Bitcoin © Getty Images

Now the bitcoin bubble’s burst, what’s the next big thing?
By: Merryn Somerset Webb
22/01/2018


The bitcoin bubble has burst

There goes bitcoin. The world’s most popular cryptocurrency has spent much of the past week in the grip of an old-fashioned crash.

Its value peaked just before Christmas at $19,434 per virtual coin. Last week, it plunged to more like $9,000. Down more than 50% in a month and many, many billions along the way.

Bitcoin isn’t the only one to have flipped. Other well-known cryptocurrencies, including ripple, ethereum and litecoin, are having a torrid time too.

This will have come as absolutely no surprise to anyone with more than a decade of experience in any market. I have pointed out that the cryptocurrency boom has been about as obvious a speculative mania as markets have ever seen.

I have noted over and over that a private crypto can’t ever be money for the simple reason that governments won’t allow it to be – this crash may have been triggered by talk of banning bitcoin trading in South Korea.

I have refused to accept the idea that cryptos are somehow like gold – money that isn’t government-sponsored, but is still universally accepted as a global store of value.

Gold has many thousands of years of history as money. It is approved by central banks (they all hold vast hoards of it). It has a genuinely limited supply (algorithms can be changed, a couple of billion years of geology cannot). And it has an intrinsic value (you can make stuff with it). Cryptocurrencies have none of these things.

But none of this means you shouldn’t be interested in the crypto boom, bubble and bust. Perhaps the world of money is changing and perhaps buying cryptos is a long-term way to build your wealth.

Maybe this seeming crash is a mere stumble on the road to total monetary domination. I doubt it. But those regular readers who keep lists of my mistakes might add this one in pencil just in case.

To outperform the market, you must own the best 4% of stocks

If you want to increase your long-term wealth faster than most other people, it is worth keeping a constant eye out for the next big thing.

An interesting reminder of this comes from a new paper from Hendrik Bessembinder of the WP Carey School of Business at Arizona State University. His conclusion is that most of the things we invest in aren’t worth the candle. By his calculations, 58% of stocks return less than one-month Treasury bills over their lifetimes and “the entire gain in the US stockmarket since 1926 is attributable to the best-performing 4% of listed stocks”. Outperforming the market as a whole is only possible if you hold those stocks.

For investors that can mean one of two things.

You can recognise that separating brilliant from overhyped is really hard – something bitcoin investors may be grasping this week as, until recently, making money in cryptos had looked pretty easy. In which case, you would probably go for the full diversification strategy of just buying a tracker fund. That way, you will get the overall performance without much stress or expense of fussing about finding the favoured 4%. It seems a good idea to do this with a good part of your cash.

The other possibility is to forget diversification completely and devote your life to finding the few investments that will be the world’s big winners – or hire someone else to be relentlessly investigative on your behalf. You will say that most fund managers purport to do exactly that, using their special stockpicking skills to seek out the best individual companies to hold for the very long term. But that isn’t really so.

Look at the average investment presentation (there are plenty in my office I can send you if you have none to hand). You will see a barrage of charts, yield curve discussions, sector comparisons and relative valuation metrics. You won’t find much in the way of original thinking, or discussion about what makes any particular company more innovative than others. Corporate longevity is also ignored (company lives are much shorter than they used to be – there is a lot of disruption out there).

 

Where to find the 4%

So where should you be looking for funds that might just have a chance of holding the modern equivalent of the 4%? There are some big funds that have a go, and we’ll come back to them another day.

But bitcoin’s crash this week has coincided with the publication of the annual review of the Numis Smaller Companies Index. While jammed with the kind of charts and tables mentioned above, this reminds us yet again of the tendency of smaller companies to outperform.

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