January 2024 – Smart Money Asia

I made an appearance on Retire Japan TV on 22 January. It was a delightful conversation and many thanks to Ben and Daniel for having me on. In particular, much respect to Ben for tackling the subject of crypto, which he is by no means a believer in! I don’t think I convinced him, but hopefully, I somewhat demystified the idea of crypto, and Bitcoin in particular, as an investment asset.

I have spent the last 6 years learning about and experiencing crypto. Whenever I talk to people who have not been paying much attention, I have to remind myself that they have many misconceptions that I dispelled long ago. Watching the video back, I inevitably found a few parts that I could have explained better, but I think I covered the main points I wanted to hit:

Bitcoin not crypto – I can’t really stress this enough. If you are new to the asset class and you don’t yet have a basic understanding of Bitcoin and its four-year halving cycle, you should not be diving into altcoins. You will get rekt, which is a technical term by the way! The Bitcoin four-year cycle drives all of the price action in crypto. Get a little Bitcoin first, learn about it, and then explore other crypto assets if you are comfortable.

Go forth and diversify! – we touched on Harry Markowitz and efficient frontiers. I have covered this in a post on Asset Allocation. I also wrote a post back in 2018 on Diversifying Through Crypto. With Bitcoin, we are talking about an asset that is only moderately correlated to traditional asset classes. Non-correlation is the name of the game if you are looking for better returns without significantly increasing risk. If you only own stocks, you are not diversified. If you own stocks plus Bitcoin, now you are a little more diversified. Really you need to own a little of every asset class. Diversification becomes more and more important as the amount of capital you have grows bigger, and also as you get closer to spending it. Most people are not diversified enough. Read Ray Dalio, folks!

You are being robbed! – we are not just talking about a little bit of healthy, organic inflation here. Central banks have been printing money and inflating their balance sheets knowing that in the end, it’s the public who will pay for it. When the system makes money, it’s capitalism. And when the system creates a big hole, it’s time for some socialism. The next book on my reading list is Broken Money by Lyn Alden. Ben made the point that other investment assets like stocks and real estate offer protection against inflation, and they absolutely do, but good luck exchanging a fraction of your house to buy goods and services. The difference here is that Bitcoin is a form of money and it is programmed to be deflationary. In my opinion, it will outperform the debasement of Fiat money over time better than stocks or property.

Basic economics – I took a few economics classes back in university. I wish I had been more interested at the time. The first thing that was covered was supply and demand. It is fundamental. Fixed supply with increasing demand = number go up! Jurrien Timmer at Fidelity is an essential follow for understanding the properties of Bitcoin and how it relates to other asset classes. Read up on Metclafe’s Law and network effects. We are talking about a network here.

Misconceptions

There are too many misconceptions about Bitcoin to count. The biggest one is that someone could just make another one. Folks, we’re talking about an asset with a $785 billion market cap. Good luck making a new one that’s going to knock it off its perch. Nobody in crypto is trying to do that. The race for the underlying store of value in the space is over.

That doesn’t mean all the other coins are not investable. Some are better than others and they are simply built to do different things. But that’s a whole new essay that I don’t have time for here.

As for the idea that only a handful of people own most of the Bitcoin. That was a new one on me but it’s simply not true. There’s a great report on that by Grayscale here. Also, if you are looking to figure out what’s going on in the network, Glassnode is an amazing tool. Check out their 2023 Yearly On-chain Review.

I could go on, there are so many misconceptions. Hell, China has banned Bitcoin multiple times. So no one in China owns BTC right?

Integration into traditional finance

The rallying call of crypto folk used to be ‘We’re still early!’. Judging by how little the average person understands the asset class, I think that’s still true, but it is getting less so. A few years ago, Larry Fink, the CEO of Blackrock, was decrying crypto as a tool only used by criminals to launder money and finance terrorism. It’s a familiar refrain from those who feel threatened by the emergence of a system that competes with the one that made them rich. (We see you too, Jamie Dimon) Now Larry has a spot Bitcoin ETF and is on Bloomberg and CNN saying that all financial assets will end up tokenised on the blockchain. Stocks, bonds, the whole shebang. We’re not so early any more.

Of course, a Bitcoin ETF is a tradfi product. You can’t exit it in Bitcoin, only in dollars. But for Japan residents, that does mean it gets taxed as capital gains, not income.

Other resources

The first time I looked at Bitcoin was in early 2017. My friend came back from a conference and said “We need to buy Bitcoin!” and handed me a report called ‘How to position for the rally in Bitcoin’, which was actually published in 2015 by Adamant Research. I read that and thought he was probably right. Adamant is still publishing analysis and their latest report is called ‘How to position for the Bitcoin boom’. You can find all their analysis here.

I mentioned Microstrategy on Retire Japan TV. Their Bitcoin dashboard is quite something and can be used to compare Bitcoin returns to other assets.

So there you have it. Not content with being allowed to talk for an hour, I have now written a post to further clarify my thoughts.

The halving is in April. I would expect a couple of months of sideways chop in crypto prices, maybe even a big juicy drawdown. That’s all part of the ride. Check in on me in 12-18 months!

Disclaimer: This should go without saying, but the information contained in this blog is not investment advice, or an incentive to invest, and should not be considered as such. This is for information only.

Happy New Year everybody! I hope you all enjoyed a peaceful winter holiday and are back, raring to go and make big things happen.

For some reason, I had a feeling that this was going to be a challenging year and it didn’t really get off to the best start in Japan. For those interested, I was googling around yesterday trying to figure out the best way to donate to disaster relief on the Noto Peninsula. I found this page run by Ishikawa Prefecture. You can download a form here to request a receipt for your donation for tax purposes. Donations qualify for the donation deduction and there is a useful FAQ on the tax treatment of donations here.

So yeah, earthquakes, runway collisions, fires and we’re only a third of the way through January!

From a personal finance and investing perspective, there is some exciting stuff going on though. The New NISA has launched. I logged into my SBI account and it was pretty simple to get started. I have already set up the ‘tsumitate’ allocation and started buying some stocks for the ‘growth’ allocation. Clearly, everyone else is doing the same thing as the Nikkei is pumping so far this year!

I posted a couple of interesting takes on Japan on ‘X’ yesterday: an optimistic look at the year ahead from Jesper Koll and a much darker look at the demographic issues facing Japan from author Nire Shūhei. It always pays to look at both sides.

So how to invest in the year ahead? If you have been reading this blog over time, you will know that I divide investments up into core and satellite allocations. The core is a diversified portfolio weighted heavily to your base currency that just gets rebalanced once a year. This would typically account for around 70-80% of your investments and the idea is to keep adding to it as much as you can. If it’s a bit dull and boring, you are probably doing it right!

The other 20-30% can be allocated to satellite holdings, which may be a little more racy and exhibit a higher risk-return profile. If this part isn’t fun, then you are probably doing it wrong!

Satellite holdings will change over time depending on the economic environment we are in. So how are things looking?

Some thoughts

On the one hand, things look pretty much like they did for most of last year. The Fed funds rate is 5.5%. People who are obviously long risk assets have been trumpeting the start of rate cuts as early as March, but Mr Powell doesn’t look like he’s in much of a hurry to me. Although the Bank of Japan has adjusted its yield curve control policy and allowed long-term interest rates to rise a little, it is still continuing with its negative interest rate policy. There has been a significant amount of speculation, from both within and outside Japan, about when the BOJ will ‘normalise’ rates – I do love this term, like there is a way to return to normal with government debt to GDP at 264%! Gulp…

Despite noises being made about an exit from negative rate policy, it’s notable how quickly these ideas get put on the shelf. Comments I have heard recently include: ‘The earthquake will make it harder to normalise rates’. Probably true, but any excuse to avoid the inevitable. The Labour Ministry’s November report showed that real wages have declined for the past 20 months in a row, so there’s no sign of the mystical ‘virtuous cycle’ of wages outpacing price rises that would signal a move from the central bank.

It’s not going to happen, is it?

So if you’re waiting for the yen to get back to something sensible against the US dollar, good luck! Markets can remain irrational longer than you can remain solvent enough to go on a nice holiday abroad…

Japanese stocks, for the most part, are loving the weak yen. Any company with significant exports and profits abroad will see those profits magnified when converted back to yen. If you’re wondering why your Toyota shares are doing so well, there you are.

What kind of market is this?

Some time ago, I read the book Reminisces of a Stock Operator by Edwin Lefèvre. It’s considered somewhat of a bible by many investors. While there are some interesting tales of hi-jinks and high leverage, there was only really one key thing I got out of the book, but that one thing has stuck with me: Traders and investors should always know if we are in a bull market or a bear market.

It’s always the simple things that have the most impact, right? The protagonist in the book is a stock trader and his big-picture strategy is very simple: If he is in a bull market, he trades with a long bias. If he is in a bear market, he trades with a short bias. If you don’t know what kind of market you are in, you have no business trading, he says. The author coined the phrase ‘bulls and bears make money; pigs get slaughtered’.

Now, if you are a long-term investor, you don’t have to be concerned with trying to short-sell. You are more than likely to get into trouble. Simply replace the terms ‘long’ and ‘short’ with ‘risk-on’ and ‘risk-off’. Again, I am talking about satellite holdings here. You don’t have to overthink the core part of your portfolio.

Bull or bear?

The Nikkei 225 index gained around 28% last year. After such a positive start to the year, it is widely expected to keep on trucking. It’s pretty clear we are currently in a bull market. If you live in Japan and have a need for JPY base currency, then Japanese stocks are a good place to be.

The only question is what could go wrong? What could bring an end to the bull market?

I think the main short-term danger is a recession in the US. Although the financial press continues to focus on the ‘soft landing’ narrative, history tells us that rate-tightening cycles rarely have a happy ending. Depending on the depth of the recession, US stocks could fall anywhere between 20-50%. I don’t see how Japan just keeps sailing on if that happens, no matter how much better value stocks here may be. If you have already loaded up your investments for the year, I don’t think that’s a bad thing but be prepared to navigate some choppy seas. So it may not be a reason to go risk-off, but be prepared for some volatility.

The BOJ is another matter. If they actually did try to raise rates we would probably experience more than a minor squall. My expectation is they daren’t even try but let’s keep an eye on them. At year-end, I was watching a news feature where they interviewed Japanese business leaders and asked them their views on the stock market for 2024. When asked what they thought was the biggest danger to the Nikkei bull market, the majority of them said ‘the election of Donald Trump’. Interesting…my feeling is these guys need to look a little closer to home.

I’m not even going to get into geopolitics. Lots of risk there, but what are you gonna do?

Outside of Japan, US markets are making all-time highs. However, when you look under the hood, the good cheer is really driven by one group of stocks, known as the Magnificent Seven. If this is a new term to you, the stocks are Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla. The size of this group is truly staggering – last time I looked, the combined market cap was around $11.7 trillion. That’s about equivalent to the entire stock markets of Japan, the UK and Canada combined! This group returned around 107% in 2023.

So this bull market is clearly a Magnificent Seven bull market, and the narrative driving it is AI. If you own any kind of global stock fund, go and check their top ten holdings. I’ll bet you that these seven stocks feature prominently.

This group of stocks are a must-own. If you feel you don’t own enough of them, a US recession and corresponding sell-off in the stock market could present a nice opportunity.

Emerging markets could be worth a whole new post, but here’s the tldr: everyone is buying India, not China.

US government bonds got clobbered through this rate hike cycle. If you bought them after the clobbering, you will probably do well as rates eventually subside.

I’m from the UK, so I usually keep an eye on the market over there, but wow, that does not look to me like a place I would want to allocate capital unless I was actually moving back there. Everything about it screams bear…

The biggest bull of all

Of course, the heavyweight champion of satellite holdings is my personal favourite. Yes, the Bitcoin-led crypto bull market is upon us. I already wrote the post on that, it’s right here. You know what to do.

Or do you? I saw a great tweet by Tuur Demeester earlier, in which he said that many people will adopt crypto reluctantly. ‘Hate buying’ he calls it. He also points out how the SEC just ‘hate approved’ the spot Bitcoin ETFs. So why are people going to buy something they hate in the end?

The answer, perhaps, lies in the ongoing debasement of Fiat money, which has accelerated considerably since the 2008 financial crisis. Raoul Pal talks about this a lot and has some great charts. You think your stocks are going up, but really it’s just the purchasing power of your money going down, and you are barely breaking even. People are gradually waking up to this. And there are not many assets that are likely to outperform this money debasement over time. Gold is not getting there. Tech stocks will probably do it, and crypto will likely do it too. Maybe you’re not ready yet, but one day you will be, and you might hate it, but you will probably buy it in the end. Better to rip off the band-aid now perhaps?

On that note, I wish you a happy and prosperous 2024!