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- The bear in 3 acts, we’re in act 1
- Average bear market loses 38% in 318 days
- Would you “buy the dip” in Russia in 1917?
Buy The Dip? Not So Fast
October 26, 2022
“For the patient investor, we are talking about a values realignment and this notion that we’re only in the first phase of a bear market. We still have two phases left. You have to focus on asset preservation. And your two means of doing so are not in the bond market, by the way, but some combination of cash and gold. And with a high dollop of patience, I think you’re setting yourself up for immense success in the decade ahead.” — David McAlvany
Kevin: Welcome to The McAlvany Weekly Commentary. I’m Kevin Orrick along with David McAlvany.
Our audience, especially those who’ve listened for a while, know that we take time each Monday night to go over to a restaurant in Durango. It was called Ken & Sue’s for years. They sold recently. It’s now 636 Maine. But we have a table, table 30. We sit back in the back, and we actually have a scotch that we enjoy. We enjoy it straight up neat, both glasses and soda back. Straight up neat, no ice. We had a metaphor last night occur, Dave, that made me think a little bit of inflation. I guess it was the first time in 15 years there was a faux pas, a serious faux pas, but it was a metaphor for inflation, wasn’t it?
David: It was the last bit of Talisker. That in itself is a sad story, but even sadder still is that it was served on ice with the soda in one glass.
Kevin: And that—that is inflation.
David: I looked and I thought surely somebody didn’t order apple juice because that’s what it looked like when it was served.
Kevin: Yeah. It wasn’t quite the same, and we had to send it back, but we can’t send inflation back.
Kevin: We just had the McAlvany Wealth Management meeting. Doug was over here, came in to town to give his talk. I know, for those who missed that, you can still tune in on Thursday, the Tactical Short Call. This is quarter three coming up.
David: That’s right. So we’ll review the third quarter, look towards the end of the year, and the title of our presentation is “Prelude to a Market Accident.” Very bright and cheery, almost like running out of Talisker. So this is an important conversation, particularly as we look at the unwinding of a number of major financial structures. We’re talking about the UK, China, Japan. There is literally an unraveling taking place here in recent weeks, and it’s fascinating to me as I tune in to CNBC and Bloomberg—nary a comment on those things which are very high drama.
Kevin: This is why it’s so important, Dave, that we look at the financial, moving to the economic, moving to the political, moving to the geopolitical or geostrategic. I was looking at famous quotes from the last few years about investing and buy the dip, sell the tip. Buy the dip, sell the tip. Buy the dip, sell the tip. Most people who don’t necessarily look at the geopolitical situation are going to probably continue to buy the dip, but there are times when that doesn’t work.
David: A number of weeks ago, we brought Robert Rhea and Hamilton and of course Charles Dow into the conversation. These are Dow theory legends. We have John Hussman who quoted Rhea over the weekend. And got a lot of respect for John. He framed the current market set up very well with this quote from Robert Rhea, quote from 1932. I think it shines a bright light into the current trading setup. Rhea said this. “There are three phases of a bear market. The first represents the abandonment of the hopes upon which stocks were purchased at inflated prices. The second reflects selling due to decreased business and earnings. And the third is caused by distress selling of sound securities regardless of their value by those who must find a cash market for at least a portion of their assets.”
Kevin: So have we experienced the first, where the first phase is the abandonment of hope on stocks that were purchased at inflated prices? Are we there yet?
David: That defines the inflection point where you get to extremes of overvaluation and value was not really a part of the equation. It was hype and enthusiasm. So where are we now? We’re in a bear market rally, having completed phase one of the Dow theory three phase decline. Seasonality is turning positive. We’ve got a technical bounce, which is overdue. However, we have a long and painful road ahead, and I think this rally runs its short and sharp countertrend course higher to terminal levels. But in the final analysis, what are we doing? We’re working our way back from extremes of overvaluation reached in late 2021 and early 2022 to an extreme of undervaluation. That’s mean reversion. Mean reversion is what markets do, whether we like it or not, and the time involved as well as distance yet to travel remains protracted.
Kevin: And this is where the “keep your powder dry” quip is pretty important. Morgan Lewis, he’s defensive for a reason. Morgan’s on the team, and that’s something our listeners can also read.
David: That’s how he titled the Hard Assets Insights for the weekend. I’d go read it.
Setting aside the allure of a trend change and the relief from selling pressures, we’ve got a little bit of a pop in price. We have a few minor problems still to deal with that need to be priced into the markets, and Rhea is correct. The second phase of a bear focuses on earnings and a decline in business. We’re now just edging into a recessionary environment here in the US. If you look at housing statistics, if you look at auto statistics, they’re getting ugly. Last week’s Ally Financial debacle, largest lender to the automotive industry— This comes as no surprise, right? I mean if you’re talking about housing and auto, they’re incredibly sensitive to borrowing rates. So the increase in interest rates is obviously having a deleterious effect. Next six months, our view is it’s time to embrace the suck. Embrace the suck of a declining economy. The prices that reflect the earnings compression immediately ahead.
Kevin: So embracing the suck, and you said over the next six months, I think about it, we have had a beautiful fall. I mean 70-degree days. It’s like being in San Diego, 70, 72. And then all of a sudden things changed over the last couple of days. When I take the dog out, I can’t wear shorts anymore. You know what I did this morning? I put wool pants on. In that way, I’m embracing the fact that it’s over for the next six months. It’s going to be cold. I need to dress in something other than shorts. Is that embracing the suck?
David: No. I think you would’ve stayed in shorts and just toughed it out if you were really—
Kevin: So what is embracing the suck if you’re in the markets?
David: You just better get ready for a lot of downside. I mean, it’s not going to get better from here.
Kevin: I gotcha.
David: Maybe it does for the next two to six weeks, but our friend Alan Newman helped solidify this view, bringing in some helpful historical numbers to bear in mind. The decline thus far needs to be put in perspective. First, you’ve got the historical average declines if you’re looking at each of the bear markets at the last a hundred years. The average decline is 38% in price.
David: In 318 days of time. And just to bring that into perspective, we’ve got a 25% decline currently in about 195, 197 days.
Kevin: Well below the average then.
David: We’d be on the easy. We’d be on the light. We’d be on the shallow side of a bear market if it ended today. I think it’s worth reflecting on the starting point. Coming from the most extreme levels of overvaluation in market history on multiple measures. So the reality is we could linger in the doldrums for two to three times longer. That would match the 1929 duration of 678 days in a bear market, again versus the current 195. Or the 1946 decline of 761 days. And if you say, okay, that was then, this is now. Closer to the age of high tech and algorithmic training, we’ve got the year 2000 post decimalization, the year 2000 with a decline that extended for 637 days, and now we’re coming off of levels of overvaluation, again, that we’ve never seen before. We should expect an additional decline of 35 to 45% from these levels.
Kevin: So embracing the suck, it could be for quite a bit longer.
David: Yeah. And why did we talk to Smithers? This is important. That would bring us back in line. If we had just a decline of 35 to 45% from these levels where a correction has already occurred, that would bring us back in line with the valuation lows of 2009. So keep in mind how overvalued we still are, right?
David: If we decline another 35 to 45%, then that brings us back to valuation lows of 2009. And that would be considered quite modest from a historical perspective because 2009, you had the cyclically adjusted price earnings ratio at 15, 15. You’re still a long way from the single digits, which we saw in an earlier cycle.
Kevin: Well, and that has happened. I mean, when you talk about single digits, didn’t the market itself at one point get down to about seven?
David: Yeah. Now, I’m referencing CAPE, cyclically adjust— or Shiller’s PE, which is a little bit higher than the regular PE measure. But what have we had so far? We’ve had a lot of negativity in the sentiment indicators. You’ve got a lot of bears out there. But we’ve not seen any real panic selling marking that third and final phase of a bear market as noted by Rhea. So the folks who are kind of putting on trades today, I mean, I think there’s nimble traders who are going to be out— in and out of the market by the time you consider your first trade.
Kevin: You wonder sometimes, too, if these cycles where you have despair and then you have hope, and then you have despair and you have hope— A lot of times people just want to get back to what they felt like a few years ago. And that can be a false hope. I know I’ve talked to a number of clients who seem to think that a red wave in the political scene here coming up in the next couple of weeks is going to turn into economic boom town and that the recession will be averted.
David: Elon Musk wants to get back to where he was just a few years ago.
Kevin: That’s true.
David: Tesla recorded $170 million impairment on their Bitcoin holding. Whoops a daisy. I mean, it’s down almost 60% from its peak. Actually, almost 70%.
Kevin: He might make it back though if he gets Twitter and then just fires everybody. That’s the latest thing. But let’s talk about this. There’s naïve hope that the worst is behind us. And oftentimes when we have that hope, we find something to support it.
David: Yeah. The challenge here as we move from phase one of a bear market to phase two is that that hope drags in the naïve investor. It drags in the retail investor. It drags in even the most sophisticated investor who says, “Look, we’ve got a trend change. We can’t afford to be out.” I sat in an investment committee meeting not long ago where the attempt was made to say, “Here’s the math.” Actually it was not presented. It was just implied. “The math says it’s more consequential and you lose more if you’re out of the market than if you’re in.” And I thought, Really? That’s interesting.
Kevin: Show me the math.
David: Through phase one of three, and where do we go from here? Unfortunately, the retail investor and those who are eager to get invested again are in for a serious drubbing.
Kevin: So we have to look at the world right now.
David: You do.
Kevin: I mean, is China going to go away? How about the Russia-Ukraine thing?
David: Well, phase two is informed by a decline in earnings and a repricing of stocks to reflect less profitability, less activity, a slowing of the business cycle. And we’re just now entering that phase two. Well, there’s all kinds of things that can cause the consumer to participate in that. Concerns which would slow retail spending and other business investment. So keep in mind the global picture when you’re considering the duration of this bear market and that naïve hope that the worst is behind us.
Are we at the point of resolution with China? In fact, we’re at the front edge of a growing economic war with China. So not exactly in the rear view mirror yet. How about resolution in Ukraine? I mean, the only growing resolution I see there is amongst our at-risk politicians, those who may not make it past the next two weeks, and their call to cut arms supplies so that the war can finally end. That’s right, with Russia, the Victor.
You’ve got Republicans and Democrats who, conveniently for their own political legacies, they’re neglecting the fact that the new world order centered on China and Russia really doesn’t need military encouragement. No, no. Take whatever you want whenever you want. Again, I mean, did Russia end with their encroachment into Crimea in 2014? No. So ending our armed supplies to Ukraine, whether you like it or not, consider the cost. Is it an improved global landscape that we get with a Russian victory, right? I’m sure, seeing a Russian victory, wouldn’t that temper Xi Jinping’s territorial ambitions.
Kevin: Not at all.
Kevin: Yeah, not at all.
David: So reasons remain for uncertainty in the markets, and for further contraction in business activity on a global basis. And that’s been happening. Now, we see it migrating to the US. If that’s the case, then corporate earnings remain at risk. Stock prices based on elevated valuation metrics also remain at risk. Ergo phase two of the bear.
Kevin: So if you were accused of loving cash right now in your money management. Cash is king right now. And I know— I’m being sarcastic because I know what you think about cash in the long run, but sometimes in the short run it’s your only option.
David: And Doug and I will discuss this at length on Thursday. I would register for the call. Not just cash, but the nature of preserving assets through periods of compression. What are we trying to sidestep here? Dow 20,000? NASDAQ 5,000? S&P 500 under 2250.
David: These are phase two possibilities, not to speak of phase three panic selling. We like cash levels high, not because we’re in love with the US dollar, although the run up in price has been good for us, but because long-term positive returns are based primarily on buying good value. Let that sink in. Long-term positive returns are based primarily on buying good value.
If you were listening to Andrew Smithers, not only in our last interview with him, but in past interviews, this is the basis of compounding returns at double digit rates over a decade or more. What did you pay for the assets? If you overpaid for the assets, you’re going to see subpar returns for the next decade or more. If you paid rock bottom prices, then you are talking about lining up for 10, 12. The statistics would show as much as 16.6% annualized rates of returns over a decade if you bought right.
So are we in love with cash? Are we in love with the US dollar? Well, no. But this is the point of multiple conversations with Andrew Smithers. This is the whole point of mean reversion. This is one of the takeaways from our conversation with Ed Easterling. Go back and listen to that interview with Eddie Easterling. Navigate the downside volatility of a bear market as best you can, and reengage with full allocations when valuations are compelling.
Kevin: When you look at guys who sail across the oceans, maybe world travel or what have you, they know when to take the sails down so that they can put them back up for a fair day. So if they see a storm coming in, hurricane or what have you, they take down what needs to be preserved for another day. That’s what it reminds me of.
David: Yeah, there’s no doubt. If you look at 2009 as an example, 2009 levels were not that compelling from a valuation standpoint. We talked about the cyclically adjusted price earnings, multiple getting to 15, 16. Part of the reason it didn’t go lower, as it typically does, is because of the scale of central bank interventions and the market’s responsiveness, the belief in the efficacy of those interventions.
Are we going to get through the teens and into the single digits for the Shiller PE this time around? Think about where the central banks are today in terms of their credibility and what is at risk in terms of their credibility. It’s possible. It’s possible that we see single digit cyclically adjusted 10-year rolling average of the price earnings multiple. What that implies, we can bandy the idea of a 35 or 45% decline from these levels to getting us to 2009 levels. But what that implies is a 40 to 60% decline from here to get to those single digit numbers. These are real losses. These are real losses. You reminded me of a quote from Bruce Lee this last week that calm is a superpower.
Kevin: Calm is a superpower.
David: And then the question is, how do you maintain calm in the context of market chaos? I can tell you how you maintain a good degree of calm in the midst of market chaos. Have a large allocation to cash. And make sure that you’re not writing that cash position into the ground with bad monetary mismanagement. Make sure you’ve got a metals allocation that rides alongside that cash so that you’ve got two forms of liquidity. One ensuring that the other does not go sideways on you. I’ll tell you, that is how you maintain calm in the midst of market chaos. Calm is a superpower. Calm is also an allocation choice. And if you haven’t made it, you better make it now.
Kevin: And you’ve been critical, rightfully so. Let’s say the person only hears to this part of the Commentary and they say, “Okay, I’m convinced. Stocks are going down.” They shut it off. They go down to their broker. The broker says, “Buy bonds. That’s what we do.” When stocks go down, you buy bonds. Look at the British. Look at the British right now. I mean, interest rates rising. You’ve got a bond market that doesn’t offer any more safety right now than the stock market does.
David: One month ago, the US treasury market was down 30% for the year, about 27.6% to be precise. Two months ago, the US bond market, again represented by TLT if you want to chart it, was down 21%. Now it’s down 36%. So we’re going 21 on a year to date basis; two months ago, 27, 1 month ago, 36.
Kevin: This is the 30-year, right? 30-year bonds?
David: More like a 20-year proxy.
David: More like a 20-year proxy. And so we’re now down 36% in the US bond market, 13½ in high yield debt. 23, almost 24% in your investment grade debt. And you think, well, things cannot get worse. I mean, surely this is the most volatile bond market we’ve seen in many decades within the US. Can it get worse? Let’s just go to exhibit A in terms of things going from bad to worse within the credit markets. If you look at the Chinese high yield market, they’re now at 28% on average.
Kevin: They’re paying 28%.
David: That’s right. That’s the interest rate. And this is up from 21% a month and a half ago. This is 21%. If you strip out China, which has some serious problems in its real estate sector, and you just go all of Asia, now you’re talking about a 20½ percent yield. These are high yields, and it gets even crazier when you think about what’s happening within the Chinese developer segment. We’ve referenced this before, whether it’s long for Sunac, Kaisa, Country Garden. Of course everyone has heard of Evergrande at this point. But two months ago Evergrande yields were 155%. Now, they’re 263%.
Kevin: Gosh, if you could just capture that.
David: Do you understand what that’s communicating? This is not just a zombie company. This is an already-absorbed-into-the-government-structure company.
Kevin: Buy the dip.
David: Country Garden. Again two months ago, two and a half months ago, 30% yields you would’ve said, “Man, this is rough going for one of the largest developers in the world. Oh, now they’re at 80%.” And that’s up from 66% just two weeks ago. Any of these developer— I mean, it’s astounding. It’s astounding. And I think for us to lose focus of what’s happening in the Chinese currency markets, in the Japanese currency markets, where central bank credibility is falling to pieces and no one seems to care.
Kevin: Isn’t that interesting how you can have that kind of news and not have an emotional reaction to it? It’s because we have a lack of context as a society. I would like to talk about Britain because that is sort of the kingdom and crown. I know that British gilts had a terrible time right about the time of World War II. But they have lost more now than they did even during World War II when the Battle of Britain was previewed. It looked like Germany was going to attack England. And gilts didn’t go down nearly as much as they have over the last month.
David: Yeah, I mean these LDI schemes that were stuffed into the pension schemes over there. 30- to 50-year paper, which is down between 30% if it’s the really short-dated paper to as much as 80%. Huge losses. Huge losses. Which on a leverage basis is why you had margin calls. So amazing. Rishi Sunak. He’s the ex-Goldman alumni, takes over number 10 as the new British Prime minister this week. He was previously Chief Secretary of the Treasury and Chancellor of the Exchequer. Rishi does understand financial markets, and I think he’ll take a good bit of the panic out of the markets, at least for now. He is the equivalent of a British [former European Central Bank President Mario] Draghi, there to do whatever it takes. So he’s got some credibility coming in. The question is, do any central banks come out of this with credibility intact? As we’ve said, the gilt market has been eviscerated. Government paper is trading in the UK in a range of 30 to nearly 80% losses, depending on the length of maturity. It’s a mess. That’s what he’s inheriting. But like so many contemporary market dynamics, the mess was not created yesterday. It’s been created over decades. In the UK, it was not Liz Truss who blew things up. She just rocked the boat. Right? A boat that’s sort of full of nitroglycerin.
David: You got these unstable financial conditions, which define most of the overleveraged, thinly capitalized world as we know it. And that was created over multiple decades. Now, we’re dealing with the dislocating effects of higher interest rates. There’s a lot of boat rocking. It’s not just in the UK. This is not just Liz Truss. This is all over the place, right?
Kevin: Well, and boat rocking can be taken in a number of ways. The Navy is now warning that we need to be preparing currently for a Chinese invasion of Taiwan as soon as 2024. Wasn’t that moved up from— Weren’t they saying 2027, 2028, something like that?
David: Yeah, it was featured in the Financial Times here the last couple of days. The head of the US Navy is warning that preparation for a Chinese invasion of Taiwan before 2024, that should be our baseline assumption. The previous timeline was 2027. 2024 is more in line with Anthony Blinken’s “reunification is now on a faster timeline” comments here recently. And then of course we’ve had, four times, the promise of intervention from Joe Biden. We have to assume that military aid, if not more direct means, would be employed in sustaining Taiwan’s economy.
Kevin: So what are you seeing in this selloff, this equity selloff in China?
David: Yeah. Just keep in mind, this takes an economic conflict of interest with China to a much more depressing place. It’s the possibility of a hot war. And so the equity selloff in China in recent days has been dramatic. I mean, we’ve had some stocks sell off as much as 20 and 30%. The equity market selloff in China signals a change. And I think it also highlights a weakness in quantitative investment analysis. Major selloff, and of course, immediately you’ve got some Wall Street firm who jumps in and says, “Buy the dip.” JP Morgan looks and compares the recent decline to other declines of similar magnitude. Again, we’re just talking about going a certain distance. “Oh, this decline relative to other declines seems extreme. Better buy the dip.” They advise positioning a portfolio for a strong rally in Chinese equities.
Now, I’m curious. I’m curious if those past episodes of decline were accompanied by a third and final—that’s in my humble opinion—by a third and final appointment of a leader that openly rails against private wealth creation and instead prioritizes common prosperity—again, his scheme of redistribution and equalization, which forcibly shifts resources from the private sector to the public domain. Don’t you think that capital scurrying for the doors might be indicating that there’s a little bit more going on than just a normal dip?
Kevin: Do you think that the equity markets are starting to see what has happened in the real estate sector in China? You think they’re seeing the handwriting on the wall?
David: Yeah. When we watch the complete destruction of the real estate developer sector in China, what you have is the market vote that the sector is so badly mired in debt and the government so vocally intent on seizure of assets that there is nothing recoverable for the equity investor. And more intriguingly, nothing recoverable for the debt investor who would traditionally be at the front of the line for asset disbursement in the event of a bankruptcy. Why is it different this time? Why are we looking at those ridiculous interest rates that I was mentioning earlier? Again, we’re talking about Evergrande, 263% this week. Country Garden, 80%. You realize they were single digit less than a year ago. That’s the largest developer. Vanke now at 12%, probably the best run. But they were three. They’ve gone from three to 12 in no time. Sunac, 167%. Kaisa, oh, only 214% yields.
Kevin: This is a meltdown, Dave.
David: This time is different because bankruptcy in China is different. Yes, equity gets wiped out, but creditors claims being eliminated in favor of the state’s prerogatives, which is the most likely outcome, that appears to be priced into assets today. It’s a game changer. And flight capital should pick up dramatically in the months ahead if they can find a way out.
Kevin: And here’s what I’m thinking, because you introduced me to a book a couple of weeks ago that we’re both reading called The Story of Russia by Orlando Figes. And it’s interesting because you see the phases— I’ll personally admit, I need to know more about Russian history because I can look at the world— I mean eight time zones. That’s a huge, huge country. But you go back and you look. There were times of complete change in Russia where buying the dip would’ve been the wrong thing. And the end of the tsars, the age of the tsars, 1917, you could have looked at that and said, “I don’t think—” Tsars have been around for a thousand years in one form or another. “I don’t think that it’s going to be any different. Let’s buy the dip.” 1917 to 1918, are we there in China? Are we possibly at a 1917 Russia moment in China right now?
David: I mean, this is what makes me laugh. JP Morgan recommends buying China on the dip because the quants— this is how the numbers stack up. You build a case on the basis of quantitative analysis, and forget that there might be another view to investing. Sometimes quantitative analysis works great, but does the transition from quasi-capitalism to a not so quasi-communism show up in your back tested studies? Not on your life. And it really is. It looks and it feels like going long Russia in 1917. Buy that dip. Buy that dip.
History doesn’t always repeat, but I think you have to look at regime change and ponder its consequences. You might think, “Well, this is absurd. We’re not talking about regime change.” Two terms with Xi Jinping may not on the surface appear to be regime change. But when you look at what happened in the last week, seven carefully selected members for the standing committee, 24 members in the politburo—
Kevin: And those who are against Xi are being forcibly taken out of the chambers. Did you see that? They’re literally being forcibly taken out of the chambers. So talk about cancel culture here in America.
David: Was that Hu Jintao? Yeah. So Hu Jintao is dragged out of the meeting, right?
David: And he resists leaving. And the best they can come up with when they put it to the press—
David: Yeah, they put it to the press that, “Oh, he wasn’t feeling well before the meeting.” Right? So he’s dragged out and he’s resisting leaving. What a complete and total show of power for the current premier to say to the previous premier, “You can leave now. You’re no longer a part of this party.”
Kevin: You don’t get to be a dissenting voice. But look at here in the West, Dave. I mean—
David: I know. But that’s the thing. In the West, we’ve moved to shaming and canceling people that don’t agree with us. Differences of opinion are vital for a healthy body politic. That is reality. You can take that one to the bank. If you try to seek and unify and define collective thinking, as we’ve seen in past periods of history—you will think like us or you will be reeducated—never a winning recipe for human flourishing. Never. So in the West, for political reasons, we seek to create an informal social screen that separates the good from the bad and then defines the good as in keeping with our viewpoint. And you know what that’s left us with? It’s left us at the shallowest intellectual moment in 200-plus years of national existence.
Kevin: Yes, but when you’re hungry for power, and you’re starting to taste that power, the last thing you want is a dissenting opinion.
David: Right. The gloves are coming off in the West. The hunger for power is inconsistent with conversation, with dissent, with dialogue, with debate. Public debate is an incredibly healthy expression within a society. And when it’s eliminated—again, as social media and traditional media sought to do in recent years—the citizenry suffer a collective lobotomy. I mention this because it’s not fair to criticize Xi Jinping and the uniformity of thought now represented in the politburo and the standing committee without reflecting on how perverse our embrace of thought control has been in the West. Tolerance amongst left-leaning politicians is dead. Dialogue and debate have been buried, and in their place have come more and more radicalized manifestos, whether those be environmentally inspired, sexually inspired, or otherwise. You go to Yale. You go to Brown University, and you try to make the case for anything other than the party line. Freedom of thought as a criminal offense punished with tar and feather.
Kevin: So like Xi, there’s only one voice. That’s what we’re gearing toward. Even here in the West, we want one voice, and it needs to be the politically correct voice. Xi is one voice in China. He’s got 31 guys who agree with him, right? He’s one voice.
David: Yep. Seven plus 24. There you go. Xi has the univocal power structure backing him. He’s got the chorus. And it’s dangerous because it creates the way for Xi to do whatever he wants, whenever he wants. The markets are selling off in China on a very reasonable basis. This is a historically informed opinion that understands that a dictator was just affirmed. You’ve got one US index of Chinese equities, which sold off 21% in a day. That’s what we had in 1987, what we call Black Monday, right?
David: And Black Monday was very significant. It lives on in the memory of equity traders here in the US.
Kevin: And that just happened in China.
David: It just happened here in the US with this collection of 65 Chinese companies—sold off 21% a day. Was the appointment for five years or was it really for life? Because there is no heir apparent. You look at the ages of all the people he surrounded himself with, and they don’t have enough youth to be elected as his replacement in five years’ time. There is no heir apparent because there is no fourth term. This is the third and final.
Kevin: So if we had perspective, would you say there is panic selling this week? Hong Kong, Mainland? What’s going on in China needs to be taken into perspective.
David: Anyone and everything can now be defined as the enemy of the state with no recourse to the law. So yes, there’s panic selling this week in Hong Kong and on the Mainland. You don’t have multiple voices, right? Think about this. This is the first time in 20, almost 30 years that that 25-member politburo—they shrunk it to 24 this time around—but that 25-member politburo has no females. This is not only reflective of Xi’s mind, but it’s lacking anything representative of the Chinese people as a whole. It’s an all male cast of characters. This is his war cabinet. This is his war cabinet.
So I come back to the quants at JP Morgan. One thing this means is that quants are looking at the unfolding scenario from a limited and maybe even dangerous perspective. Buy the ruble in 1917. Buy any Russian asset at some historically discounted price on the eve of a Marxist-Leninist bloodbath. What is the cost to achieve common prosperity? I think you’re going to find that it’s measured not in pints, but barrels of blood.
Kevin: It always has.
David: We will see the faltering credit markets in China and the declining economic prospects in China translate into a radically nationalist sentiment, then provide whatever needed pretext for war so that it can be sold and packaged to the Chinese people as a rallying point—to distract people.
Kevin: The Chinese people. You’re not against the Chinese people. This isn’t the Chinese people actually doing this. This is a government. We have listeners in China who comment on the show. We have listeners in Russia and Ukraine. We have people who comment on the show. This is not about the people, this is about the politics.
David: It’s about the politics. It’s about an unfolding credit drama, which ultimately impairs the economy and eliminates the ability for the economy to grow at a healthy pace. This is a major sea change for China. I look at Taiwan and I think, “Okay. Taiwan’s freedom now hinges on American resolve. And in case you think we can avoid being involved, I’d like for you to make your list, make your list of 21st century conveniences and see if any of those function without the tech we import from that little island. Don’t be silly. Don’t think that we can’t be involved. Global recession turning into global depression is a high probability scenario when manufacturing comes to a halt or is held hostage by Xi’s new war cabinet—again, as a result of the Taiwanese invasion, which he made very clear. It’s not a question of if, it’s a question of when. Back to our head of Navy saying, “Yeah, 2027 is pretty late on the calendar. 2024 at the latest.” Could it be 2022, 2023?
Kevin: We’ll see. And it’s good to look at these types of things before it becomes personal. Because once the sabers start rattling, the politicians will start to make it personal. It’ll be about the Chinese people. It’ll be about the Taiwanese people, the Russians, the Ukrainians. It’s no longer their politics. It’s the people.
David: That is the problem with so many things that are political. There are distinctions that need to be drawn between the people and their leadership. I don’t like Putin, but the average Russian wants what anybody else in the world wants. Opportunity, comfort, happiness. I think the same is true for the Chinese. I mean, to criticize a regime is not to criticize a people. I have tremendous respect for the Chinese people. Industrious, ambitious, disciplined, focused. The 21st century tragedy looks to include more politicians creating animus that doesn’t naturally exist, isn’t necessary, but will be used in the process of harnessing a power and an energy—the energy of the masses towards particular policy objectives.
Kevin: Dave, remember we were talking last night about this Story of Russia, and it was talking about Peter The Great. Russia would develop very large militaries, and their strategy was just to lose more people than everybody else until they won. And that’s an amazing thing. So I’m going to read a quote from page 107 of this Story of Russia. He says, “This is how Russia from now on would fight its wars, by expending more lives than more advanced adversaries.” It was why it lost so many troops in the two great wars of the 20th century. That’s not a strategy, but the people in these cultures, oftentimes. It’s the people that are expendable.
David: Well, that’s right. So reading on Russian history, the great battle victories of the Russians boil down to spending their citizens like a Gatling gun spends bullets. Three times the casualties of their enemies. It’s the math that brought them victory, rooted, of course, in a history that conveniently legitimizes the current leaders. And again, there’s some mythology to that. Each person who comes in has to borrow from and recreate the historical narrative that puts them in a position to be the greatest leader for the future.
Kevin: And almost always, there’s a tie. The leader is tied directly to God. Like with Russia, the tsar was everything. And in a strange way that translated even into the communist side of things. Xi is behaving like that too.
David: Well, I mean his anointing, that was interesting. The language used in the Financial Times a few weeks ago. But the party is God. The party is that which is sacred. It’s the ideals of the manifesto. It’s what we have subscribed to in terms of ideology. It’s the isms. It’s the isms back from the grave. So I just look at that, and I think, whether it is the Russians—and we mentioned this last week. Twenty million through all the war period, the Russians and the communist gulag period. Fifty-five million in China.
Kevin: In China, yeah.
David: Victory at such a high human cost suggests that the value of human life in the communist world is insignificant. I wonder if the Communist Party recognizes how far out of step they are from the average Chinese person. Do the Chinese people recognize how insignificant they are to the Communist Party? A resource like any other which can be used for whatever policy prerogative Xi Jinping comes up with. This is the danger of unbalanced power. Unbalanced power is one that the Chinese already know from history. And not since Mao has there been a more dangerous political construct in China.
Kevin: So who was brave enough to report GDP in China at 3.9%? Did they go to the gulag, the Chinese gulag, for not saying 5½%?
David: I know, I know. 3.9 was higher than the Wall Street estimates of 3.3. So there’s that in terms of beating expectations.
Kevin: Was that Xi’s number, though? Was that Xi’s number?
David: No, no, no. Xi’s was 5.5, and negative growth is more in keeping with what we see in retail, real estate and other economic inputs. So 3.9 is not very believable, but statistics will, over the next 2, 3, 4, 5 years, his third or perhaps his forever term, they’ll say whatever the politburo wants them to say. Those statistics will say whatever the PBOC wants them to say because now you are talking about constructing reality to support a political narrative. That’s a political narrative designed for the Chinese people, but also to be projected towards the enemy. And so they will be strong, and you’ll have to look at things like electricity inputs and things like that. How much energy are they actually burning to see— does it correspond with export? Does it correspond with economic activity?
Kevin: Well, and the sad thing is we still have the freedom to say we’re not going to buy the dip, but Xi probably will tell them, “You will buy the dip.”
David: What’s really fascinating is we see two groups, both the Chinese and the Japanese, who are really in an awkward position. We talked about, several months ago, the Chinese currency, the RNB or the yuan, breaking the seven barrier, and it’s under greater weakness now. They provide for about a 2% trading band on a daily basis, and it’s edging towards that 2% as often as it can. So is it controlled? Yes, it’s controlled. How long is it controlled? That’s another question. The Chinese have the ability to control it for a good period of time, $3 trillion in foreign currency reserves in one form or fashion. We don’t know exactly what form they hold that in, but they can defend their currency for some time. It would seem that they are losing grip to a small degree. The Japanese, on the other hand, are losing grip to a very large degree. Friday, there was a massive intervention in the yen. It breached the 151 level. They brought it back to 145. And within a matter of hours it was back to 149.
Kevin: Yeah. So the cracks that you talked about last week, they’re getting bigger.
David: If we said over the last four days that Bank of Japan has intervened with $60 billion to support the currency, and what did they get for it? The answer is virtually nothing. Which says that they are between a rock and a hard place. They can’t have it both ways. They can’t support the JGB market and expect currency stability. Something’s got to give. One of the things that is giving, regardless of pricing, is credibility. Right? Now, the People’s Bank of China doesn’t have to worry about credibility because they have the imprimatur of Xi Jinping.
Kevin: The single voice, the single voice.
David: They will do the bidding of Xi Jinping. The market dynamics that we’ve come to take for granted, they’re gone. They’re gone. That’s why flight capital will pick up in China. There’s an interesting byline or story here with gold because I think when you see currency and stability like we have with the yuan, with the yen, and as we’ve mentioned before, you’ve got, what is it, seven and a half billion people around the world who look at gold and say, “Gosh, this has been a great year. Double digit returns.”
David: Positive year.
Kevin: Unless you’re in America. I mean, in America it’s like, “Well, it’s down 11%.” But what’s 11% even in comparison to the markets right now?
David: All that is, is a dollar narrative. The dollar had its strongest run in 20 years.
Kevin: But against the yen, it’s double digit.
David: And the likelihood, the likelihood of the dollar sustaining this trajectory—
Kevin: Double digit up.
David: Not likely, with one exception. And this is why I bring in the gold narrative and what investors should be doing in terms of their dry powder, and not only what they have in cash, but also what they have in metals. What we see developing in the yen and the yuan, that weakness there, that is the precursor to a final dollar parabola where it moves to say the 120 level and then is simply out of gas. At that point, I think we’ve put in the high perhaps for 10 or 15 years for the US dollar. And we’ve put in the low for gold perhaps the next 10 or 15 years.
Kevin: You know what it reminds me of? It reminds me of people who wish that they sold their house at the peak of the real estate market and then waited until the market crashed. Like in 2006. In the same way we’re sort of getting a peak dollar to gold buying power right now.
David: Oh, that’s exactly right. That’s exactly right.
Kevin: If you just move to gold, I’m going to get out of cash, I’m going to move into gold.
David: It makes sense.
Kevin: And I’m going to wait.
David: No, it makes all the sense in the world.
David: So for the patient investor, I mean, we are talking about a values realignment, right? That’s what we were arguing for earlier in our conversation with reference to Robert Rhea and Dow theory, and this notion that we’re only in the first phase of a bear market. We still have two phases left. You have to focus on asset preservation. And your two means of doing so are not in the bond market, by the way, but some combination of cash and gold. And with a high dollop of patience, I think you’re setting yourself up for immense success in the decade ahead.
Kevin: You’ve been listening to The McAlvany Weekly Commentary. Now I’m Kevin Orrick, along with David McAlvany. You can find us at mcalvany.com, M-C-A-L-V-A-N-Y.com, and you can call us at 800-525-9556.
This has been The McAlvany Weekly Commentary. The Views expressed should not be considered to be a solicitation or recommendation for your investment portfolio. You should consult a professional financial advisor to assess your suitability for risk and investment. Join us again next week for a new edition of The McAlvany Weekly Commentary.