A bubble is “when the prices of securities or other assets rise so sharply and at such a sustained rate that they exceed valuations justified by fundamentals, making a sudden collapse likely…” This commentary is going to be expanded as time goes on. But I wanted to quickly put something out into the world to explain my concerns with bitcoin and other high risk asset classes.

First, when I say that a sudden collapse is likely, it does not mean that one is imminent. It means that there is a high probability of it occurring. There are ways in which a bubble can end, besides in a crash. Speculation can die down slowly and allow the price to level off or drop slowly. Or the reasonable valuation of the asset can rise due to changes in supply and demand. Either of these situations would cause the bubble to end without a crash.

Bitcoin

It is argued that $BTC is not in a bubble. One argument used is that people have been claiming that it has been a bubble for a long time, and yet even new adopters have been profiting substantially. But as I said in the very beginning, a bubble just implies a high probability of crashing. A bubble can last for a very long time before it does, if it ever does at all. Many argue that the $USD is in a bubble, by the same people who profess that bitcoin is going to continue to grow and grow and grow. I agree that the dollar is a bubble. It has yet to crash, but that does not mean that it is not a bubble. The stock market has been argued to be in a bubble. Again, I agree. Months ago I wrote an article about how stocks were overvalued. Since then, stocks have continued to climb higher, but this climb has just resulted in greater risk.

What makes $BTC a bubble? Aside from the rapid spike in price, the high volatility associated with rampant speculation are to blame. Much of the exchange volume is due to speculation, and very little is due to use. This result has been caused by the inherent deflationary nature of the cryotoasset.

Stocks

One reason why I think $BTC and other cryptoassets are growing in price so much is because people who would normally be shorting the market are instead putting their money into $BTC et al. Because of the “BTFD” mentality, shorting stocks right now isn’t getting anyone anywhere, but most traders do not want to just leave their money on the sidelines. Because of the cryptoasset bubble, even though there is a lot of risk, the reward seems much better than stocks, and so money is flowing into the cryptoasset market. However, that also means that once things start to go south with the stock market, money very well may flow out of bitcoin and others and into short positions in stocks. Now, some of the long positions may transition to bitcoin or another cryptoasset, which may buffer the price, but it is hard to tell. What I do expect is a waterfall effect for the S&P 500 and other indices.

Conclusion

People can certainly profit during a bubble. A bubble may never really burst. However, the risk is great, and that point should be made clear. Also, the way in which the cryptoasset markets, precious metals markets, and stock markets are interacting, make the risk for stocks even greater.

Further Reading

• Gold vs Bitcoin
• Investing 101

The post Bitcoin: A Major Asset Bubble appeared first on Trading Politics.

One of the most important aspects of investing is improving your own “human capital” through education. The more you know, the better off you are.

Your knowledge, skills, and work ethic, and social network all help determine how successful you will be over the course of your life. Of course, luck is always involved, but as Branch Rickey said “luck is the residue of design.” Setting yourself up to be able to take advantage of opportunities, and noticing those opportunities when they arise, is really important.

Economics

Economics is essentially the study of “choice.” Having a solid understanding of economics comes in handy. Microeconomics addresses concepts like opportunity cost, utility, etc and helps us make personal decisions, while macroeconomics addresses GDP, monetary theory, etc, and helps us understand the decisions that governments make. Coursera offers courses in both microeconomics and macroeconomics.

Just a warning with these two courses. Both show a clear bias towards Keynesian economics, although the proctor does a fairly decent job at explaining multiple competing theories, and it is not too off putting.

Corporate Finance & Markets

Now, if beyond investing in yourself, you decide to invest in someone else’s business, either through a startup or through publicly traded companies, you’ll probably want to have a solid grasp of the basics of corporate finance, as well as the nature of the global capital markets. Understanding the difference between book value and market value, knowing basic ratios which help identify how profitable a company is, etc will help you select specific companies. And knowing how equity markets, debt markets, etc all interact with one another, and how companies use these different markets will further help you understand the ups and downs of your investments.

Again, Coursera has some useful courses on these topics. In this case, they’re part of a five course specialization.

Learning Probability Theory

I added this one because of a conversation with an author on Seeking Alpha. Fear and Greed Trader argued that the “naysayers” have been wrong. It is true that we have been calling for a correction or collapse of the markets. However, at least when I address such matters, I am addressing probabilities.

One might argue that since a major correction has not happened in a long time, it will not be likely to happen. Or someone might argue that if a correction has not happened in a long time, it is long overdue and must happen soon. However, in many ways, when a correction happens is largely independent of what has happened in the past. We can only look at the conditions of the markets now. The same is true in the opposite direction. It similar to arguing with someone who has had a winning steak while playing slots. They may argue that since they’ve had a winning steak, they are likely to keep winning. But if you understand probability theory, then you know that this is not the case.

Skills

There’s nothing wrong with simply investing in stocks. However, maybe you don’t want to just profit off of someone else’s work and imagination. Maybe you want to profit off of your own. In that case, you’ll want to gain a marketable skill, or set of skills. Programming is a big one these days, and if the project is small enough, you can even handle the entire thing yourself. If not, a skilled programmer should at least be able to produce a proof of concept, which can then be used to convince investors to get involved.

Two skill sets which should be strengthened, regardless of profession are writing and interpersonal skills. If you’re looking for investors, you’ll want to be able to write up a proper business plan in order to pitch the idea. And similarly, you’ll want to be able to draw people in and convince them of the profitability of your idea. And the idea of interpersonal skills leads us to the next investment.

Networking

It’s difficult to be successful on your own. Spending time building your network is often key to being successful. Now, you might think that you can just rely on your friends when you need something, but that’s not true. Think about it. Suppose you’re looking for a new idea to invest in. Asking your friends probably won’t help that much. If they knew someone with a novel idea, you probably would know that person already too. Or let’s say you’re looking for an open position for a job. Again, if your friends know about the option position, odds are you would too.

That’s why acquaintances, or what’s known as “weak ties” in social network theory are often at least as valuable, if not more valuable, than strong ties like friends and families, even though friends and family are going to be more likely to take on risk for you. So it’s always a good idea to get out there, meet people, and keep track of contacts. Keep a solid contact list, which includes not only how to contact the person, but some basic information so you remember who they are.

Disclaimer: I am not a professional investment adviser. I offer no warranty on this information. Any risk taken is your own.

Further Reading

• Investing 101
• Investing: Less than $10K
• Understanding Social Networks: Theories, Concepts, and Findings Kindle Edition

The post Investing: Human Capital appeared first on Trading Politics.

Black Swans do not seem like something we have to worry about, but they are incredibly dangerous, especially when there is a whole flock of them.

North Korea’s threat of war, Spain’s treatment of Catalonia, and its potential wider effects on the European Union, risk of whether or not key legislation is going to get passed, and Trump’s legal issues are all separate low probability events that when coupled represent significant overall risk to the markets.

Black Swans

Black swans are extremely rare events. But just because the probability of any specific black swan event occurring is low, does not mean that the probability of some black swan event occurring is low.

What we really want to know is the probability of at least one of these events occurring. Mathematically, the probability of at least one event, P(at least one), equals 1 – P(none). As we include more possible black swans, that second term gets smaller and smaller, and the probability of at least one black swan event occurring goes up.

We can get very specific by making some assumptions. Suppose that we have four different once in ten year events that would be bad for the market. It may seem like we do not have to worry about them very much for a while, but the probability of at least one of those events occurring in the next year is 33%.

Systemic Risk

But what makes the situation worse is that the market bubble (yes; stocks really are overvalued, even though the market can still go higher) is built on so much interconnected risk. I have written about some of this before. For instance, a lot of the increase in the the S&P 500 and other indices are due to rising profits in the banking industry, and bank profits are largely dependent on the market going higher.

ETFs

The influx of money into index funds like SPY have boosted more than just the sectors that are seeing growth, since you purchase all stocks in the S&P 500 index when you purchase SPY. This drives much of the market higher.

Margin

Another issue is that a lot of buying has been on margin. Every dip people are buying up stocks, and a lot of that purchase is debt based. This analysis of margin debt, while admitting that the peaks and troughs are not enough to use as a forward indicator, show high levels of margin debt when compared to historical levels. A sharp drop in the S&P 500 and other stocks would result in a sell off as margin calls are initiated.

Consumer Credit

But that is not the only debt that his propping up this bubble. The most November 2017 consumer credit report puts September’s provisional outstanding credit growth rate at 6.6% p.a. Total outstanding consumer credit is now $3.79T and it continues to grow at a rate far faster than the rate of inflation. That means that a lot of this recovery is dependent on debt, and it means that reduction in ability to pay debts would have a significant impact on bank profits, which again are largely responsible for market gains.

Volatility

Finally, XIV may be indirectly driving the market higher, or at least preventing it from dropping. The buy the dip extends to XIV because it has done so well as a profit making system. That in turn suppresses the VIX which bolsters the S&P 500. While it is unlikely, a large drop in XIV could result in it being shut down, and at that point, VIX would see a massive spike and the floor would fall out from under the S&P 500.

Summary

While the odds of any specific black swan event occurring is low, the more types of black swans there are flying around out there, and right now we have a lot, the more likely it is that at least one of these events will be triggered. Maybe North Korea will follow through on its threats. Maybe the Catalonian crisis will get out of hand. Perhaps tax reform will fail. Or maybe we will see legal action brought against Trump. Or perhaps something completely different will trigger a major stock sell off. Do not assume that just because a single event occurs with very low frequency that some major event is not right around the corner. Furthermore, we need to recognize that a major sell off can be far more devastating due to the increased systemic risk generated by ETFs, the co-dependence between the markets and the banking industry, and the recent way in which people are trading volatility as a real asset class. While none of these conditions implies that a meltdown is imminent, they do increase the probability of one occurring and increase the probability of it being extremely severe.

The post A Flock of Black Swans appeared first on Trading Politics.

This is a very quick analysis based on last week’s closing signals. First, (SPY) is not showing all that much direction, at least on the daily time scale. It could go either way. The Russell 2000 (IWM) is signaling a strong downward movement. Friday’s candlestick sets up a new resistance level at 1452. Look for confirmation of a downward trend today.

The S&P 500 is showing continued positive movement on the weekly time scale, but last week’s candlestick was much weaker than the prior week’s. The Russell 2000 finished last week off fairly weak. I would not call it a traditional shooting star doji, but it is close. At the very least it is showing increased consolidation.

Risk appetite is still fairly strong, based on the extended risk appetite index. However, both gold (GLD) and usd/jpy (FXY) is on the downtrend, with the yen reaching a ten handle last night. However, VIX is still near record low, which is signaling limited expectation of volatility in the short term.

Market Snapshot Image

Watching

There’s a fair amount of information coming out this week. One that everyone will be watching is the GDP estimate for Q2. The Atlanta Fed’s GDP Now estimate has been declining, more or less consistently, since the first estimate for Q2 was released. It is now holding at around 2.5%. Consumer confidence data is going to be released on Tuesday, although the perception of the economy and how it is actually doing seem to be fairly disconnected right now. We also have the FOMC announcement on Wednesday, even though it is not expected that there will be any change in rate policy.

The post Morning Snapshot 7/24/17 appeared first on Trading Politics.

Cryptoassets are an emerging class of assets with a lot significant potential for wealth generation and preservation. Involvement in the “Cryptocurrency Ecosystem” requires a fair amount of knowledge about underlying block-chain technology, but it also requires significant understanding of monetary theory. $BTC, $LTC, $ETH, and many other cryptoassets have a hard cap. Once reached, no new coins are created. This drives the already speculative asset class towards even higher rates of deflation.

Asset Comparison

This natural deflation makes “cryptoassets” like $BTC interesting speculative vehicles, but it is problematic if the desired goal is widespread adoption of the asset as a currency. Consider the following thought experiment. Suppose we have two assets, A and B, where A holds its value at a roughly constant level and B is deflationary.

Given the option, a rational person would spend A first. A week from now, a unit of A will still be worth the same. A unit of B will be worth more, on average, and so if a person spent B instead of A, there would be an economic loss. This means that consumers, businesses, etc, while probably having little issue with accepting B, will not be willing to use B for purchases, payroll, and other expenses.

This drives B out of circulation as hoarding increases. That further drives up the market price of B as the available supply continues to decrease. Of course, while someone might prefer to be paid in units of B, very few would say no to money and so A will be the asset that is actually traded around. To be a form of currency, an asset must be used as an intermediate item of exchange. In the thought experiment, B is driven away from being a currency while A is pushed through circulation.

Consequences

Therefore deflationary assets make poor currency. They are at best investments, and at worst, high risk speculative vehicles. That is the case for the major cryptoassets. The risk stems from the fact that miners are needed to maintain the security and stability of the underlying block-chain. Right now, miners are making their money through payments for generating new coins, but once the hard cap is reached, the only source of revenue will be transaction fees.

Transaction Decline

Transaction fees are more or less capped. A person will not pay significant more for a transaction just because the asset is worth more. If a person is willing to pay 1% for a transaction now, they will not pay 10% just because the asset has increased in value. They are still spending more value. Therefore a declining number of transactions resulting from the deflationary nature of the asset class will result in declining transaction revenue. This will push miners out of the market and make transactions more difficult, while also creating voluntaries in the block-chain. At best, this will mean that it will be difficult and expensive to make transactions. At worst, this will result in a collapse of the block-chain itself.

Investment Strategy

For the time being, hard capped cryptoassets will likely continue to be reasonable speculative vehicles. But there is likely to be fluctuations in which assets are popular and it is unlikely that any of these assets will become used as a broadly accepted currency. For long term investments, seek out stable cryptoassets without a hard cap or ones that have hard caps that are so large that they will not be reached any time soon. $LTC is further away from the hard cap than $BTC, but not by much. $DOGE is a fun cryptoasset without a cap and it is being used on a day to day basis by its fans, but past scams related to the currency have driven down widespread acceptance. I personally am still looking for the best solution.

Further Reading

• Gold vs Bitcoin

Donations always accepted: Donations

The post Deflationary Cryptoassets appeared first on Trading Politics.