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Laser-Eyed Focus on Value

23 June 2021   |  

This recent ransomware attack on America’s energy infrastructure has me concerned. Imagine the chaos if the clandestine cyberweapons market shutters America’s electrical power grid. I mean, how would Americans access their trillion dollars of crypto?!? How will I know if my friends have laser-eyed avatars and will get offended when I don’t accept bitcoin as barter for my backup generator?

As I become middle-aged, I can better sympathize with those who stockpile physical gold in lockboxes to get out of the financial system. Sorry, using a crypto coin to do the same makes zero sense—have these speculators not seen the ending to the movie Fight Club? I say “speculators” because retail traders either bored of stocks or tired of losing fiat on their SPACs have graduated to “currencies” such as bitcoin and dogecoin to get their kicks. These diamond-handed investors have decided they can properly time a Ponzi scheme. Bloomberg notes how influencers are saying the quiet part of Ponzi-pumps out loud.

Speaking of schemes needing more people to enter them to stay afloat, America’s “demographic exceptionalism” has been under threat as well. I don’t care how much fiat money #JPOW prints, an aging and declining population is inherently deflationary and weighs on long-run growth. I’m not saying deflation is imminent, but demographic declines are worth considering in a news cycle dominated by the usual inflationistas, gold bugs and the new bitcoin-as-inflation-hedge proponents. Yet the ~1.6% US 10-year yield somehow still attracts bids. After all, the market has a long history of overestimating inflation. True, Federal Reserve and government economic support created an enormous cash stockpile at US banks that could help fuel economic growth and perhaps even inflation if loan demand ticks up. Alas, there is no loan demand. Wait, perhaps we finally see a use case for crypto! Banks should buy crypto coins with all that cash! The benefits would be myriad. Big bank CEOs could do financial TV hits sporting laser eyes, pitching bitcoin as a low risk-weighted asset since it’s a “store of value” while attempting to recruit celebrities to ultra-high net worth practices. While one could construe this capital deployment scheme as an offset to the billions of fiat banks spend each year preventing money laundering, I’m sure the OCC would look the other way.

Another negative is how bitcoin’s and dogecoin’s price volatility depends partly on what an automotive CEO says on SNL or Twitter. Perhaps a stablecoin like tether would do the trick. After all, tether claims to be 100% backed by reserves. In another unequivocally positive, what-could-possibly-go-wrong development, tether has climbed the proverbial wall of worry, increasing circulation 57% since the New York Attorney General said, “Tether’s claims that its virtual currency was fully backed by US dollars at all times was a lie.” Whatever, Boomer.

Back to that SNL host for a moment. I’m perplexed that Tesla bought bitcoin in the first place given crypto’s horrific carbon footprint. According to reports, purchasing $1.5bn bitcoin is akin to putting 1.8mn cars on the road for a year. Therefore, Tesla’s purchasing $1.5bn bitcoin put more guzzlers on the road than Tesla has sold in its entire history! Not a great outcome for a company dependent on selling environmental regulatory credits to show profitability. Also noteworthy: Tesla doesn’t seem to sell many cars. Hmm…  

As a fan of classic movies like Ferris Bueller’s Day Off and Trading Places, I’d be remiss not to mention the trading pits closing for good. The antics of the Archegos, GameStop and ARKK feel like they trade in different pits than our value stocks. It’d be nice if it were true and we could physically see and avoid the most speculative pits! Picture it: 20x1 equity total return swaps in a pit over there. WallStreetBets stock pump pit beside it. SPACs over yonder. Would you like to purchase out-of-the-money calls on innovation ETFs? Right this way!

On the bright side, a different exchange is quite literally true for crypto. But for how long? Crypto coins represent ~$1.5tn market cap globally—approximately the same notional size as the US high yield bond market while emitting nearly the same amount of carbon as the Netherlands. Based on Coinbase’s geographic revenue split, the US potentially represents ~75% of this “wealth.” We pride ourselves on not being single outcome investors, so let’s consider a few different scenarios. One outcome is the entire $1.5tn crypto market is good as gold and its evangelists will pump it louder than gold bugs for the foreseeable future. Another outcome is regulation, a stray tweet or a collective realization of climate implications sink the value from $1.5tn to, I don’t know, $0. Unfortunately, even for prudent investors focused on long-term compounding, it doesn’t matter what pit crypto currency trades in. While $1.5tn doesn’t mean as much as it used to, contagion threats are real. The simple questions become: How much crypto wealth directly or indirectly collateralizes transactions in the real world, and who is exposed? Additionally, only some crypto investors must fear losses to cause a problem. Some estimates suggest a 1% move in bitcoin can be caused by flows of a mere $93mn. When the largest component of a $1.5tn asset class can move 1% on an odd lot, disciplined investors should probably start considering systemic risk transmission mechanisms.

Look, I hope all this crypto coin stuff works out. It’s in my nature to worry, which is why I’m a value investor instead of on the short list to host Saturday Night Live. We don’t let these worries distract us from our philosophy and process. In fact, casting wary laser eyes on other trading pits IS part of the process. Importantly, the opportunity set within our value pit remains pretty normal, and as such we’ll keep mining for out-of-favor, cash-producing business with double-digit compounding potential.

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