sectors. But when the bubble burst, ­trouble popped up in unexpected areas.” Financial complexity brings prosperity but also increased fragility. Since the Lehman collapse it’s been a long and slow recovery. But the underlying problem remains: The entire edifice is built on confidence, and that can evaporate pretty quickly. The next global crisis will stem from failure of confidence somewhere.” The recent drop in Bitcoin values would suggest many investors have lost confidence in their cyber-coin investments.

Conclusions

When I began writing this article, the town of Zermatt at the base of the Matterhorn was attempting to evacuate 13,000 tourists. The mountain received nearly 12 feet of snow in a matter of days triggering avalanche warnings. The obvious fear was the town would be swept away in an extraordinarily large avalanche. Thankfully it didn’t happen, but that didn’t mean officials didn’t take it seriously and prepare for the worst. If you are sitting atop your own investing Matterhorn be prepared for a bumpy descent down. Remember climbers die on the way down not the way up. Ask any investor in technology stocks in 2000-2002 or financial stocks in 2007-2009 and most remember the ride down not the ride up. It is truly time to tighten the helmet strap.

As always I look forward to your thoughts and comments.

Tom Macpherson

Tom Macpherson is a portfolio manager at Dorfman Value Investments LLC

[1] For a fascinating analysis on why descending Everest is far more dangerous than ascending see https://blogs.scientificamerican.com/news-blog/death-on-mount-everest-the-perils-o-2008-12-10/

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