Bubbles All Over The Place

Isaac Newton was not only the physics genius we remember him as, but was also a financial whiz. He was England’s Chancellor of the Exchequer at a time when that was one of the world’s most prestigious financial posts. Yet even he managed to lose money in the South Sea Bubble, quoted as saying that he could “calculate the motions of the heavenly bodies, but not the madness of men”.

Investors (if that’s even the right word) have thrown all caution to the wind and blown twin bubbles in artificial intelligence and digital coins. Last week Nvidia stock went parabolic, and this week bitcoin is stealing its thunder. The NVDA moonshot was not without fundamental basis given its blowout earnings, but the net result was a sort of double counting as the stock had already been priced into the hereafter. It would have to keep up its frenetic earnings growth for years to justify the price it was already selling for.

This isn’t a knock on the company … its tensor architecture processors are marvels of engineering. At a tenth of current prices, I’d love to own it. But NVDA doesn’t even make them; that task falls to TSM, Taiwan Semiconductor. Not that investors haven’t taken notice of the latter; it’s doubled recently and now takes the top spot in emerging market indices. Not to mention ASML which makes the equipment used to make them.

But the big NVDA stock problem is this. Those earnings aren’t going to stockholders. Earnings that a company must reinvest in the business to maintain its competitive position aren’t really profits; they’re costs of doing business. Of course a company can also “return capital to investors” by buying back stock, but the benefit of buybacks disproportionately goes to insiders with stock option packages. Options are leveraged over the strike price. And this edge is also a cost of doing business as it embeds a form of employee compensation. Bloomberg reports insiders sold over $80M of stock in the latest rally … between the sellers and buyers it’s not hard to guess which is the smart money. The bottom line is that dividends are the only earnings ordinary stockholders can count on.

Earnings are when the company tells you how much money you made.

Dividends are when it sends you the money.

Artificial intelligence isn’t even new. An original Star Trek episode, “The Computer” even deals with the issues of artificial intelligence turning on humans in pursuit of its own survival and of its dependency on the wisdom of its human teachers. Many contemporary media-steeped AI infatuates might think those questions just came up. But that was 1968. IBM’s chess and Jeopardy winning Watson and Apple’s Siri have been around for years. The only truly new thing in the 2020s was the very public emergence of ChatGPT making it an internet sensation.

Our other, even more spectacular, bubble is bitcoin. At least Nvidia stock has intrinsic value. I would cite the percentage gains in just the past 72 hours or so. but they would be moot before I even finish this paragraph. Just for digital bits of nothing. The only real justification is limited supply, apparently the only thing that distinguishes it from other forms of man-made money. But other forms of man-made money have started out with limited supply too. And even that limited supply turns out to be unlimited when you consider the thousands of digital coin alternatives and low barriers to entry. Maybe it’s all just marketing.

Nevertheless I confess to having participated in both of these bubbles to a small degree. Some of the stock funds I own (Model Portfolios) hold NVDA. And I have a small position in GBTC as part of my commodity allocation. But why would I even consider owning something I don’t believe in?

Recall my starting point for portfolio construction is the Global Market Portfolio. Since it is the portfolio with the least possible risk due to asset selection, a choice to omit something that makes up a meaningful proportion of it is taking a risk. And at well over a trillion in market cap, bitcoin has grown too large to disregard. And even if it does ultimately converge to its intrinsic value of zero, for now it has powerful promoters and its hot streak is attracting many more.

The other side of the (bit)coin is that the frenzy may already be too wild. Things that run up so quickly are prone to running down just as quickly. It’s not for money you can’t afford to lose.

On the plus side, with no fundamental value, technical analysis all you need. On the minus side, it’s all you have. Crypto-arcana like halvings, forks and other digital metaphysics aren’t something the average investor can understand better than crypto-geeks and are already built into the charts anyway. The likely catalyst for the next big move – in either direction – is something you won’t hear about until it’s public knowledge and largely priced in. It’s a safe bet that, as with Nvidia, those making the big money right now aren’t the buyers, but the sellers.

It always goes without saying, but here more than ever, investing involves risk.

But where is all the hot air coming from in the first place? Absent general inflation, the only way one price can go up is for another to go down. At least part of it is the public’s conviction that its central bank money is going to continue to lose value. There is way more of it than people already want and they’re locked in desperate pursuit of anything they can trade it for. Trouble is, while an individual may get rid of it by trading it for something else, doing so always involves someone else gaining it. Until taken out of circulation by the banks, it never goes away.

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