Mississippi Investment Management

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“The most important thing in life is to stop saying 'I wish' and start saying 'I will.' Consider nothing impossible, then treat possibilities as probabilities.”
— Charles Dickens, David Copperfield

The Greater Fool

January 9, 2018

Depending on the account, Turkey transported their first tulips to Europe in the middle 1500s. They reached the Dutch about fifty years later; a decade or two before the Thirty Years' War began, which we're sure was simply a coincidence. 

Since those first flowers were a drab, single color, again depending on the account, either skilled European greenhouses developed new shapes of striped and variegated breeds, or a non-fatal virus developed, altering the flower to produce petals with vibrant colors and intriguing shapes. With Galileo/science being tried for heresy during this time, we're opting for the latter account. 

Tulips were a fascination to the Dutch, if only because what flowers were then available were found in the wild. Few saw a tangible utility to growing flowers, though, when vegetables were far more valuable. Still, Saint Valentine had been around since the High Middle Age and women recognized that receiving a turnip meant she had to cook it. The allure of tulips began. 

With their changing shapes and colors, tulips began to rise in price based on their uniqueness and scarcity value. Bulb buyers, akin to hoarding, stocked their inventories, further depleting the supply and fomenting increased demand. Soon, prices were escalating so swiftly that people were trading their land, life savings and anything else they could liquidate to acquire tulip bulbs. In what amounts to a modern day futures contract, certain merchants sold bulbs that had either just been planted in soil, or not planted at all, before knowing the "value" of the tulip. Too, and akin to the worst penny stocks, tulip certificates were created, sometimes backed by bulbs, sometimes not. 

Prices reached such heights that consideration for value was long lost. By one account, a single bulb was selling for ten times the annual income of a skilled craftsman. One particular bulb variety rose to where three single bulbs almost equaled the price of a house on the canals in Amsterdam. No matter, folks madly speculated that naive foreigners or some other uninformed person would perpetuate what had come to classically define the greater fool theory. 

As happens in times of such speculation, the bubble burst. Yes, some prudent folks sold and booked incredible profits, but the domino effect of progressively lower and lower prices caused people to panic and sell regardless of loss. Former landowners, stunned by the reality of trading their property for a single plant, panicked. The government, as governments will do, stepped in, attempting to bring order by declaring speculative contracts invalid and setting a fixed price per bulb. Still, the market continued to fall, to the point such controls no longer worked. An economic depression followed, making even those who had sold high suffer. 

Speculative bubbles have occurred throughout history. More recently, we've endured the dot com bubble of the late 1990s and the housing bubble of ten years ago. Today, we have bitcoin. 

Bitcoin, its supporters say, is a digital currency that can be traded for goods and services. It is also often referred to as cryptocurrency. We find that term interesting since "crypto" originates from the Greek and is defined as being hidden. That has dual meaning here since bitcoin originally found a home in the dark web funding illicit activities. Today, we also see the definition prompting one to ask where the underlying or intrinsic value is. Granted, intrinsic value encompasses both tangible and intangible assets, but no one would value Coca-Cola's trademark in the billions of dollars if the company wasn't selling sodas all over the planet. 

Bitcoin has long been considered the currency of the future and is well known to be forever capped at 21 million "coins." If indeed a currency, a fixed monetary supply ignores a global economy seeking growth. As such, left to its natural conclusion, goods, services and worker pay would be cut each year, leading to political and economic unrest, as price controls do. 

While futures exchanges now offer bitcoin trading, certain brokerage firms and even governments are beginning to restrict, if not ban trading. But for every ban comes a new entrant, enticed by the trading fees they'll obtain regardless of whether their client makes money or not. It doesn't surprise us that after several years of market gains and scarce market volatility, speculators have found a new casino. For example, a biotech company recently gave up their research and development effort to use their computers to "mine" bitcoin. The shares went from $3 to $46 before being cut in half recently. 

Keeping in mind that Madoff Securities presented themselves as a well established and endowed old line firm, it's not been since First Jersey Securities in the 1980s that such public avarice exists for an "asset" with no tangible worth. So it is no surprise that with bitcoin's success has come new cryptocurrency entrants, eager to prey, uh, fill the demand for such greed. Bitcoin, ethereum, ripple and litecoin are four of the most widely known cryptocurrencies of the 1,385 currently available. Visa, Mastercard and Ripple accepted here. We think not. 

Jamie Dimon, the Chairman and CEO of JP Morgan, once called bitcoin a fraud. We're not willing to venture that far, but we don't see it, as some do, as an asset class either. The ones most likely to make money are the traders, also affectionately known as bookies. We strongly suggest staying away.  

As this is written, the Dow Jones Industrial Average has surpassed 25,000. Large, round numbers can be difficult for the market to digest. For example, it took eight years to maintain a level of 1,000 between 1972 and 1980. Only time will tell if the caution we most all share is warranted. That said, we've always stated earnings drive stock prices, and earnings are expected to be good for at least the next few quarters, as corporate tax savings and global growth fuel corporate revenues. 

In anticipation of this, we have made a few changes. International assets, for example, have taken a meaningful place in equity portfolios. We've historically been hesitant to invest overseas because our companies typically drive material sales outside our border. We believe, however, that with European and Asian economies experiencing organic growth, coupled with monetary policy that has yet to begin increasing rates as the US has, opportunity exists for foreign companies to outperform their US counterparts. 

We also like adding smaller companies here. Mid to small companies with be the greatest beneficiaries of the recent tax law changes. They suffered against their larger cousins in 2017, but we believe that will reverse in 2018. We primarily use exchange traded funds to gain exposure into these equity styles because of their diversification and very low cost. In addition, we prefer the S&P indices over Russell because the folks at Standard & Poor's create portfolios and have superior underlying fundamental characteristics. For example, at any given time, one-third of the Russell 2000, a proxy for small cap stocks, may not be profitable. 

In conclusion, we are cautious here. We spent much of the fourth quarter making sure portfolios did not exceed their equity targets. In fixed income, we remain bearish. We do not want to be in long dated bonds and especially not in a typical fixed income bond fund or ETF. Despite three rate increases by the Federal Reserve, the ten year bond managed to end the year about unchanged in 2017. The Fed is stating there will be another three increases this year. We believe them. While there are global forces at work currently keeping a lid on our interest rates, at some point, this changes, and we don't want to be fighting for the last chair when the music ends. 

Despite short-term rates rising, as is typical, banks and other financial institutions are slow to pass along this gift to the investor. As a result, cash still pays nothing. With all but short-term bonds a sell, fixed income also remains an unworthy investment. This leaves stocks. While the market desperately needs a correction, the current backdrop of growth, fiscal stimulus and continued, but contracting, monetary stimulus still favors the historically riskier asset. As long term investors, this is where we remain. 

Thank you for your continued trust and business; we are indeed grateful. 

Be at war with your vices, at peace with your neighbors and let every new year find you a better person.
– Benjamin Franklin 

Happy New Year! 

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