Many large financial institutions are now selling products or services tied to cryptocurrencies without really investing in the currencies themselves, since “hey, if we can make money off this craze, without really investing or believing it, why not? We are just fulfilling a demand in the market.” However, investors get confused easily. Do they think if a large institution provides services or products, they must believe in the long-term opportunity? Remember no money down mortgage loans in the U.S. in the 2000s, which led to the housing bubble burst in 2008? Banks created a no-money-down mortgage product since it was easy to sell. They pocketed upfront fees and sold off the mortgage to other suckers who took on the risk of default. Those who bought the mortgages re-packaged the loans into mortgage pools and sold them to pension funds and municipalities as low-risk investments. Does anyone stop to think about what they are buying with their own money or other people’s money?
These days it seems that everyone is investing, or should I say speculating, with cryptocurrencies in their long-term and day trading portfolios. When the average taxi driver, hairdresser, schoolteacher, etc., seems to be playing a new investment and making money on it, a major red flag should go up in your mind! How is everyone an expert in Bitcoin or other cryptocurrencies? Even bitcoin investment clubs meet weekly to discuss their investment strategy. Huh!? I guess talking or investing in these “new age” digital currencies for less than one year makes you an expert these days. The irony is that the experts on TV are always bullish on the price without a true rationale except for “there’s more demand than supply.” These experts call it a land grab; get some before it’s gone, or you will be left holding the bag. This sell-on fear is a powerful motivator for most people to buy. According to CoinMarket Cap, there are 15,502 cryptocurrencies today (with more being launched every week), with a market capitalization of US$2.3 trillion. Compare that to Microsoft’s or Amazon’s market capitalizations of US$2.6 trillion and US$1.8 trillion or Canada’s 2021 economy estimated at US$1.7 trillion. Really? – these ‘currencies’ are worth more than real companies that generate profits or the Canadian economy?
The irony about Bitcoin and other cryptocurrencies is that some of the most intelligent people in the world have said it doesn’t make sense. Among them are Nobel Peace Prize winners and most major central banks that do not see cryptocurrency as legal tender. The only “economic powerhouse” of a country (I joke) is El Salvador that has adopted it as an official legal currency. The government plans to build a Bitcoin city at the base of a volcano, using geothermal energy to power bitcoin mining, which is the power needed to run the massive number of computers to generate new coins. The country would issue US$1 billion worth of bonds, of which US$500 million is going to build the actual city and the other US$500 million invested in Bitcoin for five years. The assumption would be that the Bitcoin price would increase by a factor of 20 from US$50,000 to US$1 million in five years and then be sold to pay off the bonds. The government plans to pocket the difference. Has the world gone crazy?
FOMO: Beware of the Dark Side, Jedi
The epic Star Wars saga is a constant battle between the Force’s light side (good) and the dark side (bad). In investing, that analogy plays out as a battle between fundamental research investing versus emotional fear and greed investing. Fear and greed are the strongest basic human instincts. The fear of missing out (FOMO) drives investors to many irrational decisions. The feeling that everyone else is making easy money in a particular investment means I also deserve to; thus, I should invest or rather “speculate.”
Once you make an emotional decision to invest, that’s when the daily roller coaster of watching your investment go up and down starts. Your decision wasn’t based on fundamental research or a thesis. It was based on “hey, the price is going up, plus everyone’s doing it.” If the price is going up, you feel vindicated with your decision, but once the price goes down and you’re losing money, you look for information on the TV or internet to confirm that you should continue to hold your investment and that you’re right. If the price goes back up, you feel better, then maybe you buy more, then the price goes down, and the roller coaster starts all over again.
The Greater Fool Theory
In investing, there is the concept of the greater fool theory, which argues that prices go up because you can sell overpriced securities to a greater fool. Investors ignore valuations, earnings and all other data, and the buy/sell decision is strictly made on price direction. Ignoring fundamental data is a risk, and investors could be left holding the bag after a major price correction.
Investors forget that the stock market valuations for certain speculative assets can be irrational for a long time. These valuations can be different from the true value of the asset. An old investing saying goes: the price is what you pay, value is what you get. Most investors do not understand the difference. Most people do not know the difference between investing versus speculating in the stock market. Investing involves time and energy to research and build a long-term thesis on why you should invest and what price to buy and sell. Speculating is fast and easy – read a few articles, search the internet, watch TV, talk about it, and voila! You’re done! Now you can decide to go out and use your hard-earned money to speculate.
The Bottom Line
Valuations always matter when it comes to investing. If you cannot value an investment, how do you know if it’s overpriced or under-priced, given the market valuation is not always correct in the short term? The disciplined M-Factor investment process that we put all our portfolio holdings through looks at several financial factors. These factors include Valuation, Earnings, Income and Return on Equity. Our approach isn’t sexy – it’s actually boring – but it works overtime to generate returns without the emotional roller coaster or the fear of missing out on the latest investment story. As with all investing, buyers beware! Know what you are investing or speculating in and why!
Are you looking for some advice on whether or not you’re speculating within your portfolio? Book an appointment now!
Anil Tahiliani, MBA, CFA
Portfolio Manager, Canadian Equities
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