Dorato News, July 2021
Portfolio Issues - Bitcoin
We’ve alluded to the silliness of Bitcoin. We thought it time to add some more thoughtful words. In short, our advice can be summed up in a few words: Don’t do it!
Bitcoin is not an asset class or a currency or an investment. It is a gamble. The only people who should be messing around with Bitcoin are people who like to play poker. Because mostly what you’re doing is guessing what other people think a Bitcoin is worth. Because that’s the sole determinant of its value: what other people are willing to pay for one.
Bitcoin is not blockchain technology. It uses blockchain technology, and that is a valuable technology that has the potential to reduce inefficiencies in all sorts of transactions. But Bitcoin is not blockchain.
People tell us that there will be only 21 million Bitcoin, so that’s what makes it valuable. But anyone can create a new cryptocurrency (and they are). So that scarcity argument is a red herring.
The reason people talk about Bitcoin so much is because in just six years the price rocketed from a few hundred dollars to more than $60,000 (now about $30,000). But don’t confuse price with value. The Dutch did that with tulip bulbs a few hundred years ago.
One last point: at any time, governments can declare Bitcoin to be illegal. The US probably won’t, because Bitcoin will always be of limited size and importance, but it’s possible. And then, if you hold some, you can try to find someone to buy it from you on the black market, or you can use it to buy illegal goods. Not a great set of choices for a law-abiding citizen.
“You’re pitching great. I really came out here to ask you what you think about Bitcoin.”
Market View - Inflation
The current US stock market is defined by one issue: inflation. We watch this play out on a daily basis. On those days when the 10-year US Treasury yield rises, due to the fear of inflation (investors demand a higher interest rate if inflation returns), bond prices fall and growth stocks fall. Value stocks tend to do better. On those days when the 10-year rate falls, the reverse is true.
It seems a bit simplistic to focus on this one item, but we believe that it shows how expensively priced some sections of the market are. Those prices make sense only if the conditions of the recent past continue to hold—fast revenue growth for technology firms and low inflation. Take away either of those supports, and prices for those growth companies look out of whack.
The Federal Reserve, our arbiter of inflation, continues to say that the current rise in prices is only temporary. That’s possible, and right now, it seems that investors give them the benefit of the doubt. But if they’re wrong, and inflation persists, the Federal Reserve will either have to raise interest rates to prove they still care about fighting inflation, and cause the economy to slow, or they can keep interest rates low and start to lose credibility. Neither choice is all that great.
With inflation or not, we continue to think that the big technology companies are priced far too high. We understand that in a low-inflation, slow-growth world, investors will pay up for above-average growth. But there’s a limit to that line of reasoning. For all of them — Apple, Amazon, Alphabet, Microsoft, Facebook —analysts expect double-digit long-term earnings growth. In Amazon’s case, analysts currently have long-term earnings growth pegged at 30%.
Now just stop and think about that for a moment. Amazon’s earnings (profit) in 2021 are expected to be about $24 billion. If earnings were to grow at a 30% rate, they would be at more than $300 billion in ten years. The current US economy in total is about $20 trillion, and growing at about 2-3%. And total corporate profit is currently about $2 trillion. If we assume corporate profits grow a little faster than the economy, say 5%, then in ten years Amazon profit will grow from about 1% of US corporate profit to about 10% of all corporate profits in the US. The story is similar, if not quite as extreme, with the other big technology stocks. Prices make sense only if you think these companies will take over the US economy. We think that’s unlikely. It doesn’t matter how good the good times are right now, they don’t last. Betting that they do seems a silly bet.
Another segment of the market that’s showing a bit of silliness is junk bonds, euphemistically called high-yield bonds. The extra yield you get from a junk bond, above what you can get on a US Treasury bond, is dragging along at historically low levels. This is a sign that investors are taking on more risk to get a little more interest. We don’t include junk bonds in portfolios because they do not offer any diversification benefits — they have similar risk characteristics to stocks. But we especially don’t like them now. Investors inevitably hunt for higher yield when interest rates are low, and it never ends well.
At times like these, when people seem to be reaching for yield, and some folks seem to be engaged in gambling rather than investing, we think it’s a good idea to keep our wits about us, and keep our investments from taking on too much risk. Risk is always with us, as we were reminded in March of 2020. And like an old jack-in-the-box toy, risk will pop up again.
Remembering risk doesn’t mean that you sell everything and lock yourself in the closet. We would never recommend that. Closets are stuffy. Stay invested, but within parameters that we’ve set, and with which you’re comfortable. That’s the path to building wealth.
Sources: Economist, Wall Street Journal, Value Line, Vanguard, Applied Finance Group, TradingEconomics