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Fools Rush In – Why Asset Valuations Will Always Matter

Author: Adam Keller

Contributing Editor: Harrison Long

In 1997, Matthew Perry and Salma Hayek starred in the movie Fools Rush In, to little acclaim. On January 6, 2021, the United States Capitol was breached for the first time since the War of 1812. Fools rushed in, again. Timely political connections aside, this article is about current events in financial markets, not politics.

“Be fearful when others are greedy. Be Greedy when others are fearful.” – Warren Buffett.

Just over nine months ago, on March 23, 2020, investors were fearful. After all, the S&P 500 had dropped more than 34% in just over a month. How much further could it fall? Turns out, as things stand, that time of fear was an incredible opportunity to buy stock in the largest 500 companies in the United States. Since that trough, the S&P 500 has increased by 71.2% in just 291 days, to its current all-time high. Any attempt to compare this magnitude of bull market movement, over such a short time, is a fool’s errand: there is no historical equivalent. From a purely unscientific perspective, current market sentiment across many factors seems to be quite bullish. In other words, I would argue that in contrast to last March, when sentiment was largely “fearful,” today’s sentiment seems a bit “greedy.”

“Another lesson I learned early is that there is nothing new in Wall Street. There can't be because speculation is as old as the hills.” - Jesse Livermore.

Let’s talk about Bitcoin:

You’ve heard of it. Maybe you know what it is on a somewhat technical level. Maybe you own some. Regardless, I would be wary before “investing” in Bitcoin at current price levels. On December 17, 2017, Bitcoin reached an all-time high of $19,783. In November of 2018 it was trading at $3500, representing a loss of more than 82%. Since then? The price has gone up by more than 1000%, depending on the day you check. That hypothetical gain represents a “ten-bagger” if you somehow managed to call the exact bottom and currently hold. Or if you held prior and continued to hold as your investment declined by 82% in less than a year.

Bitcoin went from $10,573 on October 2, 2020, to $40,675 on January 1, 2021. That represented a gain of 285% in less than 100 days. Viewed in terms of market cap, the value of Bitcoin went from roughly $200 Billion to $760 Billion. Even more recently, Bitcoin saw an intraday high of $41,520 on January 9th and fell to $30,375 on January 11th, a 26.8% drop in two days.

So, what’s it worth? That’s the ultimate question. Before jumping in, it may be helpful to understand basic concepts such as the true Bitcoin supply, or how a transaction gets into the blockchain. Even then, it may be helpful to stay away entirely. You could argue otherwise, but ultimately, Bitcoin may only have value so long as buyers are willing to pay a set amount of dollars (or another government sanctioned currency) in exchange for it. Perhaps the US Dollar will cease to be the world’s reserve currency in the near future. If that’s your bet, then knowing exactly how and why the US Dollar became the world's reserve currency in the first place seems essential.

There is a disagreement among experts as to why bubbles exist, or if they even exist at all, but the Nasdaq defines a bubble as:

“A market phenomenon characterized by surges in asset prices to levels significantly above the fundamental value of that asset. Bubbles are often hard to detect in real time because there is disagreement over the fundamental value of the asset.”

Put differently, nothing is truly a bubble until it pops and is viewed from a subsequent point in time. After all, the market tends to take the stairs up and the elevator down. Sitting near all-time highs, Bitcoin will almost surely go up, maybe by multiples never imagined, before the bubble pops, assuming it is a bubble.

Let’s talk about Apple:

I have an iPhone. Do you have an iPhone? With a 45%+ market share of all smart phones in the US, odds are almost even that you have an iPhone, in contrast to every competitor in the market, combined.

Apple became the first ever publicly traded US company to hit a market cap of $1 Trillion in early August 2018. Seventeen months later, Apple is now worth $2.25 Trillion, trading just under 4% of its all-time high valuation. In September of 2020, Apple lost $180 Billion in market cap in one day. There are currently only 36 US companies worth more than this amount. Exxon is worth less. Less than a month ago, on December 14th, 2020, Apple gained 5% in market cap, representing a value of over $108 Billion. Almost the current value of Boeing, in just a single day.

So, what’s Apple worth? That is the ultimate question. Apple currently accounts for 6.7% of the S&P 500. Less than two years ago, no company in all of history was worth $1 Trillion, according to markets. Apple gained that amount of value ($1 Trillion) and then some, which had never been seen, in less than eighteen months. Fast forward to now, and we have four Trillion-dollar companies: Apple, Microsoft, Amazon, and Google. Three more: Tesla, Facebook, and Alibaba, are not far behind. What does it all mean for the average long-term investor?

Let’s Talk about a viable long-term strategy:

We all need to invest for the future. If you continue to buy the overall US stock market, over time, you stand to make money, even if you are Bob, the world's worst market timer. The difference between dollar cost averaging over the past 40 years versus being the worst market timer would have been 127%. Significant, of course, but probably less than you would have thought. What if you were the world’s best market timer? Let’s not go there.

Jesse Livermore was a speculator. He made a fortune and went bust at least three times over during the course of his life. In the end, he died penniless and took his own life. Warren Buffett? He’s still kicking. Critics will say that Berkshire Hathaway has underperformed the past two years, and even the past decade. If the game was over now, those critics would be correct. But the hustle never stops, and it is at least possible that the market itself, the S&P 500 for discussion sake, is exhibiting signs of a bubble.

The famous Robert Shiller PE Ratio, based on the S&P 500’s price, in relation to its ten year, inflation adjusted earnings, stands at 34.77, higher than any time other than the Dotcom Bubble of the early 2000s. Maybe the technology companies of today, focused on the businesses of the internet and connecting all enterprises thereto, warrant a historically high valuation. Or maybe the psychology of investment, including concepts such as the herd mentality and greater fool theory, in connection with historically low federal reserve interest rates and the printing of $7 Trillion in 2020 alone, are driving valuations to levels that are not sustainable in the long term. It is hard to say one way or the other, with confidence.

The most accurate headline regarding the stock market I have ever read, via Barron’s on January 7, 2021:

The Dow Rose 212 Points Because Investors Are Willing to Pay More

Any time you read a headline about the stock market implying a cause and effect, i.e., “The stock market went up/down because…X/Y” – remember that the above analysis is the only correct one. The stock market goes up because investors are willing to pay more. The inverse is also true. This could rightfully be said for Bitcoin, Apple, or any other stock, index or ETF, commodity, etc. All other headlines are about as helpful as pixie dust. They will be proven to be true, untrue, and true again, over the course of a single day. Rest assured; they are not reliable.

Final Thoughts:

Do not be tempted to get rich quick by betting on short term “winners” continuing to shine. After all, trees do not grow to the sky. Instead, invest with a purpose and a plan, for the long-term. If 2020 has taught us anything, it should be that humans are resilient and seem well positioned to overcome the obstacles that nature throws in our way. American businesses seem a safe bet as any, over time. 2020 should also teach us that humans are emotional, and that prices in financial markets can often continue in an irrational way longer than you can stay solvent. The moment you alter your long-term investing plan, in reaction to short-term occurrences in markets, is the moment you derail your long term expected returns. There is no blueprint for financial success. But not having a plan is a surefire blueprint for failure.

Stay safe out there. Keep investing. Have a plan.

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