A Painful Lesson from Bitcoin

Dear Investors,

As we entered into 2018, all anybody seemed to want to talk about in financial circles was the meteoric rise of Bitcoin and other digital coins. As we have stated repeatedly in our commentaries, one of the many problems with these coins is that there is no way to calculate intrinsic value. That is on top of the fact that it is extremely difficult to transact commerce with them, they are often used for tax evasion, and there is an unlimited amount of digital coins that could be made. Even more alarming to me is the enormous amount of electricity being used to manufacture these coins, which consume enough electricity as the country of Demark, yet these coins serve absolutely no positive functions to society. Why wouldn’t governments’ crack down on this?

The primary difference between investing and speculating is that investing is based on extensive fundamental analysis that gives you a strong expectation that the investment should be profitable. When you are speculating, you are betting on price movements only, often based on some type of momentum or technical trend. The value of investing and value investing in particular, becomes most evident when markets get chaotic. If you bought Bitcoin anywhere near its record-high of $19,783, you are sitting on huge losses as it hovers around $8,000. Short-term mark to market losses are inevitable, but it doesn’t change the fact that there is no way to analyze the intrinsic value. The coins truly could be worth $10, or $100,000 at some point, but it is difficult to find any reasonable basis for coming to either conclusion, particularly the latter.

The lesson is far bigger than Bitcoin though. The largest trend that has defined the last 3-5 years is the explosion of exchange traded funds. The idea starts with a good premise in that if you invest over a lifetime, low-cost index funds should do better than most other investments. Value investing is one of the few strategies that has exceeded the indices over the long-term. If you were to buy an index fund after a 35% pullback in the market, I’d probably say that is a pretty reasonable idea. Buying index funds in year-9 of a bull market is anything put reasonable in my opinion, despite the fact that most market participants are going in that direction.

“Value investing is one of the few strategies that has exceeded the indices over the long-term.”

Do you really think the most successful investors such as a Warren Buffett, Seth Klarman, or Peter Lynch, would just blindly put their own money into any investments without any respect for valuation? Buffett might advocate for index funds for his wife when he passes on, but he doesn’t do it with his own money as a student of the game, nor would he ever have done so. That is what is occurring on a massive basis, especially from market participants that have very little experience dealing with bear markets.

As the crashes of 2000 and 2008 taught us, when you pay too much for any investment, it can take many years to get back to even, if ever. Even for indexes such as the Nasdaq or S&P, recent history shows us it can take a decade or more to surpass previous highs. Pre-WW2 experience has even greater examples of this phenomenon. This is one of many reasons that we can take comfort with the investing strategy we are implementing in these markets. We don’t own these overvalued indices or glamour stocks that are leading the way. We own deeply undervalued, yet highly profitable companies that should do far better than the overall market over the next 3-5 years, regardless of market conditions. The vast majority of them should actually benefit from higher interest rates, which is measurably different than most stocks will fair. We are able to buy more when they decline, lowering our cost-basis, because we have a good understanding of intrinsic value.

Lastly, we are able to utilize conservative income-generating strategies such as covered calls and cash secured puts, which reduce risk and enhance income. This might not look attractive in a year such as 2017 when the market uncharacteristically just shot straight up, but history has shown it is virtually impossible to credibly hedge once the pendulum begins to swing the other way.

Thank you very much and below you’ll find a WSJ article, which outlines the sharp decline in Bitcoin in just one month.

Bitcoin Is Falling Fast, Losing More Than Half Its Value in Six Weeks



Tim Travis