In the economic and stock market cycle that ended in 2000, it was the dot-com bubble. In the next economic and stock market cycle, it was a real-estate and mortgage-finance bubble. This time we have a bitcoin bubble
Do you know how much sales and earnings bitcoin will have this year, or ever? Zero. Which is why it’s a bubble.
When I sat down to write one of my first columns for 2018, I looked at one of my favorite sites, tradingeconomics.com.
The opening page lists a summary table, which shows the daily moves in global stocks, bonds, currencies and commodities. More often than not, there is plenty of fodder for my column, just from that table (see this screenshot).
The format of the summary table had not changed for more than a year until a couple of months ago, when a new line appeared in the currency section. What was it? You guessed it: bitcoin!
And given the wild daily swings that we have seen in this electronic tulip-bulb market in the past couple of weeks, it makes it hard not to “mouse over” that table item and gaze at the volatility on a tick-by-tick basis. If you zoom in on a one-minute or five-minute chart, you can see the trades coming in with $50 or higher bid/ask spreads (see chart).
What, exactly, is a bubble?
While I have written about bitcoin BTCUSD, +1.98% being a bubble in the past couple of weeks, I have not clearly defined what a bubble actually is. The key is a rapid surge in market capitalization — the number of shares times the share price — and what that capitalization discounts. The value of a company (market capitalization) is simply the discounted future sales and earnings for as far as the majority of all investors, or, simply put, “the market,” can see into the future. In that regard, the term “market capitalization,” when it comes to bitcoin or any other electronic tulip bulb, is absurd.
There will never be any future sales and earnings produced by this particular line of code. Bitcoin is a case of rising numbers of investors being crammed into a limited number (21 million maximum) of bitcoins. As long as more money is flowing in than is flowing out, the price will rise. Then, when the tipping point comes — and it may have already come a couple of weeks ago — the price will start cascading lower, as it is doing at the moment.
A good example of a company’s stock that was in a bubble that burst, but came back because the business turned out to be successful, is Amazon AMZN, +2.23% in 2000-02. Amazon’s stock in 2000 peaked at $113 a share with little sales and earnings to justify the market capitalization of the company. Then, when the Nasdaq COMP, +0.68% bubble burst, the shares plummeted by 95%, all the way to $5.51 in late 2001 (see weekly chart).
Amazon is a classic example of a company whose shares got grossly overvalued for the amount of sales it generated (it did not have any earnings until recently), which is why the stock crashed. Then, as Jeff Bezos, its brilliant CEO, built out the company and boosted those sales and, ultimately, earnings, the stock came back ... and then some. Amazon is forecasted to finish 2017 with $136 billion in sales, while 2018 sales estimates are up over 30%, at $177 billion. The same reasoning for why a spectacular share price rise is not a bubble goes for Apple, which is expected to end fiscal 2018 with $229 billion in sales.
Do you know how much sales and earnings bitcoin will have this year, or ever? Zero.
(Note: The writer doesn’t currently hold a position in Apple or Amazon. His employer, Navellier & Associates, does own positions in Apple and Amazon for client portfolios.)
The crypto boom is a warning sign
Comments on the crypto boom are making it to mainstream Wall Street. Months ago, Jamie Dimon, CEO of J.P. Morgan Chase, dismissed bitcoin as a fraud, a sentiment that I share, even though he has backtracked somewhat. More recently, Jan Hatzius of Goldman Sachs commented on bitcoin in his latest 2018 outlook:
“While we have not seen the type of large credit expansions that would be most worrisome for Fed officials concerned about financial imbalances, there are now some signs of speculative behavior in financial markets, e.g. the cryptocurrency boom.”
All I can add here is that this is completely normal in a mature stock bull market and a mature economic cycle. In the latter stages of a mature bull market, bubbles tend to happen. In the economic and stock market cycle that ended in 2000, it was the dot-com bubble. In the next economic and stock market cycle, it was a real-estate and mortgage-finance bubble. This time we have a bitcoin bubble.
As to Hatzius’ expectation that the Treasury yield curve won’t invert despite the fact that he expects four Fed interest-rate increases, we will have to wait and see for the next 12 months. As the following chart shows, the difference between the two-year Treasury yield and the 10-year hit 50 basis points in January. (See “Goldman Sees Crypto, Credit Shadowing Robust 2018 U.S. Economy.”)
The 2/10-spread shrank by more than 80 basis points in 2017. With four Fed rate hikes (most likely totaling 100 basis points), one could expect the two-year Treasury note yield to rise by at least that much. That means the Treasury yield curve may actually invert if the 10-year Treasury stays below 3%.
And that would be consistent with a mature economic cycle.