Double bubble: Tesla buying bitcoin is markets’ latest sign of froth

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To anyone concerned about stock market bubbles, the only thing more unsettling than Tesla Inc.’s decision to buy US$1.5-billion of bitcoin was the fact its share price rose on the news.

When the world’s most exuberantly valued automaker piles into one of the world’s most volatile speculations, caution would seem to be in order. But in today’s frenetic and gamified stock market, investors actually seem to be welcoming the prospect of signing up for an extra dose of risk.

Think of Tesla’s new foray into bitcoin as a double bubble. Or as a momentum play squared. Over the past year, both the automaker and the cryptocurrency have surged fivefold or more in price.

Skeptics wonder how either valuation can be justified. They also question why a car maker with more than US$11-billion in debt would choose to invest in a cryptocurrency rather than paying down its loans.

Nonetheless, the market as a whole seems delighted with the new alliance between two red-hot investments. In the hours after Tesla disclosed on Monday morning that it had bought bitcoin and intends to accept the cryptocurency as payment for its cars in the near future, the automaker’s already stratospheric stock price rose 2 per cent, while bitcoin’s price jumped 11 per cent.

“Now Tesla can rise further because they own bitcoin,” tweeted Jens Nordvig, chief executive of research firm Exante Data. “And bitcoin will rise because Tesla is buying. Interesting.”

Mr. Nordvig, who has a two-decade career as an economist and market strategist, said he could not recall any similar case in which a company bought a financial asset and both the company’s stock and the financial asset benefited from a positive feedback loop.

“2021 is different in so many ways,” he summed up.

That may be an understatement. Locked-down investors, massive fiscal stimulus and near-zero interest rate have combined to produce a speculative frenzy in several areas.

Investors have loaded up on bitcoin and Tesla shares. They have also flocked to unprofitable tech companies and to special-purpose acquisition corporations (SPACs) that raise money on the promise they will eventually find a worthwhile business to acquire.

The recent GameStop mania demonstrated how far and fast small investors can drive a stock and also how quickly they can pivot away. Shares in the fading retailer of video games rocketed from under US$20 in early January to a high of US$483 before falling back to US$60 on Monday.

To be sure, much of the exuberance is focused on U.S. tech stocks. Many stocks, especially those outside the United States, are more reasonably priced. Still, it is hard to miss the growing bubble in the most favoured sectors, notably anything to do with electric vehicles.

Tesla, for instance, is trading for more than 1,300 times its trailing earnings, a price that makes sense only if it kills most of its established competition and dominates the global auto industry. Considering the company currently accounts for around 1 per cent of the world’s car sales, investors are displaying an extravagant faith in its prospects.

The enthusiasm for bitcoin is even harder to figure.

The cryptocurrency was originally billed as a medium of exchange that could be used for everyday transactions and exist outside the control of central banks and governments. Now most enthusiasts acknowledge it will probably never directly be used for small transactions without the aid of financial intermediaries. Instead, they talk up its ability to act as “digital gold” and be used by mainstream financial institutions for large transactions.

The shift in narrative has failed to dent enthusiasm. Bitcoin’s price has shot up and down in recent years, but over the past 12 months it has rocketed from just under US$10,000 to more than US$44,500.

Maybe Tesla’s willingness to transact in bitcoin will lead other companies to follow suit and bring bitcoin further into the mainstream. But it is also possible the recent rise of both bitcoin and Tesla reflects little more than the massive amount of money being pumped into economies by central banks.

There is simply “a shortage of places” to put all this liquidity, Matt King, a strategist at Citigroup, wrote in a note Monday. Stocks have already hit new highs despite lacklustre fundamentals. However, there is a limit to how long central banks can continue to drive asset prices higher without creating bigger problems down the road, he warned.

“While few would dispute the need for central banks to act as a backstop when times are bad, many would argue that their persistent and willful blindness to market froth is counterproductive,” he wrote.

For now, investors have little choice but to try and time the bubble, Mr. King declared. Looking at the amount of money that will be deployed by the U.S. Treasury over the next few months, he is bullish on the immediate outlook. Past April, though, he sees growing reason for caution. Tesla investors may want to mark their calendars.

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