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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Is Value Investing Dead?
January 27, 2021

The McAlvany Weekly Commentary, covering monetary, economic, and geopolitical news events.

David: The winds of financial conditions, they’re beautiful when they’re at your back, but they’re terrifying when they’re sweeping across the road. As we take the turns and twists on the road, those external factors, public policy choices, treasury department tax initiatives, financial conditions, they reasonably contribute to an uncertainty of outcomes and a trajectory which can become disastrous.

Now, here are Kevin Orrick and David McAlvany.

Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. David, November was a big month for a lot of reasons.

David: Well, of course the election and five days there after we lost Alex Trebek. For your family I know, an occasional evening and dinner time and listening to Jeopardy in the background.

Kevin: Oftentimes, yeah. We put Jeopardy on, and Alex had a way of moderating the show, but also commanding just an awful lot of authority. This was a man who was well learned.

David: Now, fascinating to see the guests come and go. I particularly liked when Sean Connery was on the program. Alex, I’ll take Janet Yellen for 400. What is this week’s treasury assurance? No, that is not correct. What is $410 billion in bills, bonds, and notes? Our average duration is still under five and a half years.

Kevin: Well okay, so keep playing it, keep playing it, if you’re playing Jeopardy.

David: Okay, checking in on authoritarian history. We have the first week behind us. Alex, I’ll take history of executive orders for 200. Clinton used two executive orders, Bush, two, Obama, five, Trump, four. How many has the new president implemented in just five days?

Kevin: Would the answer be, what is 30?

David: The answer is not salute Marines. The answer, yes, correct, what is 30? That is the correct answer. The last but not least, Alex, I’ll take the Nobel Prize for three million. Sorry, that was the wire from Moscow. I meant, I’ll take the Nobel Prize for 1,000. The question, who won the Nobel Prize on his first day as president? Yes, that’s correct. Joe Biden, what is Joe Biden? Beat Obama as the fastest man to ever win the Nobel Peace Prize. He hasn’t even implemented regime change in Syria yet.

Kevin: Dave, I know you’re being tongue in cheek on the Jeopardy questions, but you and I had an interesting discussion last night on virtues and values. I’m reading a good book right now on Greek and Roman mythology and the cardinal virtues that are displayed there. Fortitude, temperance, prudence, justice, along with the weirdness that goes into the mythology. There are lessons.

David: Coincidentally, my oldest son is starting Aristotle’s Nicomachean ethics this week and I had a great time. My wife asked me, “Hey, where’s the copy of Aristotle’s ethics?” I said, “I think I can put my hands on it.” So I went upstairs-

Kevin: Being a philosophy major, I bet you could.

David: I grabbed Ackrill’s essays on… I grabbed more than he needed because I’m an enthusiast, shall we say.

Kevin: Yeah.

David: But I brought it to him this morning and I said, “Book two and three, which you’re reading this week, this is some of the most important reading you’ll do in your life because if you grasp virtue ethics, they’re in book two. You’re looking at what creates character. You’re looking at what sets in motion who a person becomes and the impact that they have on the world.” So virtue is not some obscure place that you arrive at, some point in your life. It becomes a practice and it is an expression of who you are.

Kevin: Even going back to the 1960s, 1970s, when I was in school, Dave. I was not taught virtues in school. That’s something that was taught at home through lifestyle and reading, but it’s interesting. We really haven’t, from an educational point of view in this country, for the last 50, 60, 70 years, taught virtues the way they used to.

David: Yeah, I think one of the things that people don’t realize about virtue is that it is an avoidance of extremes, at least as Aristotle writes it. The midpoint, or the mean between excess and deficiency. Neither too much, nor too little.

Kevin: Like with courage, you’re either brash or you’re a coward, but there’s somewhere in the middle where you’re going to act even if you’re fearful.

David: That’s right, and what I like about that is it requires a constant recalibration. It requires an engagement, it requires a thoughtful approach to life at every point in life. You’re never done with the process of recalibrating and figuring out where you’re at in that continuum of excess or deficiency.

Kevin: Well, and that can even play out in monetary decisionmaking, Dave. I know that you are very much into value investing, even if it’s a lonely sport for you. Sometimes you’re sitting there alone, but value investing, yeah, when I talk about value investing, I’m talking about underpaying for something and then selling it when it’s too expensive.

David: I’m stuck on excess and deficiency. We had outstanding treasury securities get above 110% of GDP. Yeah, I mentioned jokingly with Janet Yellen coming into the treasury department in this week’s issue, it’s being $410 billion. It’s a big number, it’s a very big number for one week dump of treasuries. To me, that registers as excess.

Kevin: Does that mean that we work all year long as a nation and actually we’re spending more than what we’re making?

David: Well, of course, of course, that is the nature of running those kinds of deficits. I think one of the things that bothers me about that excess in the treasury markets is it’s one of the factors, one of the primary factors, that promotes massive, rampant speculation in the markets. I think if you boiled it down to basic things that drive value and drive a winning strategy as an investor, there are few things as important as cost basis to long-term investment success. It’s been said that you make money when you buy something. Overpay and you’ll wait a very long time for very little in terms of positive returns. If you underpay, your long-term returns are easier to compound over full investment cycles. Of course, you don’t really have the opportunity to enter any asset with a low cost basis when we’re dealing with the kind of monetary and credit excess that we have in the system today.

Kevin: We were talking about virtues, and one of the virtues is prudence, which is wisdom. Value investing is wise investing, but the thing is, oftentimes you’ll look like the fool when you’re holding to one of those virtues, like prudence, when everybody else around you is just running into what everybody else is running into.

David: It’s not popular, that’s for sure. That concept of cost basis or value investing returned to the stage last week on our tactical short call during the question and answer segment. The best questions I will say, that we’ve gotten in a long time. Please, spend some time, go to the transcripts, and you can read through it. Doug did a fantastic job. You can tell there is real concern as you listen to the questions and the focus, there’s real concern. You can tell there’s a level of attention on the current financial structure. One of the questions was basically, is value investing dead?

Kevin: Well, and it’s a reasonable question. Is value investing dead, because it doesn’t look like it’s worked for a while.

David: Yeah, in fact the questioner says it seems like it’s been so for a dozen years. That was the gist of the question. I think he mentioned, is it past its sell-by date? I think that was the reference.

I think value still has a place, not to mention this is where you will often find dividends. Companies that are making money, whether they’re rewarded for that or not (you end up getting rewarded more these days for not making money), but the companies that are making money also have dividends to give back to their shareholders and that is one approach.

Kevin: Well, you would contrast that then with the other side of things. Okay, just growth and momentum. Whatever’s growing, buy, that’s the opposite of value investing.

David: It’s the other primary approach, growth and momentum. Those plays have captured most of the recent capital flows. They’ve posted the biggest short-term gains for investors, but it has not changed the reality that price is what you pay for an asset. Value is what you get, value is what you receive.

David: I said that again on the tactical short call. Overpaying for a winning portfolio is more of post-mortem commentary. In the moment, you don’t appear to be overpaying, as long as the gains are continuing to accrue. So value investing has, in recent years, looked like the loser. At least it looks that way for a period in time. But keep in mind, value investors are used to waiting. They’re used to waiting for positions to gain in popularity, and for capital to eventually return to the neglected or ignored sector.

Kevin: We’ve talked about the two T’s of investing, timing and trend. It seems like momentum investing is chasing trend. One of the questions though, with value investing, Dave is, how long do you have to wait? Because it’s hard to wait when you see everything around you giving counter signals to what you’re thinking.

David: But, I think this is again where you would approach the market from a slightly different mindset. I mentioned dividends a moment ago, it’s nearly a passé component to a successful investment scheme today. But getting paid while you wait, that is I think an important component. How long do you have to wait, that is an unknown fact. I think it’s a little like an exploration project from 100 years ago or hundreds of years ago. You arrive early and you plant a flag. Then you wait for an outpost to be built, and then you wait for a town to build up, and for others to see what you saw first. Value investing is, in that sense, it’s contrarian by nature. It includes being early and staying lonely, which is very unlike what you have today with the Reddit swarms. At least you’re lonely and contrarian for a while.

Kevin: Yeah, I think back to last year, Dave. Remember when oil went negative, and you were saying energy’s a value. Energy’s a value. Okay, so the rewards of a low cost basis portfolio if you’re right, can really pay off.

David: Yeah, and I think it’s evident with the passage of time. So what is your timeframe? Some people manage for the quarter, some people manage for the day. Some people manage for a year or a decade. If you’re managing over a lifetime, ideally you want to build low cost basis in each of the primary asset classes, stocks and bonds, being your financial assets, real estate, precious metals. I mean, you patiently wait to put money to work.

Kevin: And you did, with energy last year.

David: That was a value play in 2020, in the last quarter of the year it staged quite a comeback. Even with that comeback, the energy complex is still less than 3% of total S&P 500 market capitalization. At one time, it was close to 25%.

Kevin: But we’ve had a regime change, we’ve had a regime change, so does that affect energy going forward?

David: I mean, some might say that the sector has a more limited scope as we see not only social trends but the new administration address issues of climate change and move towards policies that incentivize a reduced carbon footprint. Carbon neutral by 2030, carbon neutral by 2050. In an age that prioritizes, and I think this is key. In an age that prioritizes virtue signaling over virtue, you can see how that argument might actually have some traction, but when I reference energy, it’s the combination of oil, natural gas, alternatives, including to a lesser degree, nuclear energy. These things I think are very relevant for an investor who has a 10 or 20 or 30 year time horizon, because I think that the road to carbon neutral is a long one, it’s an expensive one. There’s going to be periods of very high enthusiasm for that, but checked by or punctuated by radically high energy costs, which tend to beat down the environmental concerns with pocketbook and household solvency concerns.

Kevin: One of the things that I’ve noticed with clients recently, over this last year or two, is there are so many unknown factors that are coming in, like COVID. Okay, we had the liquidity crisis before that, that there are rotations, the sands shift very quickly if you don’t have a balanced portfolio strategy where it’s like, well gosh, maybe I just need to sell everything and go buy bitcoin, because that seems to be going up.

David: Well, and this was one of the comments that Doug made in the presentation last Thursday for the tactical short call. Radical, violent rotations from one sector to another there in 2020. I think one of the things that I draw or conclude from that is this reminder that value can emerge pretty quickly. The juggernaut in the marketplace has been cap-weighted index investing, which has been a force overpowering normal market behaviors. Your traditional value-oriented analysis, cheap can therefore stay cheap longer and expensive can get more expensive for a longer period of time.

Kevin: Cap-weighted investing really does cluster everybody into the same trade, does it not?

David: It does, it clusters in and you’re basically… it’s an automatic allocation process. Cap-weighted index investing is a little bit like a firestorm. The heat generated can create its own wind system, and in some instances it can even create its own weather patterns. So the structure itself, the configuration of the cap-weighted index, it’s self-reinforcing to a given trend, and that structure, I think it’s worth keeping in mind, can drive prices both directions, not just one. So I mean, as fun as it is to witness success in the equity markets, the flip side to success is duress, and that’s again where you can see the automatic nature of investing, the automatic allocation, it’s automatic pulling, as well as it is pushing.

Kevin: I was talking to a client of mine who’s a Navy Seal, and he asked me, he said, “Kevin, have you ever flipped a car?” Because we were talking about how extremes shifting, whether it’s political, whether it’s financial, whatever. You start to see these weight shifts back and forth and they can get more and more dramatic. To be honest, I’ve never flipped a car, I’m glad that I haven’t. I think he might of purposely flipped a few, he might even be a stuntman, I don’t know, but what he was basically saying is, you have to keep those extremes shifting, like you were talking about, violent rotations. Keep them shifting until you have a change and a motion to flip the car.

David: At some time you’ll have to ask Mary Catherine about her experience having flipped a car. Even for the skeptic, a supernatural experience.

Kevin: Really?

David: Yeah, you’ll have to ask her about that some time, but no, I’ve never flipped a car. She has, I think on more than one occasion.

Kevin: Oh, she has?

David: Yes, yes.

Kevin: Really, really?

David: But one of those, yeah, downtown Houston, a Jeep, flipped it and… well, anyways. You’ll have to ask her.

David: This weekend we were driving and we’re in the middle of a snowstorm. We were driving to get to 15 to 20 inches of fresh powder. As you know, I love to ski.

Kevin: Yeah, a lot of people drive away from powder. You drive into it, yeah.

David: Well, of course.

Kevin: Of course, yeah.

David: As I drove, the commentary of the kids in the backseat included instructions for driving on ice and snow. I asked them, “What scientific ideas were relevant?” I got, from two different people, motion and inertia. So I have a history buff and I have a math and science buff. The math and science geek was referencing Newton’s first law of motion.

Kevin: Not bad, not bad. The training is working.

David: No, I thought, this is great. An object in motion stays in motion with the speed and in the same direction unless acted upon by an unbalanced force. So I explained that this principle was particularly important to keep in mind when braking in advance of curves in the road. You have to slow down before you need to. When I think of the Federal Reserve, this is an element that’s been missing since William McChesney Martin famously saying, you got to take away the punch bowl before the party starts, but in essence, when you’re driving, you got to slow down before you need to. You anticipate the curves or you tempt fate with continued forward motion. The point I was trying to make was that it’s not a perfect setup when you’re traveling at speed and need to stay on the road, and you do encounter twists and turns. Then of course there’s these extra factors that are sometimes there.

Kevin: Well-

David: Road conditions are less accommodative to staying on the road.

Kevin: A lot of times the action that you have to take is counterintuitive to what you need to do, as far as steering. Remember when we were learning to fly planes? Okay, one of the things that you’re trained is stall training. A lot of guys kill themselves because as they see themselves sinking, they pull back on the yoke, instead of actually doing what’s counterintuitive and that is, pointing.

David: Pushing the yoke forward.

Kevin: Yeah, pointing at what is actually rising in the screen.

David: I know, well I mean when you’re driving there’s the ditch or there’s the dreaded fishtail. You’ve got forward motion which is then interrupted by the back end of the vehicle, swinging one direction or the other. You have to compensate, not by turning in the direction you want to go, but you have to go instead in the direction you don’t want to go. Resolving a fishtail is counterintuitive. You turn into the direction where you’re losing control. I mean it really is, whether it’s flying a plane and pushing forward on the yoke or maybe even a similarity to facing a fear. You can’t resolve it by turning away from it. If you don’t resolve the swing, the rear end of the car swings in a more exaggerated fashion in the other direction, and then you enter the spin zone where you have zero control and you’re just whirling like a top.

Kevin: I just wonder if that’s not happening in the political realm as well, Dave. You and I were talking about presidential elections and, as we come out of this, it seems to me like the feelings on both sides of the aisle are getting to be more and more extreme.

David: The swings are certainly there. I read an interesting article by a gentleman who was previously at the Booth School of Business in Chicago, is now at the Hoover Institute, Stanford, and he runs a blog. He refers to himself as the grumpy economist. He did a great presentation on bonds and interest rates and I’ve been reading through his stuff and he had also an interesting blog post on what is happening within the political realm. Obviously he’s an economist, not a political science guy, but he had some interesting comments on what this looks like, this far swing to the left. Cancel culture, I mean being in academics, he sees it more closely than probably anyone else. There’s appropriate language and inappropriate language. There is more of a squeeze on free speech in academic circles than probably anywhere else, but as we mentioned a few weeks ago, that’s coming to a theater near you. Maybe not an AMC theater, but some other kind of theater near you.

Kevin: So, I’ve got to ask you then, to shift back to the skiing. How was the skiing, because when you do drive directly into powder, there is a reward if you get there.

David: Yeah, and what I was also telling the kids is that, “Look, there’s nothing inherently wrong with losing control of the vehicle, it’s what happens next. It’s the trees, it’s the cliffs, it’s the other vehicles, it’s the guardrails, it’s the objects that can create damaging aftereffects. It’s the aftereffects, again, if you’re talking about a shift or a swing out of control in public policy or politics, it’s the aftereffects which are really nasty.

Kevin: The unintended consequences.

David: But sorry, to your point, the skiing was great.

Kevin: I figured it would be.

David: There are few things as rewarding, at least to a ski junkie.

Kevin: Well, and we’ve needed the snow, we’re getting it.

David: I know, but here I am, watching my nine-year old daughter dashing down double blacks. I took the kids to my favorite spot on the mountain, the waterfall area. A place where 13 years ago I was doing daddy daycare. I’ve got a one and a half year old in the backpack, navigating jump turns and fluffy in very forgiving powder.

Kevin: Can you still do that? Can you still backpack ski?

David: No, liability limits today restrict that kind of adventuring. So babies in backpacks, you might wonder why, but the key is, you just don’t fall.

Kevin: That’s true.

David: But what an epic return with three kids, to a place that is both terrifying and exhilarating. It’s navigable by a nine-year old, but what it requires is handling these various feelings and fears. If fears can be adequately managed and your feelings necessarily tamed, then it’s fun. I was prouder still to listen to the tales told over dinner. That’s what happens, there’s the owning the day’s victories and defeats. The biggest spills, the biggest jumps, it was fantastic, absolutely classic.

Kevin: Well, and the way this applies, because as we talk about this, Dave, we’re talking about the difference between value investing and momentum investing. The fishtailing, momentum investing is where that type of thing happens. Value investing can be a very calm sport, whereas momentum investing can be very, very violent.

David: So yes, this relates to cost basis. An object in motion stays in motion, that is momentum. It is the operative force in the market today, money managers avoid career risk and keep the pedal to the metal. Investors grow complacent, even as you’ve got the rotations per minute, the RPMs are pegged, the performance is hitting very impressive levels. Why does our asset management team approach this a little bit differently? Because when you have changes in financial conditions, you have to think of both the risk and reward equation, but also the damaging aftereffects.

Kevin: Well, and that’s like braking before the turn.

David: That’s correct, so there are factors that operate as impediments to continued motion, you have to be aware of what those are. There are variables that contribute to instability. I mean look, speed is one of those natural factors which increases risk and magnifies consequence.

Kevin: It’s that rate of change in a market. We’ve talked about when markets go parabolic, you know something’s going to reverse.

David: Yeah, no, I mean one of the things I have to do is coach my kids on not going so fast when we’re skiing because there’s things that they don’t know about control and about form that are absolutely vital. They like to quote, “Oh, dad. When you were at Telluride last time you clocked 63 miles an hour.” It’s like, yeah, but don’t try that. That’s not smart. There’s a number of things that you have to be aware of. A perfectly groomed run, a perfect condition day, just the right wax and tuning on the skis.

Kevin: And dad’s not completely sane anyway.

David: Well, I was going to say, 35 years of experience but maybe that factors in too, but speed is a natural factor that increases risk and magnifies consequence. Something goes wrong, there’s greater implications. In the market, we call that rate of change, ROC, rate of change. How quickly does an asset increase in value? If it goes too fast in too short a period of time, the trend will run its course. It’s over. Under normal circumstances, you see this in equities. You see this in equities where, again, something has a nice bull run, and then it takes a breather, maybe for three months or three years, but it has a good run and then it’s done. That rate of change is very significant because you’ll see 150, 200% increase in a calendar year as both excessive and exhausting for an asset class. But again, that’s under normal circumstances.

David: The hallmarks of the end of a market, this is a little different right now. Gamblers cannot go to the racetracks. Gamblers cannot hang out in Vegas or Atlantic City or Macau. Again, you expect to see a rate of change of 150 to 200% in a calendar year as both excessive, exhausting, and as a sign of the times. This is the end, but in the age of lockdowns with limited venues for gambling, the markets have been transmogrified into a better’s paradise.

Kevin: So Wall Street has become Vegas? Look at the gains of Tesla last year and what’s replacing that right now. What took Tesla a year is taking days for, what is it, GameStop?

David: Yeah, so Tesla was last year, the big winner for last year. Talk about rate of change, now it’s GameStop this week, not last year, we’re not talking about 52 weeks, we’re talking about one week or three weeks and a tripling in value. I mean, short interest is obviously a huge part of this. It’s a short stock, shorts are having to cover, but last I checked, it went from being … of available float, 142% short to now just 139% short. So some covering has happened, but the pain is still there to be felt. The hedge funds that are short GameStop are tempting fate with extinction. Again, we talk about what are the factors? Speed is one factor that contributes to instability. Mensky said that stability contributes to instability.

Kevin: That reminds me, you were talking about driving, but here in Durango, we’ve got a lot of guys who’ve got very large pickups and they can go as fast as they want in this snow. The problem is, they’re doing a little bit like what you were trying to teach your kids. They’ve got momentum that they can’t control if something were to happen.

David: Yeah, what happens if they have to brake? What happens if they have to turn?

Kevin: But it’s the stability that gives them the confidence or at least the perceived stability.

David: That’s right, and that’s in part because you begin to take forward progress for granted. The skills needed to maintain forward progress, they fade into oblivion. It’s not diligent care, it’s not constantly attuned attention, those things go away. Vigilance is set aside for a very good time, and that’s what we see in the markets today. Vigilance gone, just looking for a very good time.

Kevin: Well, just talking about that momentum driving home, yeah, I live about 12 miles from the office. Driving home, you can see the fence lines where that momentum actually continued when the curve took the road away from them.

David: Every one of us has felt the adrenaline rush when you’re moving too fast and you come into a curve in the road too quickly. Maybe your attention was elsewhere, you’re distracted, daydreaming, deep in conversation. For some of us it’s singing a stanza at the top of your lungs, not quite Pavarotti, but then you feel the inertia and it’s carrying you dangerously close to the road, it’s edge, and you can feel the adrenaline pump through your body as you go, whoa.

Kevin: Then you can see the fence coming. You can see the fence coming.

David: You slam on the brakes to slow yourself down and hope there’s nothing like … again, this is where these externals factors are important. You slam on your brakes to slow yourself down, but what if there is water or snow or ice on the road? Now, you’re in the spin zone.

Kevin: Well see, and I think you hit on something because a lot of times we’ll put our investments aside. I talked to a client yesterday who bought from me back in 1998. Okay, and he’s very pleased with his returns. I asked him, I said, “You haven’t added gold to your portfolio since 1998. I know you’re loving it.” He goes, “I haven’t done anything to any of my investments for many years. Don’t you know, I’m 77 years old? Why in the world would I change anything?” Well see, in a way, granted he’s not momentum investing, but he’s doing the opposite. He’s very, very comfortable with the stability that he feels in his portfolio.

David: Well, I think there is a luxury that comes with low cost basis. That is that you can look at some of the market’s volatility and take it in stride. When you’ve overpaid for any asset, you’re forced to play the patience game. When you focused on cost basis upfront, that does allow you to look back and say, “Oh yeah, so the market dropped 30%.” You’re still looking at what you have invested, and it’s okay. If he was buying gold in 1998, he has a cost basis under $400. So he’s up 400%. If the market’s down 1% or 2% this week or $50 or $100 next week, he’s still looking at a $350 or $400 cost basis. Like I said earlier, ideally what you’re doing over a lifetime is you’re establishing low cost basis in every asset class. That means you don’t evenly distribute your savings into the various assets. You patiently distribute only to those asset classes which are reasonably valued.

Kevin: Well, and in 1998 gold was undervalued.

David: Investors I think are in many respects like the driver going at Mach speed. Sometimes they forget that the road is not always straight. There are occasionally those external factors that contribute to instability. There’s nothing like momentum, that experience of stability, to cause investors to basically relax, be relaxed. Yeah, I mean this is about cost basis in the sense that entering the investment equation at the wrong time, peak stability, peak relaxation, peak confidence, it sets you up for future challenges even if your initial experience is an easy success.

Kevin: To go back to this client of mine, because he really was very relaxed, but he’s got assets at this point. Now, I’m not talking about the gold, but he’s got assets that he’s held for a long time that at this point are probably overvalued. The question becomes not just, when do you buy value, Dave, but when do you sell? When do you lock in overvaluation?

David: Sometimes it’s not a question of sell, but a question of exchange, because again you’re looking at not only nominal value when you’re talking about a price of an asset, but relative value, one asset class versus another.

Kevin: Moving into another asset that’s more of a value at the time?

David: Yeah, selling the premium or moving out of the premium and moving into the discount. I’ll often read other investors that I respect, and John Hussman is one such individual. In the last few days he wrote that nothing demands that investors lock in the lowest investment prospects in history. I read that, Kevin, and I thought, no, that’s right, nothing demands it, but people line up for it all day long because by the numbers, if you’re looking based on current market pricing, the S&P 500 is lined up to deliver a negative 2.5% annual return over the next dozen years.

Kevin: That can happen all at once or it can happen over the next dozen years, right?

David: That is in essence what they’re unwittingly locking in. He went on to say that a hyper-valued stock market doesn’t create wealth. At best, it provides the holders of stocks the temporary opportunity to obtain a transfer of wealth by selling those stocks to some other poor soul who will suffer the dismal long-term returns and steep interim losses instead.

Kevin: Oftentimes you will talk about the greater fool theory. As long as there’s someone who’s going to buy your stock for a little bit more than what you paid for it, that’s the greater fool theory, but that’s not always value, is it?

David: No, I mean this is a massive transfer of wealth. Only the seller of momentum is going to emerge unscathed. That is the seller of momentum, not the buyer of momentum. So again, you’re moving in the opposite direction from the mass investment herds. What I described earlier as the Reddit swarm. Today’s buyer is tomorrow’s crier. I know, that’s pretty bad, isn’t it?

Kevin: Well, at least it rhymes.

David: I know, I know, but I think today’s index investor is at the opposite end, at the opposite end of the value spectrum, value investment spectrum from where you would want to start in order to compound returns for many years into the future. You still have momentum trades, you still have inertia carrying stocks farther to the upside, but prices are well above … looking at the markets today, prices are well above pre-pandemic levels. Those levels were pricey even when the world was functioning in a normal environment.

David: Today you have uncertainty. Uncertainty which is one of those external factors. I mean, call it the ice of public policy choices, or the snow of treasury department tax initiatives. Have you ever gotten hit by a strong crosswind? It’s really no big deal when you’re in a big, fat truck, but when you’re on a motorcycle or a bicycle, you can really feel it. The winds of financial conditions, they’re beautiful when they’re at your back, but they’re terrifying when they’re sweeping across the road. We’re on a normal course, we’re on a normal course, which is, as you know, it’s not a straight line. As we take the turns and twists on the road, those external factors, public policy choices, treasury department tax initiatives, financial conditions, they reasonably contribute to an uncertainty of outcome and a trajectory which can become disastrous.

Kevin: This brings me back to what we were talking about with Aristotle and what your son is studying. You can take the extreme and just say, well then, I’m going to get out completely, I’m not going to invest. Or you could take the other extreme approach and say, well everybody’s investing so I’m going to stay in. But there’s a moderation, remember, we were talking about the virtues. There’s fortitude, temperance, prudence, justice, but temperance has something to do with that middle ground. Does it not?

David: Just a few weeks ago I was on … there’s a local college here in town and I’m on the investment advisory committee for the foundation, which helps with scholarships for students in need. My suggestion to them was, look, we’ve had a phenomenal quarter, it’s time to take something off the table. Why? Because I can promise you we’re going to have a conversation in the next market downturn where we’re going to have to stay the course, we’re going to have to be patient, we’re just going to have to wait, you can’t time the market, you got to be invested for the long run. My point was, doing something today, reducing risk today, selling a little bit of a position today puts in your mind what the action of tomorrow is. If you want to be the man with courage, the woman with courage in the context of the world losing their minds, this is again something that you practice, pre-rehearse, and take action on. Yes, very much in line with virtue ethics.

Kevin: We’ve talked about that with survival. The people who survive are the ones who’ve oftentimes practiced how they will behave at a certain level. I remember the book Into Thin Air. That was Krakauer’s book about not turning back in time from Everest. A number of people lost their lives because they had pre-decided when they were going to turn around. They got so close to that top, it was like, no, let’s don’t, let’s keep going, we’ll get there soon. Unfortunately, what they had rehearsed was not what they practiced.

David: Yeah, and what I did not say in that committee meeting was, sell everything, move to cash or move to gold. It was …

Kevin: You’re training a discipline.

David: If you want to have an empowered decision in the context of a market selloff, then decide what money you’re putting to work at the market lows and create that liquidity now. I’m afraid it fell on deaf ears, no actions have been taken. Maybe that’ll change in the weeks ahead, but there is the idea that you just pull out, don’t play. Someone might think, well that’s just crazy. Why do you take your kids in a backpack skiing or why would you go out in the middle of a storm? You could say, get off the road, don’t go out into the middle of a storm. Well, sorry, the skiing is best when the conditions are least stable, and it’s no different.

David: My brother lives in Indonesia, loves surfing, and he’d tell you the same. The sea swells in the context of a storm. The best rides are on the toughest days. So having a sharpened sense of risk and the appropriate skills to navigate those conditions is critical, not only to enjoyment but survival.

Kevin: But back to the markets, okay. When you have people who are investing in the markets for value or investment, that’s a completely different dynamic than when you have a Federal Reserve that’s either buying everything or the new movement, what you talked about is, the gambler has moved from sports to Wall Street.

David: Well, and I think this is the rub, this is the rub. You’ve got an investment community today that is not well trained, does not have much in the way of financial history. By the way, even the market professionals who have financial history recorded on their backs, if they showed you the scars, they’re quickly forgotten. Quickly returning … what is the famous quote? The shortness of memory and the permanence of greed or something like that. This is the nature of Wall Street, but this is the rub. You know a person who’s unfamiliar with the terrain and conditions a mile away.

We joke about the Texan, the skiing in jeans, wearing a cowboy hat and sunglasses. In the markets, it’s not jeans and a cowboy hat, it’s a hoodie, it gives it away. There’s a lot of people involved that don’t know how to safely navigate an environment of increasing risks and rewards. Now of course, I’m talking about the Robin-Hoodie. You see, the hoodie, you see it and you know where you’re at in the market cycle.

Kevin: One of the ways we can tell when a market is overvalued is just simply how much people are borrowing to buy.

David: And I mentioned last week, November’s margin debt figure, $722 billion. Four days ago, FINRA released the December figures. Margin debt moves to a new all-time high, over 7% to $770 billion. $770 billion in borrowed money. You don’t have the money, but it’s such a sure thing, why don’t I borrow from the House, pay interest on that and I’ll just make money. If a little is good, a lot is better. One of the things that can be said about the margin debt figures, we may have already peaked in the stock market. Put in a top here in the first quarter of 2021. Market values will head lower on a lagging basis, relative to that margin number. Again, it’s typically the case insofar as the margin numbers are tabulated and released on a delayed basis.

David: But what does it look like? It looks like jeans and T-shirts on the ski slopes. It looks like hoodies in the option market, it’s the same difference.

Kevin: So you’ve been pointing out that we have been in a bubble in a number of areas. Do people see bubbles and continue to invest?

David: Yeah, I mean it’s difficult. This is one of the things that Doug mentioned last week on that call is, when questioned about the crash in 1929, market professionals responded, “Of course we saw it. We saw it in 1927, but we had seen it for a couple years and we just … we got tired we had to participate. You can only be the naysayer for so long. You can only be the Chicken Little for so long. What didn’t compute, what didn’t add up, ultimately you just don’t know when it’s going to end so you throw in the towel and join in the party.

Kevin: Well, and sometimes you’re competing with other professionals and having to show returns.

David: That’s right, Deutsche Bank’s monthly investors survey, this is from Reuters, recorded 90% of respondents saying financial markets have a number of price bubbles today. Bitcoin and US tech stops were at the top of the Deutsche Bank list. Then you had Deutsche Bank strategist Jim Reed remarking that these are not normal times. Specially, what he was talking about, Elon Musk sent out a Tweet referencing a texting app. The name of the texting app, it’s a non-publicly traded company called Signal. But the market response, and again, this is just … we’re talking about when you see jeans on the slopes or hoodies in the options market, beware. Signal Advance is a publicly traded company and enough investors thought that that was what Elon Musk Tweeted about, that those shares went from $0.70 to $70.

Kevin: It was the wrong company?

David: Right. Well, we saw the same kind of insanity in the gold market. When a bread company with the word gold in it, this goes back to the 1930s. A bread company, a bread company with the word gold in it, traded in line with gold stocks. Not because their revenue from selling loaves was out there.

Kevin: It was the name and the company.

David: It was the nature of mania at that time. So are we calling a top? No, we’re not smart enough for that, but we can count the roadside accidents easy enough.

Kevin: You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. You can find us at, 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 a 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 addition of the McAlvany Weekly Commentary.

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