Happy new year to all of you. I hope you all managed to get some quality time with family and friends over the break. As we enter 2025, most investment firms are in the process or have already published their outlook pieces for the coming year. As I was penning our piece, I started to think about equity market valuations and whether there are pockets of extreme valuations and where animal spirits are present.
Over the last decade (and longer) we have gone through a period of U.S. exceptionalism on the equity market front. The outperformance of the largest technology names has pushed outperformance of U.S. stocks versus their global counterparts, growth versus value and large-cap versus small-caps. Although these valuation spreads may look stretched on a historical basis, it doesn’t feel like we are in bubble territory or animal spirits from the investor community have been fully unleashed. However, there are pockets where you can see extreme positive sentiment, pushing valuations into high altitudes.
MicroStrategy
MicroStrategy was formed in 1989 by Michael Saylor as an information technology solutions company. Their business was formed around building unique software solutions for their clients. From 1989 to 2000, the business grew rapidly and following an initial public offering in 1998, the investors were well rewarded. The stock returned around 750% for investors in just 2 years, peaking, as many technology companies did, in January 2000. The company suffered through the dotcom bust and had to restate earnings. The founders settled a case with the SEC (Securities Exchange Commission) over fraud charges.
As the stock price chart below shows, the company’s stock performance was muted and relatively benign until around 2020. So, what happened to change the performance of the company?
Source: Yahoo Finance
In August 2020, MicroStrategy invested $250m of the treasury reserves into bitcoin. At the time the company stated that they didn’t like the low returns offered from cash instruments. Over the next several years the company continued to buy bitcoin. In fact, most of the buying was done using leverage, risking potential margin calls if certain low points were triggered. As the strategy continued to become successful and CEO Michael Saylor became a vocal proponent of bitcoin, the company begin issuing convertible debt to by more bitcoin. In essence they continued to buy bitcoin with debt financing.
Bitcoin Proxy
As the chart above shows, the company’s stock performance became very different after they began buying bitcoin on their balance sheet. In late 2024 animal spirits amongst the shareholders started to kick, especially around the Trump election win.
Currently MicroStrategy holds 439,000 bitcoins on their balance sheet. With the price of bitcoin currently trading around $100,000, this values their bitcoin holdings at $44billion. The current market capitalization of the firm is around $84bn. Therefore, a little over 50% of the value of the business can be ascribed to their bitcoin holdings. In 2024 the stock price of MSTR (MicroStrategy’s ticker) increased by 358% while the price of bitcoin rallied 119%. The stock price has far outperformed bitcoin, and the stock has become a form of waging on bitcoin.
Here is where the animal spirits appear to kick in. Because the stock has been so popular with speculators, a 2X levered exchange traded fund was launched. The idea of the Defiance Daily Target 2x Long MSTR ETF (ticker: MSTX) is to replicate 2 times the daily move in the stock price of MSTR. If the stock trades up 5% in a day, the ETF should be up 10% in a day. Remember this is already a business that is levered (through debt financing) to bitcoin and this ETF provider is offering “investors” 2 times the performance! The ETF has accumulated $1.77bn in assets since launch.
As financial markets tend to do, innovation follows flows. Late in 2024 it was announced that an options market would be created on the already levered ETF. Speculators can now use embedded leverage in derivatives, to bet on a levered ETF on a leveraged business! Sounds frothy to me.
Levered Performance
The problem with leverage is that it magnifies the loses as well as the gains. Since a peak on November 20th, through the end of the year, the different forms of investing generated very different responses:
- Bitcoin +0.2%
- MSTR (MicroStrategy stock) -38.9%
- MSTX (2x levered ETF) -79.5%
Bitcoin may well have a very strong future and given the discussion around the U.S. creating a strategic reserve of the digital currency, there is good reason to believe the institutionalization of cryptocurrencies has only just begun. However, as the recent MicroStrategy example shows, it doesn’t mean people won’t get carried away in the short run.
