Zero Hedge recently posted comments from JP Morgan about Bitcoin that are a bit shocking. Add to this the spike in google searches for how to buy Bitcoin with credit cards and we see the ingredients of the melt up. The shocking part was that it only took $6 billion dollars of inflows into Bitcoin to achieve $330 billion in market cap. That’s $55 of paper value added for each $1 inflow.
If JPM is right, the implications are staggering: contrary to expectations that bitcoin’s market cap is a rough reflection of its inflows, JPM’s calculations reveal that a mere $6 billion in net inflows since 2009 has resulted in a market cap of $330 billion. This goes to what Mike Novogratz said last week when he said that cryptos are unique, because unlike all other asset classes, there is no corresponding increase in supply when prices surge.
This also means that as new capital flows into the crypto space as more retail and institutional investors scramble for “a piece of the pie”, the potential market cap gains are unprecedented.
What they fail to mention is that this process can work in reverse.
It is not the inflows alone that drive price, it is what people are willing to pay that drives price. So those inflows came with the willingness to pay a much higher price at any cost just to get in on the melt up. The fixed supply of Bitcoin is certainly a large part of the equation. Fixed or limited supply with high demand drives prices higher. Think houses in 2005-07 or corporate stocks today after buybacks.
One crucial point to understand is that stock prices are not anchored to anything but the willingness of other investors to buy them at some price. Earnings only matter in terms of what other investors value them at or as it appears today they do not care about earnings, only price appreciation.
Prices can drop overnight too. The loss (or gain) in value is not transferred from one investor to another. It is transferred to and from future returns. When prices surge overnight, long-term future returns are lowered. When they drop future returns are raised.
We have been in the phase where long-term future returns are being lowered for some time now. Stock market prices have far outrun their earnings growth. Similar to Bitcoin, supply of stocks has been limited through corporate buybacks (with debt). The central banks have removed trillions in bonds from the market. Prices moved higher from the distortion in supply by these price-insensitive buyers.
If only $6 billion dollars can grow $330 billion in market cap for Bitcoin, what did $12 trillion in central bank money creation (and purchases) do to global financial asset prices. I find it ironic today that the banking cartel is warning of great losses in Bitcoin while global financial asset prices are at the highest in recorded history.
Where are the warnings from the Federal Reserve as retail investors go “all-in” the financial markets while hitting new lows in savings rates? All we hear from them are concerns of “financial stability” and they are not talking about retail investors.
Investing in Melt-Ups
Jeremy Grantham of GMO produced a report titled “Bracing Yourself for a Possible Near-Term Melt-Up” where he states that a possible 50% melt-up in the stock market could occur in the next 6 months to 2 years. He based this on an academic report on bubbles predominantly in industries and sectors. There have been only 4 good stock market bubbles in the last 100 years in large economies – 1929 & 1972 & 2000 in the US and 1989 in Japan.
He discusses the signs or warnings that proceeded these bubbles, but does not see them as extreme now. He thinks we will get there in 2018 or 2019. What I noticed in his paper was that he did not go back far enough in looking at what I consider the current melt-up (it is not a future one). Those warnings (Advance-Decline Line Divergences) appeared prior to the 2015 market top and were part of my warnings then. These divergences are still mostly in place.
Short-term market internals do look better today, but unlike 1929, 1972 and 2000 we have central banks actively participating in the markets along with corporate stock buying. And this is what makes this time different. His timeline may be correct, but I would widen it to 0 months to 3 years since I believe we have been in a melt-up since the central banks saved the market in early 2016.
And the central banks will save the financial system until they can’t.
A salient point he made was if one exits the market upon determining a bubble exists, one misses a large portion of the melt up. He recommends riding the narrow few stocks or sectors higher in the end since speculators flock to those experiencing the largest gains. Of course, he recommends exiting before the bust but this is the challenge. It is even more of a challenge when the central banks are meddling in the markets.
One point I do disagree with is that the markets always bounce back. Japan remains 40% below its 1989 peak even after a central bank induced run up of 150% since 2012. They are still 40% below break-even without taking 30 years of inflation into account.
But what is more important to understand today is we are not just in another stock market bubble, we are in the largest global credit bubble in history with global debt to GDP reaching 325%. This Granddaddy of all bubbles has been accelerating since the financial crisis.
Maybe that is the acceleration Jeremy should be looking at and consider the consequences when it collapses. All the other bubbles of the day (stocks, housing, bonds, art, bitcoin) are riding on its back.
It is important to recognize we are investing in a bubble and that missing out from defensive allocations drive speculators toward all-in strategies – and this is what causes melt ups. It’s capitulation to the upside.
The US stock market is in a melt up of unknown duration and we are watching a few key historical signs for when it turns. We are partaking defensively, but ready to step aside when necessary. Please have an exit plan.
Categories: Perspectives