HOW OVERCONFIDENCE LEADS TO EXCESS RISK.
Cryptocurrency, legalization fraught with risk
It was a tough weekend for the Calgary Stampeders, who f umbled away a strong season by losing in the Grey Cup Final for the second year in a row. A whole year’s worth of work was once again all for naught thanks to excessive risk taking that lead to two very costly mistakes.
With six minutes left in the game and a chance to widen their lead, their slotback aggressively tried to push for more yardage near the end zone, only to fumble the ball.
Then in t he l ast f ew seconds an i nterception was thrown when the game could have easily been tied and pushed into overtime with a field goal. But to quote coach Dave Dickenson, “No guts, no glory.”
It isn’t just the Grey Cup game, though, where overconfidence and excessive risk- taking can lead to mistakes.
In our opinion, some of the latest actions by investors are turning this into a “no guts, no glory” market and putting entire seasons of respectable wins at risk. Here’s a look at two of the most glaring scenarios:
BITCOIN
The euphoria around the cryptocurrency has been quite amazing to watch. While bitcoin does have a small utility function, it has morphed into pure tulip mania driven by fear- of-missing- out with speculative buyers vastly outpacing those foolish enough to sell. Even we admit the fact that US$ 10,000 invested seven years ago is now worth over a billion dollars can be quite enticing.
What worries us is that bitcoin is fast becoming the investment of choice among young i nvestors, with a third of millennials saying they would prefer US$ 1,000 worth of bitcoin over US$ 1,000 in government bonds or stocks according to a survey by Blockchain Capital and as cited in Bloomberg.
To add some perspective on the magnitude of what is happening, bitcoin is currently valued at more than US$ 300 billion. That puts i ts market capitalization ahead of 95 per cent of the S& P 500, i ncluding such companies as GE, which has 295,000 employees and US$ 123 billion in revenue, according to Charlie Bilello, Director of Research at Pension Partners.
CANNABIS
As Canada is about to become the first G7 nation to legalize marijuana, the race is on to build out the supply chain. This includes the producers themselves, biotech firms developing medicinal marijuana and those providing the supplies needed to cultivate and grow the plants.
As a result, more than US$ 770 million was raised in the first six months of 2017 c ompared to only US$ 43 million raised over the same period last year as tracked by Viridian Capital Advisors — and the returns for investors buying into the sector have been impressive.
For example, Canada’s biggest marijuana producer, Canopy Growth Corp. ( WEED: TSX) is up an astounding 90.5 per cent this year. Horizons Marijuana Life Sciences Index ETF ( HMMJ: TSX), which tracks the performance of a basket of North American publicly listed companies with significant business activities in the marijuana industry, has gained 40.5 per cent since its launch in April.
However, what worries us is the aggressive expectations for growth in this sector with price- to- sales multiples in excess of 55 times among Canada’s big four pot companies according to Chris Damas, editor of the BCMI Cannabis Report and as cited on BNN. Think about that: 55 times revenue.
In conclusion, moderating return expectations for the broader equity market does not mean now is the time to be taking material excess risk by return- chasing euphoric sectors such as bitcoin and marijuana. That said, while having a smaller component can add some excitement to one’s portfolio we ask why risk an interception and ending years of hard work by having too large of an allocation at potentially the wrong time.