Over the last couple of years, we’ve seen a flood of investors enter the market. Clearly, people have come to the realization that they need to invest.
But why now? Some would say because we had a pandemic. But it can’t be the pandemic in-and-of itself. What about the pandemic caused people to invest? Instability. Political, economic, and global instability.
People lost jobs that they thought were reliable sources of income. They saw empty store shelves, meanwhile the price of rent, utilities, food, and insurance increased. Those who were fortunate to keep their jobs saw salaries increase by modest single-digit percentages as the price of some goods and services rose two-fold.
Those who owned assets saw their wealth skyrocket. Those who didn’t own assets wanted a piece of the action. Multiples expanded and assets prices kept going up.
Then, the financial establishment started blaming retail investors for irrationality in the market. Any asset associated with retail investors was deemed a meme. When the “smart money” lost, it wasn’t because they were “dumb,” it was because the system no longer worked. The SEC needed to intervene to protect retail investors from themselves.
However, the reason these so called “bubbles” developed was not because of irrationality, it was borne out of a rational awakening of the retail investor, who realized: I need to invest.
But the retail investor couldn’t wait to grow his money slowly. By the time he reached some semblance of stability, it would be too late. He needed outsized returns. So he invested in GameStop, AMC, Tesla, Bitcoin, Ethereum, Dogecoin… Anything he invested in was deemed speculative, mere gambling. But some of these were legitimate businesses and crypto assets. Nevertheless, he got little credit.
The great irony was that smart money was invested in these assets too. Soon, smart money started to argue with itself. “My asset is real, your asset is a lottery ticket.” Both sides of smart money truly believed they were smarter than the other.
It turns out, smart money was just as dumb as retail. The difference was that smart money already held the assets before this all began. It didn’t matter what smart money owned, everything went up in value. The reason assets went up had little to do with intellect.
It had to do with the money supply.
During the pandemic, the money supply ballooned, but the number of assets stayed more or less the same. It didn’t matter what they were: commodities, stocks, real estate... Whatever it was, the money supply was increasing faster than stuff was being created. As a result, the prices went up.
So, things became more scarce. The retail investor and smart money were purchasing scarce stuff. Its value was increasing in nominal terms. The scarcer and more desirable the asset, the more it went up in value.
But is this not the essence of investing, or the answer to the how of investing? Investors are looking for something scarce. But it is not just numerical scarcity, it is a more abstract sort of scarcity.
The iPhone was scarce, but many people did not see or understand how it was scarce. The world had millions of Nokias and Blackberrys, another cell phone was obviously not scarce. But what they didn’t understand was the iPhone wasn’t a cell phone. It was a new technology that never existed before. It was, in fact, extremely scarce. No other company, but Apple, could make the iPhone. Therefore, Apple was scarce.
People are making the same mistake today with a company called Tesla. Teslas cannot be scarce because cars abound. We already have Ford, GM, Volkswagen, BMW; you name it. The only problem is, a Tesla is not a car, just as the iPhone is not a phone. It is a new technology. This technology and the engineering talent that designed and scaled it, are scarce. The vertical integration and operating margins are scarce. People like Elon Musk are scarce.
The same could be said of Bitcoin. Bitcoin has numerical scarcity because it has a fixed supply of coins. However, that is only one aspect of Bitcoin’s scarcity, for Bitcoin’s code can be readily replicated and another coin can be made with a supply far smaller. This is how some people argue Bitcoin is not scarce.
But what these people do not see is Bitcoin’s scarcity lies in the resources and energy allocated to it (which are incentivized by its protocol), making it the most secure and decentralized blockchain. The real hardware, energy, and infrastructure required to secure and run the network continues to grow each day. As this happens, more users derive value from it and therefore adopt it. Dominant digital networks are not readily replicated. This is why we only have one Google.
So why do people invest?
They invest for the ability to purchase more of what they want and need in the future. They do this by identifying, purchasing, and holding something scarce. If that something is truly scarce, and can remain scarce over time, others will want to own it and its value will increase in the future. Smart money and retail investors intuitively chase scarcity, they just don’t always identify it.