In the last couple of years, interest in Bitcoins and other cryptocurrencies has surged, which in turn has led to increased investments in this complex asset. Though many people have argued about the validity and even existence of the true intrinsic cost of this asset class, this has not been persuasive enough to keep investors out of the market. The rise in price was so high that it seemed to endorse a well-known axiom that the interest of people is more into things which are incomprehensible to them. But the rise in prices of cryptocurrencies also coincided with the decline in equity prices, suggesting that investors were attracted towards it due to the lack of good investment opportunities in the equity market and record-low yields by sovereign bonds. Now, with a plethora of macroeconomic and political challenges plaguing the United Kingdom, can investors find returns in the equity market or should they try to be more adventurous by speculating in cryptocurrencies?
In the last one year, the FTSE 100 index, which is a share index that tracks 100 companies with the highest market capitalisation listed on the London Stock Exchange, has remained largely flat with total return of 0.87 per cent, while Bitcoin Futures, which is listed on Chicago Mercantile Exchange (CME), has returned 59.69 per cent. Many other cryptocurrencies have offered a much higher return in the past year, which has further fuelled interest in this asset class. But the attractive returns offered masks the risk behind it, prompting questions like whether the returns are justified by the huge risk investors have to take.
A very simple yet convenient method to calculate risks of an asset class is its 52-week range, which shows the total variation of an asset between its 52-week low and high. The 52-week range of the FTSE 100 index has been 6,536.53 - 7,727.49, which gives a range of 1,190.96. This suggests that at most, the blue-chip index has risen by 18.22 per cent over the 52-week high in the last one year. Investors must remember that this has been a period of high volatility due to the Brexit saga, where even the sterling was not left untouched. The comparative range for Bitcoin Futures has been 3,120 - 13,915, giving a range of 10,795. This shows that the highly speculative asset has risen by around 346 per cent over the 52-week low in the last one year. So, even in times of high uncertainty, the risk, as measured by range, of Bitcoin far exceeds the associated return, calling into question whether the risk-return profile of Bitcoins is in investor’s interest and whether they should be investing in it.
To understand if it is the right time to invest in the London market, and hence in the FTSE 100 index, we need to see what drives the market. Since Brexit, depreciation in the pound is the major driver of the index. HSBC Holdings PLC (HSBA), BP PLC (BP), Royal Dutch Shell PLC (RDSA and RDSB), AstraZeneca PLC (AZN) and GlaxoSmithKline PLC (GSK) are the top five companies in the index, with a total weight of 31.56 per cent. Interestingly, all these companies have a majority of their operations outside the country, resulting in better earnings as sterling depreciates. The prospect of improved earnings in local currency due to a fall in the value of sterling has driven the FTSE 100 index lately.
However, the index has had to shed most of the gains due to uncertainty regarding the Brexit. First, businesses and even lawmakers are not sure whether Brexit will even happen, or will the country leave the European Union on the latest exit date - 31 October - and if not, then for how long the country would be able to ask for an extension. On Monday, Boris Johnson will hold his first face-to-face talks with Jean-Claude Juncker, European Commission president, while Brexit Secretary Steve Barclay has said that Britain could stay in a standstill transition deal with the EU until the end of 2022. This leaves executives unprepared for any future outcome, which has reflected in decline in investments in the country. This is better shown by the FTSE 250 index, which is skewed more towards domestic operations. It has fallen by 0.88 per cent over the one year.
The possibility of exit is not the only issue which has kept British executives on their toes; the trade relationship with the European Union and other countries is also a very serious matter of concern. At present, countries based in the UK have to follow the rules made in the European Parliament, where the UK has a say in every matter concerning the bloc. This has ensured smooth supply chains and made the UK the favourite spot for investments related to the financial service sector. But after the country leaves the bloc, and in the worst-case scenario it leaves without any deal in place, all the trade pacts with other countries would not be applicable, and companies based in the UK would have to find alternative supply chains. To deal with this matter, companies have spent billions of pounds to prepare themselves for such a scenario, impacting the financials and investment decisions.
So, investing in the British equity market for the short-term horizon or with low-risk taking capacity does not seem to be the wisest option currently, and many experts have recommended to ride out the storm by focusing on high-dividend yield stocks with historically volatility-resistant price movement. These include some good utility stocks or companies which are mainly focused outside the country. However, for investors, who have enough firepower and are looking to make money in the long-run, the market has thrown decent opportunities time-and-again. In comparison to other international markets, the British market is sufficiently undervalued, with good long-term potential. Any dip unrelated to the fundamentals of any respective company seems like a lucrative option not to miss. However, investors must not forget that every sharp decline is worthy of investment and should pay heed to advise by experts.
When it comes to Bitcoin and other cryptocurrencies, the primary constraint before investing should be the risk profile and investment horizon. It should be remembered that buying cryptocurrency is never an investment but a trade, especially as it is trading at a highly inflated level. Short-term investors and risk-averse investors might find Bitcoin too enticing to miss, but any unfavourable movement in the price can wipe out the portfolio in double-digits. So, such investors are advised to keep away from investing in cryptocurrency. Long-term investors must never forget the old but pertinent adage – do not put all your eggs in one basket. So, although trading in bitcoin is highly speculative, some investors can do it using a small proportion of their investable portfolio. Moreover, if it has to be done, it is better that investors do it using dedicated funds meant for it, instead of pursuing it on their own.
The financial market is full of opportunities and risk, and though an asset might look lucrative at a given point, small and uninformed investors should be mindful that they are not investing at the end of a rally. Both the asset class, along with a plethora of complicated and complex financial products, can offer good returns. But the most important thing is that investors should understand their risk profile and the goal of investment to better align their interests with the risk-return profile of an asset class.
Share Price Commentary
Daily Chart as at 16-September-19, before the market close (Source: Thomson Reuters)
On 16 September 2019, at the time of writing the report (at 2:52 pm GMT, before the market close), FTSE 100 index was trading at 7,344.85, down by 0.3 per cent against the previous day closing price. Index’s 52 weeks High and Low is GBX 7,727.49/GBX 6,536.53.
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