Tuesday, December 12, 2017

Bitcoin Making a Mockery of the Capital Market System

When I wake up every trading day, I usually check the business news and its impact on the market outlook.  Lately there have been two consistent themes.  One, the DOW futures are trading higher.  I don’t know the exact number of times over the past year this has been the case, but it must be well over 80% of the time. 
 
The second theme is that Bitcoin is trading at another record high.  And on December 11th, with the launch of Bitcoin futures contracts on the CME, the price of Bitcoin surged yet again, and the futures traded up to the point that trading needed to be halted.


The markets for risky and speculative assets are in a trading frenzy unlike none I have seen in my lifetime.  Sure the stock went up rapidly in the 80s after the Reagan tax cuts.  But real economic growth in this time frame was 5-8%, and the gains relative to GDP and the falling level of interest rates made the stock valuation moves justified, at least until a breaking point was reached in 1987. 

The market experienced a similar euphoria in the late 1990s, only to be knocked down after the turn of the century.   Again, high rates of real economic growth coincided with the rise, and the advent of lower growth post year 2000 knocked the expectations for stock returns down, and the market fell.

The big difference with today’s market and these past experiences is the contrived nature of the market movements.  News about the economy means very little in the derivation of what investors should expect as a rate of return going forward.   There seems to be a complete disconnect across all markets.   Sure corporations publish their profit reports, and the level of earnings and the management outlook provide some degree of input into the process of determining how one stock stacks up against another in a relative valuation.  But, the Russell 2000 (IWM) is priced at 24x earnings!  And the DJIA (DIA) is up year over year over 30%.  High yield companies (HYG) are floating long-term bonds at 4%-5%.  And the 10 year Treasury (IEF) is stuck between 2.3% and 2.4% even though the Treasury is in the process of borrowing almost $1 Trillion over a 6 month period. 

These are return and valuation metrics which might be appropriate in a market rebound after a steep correction and hard recession.   But in today’s market, these turbo-charged market returns and valuations are a sign of a more serious problem in the financial markets.  And, the Bitcoin craze is leading the charge in making a mockery of the current state of the so-called free market system.

What basis do I have to say this about Bitcoin?  For starters, Bitcoin is not a real investment asset because it has no natural underlying rate of return.   It is scam founded on the same principles as