Will Bitcoin Go Up in 2015?

With 2014 coming to a close, most investors can look at their portfolios with a strong sense of satisfaction.

The S&P 500 (^GSCP) is sitting on a 12% gain, bordering record highs. The Dow Jones (^DJI) is up 7.9%. The Nasdaq Biotechnology Index (^NBI) is closing out at a mouth-watering 40%. And even the Nasdaq Composite (IXIC), which was down as much as 3.5% in October, has rallied to end the year with a 9.2% return.

At the same time, though, we all need to remain cautious in our celebrations. Bull markets come and go, and stocks don’t go straight up forever.

The smartest thing you can do as an investor right now isn’t to bask in your above-average performance this year, but to begin questioning whether or not the rally will continue through 2015.

The reality is that for the market to perform as well as it has been, stocks need to go up in price. At first glance, that might sound like a good thing (and in many ways it is), but it also means stocks are getting increasingly expensive.

Take, for instance, the current Shiller PE for the S&P, which is at 27.19. This is 64.5% higher than the historical mean of 16.6 and implies the lowest five-year return of almost any other Shiller PE value range.

Source: Credit Suisse/CNN Money

Granted, the historical high for the Shiller PE is 44.2, which means we’ve moved well above this mark before and presumably can do it again. But the risk of a crash is still statistically higher than usual, and you’d be wise to diversify a portion of your portfolio out of pricey equities this year.

There are, of course, always the standard vehicles for pulling this off.

Bonds and real estate both offer low correlations with equity, allowing you to sidestep the effects of the stock market. Bear funds have a strong inverse relationship with stocks, and gold is commonly believed to as well, providing a form of insurance.

There are also a number of fixed-income investments such as Treasury bills, certificates of deposit, and banker’s acceptances worth considering.

But many of these conventional diversification vehicles have recently lost their appeal.

For one, bond and Treasury bill yields have drastically declined over the last decade and are expected to plunge in 2015. This is actually is one of the primary reasons the equity market has rallied so hard (there aren’t many promising returns anywhere else).

At the same time, the relationship between precious metals and stocks has gone haywire. Contrary to the common belief that when stocks go down, gold goes up, in the past 10 years, the correlation coefficient between gold and stocks has been mostly positive.

In other words, gold has begun to move in tandem with equities, which greatly lessens its usefulness as a diversification vehicle.

Credit: Iacono Research

With stocks priced well above the historical average, bond yields offering historically low returns, and gold losing its consistent correlation to the market, investors may want to step away from traditional diversification methods.

One option well worth considering (believe it or not) is Bitcoin.

Can Bitcoin Actually Be a Legitimate Investment?

If you’ve been following the price of Bitcoin this year, you may just think I’m crazy for recommending digital currency right now.

2014 was a disastrous year for the cryptocurrency. Bitcoin tumbled from nearly $1,000 per unit to $319, making it one of the worst investments of the year.

But when you look at the price of Bitcoin from a purely technical standpoint, the market has clearly matured.

Average volatility has greatly decreased since 2013, and prices have consolidated in the $300 to $400 range for the last three months after what was a painful crash for the digital currency.

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This recent consolidation and decreased volatility of Bitcoin implies both a strong support around $300 and a relatively stable market for 2015.

In other words, Bitcoin is losing its place as a day-trading vehicle and approaching the status of a legitimate long-term investment.

In addition to the technical story, an increasing amount of financial research is being released in support of Bitcoin as a diversification vehicle.

Here’s a quote from a research paper titled, “Virtual Currency, Tangible Return: Portfolio Diversification with Bitcoins” (emphasis mine):

Bitcoin investment has highly distinctive features, including exceptionally high average return and volatility. Its correlation with other assets is remarkably low. Spanning tests confirm that Bitcoin investment offers significant diversification benefits. We show that the inclusion of even a small proportion of Bitcoins, say 3%, may dramatically improve the risk-return trade-off of well-diversified portfolios.

And from the Journal of Financial Planning’s “The Value of Bitcoin in Enhancing the Efficiency of an Investor’s Portfolio”:

Bitcoin had low or insignificant correlations with major investable asset classes, such as stocks, bonds, real estate, commodities, and the fear index. It is remarkable that almost all of the daily returns of major currencies and various asset classes… had a negligible impact on the daily returns of bitcoins. This indicates that bitcoins could serve as a potent diversifier for an investment portfolio.

Further adding to the bull case for Bitcoin is the fact it’s increasingly being used as a currency, as evidenced by the average number of daily transactions over the last two years.

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Earlier this month, even Microsoft (NASDAQ: MSFT) joined the list of companies that either accept or have announced plans to accept Bitcoin by allowing payments through its online app exchange.

This list of merchants now includes:

• Microsoft
• Overstock
• NewEgg
• Tesla (NASDAQ: TSLA)
• PayPal and eBay (NASDAQ: EBAY)
• Zynga (NASDAQ: ZNGA)
• OKCupid
• TigerDirect (NASDAQ: SYX)
• Reddit
• Hundreds of other real-world businesses

As the number of daily Bitcoin transactions continues to increase, and as more vendors begin to accept the digital currency, people will become more trusting of this relatively new idea.

For Bitcoin, 2013 was a year of hype and speculation, 2014 was a year of correction, and 2015 will be the year where people actually begin to invest. 

Of course, if you’re getting in, just make sure you’re not betting the farm. It’s been suggested through research that young investors (under 35) dedicate between 5% and 25% of their portfolios to cryptocurrency, middle-aged investors (35-55) between 1% and 10%, and those nearing or in retirement (above 55) between 1% and 5%.

Until next time,

Jason Stutman

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