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Looking Back at Bitcoin

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Benjamin Graham once said, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”  That statement is a little hard to interpret.  The market is only open now, in the short run.  The way we interpret Graham is to say although investors may be swayed by emotion and folly in the short run, particularly if information is nebulous, as things become clear the market eventually gets it right.  The trick to being an intelligent investor, according to Graham, is to realize now what the market will only come to appreciate later.  That is to invest based on wise assessments of fundamental value.

That brings us to Bitcoin.  In our book, The Conceptual Foundations of Investing, we discussed bubbles.  We argued that bubble can arise when enough investors buy an asset because the price has risen in the past and, as a result, they believe the will be able to sell it for even more to someone else in the future.  If enough participants employ this strategy, it can become a self-fulfilling prophecy and prices can rise without a fundamental reason for the increase.

In our book, we offered Bitcoin as a modern-day example.  We warned that we could see little fundamental value for Bitcoin as either an investment or a medium of exchange.   We said, “The problem is that if the main source of demand is the general expectation of higher future prices, as soon as prices stop rising, demand evaporates.  With few, if any buyers willing to purchase on the basis of the security’s fundamental value, prices collapse. We suspect this will happen to Bitcoin” (page 123).

At the time of our writing, Bitcoin’s price had been skyrocketing and it was trading at over $15,000.  Not surprisingly, it was the focus of a vast amount of attention in the financial media.  Now Bitcoin is in the headlines again, but for the opposite reason.  As shown in the chart below, its price has fallen from nearly $20,000 to less than $4,000.  We suspect it will fall further still.  As Benjamin Graham stressed, in the long run the market will get it right and prices will converge to fundamental value.

An Eye on Profitability

By | Papers

Assessing profitability lies at the core of valuation and investment analysis, but it is far from straightforward.  The most widely reported measure of profitability is return on equity, or ROE.

The Value Effect and Stationarity

By | Papers

Empirical studies routinely find that value stocks, defined as those with high book values compared to market value, outperform growth stocks with high market values relative to book value.  Though this may seem odd at first blush…

An Alternative Hypothesis to Market Efficiency

By | Papers

On repeated occasions, Eugene Fama has claimed that critics have failed to offer a complete alternative to the efficient market hypothesis (EMH). More specifically, in his Noble speech, Fama said, “Most important, the behavioral literature has not put forth a full blown model for prices and returns that can be tested and potentially rejected – the acid test for any model proposed as a replacement for another model.” Here I argue that Fama’s complaint is too strong.

By Brad Cornell

Yes. It’s a Bubble. So What?

By | Papers

With sky-high valuations in the US stock market, and what we believe is a tech bubble that has dangerous implications for other areas of the market, we suggest four actions investors can take now to avoid the inevitable bursting of the bubble, and which will likely benefit their portfolios’ long-term performance potential.

By Rob Arnott  Bradford Cornell  Shane Shepherd