Madness continues in cryptocurrency stocks

The only thing dumber than buying into cryptocurrencies may be to bet against them.

Last week, shares in Kodak more than quadrupled over a 24-hour period after the ailing camera company announced it was launching its own cryptocurrency, KodakCoin. Other well-established names also experienced cryptocurrency-related jumps. Shares in data storage giant Seagate surged 14 per cent following rumours it may have a stake in cryptocurrency firm Ripple, while a similar rumour helped engineer a nice share price pop for Western Union.

The interesting part is gains tend to be sustained, as opposed to temporary bounces driven by excitable, uninformed traders. The extent of Kodak’s gain last Tuesday was self-evidently ludicrous – even the company’s chief executive admitted as much.

In a rational market, Kodak would have quickly given up its gains, but it continued to go skyward on Wednesday. Susquehanna analysts warned Seagate’s rumoured investment was not a “material upside driver”, but it too held onto its gains, as did Western Union.

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Ordinarily, market over-reactions are short-lived, but not with cryptocurrency-related stocks. Last month, a Reuters analysis of 17 stocks that made cryptocurrency announcements found they averaged sustained gains of 224 per cent.

Markets, as Keynes famously observed, can stay irrational longer than you stay solvent – a point also made by Warren Buffett last week. “I can say almost with certainty that they [cryptocurrencies] will come to a bad ending,” said Buffett. “But I would never short a dime’s worth.”

Signs of euphoria as investors get giddy

Markets have enjoyed a very strong start to the year and the northward ascent is triggering giddiness among investors.

It's often said the nine-year bull market has been the most-hated rally in history. Investors have been reluctant bulls, forced into stocks in a low-yielding world, but that reluctance is fading. Morgan Stanley argued recently we have finally entered the "euphoria" stage of this long bull market, a suggestion borne out by recent sentiment surveys.

The weekly American Association of Individual Investors (AAII) survey shows there are four times as many bulls as bears, with optimism levels hitting seven-year highs. Last month, equity allocations among AAII members hit their highest level in 17 years, while brokerage firm TD Ameritrade says retail clients now have record levels of market exposure.

The bull market is nearly nine years old and the S&P 500 is more technically overbought than at any stage over the past two decades. What could possibly go wrong?

Stock surge suggests volatility may be returning

Is volatility about to make a comeback?

2017 was a stellar year for the S&P 500 but it was a slow-motion breakout. Not once did the index post a weekly gain of over 2 per cent. That volatility drought – the third-longest streak in history – ended in the first week of 2018. The index's 2.6 per cent weekly gain "could be the first clue", said LPL Research's Ryan Detrick, that volatility is finally making a comeback.

The strong start augurs well for the rest of 2018, said Detrick, who found 15 previous years where equities gained over 2 per cent in the first five trading days of January. Stocks rose in all 15 years. Gains averaged a “very impressive” 18.6 per cent, with double-digit gains in 13 of the 15 years.

While those years may have been good ones for investors, they were not without incident. On average, stocks endured an average intra-year correction of 11.1 per cent. Stocks got through 2017 without as much as a 3 per cent pullback, but Detrick advises investors not to assume another “smooth ride” in 2018.

Stock-pickers: not dead yet

Talking of comebacks, active managers are busy congratulating themselves on their recent uptick in performance.

Active managers and stock-pickers have endured a miserable few years and many wrote off the industry as investors flooded into index funds and exchange-traded funds (ETFs). However, while only around a quarter of fund managers beat their benchmarks in 2014 and 2016, almost 50 per cent did so in 2017 – the highest percentage since 2013, notes Credit Suisse.

In recent years, stocks have largely moved in unison, with macroeconomic developments trumping stock-specific news. That changed last year: by the end of 2017, stocks were trading more independently of macro factors than at any point since 2001, according to Morgan Stanley. The collapse in correlations is good news for active managers who believe they can earn their crust by identifying the best stocks.

However, the stats are hardly a cause for celebration – after all, more than half failed to beat their benchmark. Indeed, a closer look at the Credit Suisse data shows a majority of managers have beaten benchmarks in only six of the last 21 years.

In other words, the improved performance means active funds are a better bet than they have been of late, but they’re still a bad bet.