There has been a lot of talk about bubbles lately because of the incredible prices bitcoin, ethereum, stocks and real estate in some markets.
Cryptocurrencies are definitely in a bubble right now, bitcoins were trading at $2,561.94 and ethereum was fetching $193.96 a unit on the morning of May 25, 2017. Litecoin might also be beginning to bubble its price went up to $32 on the same day.
Bitcoin’s ascent has been incredible; Coinbase calculated that a bitcoin’s increased by $2,035.49 between May 25, 2016 and the same day in 2017. Ethereum’s increase is also astounding just four months ago on February 24, 2017; a unit of Ether was trading at $13.30.
Such price gains definitely indicate a bubble, but how do bubbles work, and more importantly how can one tell when they are about to burst. The best way to get a better understanding of bubbles is to clear up some of the myths about them.
A Few Important notes about Bubbles
A few things you should know about bubbles include:
- Bubbles are not always based on hype and hot air. History shows us that bubbles can be based on real assets or technology. Amazon (NASDAQ: AMZN) stock is in a bubble, (trading at $997.85 a share on May 25, 2017) but the company is making a lot of money. It reported $16.81 billion in cash from operations on March 31, 2017.
- Sound assets or stocks are just as likely to bubble as bad ones. This occurs because bubbles are based on emotions not on logic.
- Bubbles can go on for a long time; the Australian real estate bubble started in 2001 and it is still going strong. The present U.S. stock market bubble started in 2009 and shows no sign of ending.
- It is almost impossible to predict when a bubble will burst. Analysts have been predicting the bursting of the Australian property bubble for years but it keeps rising.
- Stupid money always comes in close to the top of the bubble. This occurs because people become afraid that they are missing the good thing. Cryptocurrencies seem to be at this stage of bubble right now.
How will the Bitcoin Bubble End?
Today’s bitcoin frenzy reminds me a great deal of the tech bubble of the late 1990s. A lot of the companies and technologies involved are sound but they’ve been greatly overhyped.
Crytpocurrencies; like the internet in the 1990s, are a great technology with a bright future but people are being over optimistic. Just as it took 20 years for online retail to mature and go mainstream, so it will take 10 to 20 years before cryptocurrencies truly go mainstream. Expect a lot of ups and downs between now and then.
My prediction is that both bitcoin and ethereum will take a big fall real soon. Wait until that happens and buy because they will come back. The technology is good but it is grossly overpriced.
This brings me to the most important rule of investing look at the actual investment not the behavior of the market. Remember Mr. Market is insane, never trust him and always question his actions.
A Good Rule of Investing and Beware of CEOS
Another rule of investing, I’m considering involves CEOs and other corporate leaders. It is if you know the name of the company’s CEO seriously consider selling the stock. Chances are if you know the CEO’s name; it is because he or she is in the news, and that news is probably bad.
This rule is based on one of Warren Buffett’s most famous pieces of advice, which is explained in this Business Insider article. Back in 2010 Uncle Warren summed it up well in this statement to the Financial Crisis Inquiry Commission:
“I knew nothing about the management of Moody’s,” Buffett admitted. “The — I’ve also said many times in reports and elsewhere that when a management with reputation for brilliance gets hooked up with a business with a reputation for bad economics, it’s the reputation of the business that remains intact.”
“If you’ve got a good enough business, if you have a monopoly newspaper, if you have a network television station — I’m talking of the past — you know, your idiot nephew could run it,” Buffett said. “And if you’ve got a really good business, it doesn’t make any difference.”
Always keep this in mind when you hear about a genius or visionary CEO. It is entirely possible that the celebrity chief executive is an idiot; or a dullard, who is simply lucky enough to be in the right business at the right time. For example Jeff Bezos’ success might stem from the availability of technology and business conditions that make ecommerce profitable right now, rather than his brilliance.
The lesson here is that companies are not football teams, good ones can flourish without star players or great coaches. Always look at the business not the person riding around in the corporate jet.
Remember you are buying stock in a company not in a person. That person might be gone tomorrow; and if the company cannot get by without him or her, it is a bad investment.