In the last several weeks, we’ve seen an enormous amount of chatter about market valuations. The Dow hit a record 26,000 points the other day, only two weeks after hitting a previous record of 25,000. Bitcoin traded above $20,000 not long ago, then crashed to somewhere less than half of that, and has since partially recovered. If you work anywhere remotely connected to the tech industry, you’ve probably heard a lot about all of this. It’s impossible not to notice the large amounts of money sloshing around out there.
I started writing a post about Bitcoin, and cryptocurrencies, but then realized that what I was really talking about was the weaknesses humans have for risk. The pernicious thing about bubbles – whether in the stock market, or cryptocurrency or elsewhere – is that they create a lot of overnight geniuses out of early speculators. They also spawn a class of Explainers, who shape and evangelize a bullish narrative out of every bubble with a clear logical conclusion: to invest, now. You see this happening on CNBC every single day, as well as in the legion of private “crypto” chat groups popping up all over the place.
But first, indulge me in a little story about craps.
One perk of working at IBM was that I’d get out to Vegas about once or twice a year for a few days for one of those giant tech mega-conferences. (This is the ideal amount of time to spend in Las Vegas.) When I did so, I’d always carve out a little time – often late at night – to go play craps. Craps is my game – I love it. I don’t play any other games in the casino. I never go overboard or anything, but always make a point to bring a few hundred bucks to go have fun at the Vegas craps table when I have the opportunity.
I very keenly remember one of my early craps games in particular. I’d been playing for about two hours. In that time, I’d been up, then down, then up again, and then, gradually, dwindled my chips down to basically nothing. I’d lost the $300 or so that I came to the table with, and was ready to hang my head in defeat and call it a night. Finishing my drink and putting on my jacket, I placed my last bets – probably something on Don’t Pass and, as one of my signature moves, I put some chips on what’s called an All Bet. This is basically a bet that, in consecutive rolls of the dice, the shooter will hit a 2, 3, 4, 5, 6, 8, 9, 10, 11 and 12 before rolling a 7 (which is, of course, the most likely number). All Bets are a sucker’s bet – a really long shot – which is why the payout is something like 175:1.
I then watched, in growing amazement shared around the table, as the shooter did precisely that. When the final number rolled, the table went up in a cheer. I made $350 from a $2 bet. From being utterly tapped out, I was officially right back “up” for the night.
At this point, a part of my brain was longing to get settled again, order another drink and try again to win big. Instead, I did the sensible thing: I tipped the dealer, flicked a $10 chip at the shooter with my thanks, and called it a night. I went home having made a little money in Vegas. Everyone who gambles sensibly will agree that this is the right thing to do; unfortunately, even for a reasonably sensible person, I can attest that it isn’t exactly easy.
I think about this experience a lot in the context of the ever-present chatter today about rising values for everything in sight – the stock market, crypto, housing, companies – and what we mean about “investing” in them.
The crypto “investors”
There is a small group of people out there who are sitting on enormous holdings today in Bitcoin (and a handful of the other valuable cryptocurrencies). Bloomberg estimates that about 1,000 people own fully 40% of the BTC in existence, and most of them know each other and coordinate. As the joke goes…
There were, indeed, very few plausibly legitimate reasons to buy Bitcoin up until very recently, and that group of original hoarders contains a lot of people with very weird ideas. But more importantly, it’s also a group of people for whom “investing” $10,000 in a magic internet money scheme was not only an option, but seemed like a good idea. And if you were buying $10,000 of Bitcoin, chances are good you were also buying other speculative “assets” as well, like gold, silver, canned food or healing crystals.
No one, as recently as just a few months ago, could’ve possibly credibly predicted that Bitcoin would explode in value as it has. (If you had put down $10k into Bitcoin in just the middle of 2016, you’d have made something like a 48,000% return by now.) Yet, like myself at the craps table, these guys were putting down money that they could presumably afford to lose on a ridiculously long-shot bet. That isn’t investing. It’s betting, better known as speculating.
(Not that I have anything against speculating! In fact, I dabbled in it a bit myself. I made just a few hundred bucks gambling on Bitcoin. We’re paying for NYC childcare now, you know. I’ve cashed out now, though.)
I am personally of the opinion that Bitcoin is probably here to stay. It obviously has no intrinsic value, but then, neither does gold nor silver, and they’ve been used as stores of value forever. The blockchain technology underlying Bitcoin has tremendous potential, and the promise of a decentralized, anonymous, internet-based currency among other global reserve currencies is obvious. But it’s equally obvious that much of Bitcoin’s current value is the result of hucksters pumping it like a penny stock to the unsophisticated. We’re at the “YouTube celebrities hawking $49 Bitcoin newsletters” stage of this bubble, which does not augur for great times to come.
A bubble of money
If anything, the bubble in crypto seems like a smaller companion of the broader, rapid expansion of equities values. As I mentioned earlier, the stock market is hitting new all-time-highs every few months (or weeks) now. I keep a little Google Sheet full of tech company stock price data, and most or all have increased by 50-80% in the last year. In fact, the Tech category is almost singlehandedly responsible for most of the gains in the S&P 500, with just 5 companies (Google, Apple, Amazon, Facebook and Microsoft) contributing almost half the growth.
Homo economicus would interpret this as a sign that investors are increasingly confident in these companies’ future revenue potential – and indeed, they’re not wrong to do so. These are good companies. But I think the enormous rise in these firms’ market caps is also explained by a large amount of stock speculation. This is good for these firms’ employees and, certainly, executives, who probably don’t mind the boost, but it is creating a large group of bagholders who are buying in at very high values and will be left in the bathtub when this cycle slows down again.
Google is a tremendous company, but has their actual enterprise value really increased 40+% in the last 12 months? Has Facebook’s? Count me skeptical. It’s not hard to see a lot of this rise driven by people hoping to ride the train to even higher values and turn a quick profit.
There are no geniuses
It is an age-old lesson of the stock market that no one beats the market over the long haul. No one can “pick stocks” or time the market. There is an entire industry of people who try, and yet, mountains of economic research (including Warren Buffett’s famous bet) repeatedly demonstrate that passive index funds beat stock-picking, every time.
The same is true of early-stage investing. Many tech venture capitalists are celebrated as geniuses for much the same reason those early Bitcoin “investors” are – they’ve managed to make a lot of money from the outsized performance of a few early investments. Yet the truth is probably closer to being in the right place at the right time. If 90% of a VC fund’s investments lose money, and only 2-5% make significant returns (a pretty typical distribution), are those investors actually good at predicting the future? Or are they simply good at spraying enough money at enough targets in a market seeing long-term, cyclical growth – and fortunate enough to have the pre-existing wealth to do so?
Of course, the monied classes have always enjoyed investing opportunities that the rest of us don’t. Your typical retail investor (like me) does not inhabit the same world of potential returns that Warren Buffett, Marc Benioff or Jeff Bezos do. (This is why I have not launched my own spaceflight company.) Similarly, the elite VC class equally has access to information, people and market intelligence that we normals do not. This cozy ecosystem is partly to blame for the hyperconcentration of personal wealth in Silicon Valley and the country as a whole, and equally the reluctance of many VC-funded companies to go public and share their destinies with retail investors.
But perhaps the biggest advantage that wealth confers in investing is the ability to do it at all. “Normal” people do not have tens of thousands of dollars to “invest” in questionable magic internet money schemes (nor would doing so be a responsible choice for most people), much less a million or two to experiment with angel investing. This is how wealth begets more wealth.
Early investors in Facebook or Salesforce or Google were no more “geniuses” than the guys who made $10,000 bets on Bitcoin in 2014. They could not see into the future. I don’t mean to suggest that investors like these didn’t do their due diligence, only that analysis like that can provide very limited information about what the future holds. Post-hoc narratives get crafted for success, but rarely failure. This feeds the mythology of “genius” investors getting rich with their sagacity and wisdom, and the FOMO that narrative engenders: the creeping feeling that “everyone” is getting rich – except you, because you’re not as smart.
Market FOMO is what pumps every bubble – everyone rushing to get a piece of the action before the party is over. This is true whether it’s the stock market, cryptocurrency prices, housing or anything else. As I said, I am actually a believer in the long-term potential of Bitcoin, and certainly for the technology industry as a whole; but the market values we see today are more related to buyer psychology than underlying value. That won’t last forever.