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Exclusive Interview: Robert R. Johnson Says Cryptocurrency “Laughable,” Won’t End Well

Exclusive Interview: Robert R. Johnson Says Cryptocurrency “Laughable,” Won’t End Well
June 25
00:03 2019

You may well recognize Robert R. Johnson, PhD, CFA, CAIA, is CEO and Chair of Economic Index Associates. He’s been a regularly quoted source for articles as well as other media outlets. He is also Professor of Finance, Heider College of Business, Creighton University.  He is co-author of Invest With the Fed, Strategic Value Investing, Investment Banking for Dummies, and The Tools and Techniques of Investment Planning.

FN: Bob, tell us a little be about yourself. What key events led you to where you are today?
Johnson: I am CEO and Chairman of Economic Index Associates (EIA), a NY City-based firm that develops investable indexes for fund managers using economic indexing. I am also Professor of Finance, Heider College of Business, Creighton University. Prior to establishing EIA, I served as President and CEO of The American College of Financial Services (TAC) for 3½ years. I joined TAC after serving as Deputy CEO of CFA Institute where I oversaw the CFA Program. I have devoted the lion’s share of my career to financial education.

The focus of my academic research for the past 30 years has been the influence of Federal Reserve monetary policy on capital markets. After publishing over 50 academic and practitioner journal articles on the subject, I co-authored Invest With the Fed (McGraw-Hill) with colleagues Gerald Jensen of Creighton University and Luis Garcia-Feijoo of Florida Atlantic University. Luis and Gerry are both founding directors with EIA. EIA affords us the opportunity to implement our academic research into practice. Additionally, it affords us the luxury of working with each other. The ability to choose who you work with is the greatest gift in one’s career and I now work with great people.

A native of Omaha, Nebraska, I have been strongly influenced by Warren Buffett. I co-authored Strategic Value Investing (McGraw-Hill), and Mr. Buffett has selected it for the Berkshire Hathaway Annual Meeting Reading List for each of the past four years. I consider earning Mr. Buffett’s “seal of approval” to be the highest honor of my career.

FN: What are the some of the investment fads we’ve seen during past market tops?
Johnson: Warren Buffett is quoted as saying “Price is what you pay. Value is what you get.” At any point, an asset’s price is subject to the laws of supply and demand. If demand for an asset exceeds the supply of that asset in the short run, then the price of that asset should rise and may exceed the long-term value of that asset. Prices can increase dramatically when seemingly everyone wants to buy an asset (remember the internet bubble of the late 1990s and the real estate bubble that precipitated the financial crisis).

In both cases, when market prices exceeded the long-term intrinsic (real) value of the assets, and when buyers stopped buying, prices fell dramatically. Similarly, if there is a large supply of an asset but few buyers (low demand) at any point, then the price is likely to fall, perhaps below intrinsic value. If investors recognize this value and start to buy the asset, demand increases relative to supply, and the price should rise. Value investing is the practice of buying assets when their intrinsic value exceeds the current market price and selling assets when the current market price exceeds the intrinsic value.

Perhaps the biggest bubble that we are currently experiencing is in cryptocurrencies. This is the quickest way for investors to self-destruct, and there is, in my opinion, a fad that is the biggest I have seen in my investment lifetime. I believe that the entire cryptocurrency market is a bubble and that it won’t end well for “investors.” I put “investors” in parentheses because investors aren’t making capital commitments to cryptocurrencies. Speculators are doing so. There is nothing to support the valuations of bitcoin or any of the other so-called cryptocurrencies as they don’t have any cash flows associated with them. Like gold, it doesn’t pay dividends or have earnings. But, at least gold has some industrial and other uses and some real, not virtual, limits on supply.

In order to profit, speculators rely on the “Greater Fool Theory” – that is, that some greater fool will come along and pay you more than your purchase price. But, if you can’t compute an asset’s intrinsic value, you can’t contend that you are investing. You must admit you are simply speculating. One can certainly get very wealthy if your speculation is correct. You don’t, however, want to find yourself without a chair when the music stops.

Despite my skepticism, cryptocurrencies and blockchain technology may very well transform the way we do business. In fact, let’s assume that happens. According to there are over 2,600 cryptocurrencies. This is before Facebook’s widely heralded announcement of the launch of Libra. For an example of how crowded the crypto space is, one need to look no further than the recent announcement that former US Senator Rick Santorum is involved with a project to launch a Catholic cryptocurrency called Cathio. The question one should be asking is “If cryptocurrencies do have staying power, which of the cryptos will be the ultimate winners?”

I am reminded of an anecdote that Berkshire Hathaway Chairman Warren Buffett relayed in a 1999 address before investment professionals in Sun Valley, explaining that many investors in innovation end up disappointed. Arguably the most important invention in the last century was the automobile. Yet, in the early part of the last century there were two thousand auto companies. The advent of the automobile had a transformational impact on how we live. If one had a crystal ball and knew at the time of the first cars how much this country would rely on automobiles, one would likely have invested heavily in the technology. Buffett explains, however, that of the two thousand companies, as of the late 1990s, only three car companies survived.

He went on to say that at one time or another, all three were selling for less than book value, which is the amount of money that had been put into the companies and left there. While autos had a tremendous impact on society, investors weren’t duly rewarded.

Many of these bitcoin speculators would be wise to be reminded of perhaps the recent market bubble that occurred in residential real estate in 2007-8. Many speculators leveraged and purchased multiple homes with the intention of flipping them as the price rose. The popping of that real estate bubble precipitated the financial crisis.”

FN: What is the difference between an investment fad and an alternative investment?
Johnson: In the investment world, an alternative investment is any investment outside of stocks and bonds. Anything from real estate to precious metals, commodities and even bottles of vintage wine are types of alternative investments that are increasingly attracting the attention of many institutional and well-healed individual investors. Interest in alternative investments tends to increase when the traditional asset classes – stocks and bonds – are providing pedestrian returns. And, of course, that is when investors are most likely to be disappointed.

FN: What are the similarities between an investment fad and an alternative investment?
Johnson: Purveyors of speculative assets – like cryptocurrencies would like investors to consider them alternative investments. In fact, there are many cryptocurrency advocates who would like people to characterize them as a new asset class. And, the fact that there is a debate within the financial community as to whether they do represent a new asset class is remarkable.

Most financial advisors would characterize the major asset classes as stocks, bonds, cash and real assets. The importance of asset classes is demonstrated by empirical studies demonstrating that asset allocation (the broad categories of assets) is more important than security selection (the specific securities within an asset class) in determining ultimate portfolio performance.

To find a parallel to the sudden prominence of cryptocurrencies, one only need to go back a few years to the rise of hedge funds. Although some people refer to hedge funds as an asset class, they’re more accurately defined by their strategies (long-only, equity long-short, event-driven funds, global macro funds, etc.).

Asset class labels can make a profound difference, as they can influence asset allocation decisions by investors. Many foundations, endowments, and public pension funds shifted a significant portion of investments away from traditional stocks and bonds and into carefully selected hedge funds, private equity, real estate, and other alternative investments. Following the so-called “Yale Model” (named after the university endowment that popularized the concept), institutional investors plowed assets into hedge funds and other alternative investments, only to be disappointed because the strategy underperformed (largely due to high fees) and proved to be highly illiquid.

Labeling cryptocurrencies as an asset class (or as a currency, for that matter), in my opinion, is laughable, but that the debate even exists shows that cryptocurrencies are capturing mindshare of the investing public. Of course, for all of the excitement around the topic, few can cogently explain how cryptocurrencies interact with blockchain technology, how they are “mined,” which tokens will ultimately prevail in any sort of business application, or other important details.

Cryptocurrency advocates gain markedly if the debate even takes place. The primary catalyst of legitimizing cryptocurrencies is the financial news media. Logging on the Yahoo! Finance homepage, one finds the price of bitcoin prominently positioned between the Dollar/Yen exchange rate and the level of the FTSE 100. It is one of only 18 assets/indices listed.

FN: What do you believe are some of the investment fads that we are beginning to see today?
Johnson: One has to look no further than marijuana stocks, cryptocurrencies, blockchain and plant-based proteins to see investment fads that we are witnessing today. We witnessed madness a couple of years ago with blockchain fever. Seemingly, any company with blockchain in its name rose in value. The height of absurdity was in 2017, when Long Island Ice Tea Corp changed its name to Long Blockchain Corp and its shares soared. In the long-run, rationality prevails and shares of the company that traded for over $10 in 2016, now trade for $0.40.

While hindsight is 20/20, today’s stock market is replete with many faddish stocks that long-term investors should avoid. Beyond Meat (BYND) is the latest cult stock to capture the imagination of investors. The recent IPO sells at 73 times sales. That is 73 times SALES, not 73 times EARNINGS. The firm can’t be valued on a PE basis as it is losing money. BYND soared 24 percent after a sales beat. But, the firm also reported greater losses than expected. I can hear value investors like Warren Buffett saying that while plant-based protein may indeed be a huge trend in food sales in the future, the fundamentals of the company are precarious because there is no moat with the product. In fact, Nestle is entering the plant-based protein space in the US with the Awesome Burger. The bottom line is that you may want to consume a Beyond Meat burger but refrain from buying the stock.

FN: How might investment fads impact retirement investors in a good way?
Johnson: Once the bubbles burst in investment fads, funds will flow into more traditional investments (stocks and bonds) that retirees hold. This could drive up the prices of those more conventional assets and buttress retirement investors’ returns.

FN: How might investment fads impact retirement investors in a bad way?
Johnson: If they stay away from these speculative assets, speculative assets shouldn’t negatively impact retirement investors. The majority of retirement investors would be well-served to adopt the KISS mantra – that is, Keep it Simple, Stupid. The best thing for most investors is to invest in a low fee, broadly diversified, stock market index fund.

FN: Besides investment fads and trends, what other insights can you share with our readers?
Johnson: Investing without a plan is like taking a trip and not having a roadmap or GPS. With the help of a financial professional, investors should establish an Investment Policy Statement (IPS) and follow it. And, yes, investors should establish a relationship with a financial professional. When we get sick, we go to a doctor. When we get into legal difficulties, we consult an attorney. Yet, for some reason many people thing they should be able to navigate the complex financial waters on their own. This is despite the incredibly low level of financial literacy in the United States. Failing to plan is planning to fail.

FN: That is surely sound advice every 401k plan sponsor and plan participant should follow. Thank you for sharing your thoughts and ideas with our readers. There’s a lot of “wild west” in the markets and you’ve revealed some of the wildest!

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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