Random Market Thoughts

        I'll start by both praising and criticizing the recent chest pounding of value investors. Clearly, you were right about Fed tightening compressing multiples and hitting hyper growth stocks first. I did figure it out because I purposely pay attention to people who have the opposite view of mine. The criticism I have of value investing can be best expressed in a story. I recently stumbled on a video of a value guy from May 2012 doing DCF analysis on Disney, which was trading at $44, and the 10-year yield he used as the discount rate was 1.79 at the time, so the discount to book value price he came up with was $40, therefore he said he would never buy Disney because it was overvalued.  For technicians, on the chart Disney was breaking out above three long-term technical peaks around $42. Last March Disney was up nearly 500% since then (not including dividends). You could sell right now 30% off the highs and still be up over 300%. And that's just one stock. Apple split-adjusted is around $36,000, and it's not likely it fit in any value investor framework for many years unless you broke the rules like Warren Buffet did. If digging through the dredges for near bankrupt companies trading below book value works for you, then have at it. I would never succeed at that. 

     I like clearly established megacap tech companies with huge growth potential and eyes on the metaverse. That includes APPL, GOOGL, MSFT, AMZN, TSLA. I've always irrationally hated NFLX. I think FB will be good in the long-term, but I'm too worried about the issue with Apple in the short-term. I like Disney for its metaverse potential and think Omnicron and the Fed is offering a good buying opportunity, although I happen to think the upcoming short-covering rally will fizzle so everything has lower to go, but who knows. My guess is TSLA revisits the $600's and then 10x's from there. I expect megacap tech to double from here.  It's just likely to go down a lot more before then. In smaller size I also like RBLX and U, and other metaverse stocks that have taken a beating. 

     Here's another reason value investing doesn't work for me. Twenty years from now after TSLA has grown 200,000% from inception like Apple did, and they have so much cash they're buying back shares and distributing dividends, and the P/E ratio is like 20, it will finally pop on the radar of value investors scrapping the barrel for safe dividend yields. Valuations are misleading. Here's what matters:

1. Is the business meeting or exceeding growth expectations? (Meaning, are you right that you bought a world class business that is expanding its market share and TAM.)

2. Position size.

3. Time in the market. 

4. Outside income to dollar cost average. 

5. Cross-asset and cross-strategy diversification.

     What you want is a balanced portfolio that can weather different market regimes. The problem with balancing bonds with tech is they both go down when rates rise. Value stocks will hold up better than tech, but when the market really gets hit all correlations go to 1, and the idea of beating a benchmark because you lost less is absurd if you don't have clients to appease. You can sell into strength or rebalance in a tax deferred account, but the reality is unless you're good at trading, which requires a specific skill set, and the dedication to put in the time, most people are better off not making decisions. The only thing you can control is how much you're willing to risk and then gauge the probabilistic drawdowns based on your portfolio construction, and be aware of what market regimes will hurt or help you, and make adjustments, or put on hedges, accordingly (although that's decisions).  The number one rule in investing and trading is you have to know how much you're risking and then deeply accept that risk. If you're risking too much you find out at the worst possible time. 

     The worst case scenario for nearly every portfolio construction (and how this entire bubble blows up) is when the Fed loses the ability to ease because inflation is spiraling out of control. I happen to think both camps are right about the current situation. It isn't fair to call it transitory, but it also isn't going to last because it's mostly supply chain problems that will self-correct, and the bond markets are saying this. There are two concerning elements, though. 

    1. The labor gap seems to be largely caused by boomers retiring to avoid Covid risk, which is creating upward pressure on wages to fill those positions. I'm not sure if they will come out of retirement or not when this is over. Wage increases that level off will cause price increases that level off.  But if the boomers stay retired for good, it could be a longer-lasting change. 

    2. If the long oil crowd is right about the lack of capex leading to reduced supply, then a reopening economy going back to full tilt will keep upward pressure on oil, which is fine as a trade, but it's as dumb as being short bonds for any length of time because the success of the trade causes its own demise. Higher rates and higher oil cause lower rates and lower oil. In comparison, Apple is $36, 000 a share because its success causes more success.  

     I want less decisions in my life, so the more I can buy great businesses with a time frame of forever and with size I can tolerate drawdowns and dollar cost average, the better.  It's unfortunate that I developed decision fatigue and realized this after the market doubled in 18 months, so I'm being cautious because dealing with drawdowns is not my speciality, but that's because size in trading is way different than size in investing, which I've already learned the hard way. I also suffered from mixing up time frames doing both myself, so I gave half my money to a broker friend for investing, and half I'll have for shorter-term or opportunistic stuff. 

     Now that the market making banks stole billions from option buyers by crushing the market into OPEX, maybe we get an oversold rally. I personally think any rallies will be hard to sustain due to lack of conviction and emboldened shorts in a rising rate environment, but as long as the Fed doesn't surprise hawkishly, it would make sense to chase shorts out before rolling over again, especially into earnings. Personally, I'm thinking of waiting until the first rate hike. We'll see.

     This market seems like it's not a V bottom kind of market. Obviously, anything is possible, but it sure seems like there's not much fear of missing out, so before I get fully invested, I want to see a double bottom, or a clear reversal hammer on the weekly.  It sure seems like it can go a lot lower. Another way is waiting for a downtrend line to break for several days and then buy weakness. If your time frame is 5-10 years, then why fret over a couple of percent?  A trick I've used on shorter time frames is picking a spot on the chart that means the bottom is likely in, and then waiting for it to cross over that area, which is usually a breakout of some sort, then waiting for weakness because breakouts never work in stocks. You do miss out on some gains, but you also avoid a lot of fake-out rallies that go south before you can finish a sandwich. 

     Everyone is looking for an answer and there isn't one. What you realize at some point is the worst thing you can have is an idea because if the market goes in your direction you will feel like you are right when you might be, but those are two separate things most of the time. And when the market goes against you, you'll end up not wanting to sell and miss out on your thesis, which can turn into deep trouble. How much are you risking?  After you make both mistakes enough times, or misjudge a market regime, or get blindsided in one way or another, or your thesis doesn't work out, what you figure out is that it's best to be balanced and never risk too much in one thing, except I must admit I do agree with the notion that once in awhile your perfect pitch comes along (and it's different for everyone) (one for me was Oct Opex), so that is the time to swing for the fences and be aggressive. The rest of the time it's more important to figure out how to keep the gains. At some point in the future, and I'm currently thinking it's years away, the Fed's hands will be tied and the market will once again go down 80% and erase a generation of gains.  That's what happens in debt-fueled markets. I like the idea of thinking about how you would construct a portfolio that lasts 100 years with no changes. Usually, lessening drawdowns means giving up some upside too, but how do you make it through the waterfalls? 

The Universal Stablecoin

~3500 words ~15 minutes

 

Dear Federal Reserve Board and Bank For International Settlements,

 

    The history of this world is a relentless battle between freedom and power - militarily, economically, and philosophically. The three-branch self-governing American system is built on a foundation of restricting power to protect freedom. The original purpose of using non sovereign gold to back the currency was to silo political power from economic power and prevent the corruption of overruling kingdoms from whence our founders fled. But gold proved to be insufficient as the chains of restraint were broken and a historic tsunami of fiscal spending and private debt enabled by the monetary policies of the Fed have engulfed this world like a degenerative disease. For the first time in history, modern technology has created an opportunity to redesign our monetary system in a way that reasserts the separation of economic and political power, which will avert and transcend the human causes of economic collapse littered throughout history. 

    This article explores private and public money, Bitcoin, gold, and the nature of value to illuminate a path forward in the spirit of public service. The thinking of government officials leans too far in the direction of control and surveillance while free market participants dismiss the need for regulation and protection of the people. The problems with our financial system date back to decisions made before any of us were born when technology was lacking to solve limitations of the physical world. Today, we stand at the dawn of a new digital age that can give birth to a system not cobbled together with haphazard and hasty ideas patched together from the remnants of the previous collapse, but thoughtfully, and proactively, designed for long lasting, even permanent, stability. 

 

Universal Monetary Problems

 

     The flaws with our financial system are all solvable with blockchain technology, but it requires a recognition and willingness to fix them proactively, or we will be doomed to repeat the same mistakes seen throughout history. Here are four major flaws: 

 

1. Interest rates underpin our entire debt-based financial system that emerged from a barter/gold system to meet the demand for credit. Since the only way to access capital was to borrow from someone else, the time value of money was born as borrowers and lenders negotiated the price of interest rates. Until now, there was no other way to do it. 

2. Centralized credit institutions arose as lenders attracted capital at one interest rate and loaned it out at a higher rate to make a profit. This evolved into complex derivatives and daisy chains of collateral connecting massive sources of capital as centralized hubs in an international network supporting the world economy.

3. Single sovereign fiat currencies are debt instruments borrowed into existence at the prevailing interest rate for both the public economic activity of government spending and the private economic activity of businesses and people borrowing from banks. But using the same currency for both private and public borrowing creates systemic risk since the government is incentivized toward fiscal profligacy, which dilutes the purchasing power of the money borrowed in the private realm as well. Until now, there was no other way to do it. 

4. Using public money as the unit of account to denominate the prices of goods and services in the economy creates an unstable inflation/deflation variable based on the market’s outlook of how government policies will affect the single sovereign currency.  Until now, there was no other way to do it.

 

Foreign Exchange Problems

 

     Throughout history we’ve tried different systems of exchange rates for our global monetary system, but all of them have tradeoffs. 

 

1. The Gold Standard is commodity money, which introduces the variable of supply and demand for gold that has nothing to do with its role of money. However, when gold backs the issuance of a paper currency it does create a restraint on the issuance of debt, and a check-and-balance on power because if too much paper currency is issued, or a problem with counterfeits arises, people (or nations) can redeem their currency for gold. As it turns out, this restraint is easy to break because it happened twice in the 20th century, so while gold does restrain governments it lacks the flexibility to meet the legitimate needs for credit in a growing economy, and it requires centralization for borrowing. 

 

2. Fixed Exchange Rates provide certainty in international trade, which makes foreign investments safer because it eliminates currency risk. Fixed rates constrain government policies from excessive spending or it results in a run on foreign exchange reserves to exit the profligate currency much like the gold standard. However, there’s no mechanism for the government to respond to shocks that cause a balance of payments crisis between countries. Fixed rates also require enormous foreign reserves, which could result in liquidity issues or opportunity costs, and while there’s no ongoing speculation, if forex markets sniff out an imminent revaluation or devaluation, event speculation amplifies it. But the biggest tradeoff of fixed rates is the inflexibility with domestic economic policies for growth, inflation and unemployment whether the rate is too high or too low. Fixed rates hamstring the government to a degree that causes its own demise - much like gold.

 

3. Floating Exchange Rates provide protection from external shocks because policymakers can respond to unexpected events - like spiking oil prices. This flexibility allows the government to pursue policies they feel are appropriate for the domestic economy. A floating rate can depreciate to compensate for a balance of payments deficit and restore competitiveness of exports. However, uncertainty of the exchange rate causes currency risk for international firms because foreign investment and trade may be adversely affected. The lack of constraint on domestic policy also allows governments to pursue excessively expansionary policies, which leads to abuse of the currency to avoid short-term volatility, or for political gain. 

 

     The common problem of these exchange rate systems is the use of single sovereign currencies as the basis for the entire monetary system in each country. What is needed is a dual system of public money and a separate universal currency based on the value creation of private businesses and the labor of people, which maintains the stability of fixed exchange rates in international trade, but leaves policymakers the flexibility of floating rates to adjust the public currency to domestic conditions. 

     What would be the best source of a universal currency to fill this role?  

 

Bitcoin Problems

 

     If you analyze the history of goods and services of this world, there is an underlying economic law: with the exception of art and collectibles, value is determined by utility. Apple is the largest market cap in the world because its products and services are embedded in our everyday life. The only time my iphone isn’t within three feet of me is when water is involved. Maybe one day it will be a chip in my head with tiny waterproof speakers implanted in my ears. That is utility. 

     While gold is no longer embedded in our everyday life, it functioned as physical money for thousands of years due to its innate qualities of being fungible, divisible, durable, malleable etc., which gave it utility as a medium of exchange and a store of value. When gold was demonetized and slowly dropped out of use, its price maintained a relationship to fiat currencies and real interest rates. As the value of the dollar was diluted, gold went up in price, thereby storing value. That utility carried on from history. 

     The US dollar could not be more embedded in our everyday lives. It’s the most widely used currency in the world. We get paid in it, everything is priced in it, we need it for taxes, and we use it for nearly every transaction everyday. The dollar’s widespread utility is the main reason it hasn’t collapsed in the face of unprecedented fiscal and monetary policies.

     Bitcoin is an innovative payment mechanism that solves the issue of trustlessly transferring value, but a group of people cannot decide something has value just because they’re buying it. Whether it has the necessary properties to develop the utility of being embedded in our lives is pure speculation, and the reasons Bitcoin bulls give are not convincing. I own a business. There’s no way I would risk my profit margins accepting a form of payment that can drop 10% in an hour from leveraged speculation that will never change. If I want to speculate, or hedge inflation risk, I can allocate after tax net profits to buy whatever is necessary to accomplish that. None of the layer one cryptocurrencies have the stability to be used as a currency in everyday transactions, which will prevent them from ever gaining the widespread utility of public money. It’s not their purpose.  

     Another reason layer one cryptos won’t work as currencies is because people buy them as investments. No one would spend their Apple stock to buy groceries either. The whole idea of investing is because you expect to make a return on the price appreciation or cash flow. Investments and currencies are two separate things, which is the primary reason for public money to exist. Public money has its own set of problems, but it works great as a currency because it’s not an investment, so people freely spend it because they’re not trying to profit on its price appreciation. The properties of gold didn’t require believing in them to give it utility, and the deep network of public money is way less volatile. The role of layer ones is to track the transfer of value on the distributed ledger and act as a seedbed for Dapps to blossom into our everyday lives to create value from utility, not to function as a currency in transactions, which requires stability.

 

The Solution: A Universal Stablecoin

 

     The goal of a stablecoin is to solve four problems:

 

1. Create a restraint on the issuance of public money.

2. Provide a stable currency to spend and accept in everyday business transactions domestically and internationally that is separate from public money. 

3. Create decentralized credit by utilizing trustless blockchain technology to allow people and established businesses to issue the stablecoin within limits. 

4. Use the value of the stablecoin as a universal unit of account.

 

     The universal stablecoin is a version of SDR + gold. Each sovereign currency would have a weighting in the basket determined by a formula based on the size of the economy, balance of payments, debt-to-GDP, interest rates etc., so the basket always equals 1. Since gold has deep historical roots as physical money and has maintained a relationship with fiat currencies, its inclusion acts as a counter to prevent a race to the bottom of all sovereigns devaluing simultaneously. 

     For example, if the weighting of the US dollar is .35, but the US debt to GDP ratio is steadily climbing past a predetermined threshold of 80% (we wish), the weighting would slowly inch downward to .34, which means another component of the basket must go up to maintain the value of 1. If the US is growing its debt faster than Europe (all else equal), then the Euro inches upward in proportion. If both are growing their debt equally, then some combination of the other sovereigns goes up, or if they’re all the same, then gold goes up, but the stablecoin always equals 1. This stable value can then function as a universal unit of account to denominate the prices of goods and services worldwide.

 

The Universal Unit Of Account

 

     Having a stable unit of account that isn’t a single sovereign currency and doesn’t fluctuate in value eliminates the currency risk for foreign investment and international trade because the same universal currency is accepted everywhere. In the U.S. a loaf of bread might cost 3.50 Unis, and while there could be local supply and demand issues temporarily affecting certain products and services, or other variables like local cost of living or other business expense differentials between countries that make the real prices of the same goods somewhat different, the inflation/deflation variable caused by prices denominated in the constantly fluctuating sovereign currencies would be eliminated. This would result in truly stable prices and offer a riskless universal currency created by private economic activity to hold your savings in as a true store of value that is accepted in worldwide business transactions.   

 

The Issuer Of The Currency 

 

      Every sovereign nation would keep its own currency to spend on government programs. Sovereign bonds would enable that spending and be interest-bearing. Banks would continue issuing interest-bearing loans to riskier borrowers. But people and established businesses would issue the Universal Stablecoin (Unis) - limited by their discretionary income - as interest-free money because there’s no middle man creating a loan and expecting a return. It is decentralized self-created credit enabled and restrained by blockchain technology.

     This money would be backed by the products, services, and future labor of the people and businesses, which creates a dual system of interest-bearing fiat sovereign currency borrowed into existence as debt, and interest-free universal currency issued by people and businesses creating goods and services. This separates the policies of the central banks and governments from affecting business activity as Unis flow through the world as the universal currency of the private realm.

     All sovereign currencies would fluctuate in value against 1 Uni, which prevents excessive fiscal spending because if everything is priced in Unis, the government currency would lose purchasing power against it and cause everything to be more expensive. By separating government currency from the universal currency issued by the value creators of people and businesses it eliminates the point of failure of using single sovereign currencies for both public and private economic activity. Central bank policies would only affect their own sovereign currency, so governments would finally be restrained from the systemic risk created by their misaligned incentives. 

 

The Universal Bank 

 

     An individual would have several accounts of interest-free credit (denominated in Unis) available to them based on their discretionary income for a house, a car, college, and credit cards. The available credit in each of these accounts would grow or shrink based on their real-time finances, and their wallet would project future credit based on increases or decreases in income and expenses. 

     The credit in each account is created out of thin air but backed by their future labor, which is the exact same process as a bank loan today except without the bank. The debt is a liability for the individual and an asset on the ledger of the system itself, which acts as a universal bank. Qualified, established businesses would issue interest-free Unis to pay their employees and supply chain to create their products and services, which would act like a currency and not a stock investment, so there wouldn’t be a hesitancy to spend it. (I wrote more about this in The Universal Bank.)

 

The Universal Wallet

 

     Zero-knowledge proofs allow wallets to be linked to a real person without revealing their identity. This makes it possible to have a system of verified users who can only send money to other verified users, and allows the wallet to be programmed to automatically send taxes to the government but without revealing the identity. The government would know who paid their taxes, but not the wallet the individual owns, so it would be impossible to evade taxes, and yet still maintain privacy of transactions. 

     Personally, I think a consumption tax system would be better but it could work either way. Consumption taxes are very regressive, but the wallets could be programmed so if you make under a certain income threshold you don’t pay any taxes at all. And the sales taxes could be automatically sent to the government wallet in real-time. 

     Universal Wallets also solve a lot of SEC issues about regulating securities because the wallets could be programmed to only “unlock” access to accredited investment opportunities if the person is qualified by income, net worth, or a course they took. Wallets that offer investment opportunities could only accept money from wallets unlocked for that tier of investment, which could also send any information the SEC requires, so there wouldn’t be any concerns over investor protection in a predominately decentralized system because it’s all controllable through open source programming people could see and trust. 

     The wallets would contain all your stocks, bonds, and currencies (US dollars and Unis), and only be allowed to spend with some combination of security features like facial recognition, 2-step text, whitelist…etc.. Smart contracts could even embed money spent with a 7-day clawback feature akin to how chargebacks work to reduce fraud. Insurance and custody solutions would naturally arise. (I wrote about this in The Universal Wallet.)

 

 Permissioned Problems

 

     The government wants a permissioned centralized system where everyone has an account at the Fed or the Treasury, and while the most important feature of what I’m proposing is the interest-free credit and universal stablecoin, which could be done that way, it’s extremely important to not allow a purely centralized system to happen for no other reason than the government (present or future) would be able to enforce negative rates and other incentives or interventions that perpetuate the same behavior of repressing short-term volatility for long-term instability, not to mention invasive surveillance of our transactions, all in the name of political gain and control. The system must be designed to be dictator proof so any kind of unforeseen hostile takeover in the future is impossible. The entire point of the universal stablecoin is to impose a restraint on power like our three branches of government. A controlled, permissioned system is the opposite of that, and it’s exponentially more vulnerable to security attacks, which creates systemic risk. 

      

The Path

 

     I understand this proposal sounds impossible to implement, but it’s not, mostly because it benefits everyone except banks. Even politicians would love to run on the people pleasing idea of interest-free credit. When something is as beneficial as this to as many people as this it’s not a matter of whether it’s possible, it’s a matter of what path it will take, and while there are two avenues forward, both involve the governments of this world recognizing we’re headed for global standards. 

     While the status quo doesn’t tend to be proactive, I believe our political and monetary leaders recognize the fragility of our financial system and can’t admit it publicly, so I implore them to not bury their heads deeper in denial and do nothing because they will force a revolution when the current system implodes, which I don’t believe is imminent, but time will run out. It is broken. With the amount of fiscal spending that happens nowadays it would be wise to at least develop this as a backup. 

     Alternatively, this could be privately developed. The free market could choose to use the stablecoin and wallet in everyday business transactions, but the interest-free credit would still require the government to allow it as legal tender. Founding investors would make billions from tiny transaction fees. I believe this project would be better funded by public money for public good, but if no one in government is interested, the private path of revolution would be scintillating.

     Once the stablecoin and universal wallet system was ready, and the government recognized the need - whether proactively or through revolt amid a crisis - everyone would transfer their interest-bearing house, car, college, and credit card loans from banks into their universal wallets denominated in interest-free Unis. Nationalizing the banks implies government ownership, which this is not. It’s more like universalizing the banks, which would dramatically shrink their size, and the vulnerability centralized credit creates. Financial crises would become obsolete. 

     Here’s a few basic categories of a wallet:   

 

 UNIS: 44,876   USD: $22,438

 

Loans	Car	House	College	Credit Cards
Balance	17,985	156,931	34,549	7,902
Tiers	Income Bracket	Sales Tax	Investor Status	Bills
	75,000	18%	Intermediate	Utility…

 

Notes

 

1. The fluctuations within the Universal Stablecoin as one fiat goes up countered by other components going down could be determined solely by a formula, or utilize forex markets that trade every currency against 1 UNI: USD/UNI, EUR/UNI, JPY/UNI etc.. (or both)  

2. Another idea beyond the scope of this article is attaching interest to the issuance of the stablecoin beyond a predetermined threshold. For example, the first 100% of a person’s discretionary income is interest-free, the next 25% has 1% interest attached and so on, which is automatically extracted from their income, and increases up to a limit where it’s capped. This would create a market of people who want to hold that money to collect interest, which would reduce the need for banks even further. This could also be applied to riskier businesses like the way junk bonds function, except it’s currency they create with high interest attached. Government money could also function the same: the higher the level of debt, the higher the level of interest automatically. In theory, the bond market wouldn’t exist because the interest rate would be determined by a mathematical formula, attached to the created currency, which would cap the level of debt as it gets prohibitively expensive. 

3. The second half of Freebird is the best four minutes of music ever recorded.