Are cryptocurrencies an investable asset?

Are cryptocurrencies an investable asset?

In a year full of remarkable financial events, there are few issues as remarkable, and divisive, as cryptocurrencies. After peaking in April this year at a collective market capitalisation of almost US$2.5 trillion, or about 1 per cent of the world’s investable assets, global cryptocurrencies have dropped 40 per cent, to about US$1.5 trillion. Bitcoin, which accounts for almost half that total, has fallen 45 per cent from its recent highs, but that’s after rising nine-fold in the 12 months before.

It is perhaps that volatility that inspires such strong feelings among those who see cryptocurrencies as a new and legitimate asset class and those who see it as not much more than thin air with a price tag. Berkshire Hathaway Vice Chairman, Charlie Munger, described bitcoin as “disgusting and contrary to the interests of civilization”, while fellow investing legend, Stanley Druckenmiller, bought some last year.

Recently Finance Services Minister, Jane Hume, proclaimed, “I would like to make something clear: cryptocurrency is not a fad. It is an asset class that will grow in importance.” That brought critics of the unregulated crypto marketing industry out swinging, pointing out there are currently more than 5,000 cryptocurrencies in circulation and a new one can be created in 15 minutes. Of itself, that is really no different to being able to list a new mining exploration company in a few weeks; the timeline is different, but the speculative element is identical.

Whether cryptocurrencies are an investable asset class and whether they belong in a portfolio are two very different questions. The usual criticism of crypto as an asset class is that it’s impossible to value because there are no earnings or dividends to model, but gold and other commodities are no different. Dan Morehead, co-CIO of US crypto fund manager Pantera Capital, points out no fiat currency can be valued either, yet relative values are determined through trading every day.

Morehead’s take on crypto is interesting. While he concedes probably the bulk of bitcoin investors are simply speculators and much of the balance are libertarians convinced of the debasement of fiat currencies, he argues it has definite utility that is steadily becoming more apparent. He sees the internet as having revolutionised countless major industries worldwide, but finance has yet to be fully disrupted. Bitcoin is simply another internet protocol for moving data around, providing the means to send money anywhere in the world instantly and for no cost. After only 10 years it’s still very early days for bitcoin, which exacerbates volatility, but as the number of users increases, he expects that volatility to settle.

Pantera has analysed the growth of bitcoin’s price and user base since its inception in the GFC and concluded there has been a remarkable consistency: both have increased, in lockstep, by five orders of magnitude since 2010, (there was one point where they diverged due to price volatility, but they caught up again 15 months later).

It works out at a US$200 increase for every million new users (exactly how they calculate ‘new users’ is unclear). Based on that, they have calculated a long-term trend, which has proven impressively accurate, albeit with that sometimes gut-wrenching volatility.

Are cryptocurrencies an investable asset chart

In an exercise that is either astonishing or one hell of a fluke, on 15 April 2020, when bitcoin was trading at US$8,988, Pantera used its mathematical model to forecast the bitcoin price month by month out to August 2021. The 12-month forecast, for 15 April 2021, was US$62,968, which required an increase of 601 per cent. The actual price ended up at US63,237, a variance of only 0.4 per cent. Then that volatility struck again, sending the May price 37 per cent below the forecast.

Morehead remains convinced the price will, once again, catch up. He argues investing 1 per cent of your portfolio in cryptocurrencies means you’re in the game if they eventually account for 5 per cent of global investable assets, and if they go to zero, it shouldn’t have hurt too much.

Asset allocation consultant, Tim Farrelly, says that since bitcoin is investable, it qualifies as an asset class. However, until he’s convinced you can get a meaningful forecast for its price and relationship to other assets, there’s no chance it will be included in his portfolios. “Do I see it like gold? I’m prepared to give a nod to 2,000 years of history that gold isn’t going away. I’m not so sure bitcoin will stack up in the same way. I wouldn’t be surprised if in 10 years’ time everyone says ‘what were we thinking?’”

The Post-Pandemic Boom

The Post-Pandemic Boom

    2021 is shaping up to be a year of strong economic growth, and, right now, the indicators are looking good for financial markets as well.

Australia

    • The government response to the COVID shutdowns  was swift and big. In total, the federal government is spending $272 billion, equivalent to 14% of GDP, and the states $122 billion. All that newly created money has to go nowhere.
    • Early on, households saved a lot of the extra cash. The June quarter savings rate hit 19.8%, 8x higher than the year before and only 0.5% below the 60-year peak set in 1974. The Commonwealth Bank estimates households will have about $100 billion of savings, or 5% of GDP, that has been accrued between the start of COVID and December.
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      • To that you can add $34 billion of super withdrawals so far, with Treasury estimating an eventual total of $44 billion.
      • After a record plunge to 76 in April, consumer confidence has now had 11 consecutive weekly gains to 108.
      • It now appears Australians are spending those gains. Commonwealth Bank reported credit card spending jumped 11% year on year in mid-November. Restaurants in New South Wales enjoyed seated dining numbers 55% higher than a year ago, while Queensland was a whopping 79% and even shellshocked Victoria was up 54%
      • Retailers have seen record spending in the Black Friday sales, prompting Gerry Harvey to say, “This is like the greatest boom I’ve ever seen in my lifetime”.

US

      • The US fiscal package injected 13% of GDP and pushed the personal savings rate to almost double what it was at the start of the year.
      • Low interest rates have ignited the US housing market, where prices are now 10% above the pre-GFC levels. Homeowners’ equity is at a record high and the increase in the pending sales index is parabolic.
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      • More than 80% of stocks in the S&P 500 are trading above their 200-day moving average, a sign of positive market breadth that has only been seen twice in the past 20 years.
      • We are seeing 52-week highs in share markets across the world, from China, to Japan, to Europe, to Australia.
      • Global equities have seen a record inflow post the COVID vaccine announcements.
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While the indicators are stacking up well, there are, of course, no guarantees that markets will play ball and they sure do have a way of wrong-footing us. However, it’s noteworthy that nothing in the economy was ‘broken’ going into the pandemic downturn; there was no particular sector on the cusp of being crushed by excessive debt and while valuations were not cheap, they were certainly defensible.

Now is not the time to be sitting on lots of cash.

Micro bubbles

Micro bubbles

After my first ride in a Tesla, climbing back into my diesel car felt very much like I’d gone back in time – noisy, slow, and those fiendish fumes coming out of the exhaust. I only know a few Tesla owners, but they all swear by them and claim they will never go back to an internal combustion driven car.

I don’t think there’s any doubt Tesla is at the forefront of an inexorable change in the auto industry, and that we are on the way to a car market dominated by electric vehicles. What I am far less certain about, is whether the seven-fold increase in the share price over the past nine months, which includes a 50% jump in the past five weeks, makes sense.

Chart 1: Tesla’s share price has risen 7x in 9 months
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I make absolutely no claim to any expertise about Tesla as an investment, and if you own the shares I’m sure as hell not suggesting you should sell them. What I am wary about, though, is that there are pockets of the share market, in particular the tech-heavy NASDAQ index, that appear stretched at the moment, to the point where you could say they have the whiff of bubble about them. To be clear, by no means the whole of the market – it’s like there are micro bubbles.

I certainly don’t think it’s reminiscent of the dotcom bubble that popped so spectacularly in early 2000, when the NASDAQ index fell 78% between March 2000 and October 2002, the biggest tech companies are reporting phenomenal earnings and sales growth that are clearly backing their astonishing performance. However, there’s no shortage of bears among the commentariat, and I recently listened to a conversation between two US-based bloggers whom I respect, because they are generally level headed and not prone to hyperbole, where they straight up called the book going on in parts of the NASDAQ a bubble,

Here are a few of the things that have caught my eye:

  • In the US there are a few online trading firms that charge zero brokerage, and they have apparently ignited a retail (as in private investors) trading boom. In its earnings report last week, TD Ameritrade reported average client trades per day had risen to 3.4 million during the June quarter, a 65% increase on the March quarter, and more than three times higher than a year ago. Its top 15 trading days had all happened in the June quarter and 10 of those were in the month of June.
  • Probably the best known of the free trading platforms is Robinhood. It has gone from 1 million users in 2016 to now 10 million, more than half of all accounts are opened by first time investors and its median customer age is 31. It too has seen trading activity triple in 12 months, with reports abounding about young investors punting their COVID stimulus cheques, and others drawn to the stock market through boredom because casinos were closed and sports betting has all but stopped.
  • Robinhood investors are becoming recognised for chasing fads. A recent example is Eastman Kodak, which announced it had been given a $765 million loan from the government to produce pharmaceutical components, and 60,000 account holders bought into the stock on a single day in which the price soared as much as 500%, having already risen 200% the day before. The shares were up 1,430% over the week.
Chart 2: Shares in Kodak jumped more than 1,400% in a week after Robinhood investors piled in
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  • As an indicator of the level of retail trading activity, trading volumes on the NASDAQ compared to the New York Stock Exchange (NYSE) have recently rocketed.
Chart 3: trading volumes on the NASDAQ compared to the NYSE have rocketed
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  • Michael Batnick, one of those US bloggers, points out there are 170 names in the Russell 1000 index that are up by 100% or more from their March bottom. Some of those include:

Wayfair, 835%
Tesla, 326%
Wendy’s, 211%
Docusign, 194%
Zillow, 165%
Chipotle, 144%
Roku, 140%
Beyond Meat, 140%
GrubHub, 130%
Zoom, 124%

  • It’s not all just retail investors punting individual stocks, inflows to tech sector ETFs and managed funds has also exploded higher:
Chart 4: tech ETFs and managed funds are seeing huge inflows as well
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  • There are other assets that have been associated with speculative bubbles in the past that are once again attracting punters, such as Bitcoin and gold, which has just hit a new all-time high.
Chart 5: Bitcoin futures have attracted speculators
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Chart 6: gold has just hit a new all-time high (in US$)
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  • Another favourite US blogger of mine, Josh Brown, recently pointed to the re-emergence of Special Purpose Acquisition Companies (SPACs) as a sign of a bubble, or, as he put it, an excess of credulity on the part of investors. A SPAC is where investors hand over money to someone who promises to invest it in an acquisition, but there are no details whatsoever of what they’ll buy, or when. It’s pretty much investing on a wing and a prayer. Just recently one SPAC attracted US$4 billion.
  • Australia, of course, doesn’t have anything like the number of tech companies, but there have been some eye-popping rises among the few we do have. For example, Afterpay has risen 125% so far this calendar year, and Kogan is up 120%. Yes, I get there are strong reasons as to why, and I agree a company like Afterpay looks set to grow its international user base numbers enormously, it’s just how far forward is it reasonable to drag earnings?
Chart 7: Afterpay has risen 125% so far in 2020 alone
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Chart 8: Kogan is up to 120% in 2020
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To reiterate, I don’t include the five tech giants, Facebook, Apple, Microsoft, Amazon and Google, in this. While there is growing consternation that they represent an historically high proportion of the S&P 500 at 22%, they also represent 18% of total earnings, and their earnings are growing way faster than the rest of the market. So while they have seen spectacular rises since the March correction, it is, I believe, much easier to rationalise, especially in an environment of super low interest rates.

I also readily concede the basis of the US dotcom boom of 1999-2000, that the internet would be transformative of how we live and do business, was dead right, it was just wrong about how they should be valued and retail investors ended up getting carried away – and then carted out backwards. This time around it’s again entirely possible the market is right about the impact of electric vehicles, small pharmaceutical companies and other online business models, it’s again a question of what valuation you put on them now, and there are signs some retail investors are once again getting carried away.

As unusual or extreme some of the above stories and examples might be, the thing about a bubble is it can go up a lot higher, and last for a lot longer, than you would ever think possible. Alan Greenspan, who at the time was the Chairman of the US Federal Reserve (their central bank), famously referred to the ‘irrational exuberance’ of the stock market in November 1996, more than three years before it peaked. It’s entirely possible if there is a correction it’s confined to a specific part of the market, leaving the rest of it largely unaffected.

As I said, this is not a suggestion to sell your tech shares, but it is a recommendation to be very careful.

Bubble Trouble Brewing

Bubble Trouble Brewing

This article by Jason Todd, a strategist at Macquarie Wealth, takes a measured look at whether the Australian share market is overvalued, and whether the tech sector is in a bubble.

The bulls versus the bears

When equity markets began to rise back in late March, we had no problem thinking that liquidity would do the ‘heavy lifting’ as long as COVID-19 cases were not still rising and economic expectations were not still falling. It was right to take this stance. Now the equation seems much harder to solve. COVID-19 cases are rising again but markets do not seem particularly concerned even though valuations have expanded by an extraordinary amount. There appears to be two schools of thought emerging to explain the current backdrop.

The first, suggests that markets are becoming irrational and are in the midst of a liquidity-fuelled rally that is fast taking on bubble-like characteristics. This view argues that investors are being driven by the fear of missing out (FOMO), paying an unjustified scarcity premium for earnings growth and that momentum rather than fundamentals matter. 

The alternative view is that markets are pricing in a combination of record low bond yields, an unwavering commitment by policy makers to keep economies and the financial system afloat and the willingness to pay a premium for structural growth. This is pushing valuations higher in areas where COVID-19 has accelerated change such as technology while pushing valuations lower in areas under downward pressure such as traditional retail and property.

It is hard to say which view will ultimately prevail as we think there are elements of truth to both sides. The risk-reward for certain pockets of the market are becoming hard to justify, but in general, we do not see broad signs of “bubble trouble” across equities. Traditional warnings signs such as speculation activity are not broadly evident even if tech valuations are looking troublesome.

Are equities in a bubble?

A ‘bubble’ is defined as a rapid rise in the price of an asset that is not supported by fundamentals. A typical sign of a bubble is a sharp increase in valuations to extreme levels. For the Australian market, valuations are high but outside of a reversion in the drivers supporting risk assets in general, we don’t think they have reached a self-correcting level.

The 12-month forward P/E multiple for the Australian market has risen sharply since 23rd March and now sits at a near-record high of 19.1x. However, the P/E multiple has been boosted by the COVID-19 induced collapse in earnings which we think is not a permanent hit. In addition, the CAPE is only 15.9x. This is well below previous peaks and is below its long run average of 16.6x. So far so good…right?

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Source: Factset, IRESS, MWM Research, July 2020

Is there bubble trouble in pockets of the market?

We do not think Australian equity valuations are anywhere near bubble territory and nor do we think other traditional indicators of bubble-like behaviour are evident. However, we cannot say the same for Australian technology stocks which are now trading on an eye watering 60x forward earnings!

These valuation metrics look even more concerning when only the WAAAX stocks are considered (Wisetech, Afterpay, Appen, Altium and Xero). These 5 stocks have seen prices rise more than 500% over the past 3 years versus the broader ASX200 index which has barely risen above 0% over the same period. This has pushed 12-month forward P/E valuations for WAAAX to a new all-time high of 168x versus a paltry 19x for the ASX200.

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Source: Factset, IRESS, MWM Research, July 2020

Part of the extraordinary price appreciation and valuation re-rating has been due to a much stronger and less cyclical earnings outlook, but it has also been fuelled by record low interest rates which disproportionately benefit high multiple/long earnings duration stocks. In fact, the WAAAX stocks have seen earnings grow 2.5x over the last 3 years – an impressive outcome versus the broader market which has seen earnings decline. However, this has been dwarfed by the near 6-fold increase in share prices over the same period!

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Source: Factset, IRESS, MWM Research, July 2020

To put this in context, the WAAAX stocks have seen earnings increase by A$181m and their market cap expand by a staggering A$41bn. Back in 2017 investors were willing to pay 71 for each $1 of earnings and now these same stocks are commanding 168 for each $1 in earnings. In other words, investors have been willing to ‘pay up’ for the superior earnings performance of WAAAX stocks but at an increasingly higher and higher rate.  

Is there a global growth stock bubble?

The re-rating of growth stocks is not unique to Australia. The WAAAX ‘bubble’ is part of a larger issue relating to the willingness of investors to bid up stocks which have a strong, structural, and/or transparent earnings growth outlook. ‘Growth’ stocks (of which WAAAX is a component) have been fiercely bid up as one of the few sources of structural earnings growth in the Australian market.

In other words, in a world where earnings growth is scarce, any earnings growth has become more valuable. This has also been seen in the recent performance of the FAANG’s (Facebook, Apple, Amazon, Netflix and Alphabet – formerly Google). This collection of stocks has also seen valuations ratios explode in recent years with momentum rising even faster in recent months because of an acceleration in their earnings outlook thanks to COVID-19. 

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Source: Factset, IRESS, MWM Research, July 2020

The other big factor, ultra-low interest rates, has also played a part. All other things equal, a lower discount rate would not only increase the fair value P/E multiple of the market generally but would also increase the dispersion between high and low P/E stocks. However, the current unprecedentedly high P/E dispersion exceeds the extremes seen during the Tech bubble of late 1999/early 2000, which suggests caution may be merited.

What’s the right price for “scarcity” value?

In a world where earnings growth is scare, what is the right price for the rarest of structural earnings stocks like technology, which the market is assuming can access that growth? Is it 50x future earnings, 100x future earnings, an eye watering 168x future earnings or something even higher? Only time will give us the right answer, but we think it is worthwhile trying to determine what conditions would need to prevail in order for these stocks to maintain these multiples (or the alternative – what would need to change for these stocks to suddenly lose their scarcity premium?). Gavekal’s Louis Gave believes there are 4 factors that would drive this reassessment:

  • An improvement in the macroeconomic growth outlook and higher interest rates.
  • Markets stop seeing technology companies as having scarcity value (i.e. government regulation).
  • Another scarce asset becomes popular (i.e. gold? Bitcoin?); and
  • Technology stocks disappoint.

We think equity markets are optimistically priced and waiting for economic fundamentals to catch up, but they are not at an extreme (bonds are even more expensive). Similarly, retail sentiment is bullish but not exuberant, cash levels have come off their highs, but remain exceptionally elevated and capital raisings are still being gobbled up (predominately by institutional and not retail money). On the other hand, there have been some anecdotal signs of rising market ‘madness’ in the US with investors fiercely bidding up bankrupt companies, retail account openings have exploded (in part because many have been stuck at home) and some daily price moves have been extreme.

The technology sector is another kettle of fish. In the US, valuations are high but nothing in comparison to our own WAAAX stocks. On the other hand, there are still few signs of speculative activity stretching more broadly into financial assets and the scale of global (and domestic) liquidity injections is nothing we have seen before. We are not saying that fundamentals don’t matter because in the end they always do, but it is quite possible that the combination of easy money and a slightly better cyclical outlook push multiples for both technology and the broader market even higher!

Over the coming 12 months, we think investors should maintain a pro-growth portfolio allocation (overweight equities versus bonds and cash) and be prepared to look through any near-term fluctuations or use weakness to reallocate back into the equity market. Despite near-term risks, we think the downside risks are more likely to slow the recovery rather than put the cyclical recovery at threat. This could lead to a more drawn out rebound, but if economic growth and corporate earnings continue a path back to trend, then, in combination with record low interest rates, this will be sufficient to propel markets higher. In addition, while valuations for equity markets are not overly appealing, they are even worse for the bond market with yields not far from their lower bound and as a result bonds continue to give away a substantial yield premium to equities.