The New Bubble: Bitcoin and Other Cryptocurrencies
Thursday, August 17, 2017

Bitcoin rose above the $4,000 price mark, adding to this year’s surge in value. The New York Times attributes the most recent upward spike to an agreement among key backers to settle “a long-disputed update to the network’s software and rules.” Regardless of the reason given, the price action exemplifies unfettered speculation.

To be fair, there are those who view bitcoin and other cryptocurrencies as alternative means of storing wealth. Cryptocurrencies are not issued by central governments nor controlled by central banks. They are tradeable globally as long as someone has an internet connection. In the case of bitcoin at least, there is a limit to how many can be ever created.

Still, the introduction of “ICO” (initial coin offering) to Wall Street’s lexicon smells of tulips, Dutch tulips to be specific. Ethereum, a competitor to bitcoin, raised more than $150 million. Tezos, another blockchain provider, raised $232 million last month. (In simplistic terms, a blockchain is an online ledger of transactions. Ethereum and Tezos have their own cryptocurrencies.) Business Insider tabulates that more than $1 billion has been raised through ICOs so far this year. The digital coin offerings have even sparked the Securities and Exchange Commission to issue an Investor Bulletin about them.

Backers and speculators are gambling that one or more of these alternative currency platforms will achieve a lasting and sizeable scale. They face many hurdles, however. While many people may have heard of bitcoin, most probably have no idea how to get it or what to do with it. Far fewer have any idea what an ether or a tez is. The number of people who are willing to transact in any of them is even smaller—much, much smaller. Go to your supermarket chain, your car repair shop or your plumber and ask them if you can pay with bitcoin. The answers will be no, no and no. Even e-commerce giant Amazon does not accept bitcoin.

For a currency to have any value, people have to be willing to transact in it and agree on a certain value for it. The dollar, the loonie, the pound, the euro, the Swiss franc, the yen and the renminbi are all widely used and accepted. While critics like to toss around the term “fiat currency,” mainstream currencies are backed by national governments and are globally accepted. There is never a problem transacting with dollars at a gas station in the U.S., in loonies at a grocery store in Canada, in yen at a restaurant in Japan, in euros at a bakery in France, in pounds at a pub in England or in renminbi with a manufacturer in China. No matter how much hype cryptocurrency backers like to spread, the use of bitcoin and competitive cryptocurrencies remains limited to the fringes of the global economy.

So why is bitcoin now worth more than $4,000 and why are ICOs attracting large sums of money? Unfettered speculation is a reflection of a lack of historical knowledge. In “Memoirs of Extraordinary Popular Delusions and the Madness of Crowds” (originally published in 1841), Charles Mackay wrote the following about the 17th century Dutch tulip bubble: “Everyone imagined that the passion for tulips would last forever, and that the wealthy from every part of the world would send to Holland, and pay whatever prices were asked for them.” Charles Kindleberger, in “Manias, Panics and Crashes” (John Wiley & Sons, 2000), lists metallic coins, sugar, coffee, foreign bonds, agricultural land, copper and gold as having been “objects of speculation” in the past, just as tulips were. None of these bubbles ended well—a lesson that should be heeded by those who are currently investing in or trading cryptocurrencies and related blockchains.

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Highlights from this month's AAII Journal

AAII Model Portfolio Update

No changes were made to Model Fund Portfolio or to the Model Shadow Stock Portfolio. Within the Model Shadow Stock Portfolio, three existing holdings met the qualification rules for purchase: Rocky Brands (RCKY), Salem Media Group (SALM) and SigmaTron International (SGMA). Alamo Group (ALG) approached the portfolio’s size and value and limits, while Ultra Clean Holdings (UCTT) exceeded the value limit.

The AAII Model Shadow Stock Portfolio added 0.2% in July. The Vanguard Small Cap Index fund (NAESX) gained 1.09% for the month and the DFA U.S. Micro Cap fund (DFSCX) added 0.47% in July.

Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 15.9% versus the Vanguard 500 Index fund’s (VFINX) gain of 9.3% per year over the same period. The DFA U.S. Micro Cap fund (DFSCX) has averaged an annual return of 11.5% over the same period.

The Model Fund Portfolio gained 1.66% in July, compared to a 2.05% increase in the SPDR S&P 500 ETF (SPY). Since its inception in July 2003, the Model Fund Portfolio has a compound annual average return of 9.0%, while the SPDR S&P 500 ETF has an 8.9% average annual return over the same period.

The Week Ahead

Just 17 members of the S&P 500 are scheduled to report as second-quarter earnings season starts to wind down. Among the large-cap companies on the calendar are Medtronic PLC (MDT) and Salesforce.com Inc. (CRM) on Tuesday; Lowe’s Companies Inc. (LOW) and HP Inc. (HPQ) on Wednesday; and Broadcom Ltd. (AVGO) on Thursday.

The week’s first economic report will be July new home sales, which will be released on Wednesday. Thursday will feature the August Purchasing Managers’ Index (PMI) and July existing home sales. Ending the week, July durable goods orders will be released on Friday.

The Jackson Hole Economic Policy Symposium will begin in Jackson Hole, Wyoming, on Thursday and continue through Saturday. The annual meeting will include speeches by Federal Reserve chair Janet Yellen and European Central Bank president Mario Draghi.

Only one Federal Reserve official will speak this week at an event other than the Jackson Hole Economic Policy Symposium. Dallas president Robert Kaplan will speak on Wednesday.

The Treasury Department will auction $13 billion of two-year floating rate notes on Wednesday and $14 billion of five-year inflation-indexed securities (TIPS) on Thursday.

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AAII Sentiment Survey

All three indicators in the AAII Sentiment Survey remained close to each other for the second consecutive week. Just 1.4 percentage points separate bullish and bearish sentiment, with neutral sentiment in between the two.

Bullish sentiment, expectations that stock prices will rise over the next six months, rebounded by 0.5 percentage points to 34.2%. The modest increase was not enough to prevent optimism from staying below its historical average of 38.5% for the 25th consecutive week and the 30th time out of the last 31 weeks.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, declined by a full percentage point to 33.0%. Even with this week’s pullback, neutral sentiment remains above its historical average of 31.0% for the 16th consecutive week and the 21st time out of the last 22 weeks.

Bearish sentiment, expectations that stock prices will fall over the next six months, rose 0.5 percentage points to 32.8%. Pessimism was last higher on May 17, 2017 (34.3%). The historical average is 30.5%.

Though up by just a cumulative 0.7 percentage points over the past two weeks, bearish sentiment is now 8.5 percentage points above its 2017 low of 24.3%, set on July 26. Pessimism is also above its historical average on three consecutive weeks for the first time since last April.

While some individual investors are encouraged by this year’s record highs for the major indexes, many others have expressed concern about the possibility of a pullback and/or the prevailing level of valuations. The Trump administration remains at the forefront of many investors’ minds and is having a significant impact on sentiment. Other factors playing roles are earnings and interest rates/monetary policy.

This week’s special question asked AAII members how big of an impact international events and news are having on their outlook for the U.S. stock market. Slightly more than two of out five respondents (41%) said international events and news are having little to no impact on their outlook. Many of these respondents said domestic events are more influential, while several others said they focus on the long term or view international events as having only a temporary impact. About 34% of respondents described international events and headlines as having a moderate impact on their outlook. North Korea was frequently mentioned, as this week’s survey period started last Thursday. Approximately 25% said international events were having a significant impact on their outlook, particularly because of the tensions with North Korea. U.S. president Donald Trump was brought up by respondents in all three of the aforementioned groups.

Here is a sampling of the responses:

  • “International news events come and go over the years and are eventually discounted.”
  • “Not too much. President Trump is all bluster.”
  • “Very much, especially the North Korea crisis.”
  • “Some impact, but less than domestic issues.”
  • “Not much for now, but could change if ‘fire and fury’ becomes more likely.”

Historical averages:

  • Bullish: 38.5%
  • Neutral: 31.0%
  • Bearish: 30.5%


This week’s Sentiment Survey results:

Bullish: 34.2%, up 0.5 points
Neutral: 33%, down 1.0 points
Bearish: 32.8%, up 0.5 points

Historical averages:

Bullish: 38.5%
Neutral: 31.0%
Bearish: 30.5%
Take the Sentiment Survey.

Local Chapter Meetings
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