What also makes the Bitcoin phenomenon so unique is how few people understand what it is and how it gets its value. We remember having similar conversations in 2007, before the U.S. housing collapse, when investment bankers came into our offices and tried to convince us to buy Collateralized Debt Obligations and Credit Default Swaps. We could not understand then how taking large numbers of high risk mortgages and packaging them together with leverage would give investors a low risk “AAA” security. With Bitcoin, we have similar reservations. For example, we do not understand why Bitcoins have scarcity when there are thousands of other cryptocurrencies. Another question concerns how Bitcoin consumers can even use Bitcoin as a currency for transactions when the price changes so dramatically minute by minute?

While all of this is interesting from an investor’s perspective, we are watching Bitcoin and its blockchain contemporaries from the sidelines. It would be surprising if the Bitcoin bubble does not ultimately pop, but in the short term, we believe that its price will probably increase substantially, as FOMO (Fear of Missing Out) compels investors to buy. With the Chicago Board Options Exchange and CME Group launching Bitcoin futures in mid-December, institutional investors will likely rush in and drive Bitcoin to new highs. More significant to us however, is what it says about the current investment climate. One of the major concerns we have had over the last several years is the unknown and unintended consequences of the trillions of excess capital in the economy from low interest rates and central bank quantitative easing. While we have highlighted in the past the impacts this has had on stock and debt valuations, Bitcoin might really be a harbinger of this capital getting misallocated. In the last few weeks, we have been inundated by small technology companies that are raising capital to launch “blockchain strategies”. These companies are raising vast sums of money with the promise of revolutionary technology, much of which is unproven. One company we would highlight is LeoNovus. This company completed a bought deal on November 1st where they intended to raise $10MM, but due to strong investor demand, raised over $13.7MM. What makes this company so extraordinary is that it has a market capitalization over $100MM with quarterly revenues of only $9,000. In September, LeoNovus had a market worth of $12MM. Two months later, the company’s stock price is 1000% higher. Is this possible based on the company’s fundamentals? Is it by chance that this coincides with Bitcoin’s ascent? While we are happy to see so many small-cap technology companies secure financing, we worry that investors are not doing their due diligence and have forgotten the lessons of the past.

In our opinion, the latest price action in Bitcoin and blockchain companies is further evidence that the economy and stock market are on the cusp of a pullback. While we have been caught underweight equities and risk for much of 2017, we believe that our extra caution is warranted and continue to position the portfolios to benefit from the long overdue correction.

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