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Don't Play a Bit-Part In This Bubble

By Alex Dumortier, CFA - Apr 5, 2013 at 7:07PM

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This is no store of value.

This morning's disappointing jobs data ostensibly fueled stock losses today, with the S&P 500 (^GSPC 1.99%) and the narrower, price-weighted Dow Jones Industrial Average (^DJI 1.61%) losing 0.4% and 0.3%, respectively. On the week, the S&P 500 lost 1%, its worst weekly performance this year. Small-cap stocks were hit even harder, as the Russell 2000 Index fell 3%, its worst weekly loss since June.

Despite the losses, the VIX Index (^VIX 0.00%), Wall Street's fear gauge, closed virtually unchanged, at 13.22, although it did hit 15.65 intraday, the highest level it has achieved since March 4. (The VIX is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming thirty days.)

Things are getting a bit bubbly
As an observer and student of the financial markets, I'm fascinated by bubbles. I'm not alone: Since the credit crisis, the financial media has bent over backwards trying to label new ones. I'll admit that 've participated in this "bubble in bubbles." Nonetheless, whether you see them everywhere, or you're a Greenspan-style "bubble ostrich," the reality lies somewhere in between. Bubbles do occur, and it's worth keeping an eye out for them, because if you get swept along in one, it can gravely damage your financial well-being.

The reality is that, since the failure of Lehman Brothers in Sep. 2008, we have likely witnessed a number of manias. I believe history will ultimately show that $1,900 gold was a bubble (even if it doesn't deflate in a dramatic manner), and that the same is broadly true of the spate of recent social networking IPOs, including Groupon and Zynga, that mirrored the dot.com bubble of the late 1990s.

My preliminary assessment of the digital currency bitcoin, is that it looks dangerously frothy. Bitcoin reached a new all-time high of $147 this week, nearly a two-thirds rise in the space of roughly a week.

On paper, bitcoin certainly has some attractive qualities, including limited supply and low-to-zero transaction costs. However, its extraordinary volatility means it is categorically ill-suited as a store of wealth. Don't take my word for it; instead, read the warnings on the bitcoin website, which include the following [my emphasis]:

The price of a bitcoin can unpredictably increase or decrease over a short period of time due to its young economy, novel nature, and sometimes illiquid markets. Consequently, keeping your savings in bitcoin is not recommended. Bitcoin should be considered as a high risk asset, and you should never store money that you cannot afford to lose with Bitcoin.

Furthermore, its popularity is bound to attract increasing attention from governments, which are rarely fond of competitors when it comes to currency. Call me the boy who cried wolf, if you wish, but I think this digital currency could do more than a bit of harm to unknowing speculators.

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Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
^DJI
$32,637.19 (1.61%) $516.91
S&P 500 Index - Price Return (USD) Stock Quote
S&P 500 Index - Price Return (USD)
^GSPC
$4,057.84 (1.99%) $79.11
CBOE S&P 500 Volatility Index Stock Quote
CBOE S&P 500 Volatility Index
^VIX
$28.37 (0.00%) $0.00

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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