Month: December 2017

Does Bitcoin belong in your Portfolio?

Recently we visited the New York Stock Exchange, and there was a Bitcoin buzz in the air. With Bitcoin futures beginning to trade on the CBOE, there were supporters and nay-sayers. Due to a recent soar in prices of Bitcoin, and other cryptocurrencies, these have become a tempting alternative investment. However Bitcoin is currently unregulated, and highly volatile. There is no FDIC to back this new currency.

So what is a Bitcoin? It is a digital currency that can be used to make peer-to-peer payments without an intermediary or bank. Bitcoins have no central backer and rely on a decentralized network of record keepers that all work the same ledger of transactions. These transactions are called the “block chain”. The idea of the block chain is to record all transactions and share this information with the Bitcoin network without having to rely on one entity to verify or control the currency. Miners are rewarded for validating transactions utilizing an equation and in return are paid in Bitcoins. The honest chain will always beat an attacker’s chain by a process known as Binomial Random Walk. This calculation is similar to the Gambler’s Ruin principal.  The Good chain will always prevail, similar to how the House always wins in Vegas.

Bitcoin is only worth what the sum of its buyers are willing to pay for it. As with any asset, if everyone stops holding it, the value plummets.

Bitcoin is officially the biggest bubble the world has ever seen as measured as a multiple of its starting price. The spike eclipses the chaos around Dutch “tulip mania” in the 1600s, the Mississippi Bubble of the 1700s, and the dot-com bubble of the late 1990s and early 2000s. Bitcoin has already surged 2000% in the last year alone. But that doesn’t necessary mean the party is over. Blockchain technology has numerous benefits and is here to stay. This technology has the potential to revolutionize transactions by reducing complexity, costs, boosting accuracy and lowering risk.

Will Bitcoin be a homerun, or the biggest loser of this century?
Only time will tell.

“Steady plodding brings prosperity; hasty speculation brings poverty” (Proverbs 21:5, LB) is written on the back of every newsletter Spectrum has written. We believe in protecting principal so goals like retirement, dream purchases, sending kids or grandkids to college, can be achieved.  So, does Bitcoin belong in your Portfolio?

The Current Market Environment: Where is the Risk?

Markets have historically had psychological booms and busts since the beginning of time. The fear/greed syndrome will continue to drive investors into making emotional decisions at the wrong time. Human nature will remain the same. Mania has always gripped the markets from season to season. Gold, tulip bulbs, real estate, tech, oil. Bubbles tend to develop, and while “bubbles” can continue a lot longer than predicted, they will all come to a very unpleasant ending. For example, Japan’s market hit it’s high in 1989 and 18 years later it was still down 55% from its high. Knowing which markets to avoid and when to exit them is an important philosophy to have present in a portfolio. While I expect the markets to continue their bull market run, we always need to sit close to the exits when technical market conditions deteriorate.

In April of 2007, I wrote the paragraph above in our quarterly newsletter to our clients. In January of 2008 we received our bear market signal and saved clients a lot of money by going to cash. Liquidity is a pillar of risk management, and our clients were positioned to make double digit returns in 2009. In 2017 I have the same feelings: While I expect the markets to continue their bull market run, we always need to sit close to the exits when technical market conditions deteriorate.

The chart below illustrates our Market Environment Model. This model has indicated a bull market environment since early 2016, following a significant market sell-off beginning in mid-2015. The indicators that we utilize illustrate higher market risk, and can cause us to significantly reduce exposure to stocks. We currently use a proprietary combination of four components: (1) Moving average model of major equity indexes, (2) Weekly Directional Movement Index model, which defines the quality of the trend, (3) Negative Leadership Composite as defined by Investech, and (4) Spectrum’s High Yield Bond signal, which confirms a healthy economy. These four indicators together are not a forecasting device, but they give us insight into levels of market risk. Depending on this evaluation, we adapt trading strategies to become more aggressively invested or more defensive to reduce risk.Created with TradeStation. © TradeStation Technologies, Inc.  All rights reserved.

With the stock market hitting new highs, investors are beginning to get overly-excited about this bull market. Since 1932, there have been 16 bull markets, the average of which lasted 3.8 years. The current one is 8.4 years old and is approaching the longest of 9.4 years in the 1990s. Clients, managers and allocators tend to forget about risk when they are making money. I always think about risk because I have seen a lot of those 16 bull markets. I remember quite well 1987 when the market corrected 30% in two weeks. That changed a lot of plans for a lot of people. Are you evaluating risk in 2018?

Spectrum Financial, Inc 2019