What I Care About This Week | 2021 April 19

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by Franklin J. Parker, CFA

The Summary

  • Earnings! The major banks reported stellar earnings last week, though much of that came from trading in capital markets (IPO/bond issuance, market-making, etc). With interest rate spreads still narrow, banks have struggled to earn profits from traditional banking (taking deposits and lending money). At any rate, earnings season will be important as investors gauge the earnestness and momentum of the recovery in the real economy. Many big companies and consumer brands report this week, such as Coca-Cola, Proctor & Gamble, IBM, Netflix, and Chipotle.

  • Fundamental economic data last week was quite strong. Retail sales figures grew by 9.8% month-over-month, which far exceeded the 6% expected, and inflation posted almost exactly as expected at 2.6%. Weekly initial jobless claims fell by the most since the pandemic started, an encouraging sign for the labor market recovery.

  • This week is light on fundamental economic data (though earnings are important). The recovery in the real economy is going to test the market’s belief in the Federal Reserve’s patience—especially as asset prices continue to stretch already-lofty valuations. While the recovery is encouraging, the primary driver of this market is the Federal Reserve. News of “normalization”—while probably good long term—would be a short term headwind for market prices.

The Details

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Let’s talk about cryptocurrencies.

I remember listening to a Planet Money podcast on how crazy the Bitcoin market was going. The price had doubled, then tripled. People were making a fortune, only to lose it all shortly thereafter. There was talk of regulation, of banning Bitcoin outright, and how people had their coins stolen from their digital wallets.

That was in 2011.

Since I started following cryptocurrencies in 2011, not much has changed in the chatter surrounding them. Prices have changed, of course, and Bitcoin has a few competitors now (Dogecoin, Ethereum, etc), but the general sentiment remains the same: cryptocurrency is considered a real part of the digitized future, fortunes have been won and lost, and security remains a top concern for owners of these digital assets.

Before we talk about my take on them, let’s first talk about what they are.

Let’s say I want you to hear a song I like. In the olden days, for you to hear the song, I would have to bring you some form of physical media: a CD or a cassette tape, for example. If I wanted to hear that song again, I would need to get it back from you before I could again hear that song I like.

The point is, in the olden days, either you or I had the song at a given time, but we couldn’t both have it at the same time (unless we were together in the same place). Now, however, I can simply send you the song file: you would have the song and I would have the song at the same time. It isn’t magic, of course, we’ve simply made a digital copy of the file—I own a copy and you own a copy.

The technology that drives cryptocurrencies solves this problem of “uniqueness.” Using this underlying technology, I could actually send you a unique copy of the song I like. It is like an old school CD or cassette tape: if you have it, I can’t have it at the same time. Unlike a CD or cassette tape I don’t give you anything physical, the transaction is entirely digital.

An obvious application of this ability to create unique digital files is currency. By creating a limited number of unique digital “coins,” they can be exchanged just like a currency. They don’t exist outside of the digital world, of course, but because they are unique, they function the same! And because they are not tied to any monetary authority, there is no real friction to cross-border transactions, or the regulations that govern traditional dollar-based banking. It is, in that respect, similar to digital gold or silver.

I do believe that the technology driving cryptocurrencies is going to be an important piece of our future (it has lots of applications beyond cryptocurrencies). But—and this is a big ol’ “but”—that does not mean serious, long-term investors should load up on cryptocurrency.

First, the very thing that makes cryptocurrencies an exciting headline and an exciting investment is what makes them terrible currencies. Bitcoin, for example, lost 8.7% yesterday. That isn’t particularly newsworthy, though, because Bitcoin moves around quite a lot (it was up 8% on March 13th, for example). But, if you are running a sandwich shop and you want to accept Bitcoin as payment for your sandwiches, it is very difficult to accept the risk that the market price of Bitcoin wipes out all of your heard-earned profits in a day. The volatility of cryptocurrencies makes them awful currencies!

My second point is best expressed through an example. Let’s say that in the mid-1980s you knew cell phones would be a big thing in the future. There was only one company you could invest in: Motorola. Motorola, however, underperformed the broader market in the coming decade, and eventually went out of business altogether! You could never have guessed that the biggest winner in the cell phone revolution was a tiny computer company called Apple. Motorola in the 1980s teaches us an important lesson: just because we get the trend and technology right, doesn’t mean we know who will win or lose in the coming decades.

Finally, and most importantly: I have no clue how to value a cryptocurrency. Unlike other commodities, they have no intrinsic value. Unlike a traditional currency, they have no significant demand from industry or commerce. Unlike stock in a company, they produce no cashflows (in fact, you typically have to pay to store them). In the end, there are no real tools to analyze whether a cryptocurrency is overvalued or undervalued. It is this problem that has kept me on the sidelines.

It is at this point I can hear you thinking: “but Bitcoin has gone from $0 to $65,000 over the past decade.” And you are right. My assessment has been flat wrong for a decade.

Even so, my general advice for investing in cryptocurrencies is the same as it has always been: only invest money you can afford to lose. I see them as I always have, as a gamble.

Price of Bitcoin in US Dollars, 2015 to today.

Chart of the Week

I have, up to now, avoided talk of Covid on this blog. However, as the economic recovery gains steam, it is worth noting the trends in the pandemic. Though Asia and Australia have generally contained the virus, and North America has begun to stabilize our caseload, Europe and South America continue to struggle. New variants are a risk, of course, but with the large economies Europe resurging in recent weeks, the economic toll is again in focus.

In short, the economic recovery depends on the continued improvement in Covid cases, both in the US and around the world. Though I haven’t talked much about it, this is an important data point!

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