The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: Marc Faber is on the line today, Dave, because Marc has, for 40 years, looked at the markets, and he seems to be ahead of the curve. Look at what he said about Apple last fall.
David: Kevin, he was very prescient in saying, “Listen, this is a stock that looks like RCA in the 1920s, a major move higher, a potentially major move lower, and it could be imminent.” Well, 40% later, we think he was right.
I love the way he starts the Gloom, Boom, Doom Report each month with a variety of quotes. “Nearly all men die of their remedies, not of their illnesses,” is one of the ways that he leads into the most recent report, a quote from Moliere.
And of course, Jay Leno’s comment that President Obama wants Congress to increase the minimum wage. Believe me, when it comes to doing the minimum for its wage, Congress knows what it’s talking about.
Just a fun way of entering into a conversation about the economy and world events. Today, in our conversation with Marc, we look forward to exploring inflation, deflation, the gold market, equity markets as they continue to move higher, and on what basis. Is that economic fundamentals, or is it just central bank money printing?
Marc, thank you for joining us again. We live in a rapidly evolving world, and what changes we do see, some are particularly positive, and of course, as the writer of the Gloom, Boom, and Doom Report, there are probably a few that aren’t so positive. Where do you see the changes that are most important coming from? Where are the greatest risks, in your opinion, as we launch into the second half of 2013? What do you anticipate?
Marc Faber: The big change is that four years ago on March 6, 2009 the S&P was at 666, and now we are at around 1550, so we had a huge upward move in equities and many equity markets around the world have gone up much more than the S&P 500. Markets like the Philippines, Indonesia, and Thailand, are up 4-5 times from their lows.
What has also changed is sentiment. Whereas as investors felt that the world was coming apart in 2009, now they are very optimistic. So whereas I was rather positive to invest in equities in 2009, and I still believe that the lows in 2009 were long-term lows, in other words we are not going to go below these lows, but I think that the valuations are no longer compelling.
Whereas the 2009 stocks were very oversold, sentiment was very negative, and everything looked horrible, now, in my view things still look horrible, but in the U.S. they look relatively okay compared to the rest of the world. I have my reservations, but as you know, many people talk about the U.S. energy self-sufficiency, and that low natural gas prices will make the U.S. more competitive.
As I said, I have reservations, but in general, I think we have gone from a sentiment that was doom and gloom, to now, essentially euphoria. I am not implying that the market will collapse tomorrow, but we are moving into a very speculative environment, where essentially, markets are held up, or pushed up, by money printing, and this money printing has, for the last 20 years, numerous consequences, including the NASDAQ bubble.
But the NASDAQ bubble burst. Then we had the housing bubble, and the housing bubble burst. Then in 2007-2008 we built the commodities bubble, and it also burst. And now we have again a stock market bubble, and a bond market bubble and a bubble in government debt and I think this will all end badly.
David: When you look at the bubbles, of course, there is short-run wealth creation, but long-run bubbles are both destabilizing and wealth destroying. Of the bubbles that you just mentioned, which do you see today as the most debilitating to the world economy?
Marc: First of all, as an economist, I have to say that you cannot create real wealth by printing money. You can create illusionary wealth, in other words, asset prices go up, but the wealth of a nation comes from work, not from speculative gain, and it comes from productivity, innovation, and capital spending. It doesn’t come from consumption. Essentially, what we have done in the Western World is to increase demand through consumer debt over the last 20 years, and now through government debt, and both are very dangerous developments because they take demand from the future and [expend it] today. But both are not sustainable in the very long run.
David: With over 40 central banks setting rates at or near zero percent, there is the potential for problems to arise in almost every part of the globe, and perhaps this fits the earlier question: Where would you see opportunities, where would you see risks, and should we have any concerns lingering in terms of the old inflation versus deflation debate?
Marc: It all depends how you define inflation. Normally, some people think, like the Fed Chairman, that if consumer prices go up, that is inflation. He doesn’t look at rising stock prices, rising art prices, rising real estate prices, rising collectables pricing, or rising commodity prices, as a symptom of inflation. But these are symptoms of inflation. They arise usually because of too much money printing.
I look at it this way. Every inflation eventually comes to an end, and is followed by deflation. I just don’t know when the deflation in stock prices will happen. To some extent, it already happened in the gold market. To some extent it already happened in the real estate market. It hasn’t happened yet in stock prices, but that is likely to happen as well sometime in the future. And when it happens, I think the consequences for the real economy will be negative.
David: We have had the Fed, most recently, suggesting that, at least in internal dialogue, they might change course from QE. Ben Bernanke then followed that up saying, “No, quite frankly, we are happy with the results of what we are doing, and with the inflation rate very low, it appears that we are making great progress toward recovery. We will continue on the same track.”
Do you see the ability for the Fed to reduce its assets? In the last five years we have gone from 890 billion to over 3 trillion in assets. Is it likely that we will see their balance sheet shrink or expand from here?
Marc: When they started with QE-1, I argued that QE-1 would be followed by QE-2, QE-3, QE-4, until QE-99. We are not at QE-99, but we are basically at Quantitative Easing Unlimited, and I think they will continue to expand the balance sheet.
David: You could argue that that is supportive for equity prices.
Marc: Yes, unfortunately equity price is not the whole economy.
Marc: So if you want to boost equity prices, or asset prices, print that much money. But as I just tried to explain, you don’t create wealth in a nation by boosting asset prices. You create wealth through employment and capital investment in factories, in infrastructure, in education, and in research and development.
David: I know things have changed since the days of the 1920s in Germany, but money printing was a solution then. Havenstein decided that as prices increased, it made sense to just create more money to accommodate the increase in asset prices so that people could afford more. Of course, that was a self-reinforcing mechanism. At what point do you get off of this particular track, the “exit strategy?” How do you implement that?
Marc: The fact is, already, if we look at the economy of the middle class in the United States and the working classes, then in real terms, in other words, inflation-adjusted, and these are inflation-adjusted figures, as used by the government, which actually understates the cost of living increase, if we look at just these figures since 2000, real per capita income for the median household has gone down.
So it is already evident that the money that is being printed doesn’t flow evenly to everybody. It flows mostly to people close to the source of the money, and these are financial institutions, hedge funds, insurance companies, funds managers, and well-to-do people. That is why last year in the Hamptons real estate prices rose 35% to record highs. That’s why high-end London properties are at records, but in other parts of the U.S., real estate prices, although they have recovered somewhat, are still way below the 2007 peak.
David: As you say, things are not evenly distributed. The misery index has, over the 5-year period from here going back to about 2007, gone from 7½ to 9½ . We have had, as you said, median household income decline from just shy of $55,000 to $50,000. People’s primary asset, the median existing home, has declined. When we look at consumer confidence, this is where we see something of a divergence. Where do you see this divergence between the S&P and consumer confidence taking us?
Marc: In principle, it is possible that as a result of rising stock prices and recovering real estate prices, confidence will increase somewhat, but I have to go back to what life is for the typical household, and what life is for the holders of capital, in other words, the 1%, or ½% of the population. For the typical middle class, the standard of living is not going up because the insurance costs are going up, healthcare costs are going up, taxes are going up. Everything is going up in price, but employment has improved.
But then, if we decompose the improvement in employment, and we analyze what kind of jobs people get, then the jobs that are being created are mostly low-paying jobs, and the jobs that were lost were high-paying jobs, so I don’t think we should just look at the number of jobs.
In the meantime, I also need to mention that the government debt since 2007 has increased by more than 6 trillion dollars, and we have deficits of around 1 trillion dollars. Having these deficits will become, one day, a problem. They may not seem a problem now because the Fed basically finances the deficit through the purchases of assets, but will they be able to do it forever? That is the big question mark.
David: I don’t know if history can help us, but with the Treasury market essentially being a rigged market today, perhaps that can continue for some time.
Marc: Yes, it’s like the NASDAQ bubble went up more than most people would have expected, or the NIKKEI in 1987-1989 went up more than most people expected, but when it eventually broke, the pain was substantial. I don’t know when the market will peak out. All I am saying is that we are basically buying equities today on the greater fool theory, that someone will pay a much higher price for these equities.
David: We have talked about liquidity. We have talked about the implications of rising asset prices. Yet selectively, we are seeing stocks break down. You pointed out, very presciently last October, that Apple looked very much like RCA in the 1920s and could be poised for a correction. Of course, we have had the correction, close to 40%. Today, there are a growing number of stocks that are breaking down in the same manner, 30%, 50%, even 80% down in a short period, and that’s while the major indices are moving higher. What does that tell you, as someone familiar with the markets for 20, 30, 40 years now?
Marc: When you have that many stocks breaking down every day, it’s not the symptom of a market that is bottoming out, it’s the symptom of a market that is already relatively high, where the bull market is already rather mature. That is what it tells me.
And by the way, I would like to add one more comment about what you said about liquidity. I’ve been in this business for a number of years, to be precise, 40 years. In the 1970s people went around the Middle East and said, “Oh, the Arabs, they have so much liquidity.” And at that time, I used to travel frequently to Kuwait, and they had a stock market, and at the peak of the Kuwaiti stock market in 1979-1980, the Kuwaiti stock market had a larger capitalization than the German stock market, and everybody always said that there was so much liquidity, it will never go down.
Fast forward: Japan in the late 1980s. Everybody told me there is so much liquidity, stocks in Japan will never go down. And then again, in the late 1990s, there is so much liquidity, NASDAQ will never go down. And for real estate the same, and so forth, and now I hear the same story. At the peak of the market, you always have lots of people who tell you how much liquidity there is around, but liquidity comes and goes, and you don’t know exactly what will happen. And I really don’t know whether the Dow Jones will peak out today, or in three months, or six months, or even a year. But we are moving into a speculative phase where my sentiment is that everything you buy today, you can buy cheaper within the next 2-3 years.
David: When you reflect on the early to mid 1970s, we were still in the context of a bear market, not particularly brutal in terms of nominal swings, but the market had been capped at about 1000. And then finally, we broke above 1000, went to about 1052, and it was reasonable “breakout.” And yet, following that was a 40-45% decline, taking us to around 586 to 600 on the Dow.
Marc: December, 1974, yes, correct.
David: December, 1974. We had, in essence, a false breakout in the context of a sideways consolidation. Is there anything to learn from what has, in essence, been a 10-year sideways consolidation in the equity markets? We’ve made a little bit of progress. Now we are breaking out. But on what basis do we carry higher? We have had insider selling at records. We have margin debts near record highs. And as we mentioned, the number of stocks that are breaking down, very considerable stocks, not just at the margins, but Apple in 2012 was the most widely held stock on the planet, or at least on the New York Stock Exchange.
These are signs and symptoms. So there is this tendency to listen to the mass media, which would say that we are moving toward 16,000, and there are now projections of 20,000 on the Dow, and certainly with an inflationary thematic, or even a hyper-inflationary thematic, you can see incredibly higher prices.
Marc: We are in an environment where a lot of people say, “Yes, Marc, we agree with you. Eventually it will end badly.” But I always said at my presentations, I think between now and the final crisis, stocks can go up a lot. That is why for the last few years I wasn’t really negative about stock prices. But now that everybody accepts this theory that between now and the end of the crisis we can still make a lot of money, I become cautious.
David: As you say, there is a combination of the greater fool theory, and the presumption that you won’t be the last one to the door.
Marc: Yes. I remember the ’87 crash, October 19, 1987. The market had already been weak before that, but when the market opened a lot of stocks were down 20%, and there is an illusion that everybody thinks, “Okay I can buy stocks, and I will sell them before everything goes down.” I think some people will be able to do that, but of course, not everybody at the same time.
David: For many years, it was the yen which fueled speculative debts. Leveraged players all over the world used it for the “carry trade.” Today we have not just one central bank, but 30-40 that have low rates. We have currency devaluation, competitive currency devaluation, or at least the talk of currency wars. What are the implications of not just one carry trade dynamic, but there being multiple carry trade dynamics, with funding currencies, not only the U.S. and the yen, but say there are a dozen. What are the implications as you unwind those leverage bets, those speculative bets, as we have a completely intertwined global economy?
Marc: To tell you the truth, I don’t know how it will end, because if you look at the outstanding derivatives in the world, close to a thousand trillion dollars, you have to wonder how this will all end, and I don’t know when it will end and how, but it can’t end very well.
David: When I look at your recent allocation suggestion of 25% of net worth in real estate, and 25% in cash and corporate bonds, 25% equities, and the remaining 25% in precious metals, you, in essence, have half of your assets in real things, real estate, precious metals, with the remainder offering some buying power, income generation, asset appreciation via selective global stock markets. Does this, in your mind, reflect a normal allocation, or is this a necessary allocation in abnormal times?
Marc: That’s a very good question, because I think that by being in gold, equities, and corporate bonds, I am exposed to the performance of equity markets. In other words, I am exposed to asset inflation. Now, in a normal world, I would probably have a heavier allocation to bonds. If interest rates were positive in real terms, I would have more bonds than I have at the present time, or I would have less gold. But these are abnormal times and we don’t know to what extent the Fed will continue to print money.
We also don’t know whether we will eventually still have the ownership of gold. Maybe not. But all I’m saying is that I don’t know how the world will look in five years’ time, and I am sure, if he were honest, which is a very big question, Mr. Bernanke would also admit that he doesn’t know. Nobody knows what will happen to Europe, what will happen to the Chinese economy, what will happen geopolitically, and what will happen to the U.S. debt and the unfunded liabilities. Nobody knows, precisely.
So my tendency is, in the absence of having a clear picture, I want to be diversified. I don’t want to have all my money in gold, because gold doesn’t provide you a cash flow, and as we have seen since September 6, 2011, it can also go down. I don’t want to be holding equities because equities can easily drop 20-50%, not a problem. And I don’t want to be over-exposed to bonds because, number one, corporate bonds have an equity character. Number two, my view would be that over time the interest rate will rather go up than down.
David: You have mentioned liquidating Treasuries and reducing an equity exposure in recent months. These are, specifically, equity positions that have been in emerging markets that have done quite well. By contrast, gold has been weak for nearly 17 months. In your view, are we at, or near, a long-term, or even a tradable low, in the gold market?
Marc: Yes, I think we are approaching a tradable low. Maybe we will have one more push on the downside, but I think we are closer to an intermediate low, from where you get a trading opportunity. Will the gold bull market resume? I don’t know for sure, but I think that compared to equities and compared to bonds, gold is now not exactly inexpensive, but a relatively good value.
David: As we wrap up, are there any things that you would suggest that our listeners be reading, studying, paying attention to, outside of the mainstream media, in addition to the Gloom, Boom, and Doom Report?
Marc: Very kind of you to say so. My concern is this. We are in an environment where we have endless manipulation by governments and it is difficult enough to make forecasts about the perfect market. In other words, in a perfect market, no market participant has sufficient influence to move prices in the market. So the market is relatively efficient. At the present time, governments can move markets, but then it becomes very difficult to make any forecasts, and historically, these interventions have ended very badly. But as I mentioned before, and as the other observers have also mentioned, we don’t know when it will happen.
If you have a car, and I have a garage, and you come to my garage and you say, “Can you please have a look at my car?” And I say, “Yes your car is okay, but the brake system is kaput. It doesn’t work properly anymore.” And you say, “Well, when will it completely fail?” And I say, “Look, I don’t know when it will completely fail. Maybe in six months. Maybe you are lucky and it doesn’t fail for another three years.” But to take the chance of driving down a steep road from the Alps to the valley and taking the chance that the brakes could really fail, I think you would be taking a huge chance, a huge risk.
And this is where I think investors are today. By rushing into equities, they do something everybody else is doing, based on the same view, that the Fed will print money endlessly. Well, they may print money endlessly, but they may not boost stock prices endlessly.
David: Thank you for joining us. We enjoy our conversations, and look forward to seeing you the next time I am in Asia, or where our paths cross here in the United States or Europe.
Marc: A pleasure. Thank you very much.
Kevin: David, Marc brought up something that I think is bugging all of us right now. It is very hard to predict these markets when the governments are the ones who are impacting and making things rise, fall, change. They can’t do it forever, but it makes it almost impossible to predict, without diversification, how to make your portfolio work.
David: Right. So with endless manipulation, as he points out, forecasts are always difficult, but in this environment, they are nearly impossible. That’s why we look at the perspective triangle and say that having a portion of cash, up to a third of your liquid assets, a third in growth and income thematics, a third in insurance – what we call insurance – actually precious metals.
And this is your liquid assets, so there is actually a great overlap between how we would allocate assets today and how Marc would, because we generally don’t account for your non-liquid assets, real estate, which we assume is also a part of your total net worth picture. So yes, that diversified approach, with an emphasis on precious metals is very important.
We don’t know the future. We don’t know the time frame, and I think that is where as someone who applies the necessary ingredients to be a successful investor, primarily patience and humility, you adopt a view that has you well positioned for whatever outcome there might be.