Bitcoin: What could possibly go wrong?

Bitcoin prices reached a new high today of $2,700 per bitcoin. What could possibly go wrong?

It’s hard to know where to start, but the parabolic arc of the bitcoin chart is one place. Spikes like this rarely end well. Here’s today’s bitcoin:

Look familiar? Here’s the Nasdaq during its halcyon days.

Of course, there are other reasons to fret about the rapid rise in value of something that has no earnings or dividends, as many of the tech wreck’s biggest failures did. One is the increasing cost of mining bitcoins. To create a Bitcoin, you have to use massive computing power to solve mathematical puzzles. The process is fairly succinctly laid out in this useful story: 

“Bitcoins are mined by getting lots of computers around the world to try and solve the same mathematical puzzle. Every ten minutes or so, someone solves the puzzle and is rewarded with some bitcoins. Then, a new puzzle is generated and the whole thing starts over again.”

The difficulty of the new puzzle — and the electrical cost of finding the answer — depends on demand. Back in May 2015, the bitcoin network ran on about 343 megawats, or enough to power about a third of the homes in San Jose, Calif. in May 2015.  Another estimate put the cost of mining one bitcoin at the same rate as running an average home for 1.57 days. (Bitcoins are granted in blocks, rather than individually).

Back then, a bitcoin was worth about $650. You can find out the current cost of mining bitcoins here.

Aside from the rising costs of mining bitcoins, there’s the theft problem. The problem with untraceable currency is that, well, it’s untraceable. Once it’s gone, it’s pretty much gone. And like many things stored on computers, bitcoins are vulnerable to hacking, as the 2014 theft of $700 million in bitcoins from Mt. Gox demonstrated.

Why invest in bitcoin? I honestly can’t imagine. If you’re thinking that government-issued money is going to go away, it’s hard to imagine bitcoin transactions in the smoking rubble of civilization. (As a friend of mine noted, it would probably be better to have a few things to trade, like food or wine). And it’s hard to imagine that governments will long tolerate alternative currencies. And bitcoin certainly doesn’t seem to be immune to bubbles. I hope you are.

Update: That was fast. Bitcoin’s down 9% today. 

Media preview

Thanks to Business Insider for the two charts, and the smart reporting.

Lots of cash and animal spirits: What could possibly go wrong?

If you’ve ever been to a particularly raucous New Year’s party, you know that there’s a logical progression from the first awkward arrivals and introductions until you’re sleeping in a car full of raccoons and empty Cheetos bags.  And, at the time, each step makes wonderful sense.

Right now, the markets are at a spot where spirits are high and cash is flowing like liquor at your broker’s annual Christmas party. Let’s take a look at the animal spirits first.

University of Michigan, University of Michigan: Consumer Sentiment© [UMCSENT], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UMCSENT, January 1, 2017.

 University of Michigan, University of Michigan: Consumer Sentiment© [UMCSENT], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/UMCSENT, January 1, 2017.

As you can see, consumer sentiment has been rising since the dark days of 2009; it now stands at 98.2 — the chart is lagged by a month. Sentiment is now higher than it was in January 2015 (98.1), and the highest since February 2004.

Soptimism-graphmall business confidence is also up post-recession, but it jumped markedly after the election, presumably on the hopes of lower taxes and regulation by the new administration.

And that confidence — plus the 12% gain by the Standard & Poor’s 500 stock index this year — has sparked optimism among investors. The American Association of Individual Investors sentiment survey now stands at 45.6% bullish, vs. its 38.5% historical average. Similarly, just 25.7%  of those surveyed said they were bearish, vs. a historical average of 30.5%. Bullish sentiment is at a five-week high, and its third-highest level of 2016.

At the same time, there’s plenty of money on the sidelines, and some of it appears to be returning to stock funds. In the last week of 2016, investors poured an estimated $118 million into U.S. stock funds. But that’s a piker compared to the previous week, when an estimated $18.6 billion flooded — more than the previous 24 months combined, according to the Investment Company Institute, the funds’ trade group.

As of the end of November, there was $2.7 trillion in money market mutual funds, earning approximately zilch. A roaring stock market provides a great deal of temptation for at least some of that money.  Stock funds had about 3.2% of their assets in cash, which is not particularly high, and that figure’s usefulness has been eclipsed somewhat recently.

Another potential source of cash: Companies in the S&P 500 have a record $1.5 trillion in cash cooling its heels on their balance sheets. They can use this for buying back stocks, paying dividends, or — and this is crazy talk — reinvesting in plants, equipment and their own employees.

The bad news is that the stock market is already expensive. The S&P 500 sells at about 24 times earnings, as opposed to a historical norm of about 17 times earnings. S&P predicts that earnings will rise through 2017, bringing down the PE ratio to about 18. Bear in mind that forecasts are notoriously unreliable, particularly when they’re about the future.

Bear in mind, too, that the Federal Reserve is likely to continue to raise interest rates, and at a faster pace if the economy grows faster than expected.

Right now, it looks like animal spirits and plenty of cash will keep the market party going, and that can be good, clean fun. Enjoy the ride. Just remember that market rallies always last longer than a sober person would think. But remember that many things must go right for the rally to continue. It’s probably a good time to readjust your portfolio back to your original goals. No one ever went broke taking a bit of profits.

 

 

 

 

Greetings from Lacunaville

SDSC_0368tarting in January, I’ve been writing full-time for InvestmentNews, doing a monthly column for Money magazine, and studying for the Certified Financial Planner mark. (This, apparently, is also a test of your prowess with a hand-held calculator). And I went to Africa.

The blog, as you may have noticed, has, um, languished. I’m hoping to revive it on a somewhat irregular basis, which, come to think of it, is pretty much its usual schedule.

I’ll be updating my links pages in the next week or so. In the meantime, here are some things to watch for today, as well as some things I’ve found interesting or peculiar.

This week, all eyes are on the Bureau of Labor Statistics’ employment situation report, out at 8:30 a.m. Friday. But the stock market seems to be resigning itself to an interest rate hike, probably in June or July. (A later hike would give the impression of a political motivation, and the Fed generally doesn’t like to do that). The current consensus estimate for new nonfarm jobs is 158,000, according to Bloomberg, with the unemployment rate falling to 5%. (And, yes, the total unemployment rate is still high, but it’s the nonfarm payrolls number that Wall Street watches.)

Wages also seem to be firming up, and it should be interesting to see if traditional summer employers, such as ice cream vendors and lawn mowers, have a hard time finding help this year. All of these would seem to give the green light to the Fed to raise rates.

Of course, we’d be talking about a lordly fed funds rate of 0.5% to 0.75% after a Fed hike, an increase that will be promptly reflected in your credit card bill and eventually in your money market mutual fund account. For those who still watch their money fund account, the average money fund now yields 0.10%, nearly triple its rate at the start of the year.

DSC_0353The stock market typically dislikes interest-rate hikes. Higher rates mean bonds become more competitive with stocks, and increase short-term borrowing rates. On the other hand, higher short-term rates mean that companies will earn somewhat more on their cash, and that savers will earn slightly more on their cash.

The old adage about Fed rate hikes — three steps and a stumble — meant that the stock market takes the first two hikes as a sign that the economy is improving, and rallies. At the third hike, stock investors realize the Fed wants the economy to slow, and stocks sell off. Bear in mind that the adage originated when a normal fed funds rate was 4% to 5%. It would take a stairway, not a few steps, to get us back to the traditional stumble level, assuming the Fed raises rates at a quarter-point a pop.

I’m an optimist, and think that rising earnings are a good thing — in fact, the one thing that the economy desperately needs for sustained growth. Most companies, despite their complaining, have nice profit margins, good balance sheets, and plenty of cash. They might even be surprised to learn that when their employees get raises, they spend more — and even on the products their employers sell.

DSC_0488The one caveat: Stocks aren’t cheap, at least by the price-to-earnings ratio of the Standard and Poor’s 500 stock index. The current PE, based on forward earnings estimates, is 17 — a tad feverish, although nothing like the levels during the technology bubble. Nevertheless, at these levels, it’s a bit like driving a bit too fast on old tires. If the market takes a rate hike really badly, investors could find that both bond and stocks slide off the road. And in that case, having a bit of cash in a money fund might be a good safeguard.

 

The week ahead

Only two things matter in this first week of the new year: China and jobs. And China, frankly, isn’t looking too good.

The market plunged at the open Monday on news that Chinese manufacturing was far worse than Wall Street expected. The Chinese purchasing managers’ index fell to 48.2 last month, vs. 48.6 in November, it’s 10th consecutive decline. When the index is below 50, the manufacturing sector is in recession.

The Chinese stock market took one look at the numbers and promptly plunged 7% before circuit breakers kicked in. Wall Street took a sober look at the Chinese market’s reaction and promptly panicked. The Dow Jones industrial average is down 318 points, or about 1.8%, as I write this.

China takes these things seriously: So seriously that Chinese CEOs are starting to mysteriously disappear. If I were a Chinese CEO today, I’d be hastily packing my bags.

The stalling Chinese economy will weigh heavily on the U.S. market, since so many U.S. companies have been counting on China for increased sales and growth. So today, the stock market will be digesting this news, and discounting stocks across the board.

fredgraphAfter that, Wall Street will spend the rest of the week fretting about jobs. And there are all sorts of indicators to watch in the run up to Friday’s jobs report. (Which, for the record, is expected to show 200,000 new jobs in December, vs. 211,000 in November.)

  • Tuesday is motor vehicle sales, which should show fairly robust growth in what was once the nation’s largest employers. Analysts are expecting fairly robust gains in December, thanks to low gas prices and the prospects of modest raises in 2016. Another factor: The average U.S. auto is more than 11 years old. Cars age better than they used to, but there’s a lot of pent-up demand for new cars.
  • Wednesday is the ADP Employment report, which is a pretty good predictor of how the Friday jobs report will turn out. The consensus on the report, which excludes government jobs, is for 190,000 new jobs in December.
  • Thursday is the volatile weekly unemployment claims report, has ticked up to the highest levels since July, when the numbers flirted with lows unseen since the Nixon administration. Another important report is the Challenger Job Cut Report, which measures mass layoffs. Many companies choose to lay off employees just in time for the holiday season, so it should be an interesting report.

 

Neither far out nor in deep

There’s an old Turkish story about a village wise man who appealed to the Sultan to reduce the crushing taxes he had levied after conquering the province. “If you’ll reduce your taxes,” the wise man said, “I will teach this donkey to talk, and I’ll present him to you.”

The throne room in Topkapi Palace, Istanbul.
The throne room in Topkapi Palace, Istanbul.

The Sultan, amused, said, “How long will you need to teach the donkey to talk?”

The wise man considered, and said, “This is no easy thing. I’ll need five years.”

The Sultan said, “Fine. But if you don’t have this donkey talking in five years, I’ll have you skinned alive.”

Afterwards, the villagers crowded around the wise man and said, “How can you promise such a thing? The Sultan will skin you alive!” The wise man shrugged. “Many things could happen in five years. I could die, the Sultan could die, or the donkey could die.” As it turned out, the Sultan died three years later.

The moral of the story is that no one can promise that anything will happen in the reasonably far-off future. Everyone would like to know what the stock market will do in the next five years. But it’s more likely that someone will teach a donkey to talk than be able to predict the market accurately in five years.

And right now is a particularly difficult time to prognosticate. An old rule of thumb is that if you take the inflation rate and subtract it from 20, you’ll get the market’s fair value price to earnings ratio. (The PE ratio — price divided by earnings — is a measure of how expensive a stock or index is. The higher the PE, the more expensive the stock market is, and vice-versa.)

The core inflation rate is 1.9%, meaning the market’s fair value is 18.1 times earnings. Standard and Poor’s says the estimate for the 2015 price-to-earnings ratio is 17.3 on an operating basis, which would make the market slightly undervalued. On an as-reported basis, which is probably less accurate, the estimate is 19.3 times earnings, which makes it slightly overvalued. We may as well split the difference and call the market fully valued.

Naturally, there are all sorts of ominous things on the horizon that could push prices lower. For example, manufacturing seems to be slowing down dramatically, partly because the global economy is so weak. Then there’s the Middle East. And Russia.

Less apocalyptic would be a slowdown in earnings, and there are signs of that already, Rather than pay employees more or invest more heavily in their own businesses, companies are electing to buy back shares — a useless exercise for anything except making your company’s earnings look better than they really are.

sentimentOn the other hand, housing prices are rising at a moderate and sustainable pace. The Case-Shiller 10-city composite home price index rose 4.7% the past 12 months ended August, and consumer sentiment is also fairly chipper. The unemployment rate is 5.1% (albeit still unstatisfying), interest rates are low, and the economy is growing modestly. We have no boom, but no bust, either.

But here’s the thing: If you’re investing for a goal in the next five years, you’re about as likely to forecast the stock market correctly as you are to find a talking donkey. Typically, stocks are a good investment for the long-term, patient investor. If you’re spending your days fretting over the next jobless report, you probably have too much money in the stock market.

This old house: A good investment?

One of the surprising things about being a personal finance writer is volume of “dear idiot” letters you get. You get used to vitriol when you write about inflation (You idiot! Do you know what a pound of chicken costs these days?) or the Federal Reserve (You idiot! Janet Yellen destroyed this country!).

What surprised me a few years ago was the response I got from what I thought was a fairly milquetoast piece on buying a house. I wrote the story in 2012 and said, basically, prices are still low, interest rates are low, and if you can afford it, this might be a nice time to buy a house.

This produced howls of outrage from people who had bought during the housing boom and were still underwater. And, as they learned, housing boom and bust cycles are pretty long. The housing market peaked in 2006 with the median home price — half higher, half lower — at $154,600, down from a high of $230,900 in July 2006. The median price rose to $177,200 in 2012, and stood at $229,400 at the end of the second quarter, according to the National Association of Realtors. In other words, after nine years, the median home price is nearly back to its 2006 peak. That’s a long time to be under water.

What has changed since 2012? Affordability, mainly. While the 30-year fixed-rate mortgage rate is just 3.86%, the NAR says affordability has declined 23% since 2012.  In other words, as housing prices have risen, the number of buyers has declined, thanks to stagnant income and higher prices.

But how good of an investment is real estate? It’s an extraordinarily difficult calculation, but generally speaking: It’s not great, unless you buy at the low and sell in the next frenzy.

Via Shorpy.com
Via Shorpy.com

Consider this fine 12-room home in Chevy Chase, Maryland, which sold for $17,000 in 1919, according to the wonderful history site, Shorpy.com. It sold in 2014 for $2.4 million.

While this may seem a dramatic price gain, it works out to a 5.35% average annual return during 95 years. It’s certainly beat inflation: $17,000 in 1919 dollars was worth $232,630 in 2014, a 2.79% rate, but lagged the Dow Jones industrial average, whose price, excluding dividends, rose 5.73% per year.

Of course, this doesn’t include the cost of owning the house, starting with mortgage interest and property taxes. But as any homeowner knows, the expenses don’t end there. Anyone who has owned an old house knows that this one was probably lovingly coated with lead paint for half a century. Most roofs have to be replaced every 20 years, so it would be due for its fifth one pretty soon. And there’s a little sensor on the furnace that senses when your savings account is too high and sends a big puff of black smoke out your chimney as the furnace dies.

And if you lose your job, owning a home can be a significant barrier to finding new work elsewhere. Even if good times, moving across country while selling a home is stressful. Moving across country and having to rent out a home you can’t sell is pure agony.

On the plus side, there’s the tax deduction for mortgage interest, which generally allows you to have enough deductions to itemize your tax return. And if you put 20% down, you’re leveraging any price gains. (As people discovered in the 2007-2009 financial crisis, you’re also leveraging your losses.)

For most people, a house is basically a forced savings plan that you can live in. And, while upkeep expenses don’t decrease when you pay off the mortgage, having no mortgage is a wonderful thing in retirement. When you rent, you can look forward to increases all your life — and you still have to ask the landlord’s permission if you want to paint the master bedroom something other than eggshell. All in all, it’s probably better to own, if you can afford it.