In PodCasts
  • Three Manias In A Generation (2000, 2008, 2019) All End Badly
  • Current Price Earnings Ratio (30.02) Is Higher Than 1929
  • Gold Priced In Yen Near All Time High


The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

February 13, 2019

“As a private investor, my insurance policy is gold. I favor stocks over bullion, but that’s just me. So I try to find values there. And if I am right about gold taking preeminence at some point when we have this Dow-to-gold ratio of 5-to-1, these gold stocks are going to do quite well. So that’s where I’m at – I have to have that insurance policy.”

– Alan Newman

Kevin:We have a returning guest, Alan Newman. As we think about the guests that we have on the program, a lot of them are in their 70s. Some are in their 80s. And there is a reason for that. Guys like Alan Newman, Richard Russell, Jim Deeds, Alan Abelson, Ian McAvity – these are guys who can bring 50 years of experience to the table. Why wouldn’t we talk to them?

David:That’s exactly right. You learn a lot in a short period of time within the financial markets, and when you begin to aggregate that through decades it creates a certain perspective and a certain wisdom that only comes with age. So you may know quite a bit in your 20s, 30s, and 40s, but knowing what it all means and how it all fits together, I don’t think that is plain and obvious until you’re a little bit more mature.

Kevin:I think of people like your dad. He’s pushing 79 this year. He’s going to turn 79, and he is as young in his mind as I have ever known him. He continues the need to share his knowledge and his experience. Alan Newman is the same way. He keeps trying to retire because the work that he does – a lot of it is chart-oriented – is very, very labor intensive, and every time he tries to retire people beg him not to do it. He says, “If I’m continuing at all, it’s just for the love of it.

David:That’s right. With decades of experience in the market you begin to see some interesting parallels between men who have been there and done that, and women who have made these same sorts of observations. And I think the correlations between perspectives can be very helpful at times. I remember Richard Russell, back in the year 2000, 2001, 2002, as I was working at Morgan Stanley – I was reading Richard Russell every day.

Kevin:He had written that letter since the 1950s, long before you were born.

David:That’s right. He became popular in the days of Alan Abelson, and he really got his start in the newsletter business through writing a column in Barron’s. Russell took the Dow Theory concepts and I remember being fascinated by it. Having neglected gold for a long period of time as I was studying philosophy and didn’t really have an interest in what our family business had been, here is a guy who is talking about the Dow and gold and the relationship, and how he expected to see it go from, what at the time was in the 40s, down to a 5-to-1, or a 3-to-1, or even a 1-to-1 relationship.

That got my attention while I was at Morgan Stanley, and actually was a part of the move back into the metals business with our family business, and ultimately, the asset management business, where these things do stand in very significant long-term relationships. Again, whether it is Richard Russell or Ian McAvity or Alan Newman, there is an echo from one to the other in terms of the analysis and the insight, but a lot of it is instinct that, to some degree, comes out of the trenches, being in the markets every day for all those decades.

Kevin:One characteristic that they share, too, is that they have outlived the value of the dollar. In their lifetimes the dollar has lost over 95% of its value, and each one – Richard Russell, Alan Newman – these are guys who say, “Look, stop measuring things in dollars. Start looking at how much an ounce of gold is worth in Dow shares,” or what we talk about, how much platinum is worth in palladium, and how much silver is worth in gold – things that don’t go away, where you are measuring value for value, not something that just disappears into thin air.

*     *     *

David:Alan, it’s great to have you on the program. You have Crosscurrents, which is your writing expression that has been there for 30+ years, and as Crosscurrents is winding down we hope to keep in touch with you and make sure that Florida is treating you well. Thanks for joining us on the Commentary again.

Alan:Thank you for inviting me on, David. It is always a pleasure.

David:Some things in the market change through the passing of time, and some are constant. We can reflect on the shortness of investor or creditor memory, or the quick return of greed to the marketplace. Psychology of the participants seems to be one of those constants. But what about when investors just start to take their marbles and go home, no longer wanting to play the game? We have this weird indicator that would say, actually, there is increased activity in the markets, and yet we know that household investors are somewhat absent. So you have total dollar trading in the market, which is again on the increase, not necessarily an indication of household investor interest. Talk to us about what these changing dynamics are.

Alan:Yes. Small investors have been pulling out ever since the NASDAQ crash, back from the tech mania – too many people got badly hurt. Then you had the same thing happen from 2007 to 2009. So the public, if it is participating at this point, is just tossing the money toward professionals and letting them try and run with it. But that has not really worked. This market is increasingly ruled by program traders, by algorithmic traders, people who put together formulas to trade with. When you have such a period as this where dollar trading volume is many multiples of what it was years ago, you are looking at an arena where only the short-term counts for professionals, and what this does is it just completely cuts values. They don’t matter anymore.

I come from the school of Graham and Dodd. I started investing in 1964 – that’s like medieval times – where people look at the price earnings ratio of a stock. They looked ahead. They looked at all the fundamentals that are seemingly ignored today, and there is so much that is based on leverage today that it can’t be safe. We have had this just enormous increase in margin debt. Again, this is multiples of what it has been in the past, and this denotes danger. The more leverage you have in a market, the more risk you have. And we saw a little piece of that risk early in the year when we had that decline, but it’s still not a bear market, and I think we’re going to get there pretty soon.

David:Alan, an increase in dollars trading in the market, regardless of the source – maybe it is the professional investor, the algorithm trader, the high-frequency trading models at work – but regardless of the source, what does it suggest to you in terms of where we are at in the cycle? You see this increase in volumes. What does that tell you in terms of growth and expansion? Are we early in the cycle? Are we late in the cycle? Where are we at?

Alan:Well, it’s the same in any bull market. You typically see volume expand into a final peak. And I think we had that, although actually, for the month of January, dollar trading volume is up even another 1.3%. But again, this is just the professionals. This is just the people who are putting together these algorithms to trade with. And they are just avoiding any concept of value. And if you’re in a market where value is meaningless, then it could fall apart at any time. I am not sure if this exactly answers your question, but that’s what I am seeing here.

David:And so value becomes an interesting concept, and maybe just a theoretical one in a period of financial history like this. Is the unique aspect of this particular period in financial history, the degree to which central banks have involved themselves in the pricing of assets?

Alan:Oh yes, this started with Alan Greenspan. He had a chance in 1996, I believe it was December 3rd, where he commented about irrational values. And he did that correctly, but he didn’t do anything about it, and by late 1998 that mania really began to take hold. In retrospect, looking back, for me, who has observed these markets for – this is the 55thyear I have been around – NASDAQ was trading over 250 times earnings. The entire NASDAQ was trading over 250 times earnings. I have never seen anything like that. I don’t think I will ever see anything like that again. I don’t think you will. I don’t your children will. That is how phenomenal that was.

And then we followed that mania by another one that really got started because of housing, and very, very easy credit – 10% down for a house that you couldn’t afford in the first place so you were buying three or four of them just to try to make some money. And that was going to fall apart, and it took stocks with it, because stocks went a little crazy into the fall of 2007.

And now, this time around, we’re talking within a generation, in the year 2000 and 2008 and 2018, another mania? I can show you that this is a mania in so many different ways. For one, Shiller’s cyclically adjusted price earnings ratio – it is known at CAPE, that’s the acronym. It is basically a ten-year moving average of earnings. That is at the second highest reading in history. It is higher than it was in 1929. This all ends poorly.

David:Looking back in time, you reference the 1920s, can you recall another period in financial history where you have had three manias clustered together in a single generation?

Alan:No. No, not at all. We have had two fairly close apart, but they were on different continents back in the 19thcentury. We have had some ludicrous arenas in the past, but what we are seeing over the last generation, I think it is an avoidance of fiduciary responsibility. Mutual fund portfolio managers have taken equity funds down to 2.9% cash assets ratio – again, the lowest in history. It has been as high as 14% in the past, and what happens when you get down to 2.9%?

Well, if you have an opportunity, you almost can’t take advantage of it because you don’t have the flexibility anymore. A lot of that is because ETFs have become such a smash hit because ETFs are fully invested, by definition. They have to be. So a typical equity mutual fund, to compete it has to be more or less fully invested. But in the long run, that hurts. That doesn’t help.

David:You talked about valuation. I want to come back to that in a minute because one of the things that is a part of the structure of the markets today, as we are talking about dollar volume, the amount of shares traded, the dollar amount, on a daily basis, we also have a tremendous amount of leverage in the system. Margin debt, as a percentage of GDP, is one aspect of leverage in the system, but we also have products, going back to the ETF comments you were making – these are structured to capture two or three or four times the increase of an asset class. Leverage – again, we think of sort of outsized bets and overconfidence being expressed and beginning to use the house’s money on a theme that you are confident with. Tell us a little bit about margin debt, where it is, and what that indicates to you.

Alan:Well, at one point last year we were up to margin debt equaling over 3.5% of GDP, and the only time that ever happened before was in 10929. It was actually worse in 1929, but you could buy stocks at 10 percent on the dollar. Now, [unclear] from the FTC has it at 50 percent on the dollar. If you have $1000 you can buy $2000 worth of stock. Back in 1029 if you had $1000 you could buy $10,000 worth of stock. So then if a stock went down 10% you were wiped out. Nowadays, if a stock goes down 50% you’re wiped out. Not that these things are actually going to happen, but it just tells you how much risk is in the marketplace.

I made the case back in the tech mania where people were taking credit card loans, or home equity lines, or whatever money they could borrow from their bank, and buying stocks with it. It seemed to be a sure bet. NASDAQ was absolutely going to the moon. And when you’re in a situation like that, and I think it is happening again today, not maybe to the same extent, there is more leverage in the system than you really know, than you can imagine.

David:So the Dow-gold ratio is an interesting way of looking at, just from a valuation standpoint, and this captures relative valuation, the generational champion of Dow theory was the late Richard Russell. Nearly 20 years ago, when the Dow-gold ratio was 43-to-1, Richard Russell was discussing a move to 5-to-1, 3-to-1, even the potential, at least historically, looking at how it had gotten to 1-to-1 on the ratio. So what we’re talking about is the relative pricing of gold to financial assets.

The ratio is like shorthand for what people feel, and how they feel about owning physical tangible assets vis-à-vis the financial assets. This kind of takes us back to market psychology reflecting itself in the price action of these two distinct asset classes. What is your target and what are your thoughts on gold as one part of the equation, the Dow as the other contributor to the ratio? What is your target? How do we get there?

Alan:The target ratio that I established, believe it or not, on 9/11, after that attack, I sat down and said, “There’s something wrong here. There has been a monumental change in our future.” And the numbers I came up with are favorites of other people, 5-to-1, but I got that as high as 5.67-to-1. Don’t ask me why I narrowed it down that much, but I think that is the upper limit. We could go from somewhere between 5-to-1, or 5.67-to-1, I would be satisfied that my super bowl gold market target had been achieved. But this depends upon the Dow. If the Dow is at 15,000, so gold is $3000 an ounce, I’m actually comfortable with that.

But just for the sake of argument, let’s say the Dow is at 30,000, which will happen someday, I don’t know how many years out, it could be 50 years out, I don’t know, but at some point the Dow will be 30,000. That’s the number I took. 5-to-1 has gold at $6000. Right now, at this point in time, I’m not comfortable with gold that high. I don’t see why it would be that high, but for the target levels that I have, it would take between 2646 per ounce, to 3000 per ounce, I’m very happy with that prognostication. I’m not exactly sure when it’s going to happen, but a lot of it is going to have to do with the Dow. If we, just for the sake of argument, have a crash, gold can go up, but I don’t know if it’s going to go up enough for us to see that 5-to-1 target, and we might see it a few years later.

David:So again, a catch here is not only the potential devaluation or decline of one asset price, but also the increase of the other asset. If you do see an increase in the price of gold, mining companies have got to have a play. In your opinion, the environment that we have today, is it something like 2015, 2016? Or, as you look at gold, gold mining companies, is this more akin from a valuation perspective, to 2002, 2003, relative to gold?

Alan:I think this dates back to after the terror attacks when we all realized that there should be some type of flight to safety, gold equating to safety. I had done a study on Islamist terror attacks. Maybe I unfairly just limited it to Islamists, but it works for me. We had a huge bulge in the five-year average, and I’m talking way after 9/11. We had huge bulge in the number of incidents, and the number of people killed. And then it calmed down again, and then it has gone up again.

Just for the sake of argument, back in 2000 the five-year average of the number of Islamist terror attacks was under five. Last year it was above 53. That is a five-year average. I think the world changed on 9/11. I don’t think we are anywhere near out of the woods. I think this is going to be a problem for generations to come. So that is basically why I got involved with gold, and one of the reasons why I am still so bullish on the market is I see many juniors at the best valuations I have seen in years.

David:Talk to us about gold as an asset class with a global audience. We price things here in U.S. dollar terms, but you’re talking about something that prices for everyone else in their domestic currency, foreign currencies to us, not U.S. dollars, and could look different. What is the global perspective on gold?

Alan:I think it’s high. We’ve had a long consolidation here, and of course, as you said, we tend to see things just priced in dollars. But if you look at bullion priced in yen, it’s only a few percentage points from an all-time high. That’s astonishing. We’re looking at gold about $1300, and we remember $1900 a few years ago, so it seems so far away. If you owned gold priced in yen, you’re just there. You’re knocking on the door of a brand new all-time high. And I think we all have to take a role here now. It’s not assets just based on the U.S. dollar, we can buy assets based in yen, or pounds, or euros.

David:For a global audience that is concerned with flight to safety, they are making the translation, aren’t they, from their currency?

Alan:Oh, I believe so, yes.

David:And it seems to be a growing trend of central bankers to focus on inflation as a solution for very large stocks of debt. It is politically palatable because most of your constituents don’t understand that that is how you relieve the pressure of an over-leveraged system – private, corporate, government debt.


David:So it seems like, between terror attacks and destabilization events like that, and monetary policy which is aggressively geared toward inflating away the burden of debt, for someone who is thinking, “What do I do with my savings,” it is not irrational to think that a modest percentage could be allocated to gold and be effective there.

Alan:Well, I have had money in real estate for my entire adult life and I’ve always loved real estate. It’s always going to be there. It sounds silly, but it is always going to be there. It is something that is quite tangible. It is actually more tangible than gold. Holding onto tangible gold presents some problems. It doesn’t make you any money, it is just an investment. It is also an insurance policy. So in terms of alternative investments, there is always a stock out there to buy.

I will give you an illustration. I’m not going to mention the name of the stock unless you want me to, but I bought my first cannabis stock recently. It is a company with revenues that are growing tremendously. I can see where this is going. I have seen a lot of research being done. I see medical centers sprouting up all over the place. My wife and I wandered into Staples a couple of days ago when we needed something for the office, and right next to it is a medical marijuana store. I noticed that there was something there, but I didn’t know what it was. It was medical marijuana. So there is always something there. Is it going to be the next Microsoft or the next Apple? I don’t know, but it is something brand new, it’s something that works, and investments like that will always be around, even in a bear market. But again, my favorite would be real estate.

David:So between real estate and other tangibles, there are still some places to go. The context that we are in has been somewhat skewed, as we said earlier, by central bank activity in the marketplace. You have the Japanese who began their process of experimenting with low interest rates 20 years ago this week. Once you go down that road, it doesn’t appear that there is any coming back, because you have the pain of repricing assets, just to reflect the realistic cost of capital. That pain seems to be too great.

What is your bet? What is your play? Can the central bank community hold at bay the consequences of low interest rates? Is this what we have on a global basis than trying to toy with asset prices, keep them elevated, manipulating monetary policy, using monetary policy as a manipulative tool for asset prices? Or what is the case that you can make for there actually being a bear market in assets where the central bank doesn’t control the outcomes?

Alan:You mentioned Japan. They have a specific problem that not many people want to discuss. They are an aging population. The average age in Japan, I think, is about 47, or 47 and change. And their economy is suffering because there are too many old people. Younger people buy more stuff, it is as simple as that. So in Japan they have no option. They have to try and boost asset prices as much as possible. I don’t think central banks can do this in the very long run. They have already done it in the long run, but at some point I think they fail.

We were just talking about real estate and gold and I was saying I still love real estate. However, gold is a safer option because it is an insurance policy against whatever happens down the road, whichever way we go. It’s a currency of last resort. As for our central bank, I think we’re going to be as ineffective as Japan at some point, but that is still years down the road. I don’t think central banks can run the world’s economies and fine-tune them. We have seen problems with this approach in the past. I think we will see problems with this approach in the future. It is kind of working right now, for us in the U.S. Inflation is kind of tame, and so far we are able to sustain debt of 21 trillion, but that is going to turn, and when it does, oh boy, I don’t want to see the fallout.

David:We had a conversation with William White a couple of years ago, who spends time in Basel, Switzerland with the Bank of International Settlements and kind of moonlights with the Organization of Economic Cooperation and Development in Paris. He made this very simple case that the central bank community is given credit for being sort of scientists and engineers for the global economy, when in fact, they are artists and get things as wrong as they do right. But for whatever reason, they have pretty significant credibility benefit. Maybe Greenspan got lucky. Maybe Bernanke got lucky. Maybe Yellen and Powell are going to get lucky.

But one of the things that you have pointed out is that, in fact, we have had manias and busts, two so far, and a third in the offing, in one generation, and this really is not a success story. This is saying that something is happening here that has never happened before, and we’re playing with perceptions of success and beliefs, maybe because we want to believe they were successful, when in fact, like William White, that is not really how the record should be recorded, because this series of booms and busts is uncommon in history. I wonder if maybe you can dive in on that a little bit. This is really not as much a success story as we are led to believe, is it?

Alan:No, no, not at all. In fact, did you say central bankers were artists rather than scientists?

David:That’s what William White claimed.

Alan:Is that the word he used – artists?


Alan:That’s wonderful! I’ve never heard that. That is brilliant. That’s wonderful. Yes, they’re not scientists. They call economics the dismal science. It is, indeed, the dismal science. If you are a good economist you are probably an artist. I love that. Now Greenspan was lucky, and he knows it because he has said it recently. He has probably felt that way since the NASDAQ crashed in 2000. It’s the same thing here. They are all blindly guessing at what is to come, and in the interim we are seeing situations we have never had before, like the aforementioned 21 trillion dollars in debt. So yes, they are bound to be artists, and that is no way to run an economy.

David:Let’s go in sort of a thought experiment, use our imagination to post-third mania, the collapse after this third mania, which is arguably, fourth quarter this last year, we got to see the revelation of cracks within the financial system and perhaps we see more of that here in 2019 and in 2020. I am concerned about what the consequences are for capitalism, for capital formation, for investment. What do you think the long-term consequences are to capital formation and investment on the other side of this third mania?

Alan:Eventually things will be all right. When stocks return to a level where you can find excellent values, you’re not going to avoid the market, you’re going to buy stocks. So eventually it all comes together, I’m not sure exactly now far down the road, but this is the way markets work. You have bull markets, then you have bear markets. You’re not supposed to have a mania followed by a bear, and a mania followed by another bear, and then a mania followed by another bear, all with, just for the sake of argument, 50% declines in prices.

But we did recover from stock prices going down 50% in 2003, we did recover from stock prices going down in 2009, and I think we will eventually recover if the market goes down 50% from here, again. But every time we do something like that we just make it very difficult for the generation behind ours. We have already mortgaged part of the next generation’s lives with the tremendous debt we have built up. But I think, eventually, at some point, it’s all going to come up smelling like roses. But we may be down to Dow 15,000 before that happens, or worse.

David:I want to come back to a couple of questions about, again, CAPE and Shiller PE in just a minute, but I am curious what you think of politics and public policy, how they fit into the narrative of boom and bust, and do you see anything developing in the months and years ahead as a reaction to the third mania and bust, some talk about banning corporate buy-backs. I’m curious about your thoughts, the public policy response.

Alan:Well, you mentioned corporate buy-backs and I’m a firm believer that corporate buy-backs exist for executives at these corporations, anybody who has a stock option plan. If a company is buying back their stock, they’re supporting the price of the stock, so your options are worth more money. As far as how politics enters, I’m not particularly a fan of either Republican or Democratic politics. I think they are at odds with one another. I think we go nowhere in the interim, except the level of debt keeps on rising. So that is the big negative. And how does that change? I don’t know. I’m not that smart. But I don’t think politics helps.

David:We have, actually, in cumulative values, corporate buy-backs have now exceeded what the central bank has put in in terms of quantitative easing from the 2008 to present period, here in the United States.

Alan:Amazing, right?

David:We’re talking about massive, massive sums of money, and I think you’re right, it is an executive gaming type thing. So you mentioned debt, and the debt keeps on rising. This is an area that you are concerned about. Maybe you can comment on these record levels. U.S. national debt, corporate debt, household debt – household debt’s at a new all-time high. Does it ever get boring to you, saying that over and over again? A new all-time high – margin debt. A new all-time high – household debt. At some point it does matter, but when and how, and what the tipping point is, maybe we don’t know. How do you wrap your mind around the trillions upon trillions upon trillions as it relates to economic growth in the future when we have all this debt to service?

Alan:You make a very good point. We can be just somewhat ignorant because we keep on seeing these numbers go up and we don’t know how to parse them. For instance student debt – just a few years ago I kept on hearing the 1 trillion mark bandied about. Well now it’s 1-1/2 trillion, and this is not a small segment of our society, this is 44 million Americans that owe this much money. How does that get paid off? Well, you know how the margin debt gets paid off, it gets paid off with stock prices. That’s not a good thing. Lower stock prices means Americans have less assets. It means they have less wealth. That means they can buy less stuff.

Well, it’s the same thing with students. How do you pay off a trillion-and-a-half in student debt? My wife was born in Havana, Cuba. She was on a Cuban loan when she was in college, and she paid it off, very simply, by teaching for seven years in the New York school systems. But she had, I don’t know how many thousands, it wasn’t that bad. But when you’re talking about students with a hundred thousand dollars in debt, or much more…

My wife and I were very fortunate. Our youngest, who has a law degree, has had seven years of school. We paid out of pocket, $185,000 – out of pocket. He had $162,000 in scholarships. So if he didn’t have the scholarships to put him through for him to become an attorney – we’re talking close to $350,000. How do people do that? I honestly don’t know. And this is one of the reasons why a lot of people fear we’re falling behind whereas other countries are catching up to us. I’m not sure this has answered your question. I think I went off on a little bit of a tangent. I apologize.

David:No, no, no, this all overlays. I think the point you were making earlier about the cyclically adjusted price earnings ratio, the Shiller PE as it is popularly referred to. You mentioned it is pretty high, the second-highest in history. Give us a little education here. In terms of the swings from overvaluation and back to undervaluation, once you get to that level of undervaluation it suggests something about what you can earn on an annual return basis. What is the current level, being overvalued – what does that suggest about the direction of the Dow and the potential depth of pricing for the Dow within a bear market.

Alan:Until we had the tech mania, the highest this ratio ever went was Black Tuesday in 1929, when it was at 30. Well, it’s at 30 today. It’s actually at 30.02. It was as high as nearly 45 in the tech mania, but I don’t think we will see that again in our lifetimes, not even your children’s lifetimes. No way. The mean and the median are way below. The mean is 16.6. The median is 15.7. Again, we’re at 30, so you’re talking about a 50% hit in prices before we get to the mean or the median.

And so far as the minimum, in 1920 it was down to under 5. I don’t think you’ll ever see that again. But you could certainly see this indicator, which has a lot of validity over the long-term, fall to, let’s say 16. That means prices are down almost 50%. Uncannily, this kind of fits my long-term bear market target which I came up with probably five years ago. That’s 14,719 for the Dow. We sure raised that Dow. I think I’m going to get a hit on that one, I really do. I don’t know when.

David:So 14,719 is your long-term bear market target. What is the difference between what you called the long-term market target and a crash, what you categorize as crash risk?

Alan:I think we have crash risk right now down to a little above 17,000 on the Dow. They are two different numbers. Long-term bear market target includes a period where you have a crash, if we have a crash. And then there is this long period of disinvestment because people, even professionals, are just shattered. So stocks go down some more in price and that’s where I think the bottom is, a little bit below 15,000. If you have a period like we had earlier in the year, but much more emphatic, that could result in prices going down about 8,000 points. I’ve seen crashes before.

David:There are a number of people on Wall Street that aren’t exactly prepared for that, either in portfolio position, or in, probably, psychological constitution.

Alan:It’s impossible to prepare for that, David. It’s impossible.

David:There is this change in dynamic amongst investors, speculators. Maybe we already hit on it when we were talking about high-frequency traders and algorithmic trading, but why do you think holding periods for stocks were so long in the early 1920s, and then actually began to decrease where they were low by the time you got to the market mania? And then you saw this increase, a significant increase, in terms of the time people would buy a stock and hold a stock that continued to grow all through the 1960s. Now again, we’re at the comparable levels to the late 1920s where nobody wants to hold things beyond a nanosecond. At what point would you say that we have transformed from being investors, and that is the playground we’re in, to really being in a speculator’s arena?

Alan:It started in 1998 when the tech mania really started to take hold. Ironically, what is going to happen some years down the road after the mania bursts, is that holding periods are going to go up, but for a number of reasons. It’s not only that people will be seeking value, and they will understand that they have to hold onto stocks for a longer period of time to realize that value, but it has also to do with the fact that they got so savaged in the fallout.

I’ll give you a story, a little illustration of how this works. My father was a stockbroker in 1929. He took everything he had after the crash and he threw it in a safe deposit box. This is what really got me started on stocks. In 1964 he had me take everything out of the safe deposit box and jot down what it was on a piece of paper. I went to the Brooklyn business library every day for six months. Yes, he had a lot of stocks. He had a lot of worthless stocks. But he had a few things that were worth money. Just for the sake of argument he had Lawyers Title Guaranty and Trust that he bought for about $400 a share. That was valueless. He had shares of Manufacturers Hanover Trust. Do you know that name?

David:Sure. Oh yeah.

Alan:That was a long time ago. He had a spinoff from Manufacturer’s Hanover. He had a decent position, the company was called Huron Holdings, and was only worth $37 total. Here’s the rub. He had Chase National stock. That’s the forerunner of Chase Manhattan and J.P. Morgan Chase. On the back of the certificates it said, “Attached, share for share, is Amerex Corp.” He was getting letters from asset tracers for years telling him, “Mr. Newman, you have some money here you don’t know about. If you give us 50%, we’ll tell you what it is.” So, he was too smart for that. He had me do the dirty work.

So it turns out that the shares of Amerex that he had, which was the forerunner of American Express, were worth $20,000 and had $4,000 in proved dividends. But understand, that stock had been held onto from 1929. That’s a long holding period, from 1929 to 1964 – 35 years. So eventually, you will have that situation again where the holding periods will go up, not only because there will be valuations there that can only be realized if you sit on it and let it grow and watch it grow. But because people got savaged in the market before and they just didn’t even want to look at their stock certificates, they didn’t even want to look at their statements.

David:This is what you were describing earlier, talking about professionals being shattered. Your dad was a professional who psychologically said, “I’m putting it in a safety deposit box,” in 1929 and doesn’t want to look at it, doesn’t care, can’t be brought back into that emotional state for 35 years. In fact, he has you do it for him (laughs).

It reminds me of something else, Alan. I had a conversation with a gentleman that runs a significant family office in the Southeast, a multi-billion dollar family office. They are in the process of moving out of exchange-traded funds, any exposure whatsoever, and they have been, over the last year or so, positioning very considerable amounts of money in cash with the idea that they will, on an inter-generational basis, be sitting on quality companies, very researched, as you suggested, from that kind of Graham and Dodd model, focused on value. As and when price reveals that value, they’re going to be happy to sit on it and hold individual shares again.

And it’s such a different trend than you hear from the small-time investor who is very interested in maximizing the last 20 basis points. And actually, this family is willing to say, “That’s fine. We don’t want to pay the fee implicit to an ETF, whether it is a Vanguard inexpensive fee or something that is very grandiose. We want to own the companies, themselves, and we’re willing to wait. We don’t want professional money management, we just want quality – forever.” (laughs) I think we’re getting to the point where they are going to have their wish.

Alan:I think that works, yes.

David:We’ve been talking about the third mania, we’ve been talking about the consequences of that in terms of how it breaks apart over time, and how professionals, those of whom who today haven’t experienced much pain, experience something of a shattering of expectations. What kind of volatility do you expect in the coming months – maybe you have to expand that out to years – but on the horizon? Talk to us about volatility.

Alan:I don’t think we saw very much in the last year’s late decline, around the 36 level.

David:On the VIX.

Alan:But in the beginning of the year we had that decline in February around 50. I’m talking about the Volatility Index. I think we’re going to see higher than 50. If I’m right at all about this bear market target we are going to have a huge decline in a very short period of time, at some point, and it is going to take volatility measures up way past where they were a year ago, and certainly way, way past where they were at the end of last year. This move late last year, I think. was pretty tame by historical standards.

Moreover, the most important consideration I’m looking at, in terms of volatility, and assurance that that cycle will be upon us at some point, is that we have seen no instances – zero – of capitulation on a daily basis on NASDAQ. Not one. Even as far as NASDAQ saw recently in the correction, there was not one day – I measure capitulation as one-to-nine up-to-down volume. That’s significant – one share up, nine shares down. In other words, 90% of volume is to the downside. We have not had one instance like that on NASDAQ, actually, I think, in about 450 trading sessions. I can’t begin to tell you how unusual that is. I have never seen a period that tame for NASDAQ.

David:So if volatility is on the increase, and your operative word there was capitulation that was lacking, I want to go back to 2008-2009. Was that a tradable low, or was that – did we actually see capitulation then in terms of investor sentiment, or was it simply a tradable low in the context of a longer-term structural bear market?

Alan:No, I think there was capitulation and one of the reasons why was, it was almost the end of the world, the way we were looking at markets and banks and brokerage companies. It sure looked like the end of the world was not that far away. But again, we have seen worse than that, too. The VIX got up to 81 then, but in the crash it was 172. What I’m talking about is, I’m old enough to understand that anything can happen. I have a couple of buddies, one of them a high school classmate, who trades naked options. I would never in my wildest dream trade even one naked option. It’s not the type of person I am. But that’s the type of situation where you get up and go to the restroom and you come back and you have a very, very big problem. And I do think that’s going to happen at some point, too, where the speed of market moves is just going to be almost incomprehensible.

David:So capitulation in, let’s say 2019, expanded out to 2023. We don’t know what the future holds, we don’t what the timeframe is. Does capitulation look any different in this period of time, central bank interventions, things like that? Does it look any different this time around than it would have, say, 2008-2009, or 1929? Talking about a VIX spike, pretty significant loss in capital, real sense of fear, foreboding, as you said, the end of the world. Is it any different this time, or are these the things that you look for?

Alan:I’m not sure, but I will say I don’t think it’s going to look different, and the reason why I say that is, what central banks did after the tech mania imploded worked. It got us to 2007. Prices were up substantially. It worked again in 2009. They actually saved us from the worst possible fate. With banks going down, brokerages going down, we were literally very close to the precipice. And I see no reason why it’s not going to work this time. I’m not saying that the results are going to be wonderful for us, I’m saying they’re going to do the same thing they’ve done twice before.

David:That argues for some version of creativity. Again, we’re back to the artist’s pallet, QE being an expression of that. Maybe there are more extraordinary things that our imaginations can’t quite latch onto quite yet in terms of monetary policy creativity. But more QE? That brings us full circle to one of the things that you want to own in a period of time when central bankers are desperate to maintain credibility and maintain asset price stability. Is it some combination of real assets and cash, keeping high liquidity and making sure that it’s offset with something that is tangible? What is the best strategy on a three-year or five-year basis?

Alan:Well, if you’re going out a little further than three or five years, because that’s what we were talking about before, if the central banks were gold investors, maybe that would be the difference for the next cycle, but I don’t see how that works. But I’m not concerned about that. As a private investor, my insurance policy is gold. I favor stocks over bullion, but that’s just me. I’m maybe crazy that way, but I love stocks. I’ve loved stocks since 1964. That’s what I excel at, so I try to find values there. And if I’m right about gold taking pre-eminence at some point when we have this Dow-to-gold ratio of 5-to-1, these gold stocks are going to do quite well. But that’s where I am at, basically. I have to have that insurance policy.

David:That complements your other real assets, real estate, which you say a clear benefit having a cash flow component, which bullion does not. And you make a good case for gold stocks. Many of them do, in fact, have dividend policies that pay out a significant portion of profits, if and when they ever have profits. On those rare occasions they do have healthy policies there for investors that are interested in income.

Alan:Yes, they do.

David:Alan, we have had you on the program every year for, I think, at least the last five or six years, and we love reading Crosscurrents and are always excited about the next issue. And now we have to await with bated breath the next issue, if it going to be released (laughs), and we’re on a need to know basis.

Alan:You’re too kind.

David:You’ll let us know if it’s coming out. Thank you for your contribution, 30-plus years, 55 years as an investor, and we’re excited to have you back on the program at some point, if it is not too much of an intrusion into your life there in Florida, and your personal affairs. We always appreciate your opinions.

Alan:I thank you very much for inviting me on again. It’s always a pleasure to speak with you, David.

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