My Bitcoin Call, One Year Later

I often say that the least rewarding phrase to speak is, “I told you so.” Any time you have the chance to remind someone that you warned them something bad would happen,  point out that the bad thing warned against did in fact eventuate, and that they (or often, we) suffered a negative result because of their failure to heed your timely warning, it means a bad thing happened that might have been avoided. That sucks.

It is rarely a good thing when bad things happen, and suffering bad outcomes is not made better by the knowledge that they might have been avoided. That just makes it worse, because objective damage is compounded by emotional regret.

Right now I’m enjoying the rare circumstance where “I told you so” is a source of pure satisfaction, because none of those suffering the ill effects from failing to heed my advice are people I especially care about.

On January 5 of 2018, in this blog post, I stated the reasons I thought Bitcoin was in the blowoff phase of a classic bubble, and advised Bitcoin holders to immediately sell half of their position and reinvest the proceeds in assets with durable value, specifically US stocks, foreign stocks, and cash. (Real cash, not crypto-nonsense.)

Anyone who listened, and I have zero evidence anyone did, would have avoided a catastrophic loss. How big a loss? When my post went live, Bitcoin was worth $14,574 per coin. At close of business yesterday, it was worth $3,556. That is a 75% loss. You don’t need to help investors to avoid losing more than 3/4 of their wealth many times to justify your entire career as an advisor .

Last month I got an email from a guy at Morgan Creek Capital, announcing a new, diversified cryptocurrency fund. Since on the face of it this appears about as exciting as announcing a sale on luxury berths aboard the Titanic, a few days after that ship’s unfortunate encounter with the iceberg, his firm is offering a challenge to sweeten the pot, based on Warren Buffett’s famous wager against hedge funds.

Back in 2007 Buffett offered a $1 million bet to any hedge fund promoter who would take it. The hedge fund person would bet that a chosen basket of hedge funds would beat the S&P 500 over the next ten years. The winner could pocket the million, or (if Buffett won) donate the winning bet to charity.

Buffett won the bet going away. The S&P 500, with its low costs and inherent tax efficiency, also produced much higher economic returns, +7.1% annually for the S&P versus a lousy +2.2% for the hedge funds.

Recently Morgan Creek has suggested a similar bet, apparently failing to recognize the obvious outcome-by-analogy suggested by Buffett’s wager. I’ll help them out.

The trillions of dollars of actual wealth represented by the S&P 500, and the hundreds of billions of dollars of actual free cash flow produced by the companies in the index, have profound and (in the long run) growing economic value. Whereas cryptocurrencies are worthless and are likely to continue to decline in value.

I predict another big win for the S&P 500.

The China Syndrome

Twice within the first week’s trading in 2016, Chinese stock markets were halted by a 7% “circuit breaker” designed to pause trading to allow panic selling to calm. When it became clear that denying investors liquidity for their shares was feeding panic, not calming it, Chinese officials wisely suspended the circuit breaker yesterday, on Thursday, January 7, 2016. Friday, Chinese markets inched higher, and most world markets followed.

China’s market problems immediately spread to the rest of the world. Here in the U.S., we had the worst first four days of trading in a new year since 1950. (Both 2008 and 1991 saw sharper declines, though they took five and six days respectively.) Those first four days alone officially qualify as a market correction for both the Dow and the NASDAQ, though not for the S&P 500.

There are several lessons here:

For years, there has been a disconnect between financial markets and the real economy, driven by monetary stimulus and access to easy credit. Rising stock prices became the self-fulfilling justification for further rises, largely decoupled from economic fundamentals. China’s problems with bad debts and malinvestment have been visible for five years or more, but the Chinese stock market continued to rise, finally peaking in June of 2015 after an astonishing 150% over seven months.

Though the combination of public and private borrowing, combined with cheap and easy money, can drive speculative excesses for shockingly long periods, they cannot do so indefinitely. In China, in Japan, in Brazil and Greece, we see again and again the ultimate consequences of stupid public- and private-sector investments fueled by borrowed funds. (Put another way, both Tom Friedman and Paul Krugman are idiots, though Krugman’s idiocy is fueled by ideology, not genuine stupidity.)

A heavily indebted world awash in cheap money is unable to generate sustained economic growth at a pace sufficient to lift incomes. More debts and more liquidity will not solve a problem caused by the destruction of both financial prudence and the possibility of rational price discovery. Durable prosperity depends on the action of free markets, with capital flowing toward projects with the highest economic returns. Empty, roofless cities in China, a train to nowhere in California, billions diverted to the private pockets of public officials in Brazil–none of these can provide a solution to stagnant global growth, but all can absorb capital, attention, and human creativity that would earn much higher rewards chasing genuine progress.

To return to robust global growth, we need a return to more normal interest rates and a reduction in the size and regulatory scope of government. (Who in the U.S. political system understands this? Certainly Fiorina, probably Paul and Cruz, perhaps Kasich and Rubio. Clinton? Surely not Trump or Sanders.)

Enough economic commentary. What are the implications of China’s meltdown for investment strategy?

For much of the last two years, our portfolio strategy has been defensive while U.S. stock prices (at least through mid-2015) continued to advance, with that advance highly concentrated in speculative tech stocks. We under-performed. Now that markets are falling sharply, our diversified, cash-heavy portfolios are holding value better than stocks in general.

We live in an interconnected global economy. That means there is no safe place to hide, while still earning positive real returns. (In a low-inflation world, you can hide in cash, but it surely will not provide returns sufficient to buy lunch, gas up the car, or put a roof over your head.) Here is the good news: globalization also means we have the ability to flow capital toward areas of genuine economic opportunity, across national borders, and between industries and asset classes.

There is a fundamental difference between 2007 (the market peak before the 2008 financial crisis) and today. Back then, nothing was either absolutely or relatively cheap. Today, there are huge divergences from historical price relationships, particularly between growth and value (value is cheaper than at any time since 1929, with the exceptions of 1998 and 1999), and between U.S. and foreign stocks. (U.S. stocks are more expensive than foreign developed-market stocks by a larger margin than we’ve ever observed, going back to the creation of the MSCI EAFE Index in 1969.)

Our long-term strategy remains the same. Avoid permanent impairment of capital; don’t own stupid, over-priced assets. Own more of those quality assets that are cheap according to robust historical measures. If the market crashes and they get really cheap, buy more.