March 5, 2024, witnessed a remarkable sight. Bitcoins set an all-time high and then plunged ten
percent in the same day. Bitcoin prices did stabilize by the end of the day and saw some recovery from
the lows. Their movement also impacted parts of the stock market, with Apple stock (AAPL) falling 10
percent before closing down 2 percent. Bitcoins went up the following day. Apple did not.

The irrationality of bitcoins has been discussed here previously. For some historical context
refer to the account of the Dutch Tulip Mania of 1734-37 as written by Charles McKay in his investor
classic Extraordinary Popular Delusions and the Madness of Crowds. In this situation tulip bulbs grew
in price to almost $500,000 in today’s prices per bulb. Tulip bulbs were being traded on the
Amsterdam Stock Exchange. One person reportedly committed suicide after he mistakenly thought his
tulip bulb was a radish and ate it.

All through this, people refused to sell their tulip bulbs on a fear of missing out on subsequent
higher prices. Finally, one day an investor looked at the bulb, decided it was just a bulb, and sold it.
The market prices collapsed in a matter of months.

In terms of bitcoins, there has been a last hurrah of sorts thanks to the SEC. Since January 11
bitcoin Exchange Traded Funds (ETFs) have been made available to the investing public. The ETFs
permit a less affluent and knowledgeable retail investor to buy a fraction of a bitcoin, say 1/10 of 1
percent, for $68. Largely due to their introduction, bitcoin quotes have gone up 59 percent since the
first of the year. Recent inflows into bitcoin ETFs have been above $500 million per day. Wall Street
makes money, the general public makes money, what could be the problem?

In the parlance of Wall Street, making bitcoins more affordable to the retail public is a
technique known as “feeding the ducks.” This means that a more knowledgeable seller takes advantage
of a less knowledgeable buyer to sell them something of an inflated value.

This has been done before. Years ago, when electric utilities found institutional investors balking at the
interest rate offered on their bonds paired with the financial condition of the issuing firm, the utility
issuers simply changed the denomination of bonds issued from $1,000 to $25 so as to sell to a general
public who seldom read the prospectus and usually did not know what questions to ask. This also led to
some preferred stock issues being also issued at $25 (down from $100). To confuse matters further, the
preferred was sometimes backed by a trust whose interest payments were treated as unsecured debt by
the trust but were dividend payments in the eyes of the investor. The common thread here is that Wall
Street does not necessarily sell the public what it needs, it sells them what they (and their clients) want.
If the SEC does not stand up to industry pressure, the result can be grim.

Unlike tulips, bitcoins can do some real damage. Terrorists and organized crime use bitcoins to
move money around the world. Governments like Russia pay for contraband imports in bitcoins,
evading tracing and permitting those who should know better to claim that they have no knowledge of
the origins of the funds.

In terms of where we are in the bitcoin cycle, I would put it after the Titanic hit the iceberg and
before the band started playing Nearer My God to Thee. Highs are obvious only in retrospect. It takes
courage to acknowledge that reality may not support the scenario that an investment needs to maintain
its price, much less prevent a decline.

The saddest investors are the ones who, while perhaps intellectually acknowledging the
investment overvaluation, refuse to sell due to capital gains taxes. Investment declines wipe out both
tax issues and capital gains. 75 percent of something is better than 100 percent of nothing.
While bitcoin is a phenomenon, AI is running a close second and is more relevant to stock
investors. Forgotten in the hubbub over semiconductor stocks like Nvidia is the fact the semiconductor
chips are a commodity.

Historically, when demand exceeds supply, customers double and triple order chips to insure
they have sufficient quantities to supply their firm. Once supply catches up with demand, orders are
slashed as inventory of chips pile up. This is how the stocks that represent such products turn on a
heartbeat. When the time comes to turn, look out below.

The Economy

Economic activity continues apace. A pool of undocumented immigrant workers has greatly
assisted the economy in moving forward. Far from experiencing a hard or soft landing, the economy
has shown itself to be stronger than almost all people expected.

If the US economy does slow down, it will be due to stricter immigration coupled with lower
world demand. China has announced that they will likely be subsume growth for order and harmony,
which is their term for government control. Economic growth creates winners and losers, which is
anathema to the Communist ideal of working for a society instead of oneself.


Inflation in goods is moderating. Inflation in services continues apace. Since almost 70 percent
of the economy is service-oriented, this implies that overall inflation will not reach the Federal
Reserve’s two percent level any time soon. The problem is that the Consumer Price Index measures
goods better than services. One inflation tracking service puts inflation in services at 5-8 percent and
in goods at 0-5 percent. Even at the lowest limit of these estimates, inflation comes in at 3.5 percent on
a weighed average basis. Too high for the Fed.

Interest Rates

Interest rates are currently a bit aimless. They are not low enough to please the public or
borrowers who have to pay above the rate of inflation to essentially rent money. Nor are interest rates
high enough to justify lowering government rates as the current rate feels needed to keep inflation in

The Stock Market

At current levels, stocks have the issue of valuation on one hand, and the vast inflow of
investment funds into index ETFs on the other.

The issue of the market impact of packaged investment products like ETFs will be explored in
greater detail in a later issue. For now, understand that ETFs do not reward companies or managements
so much as cash inflows into a given sector or index. The cash flow returns or yield on the index helps
to offset the management fee. For essentially non-managed proxies like the Standard & Poors 500
Index the management fee is minimal as there is no human involvement. For sector funds or income
vehicles the management fee can cost far more. Whether the fee is worth it depends on the amount and
the risk taken and, in the end, the performance of the ETF.

While some would argue that index funds make the market more efficient, you could also argue
they make it less so. When billions of investment dollars flow into an index it helps each holding in
proportion to the index. There is no consideration as to how a stock can do on its own merits. If a stock
is overvalued, it becomes more overvalued. If undervalued also more so, as the undervalued participate
less than the overvalued in obtaining a share of the inflows of investment dollars.

Investment strategies around index funds assume net inflows and constant liquidity in the
marketplace. Should inflows dry up or liquidity disappear, there would be no one on the other side of
an investor’s trade. Such a situation makes valuations problematic.

Warren M. Barnett, CFA
March 8, 2024
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