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- Fed is on track to commit $11.5 trillion in “gross cumulative support”
- Minsky – Moment comes when stability begets sudden instability
- Carl Swenlin says Apple’s vertical blow off months away from reversal
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“Not QE” Is Costing Every Man, Woman, & Child $183 Per Day
November 20, 2019
“Here is the present tense reality. It’s simple. The markets are on a tear higher. So we have, as we described earlier, a form of stability. And I would just remind you of Minsky, at this particular moment in time, so you don’t have to blindly go to the financial slaughter when instability becomes a reality of the moment, and I think that moment is not far from now.”
– David McAlvany
Kevin: Ah, David, the price of prosperity, and the price of calm, and the price of low volatility. All you are really asking me, and my kids, and my wife, and my parents, and every other man, woman and child in the United States, is for $183 a day. That’s it. For every head in the United States, every soul on this boat, $183 a day right now. Good thing that we have prosperity.
David: Yes, QE-4. So we have yield curve and that yield curve has now a positive slope once again.
Kevin: Ah, I’m so glad we’re back. No recession, right? That’s what that means?
David: Yes, because the inversion which was occurring and which traditionally has signaled recession, and as recently as spring of 2019 the San Francisco Fed was referencing that as a very reliable indicator of recession on the horizon.
Kevin: And an inverted yield curve is simply shorter-term rates paying higher than longer-term rates. And when it inverts, it usually says there is going to be a recession. That happened this spring.
David: We’re actually back to normal. It no longer suggests signs of a recession, and we’re glad to see the mechanics of the Fed intervention working effectively, where QE-4 they are buying down the rate at the short end of the curve and eliminating those inconvenient signals, and it reinforces the market uptrend and buttresses confidence. That is kind of how it reinforces the market uptrend. God forbid the inversion remain and investors look at that and then begin to act on the suggestive recessionary period ahead.
Kevin: What you are talking about is it is artificially being changed. In other words, this $183 a day, every man, woman and child in America is paying, that is this QE-4 or what Powell called, “Not QE.”
David: (laughs) That’s right, so all is well thanks to the benevolent, powerful steering committee at the FOMC, the Federal Open Markets Committee, and so we have established the price of peace, we have established the price of calm, at this moment, and it is 60 billion dollars a month, roughly 2 billion dollars a day. Again, if that seems like an expensive habit, or what it would take to maintain a perpetual buzz, you just look at that national addiction, divide by every man, woman and child, and as you said, it is a measly $183 a day, which, at some point, if we’re not careful, is merely going to be the cost of a cup of coffee.
Kevin: I wonder if the Fed has ever been this powerful in history. A few days ago Trump invited Powell into the oval office. It was a completely unexpected meeting, but I know that Trump tweeted afterward that he was quite pleased with how it turned out.
David: Fascinating. You always have two sides of the story. On the one hand, Trump says, “Very good, cordial meeting. Discussed, including interest rates, negative rates, low inflation, easing dollar strength, its effect on manufacturing, trade, etc. Powell walks out and one of his first comments is, “We’re going to operate according to our legal mandates.”
Kevin: Right. When I saw that, Dave, I thought, “Wait a second. With him saying we’re going to operate within our legal mandates, that already means that he is nervous, that he is probably being manipulated to do things that he doesn’t feel comfortable doing.”
David: Pressured. Pressured.
Kevin: Oh, a little bit.
David: If Trump turns on the heat through his tweets and through the public channels, what does he do behind closed doors, and the private channels? This is where I think a good question has been asked, “Is this an unscheduled meeting between Trump, Mnuchin and Powell, on the economy?” I’m not trying to be conspiracy theory oriented, but there are rumors that there is a big bank that is having problems. Ordinarily, you don’t get that group together to just sort of remind everybody of what their marching orders and what their duty is. Maybe that’s what happened. I wasn’t there, I don’t know. But we do have Trump saying, “Hey, good meeting. I communicated my message,” and Powell saying, “I heard the message,” and almost a little bit of a pushback, “I’ll operate according to the legal mandates.”
What does that mean? Price stability and full employment are the two legal mandates.
Kevin: But what was said at the Economics Club in New York? I think Trump was saying, “Give me some of that money,” wasn’t he? “Yeah, give me a little bit of that money.” What he is talking about is what the Europeans have been pumping in.
David: And I think the Fed is signaling something else, because in their view it is far more costly to not be involved in the markets at this point, and what other costs were conveyed to Jerome Powell in the oval office earlier this week. Last week, Tuesday, the president was slinging mud at the Fed for not introducing negative rates. We mentioned it in the commentary last week. Again, that was the Economics Club of New York speech, “Gimme me some of that money,” as our very eloquent president would say. “Why don’t we have negative rates in the U.S. just like the Europeans do?” And of course, his contention is that stocks would be 25% higher than current levels if he got what he wanted, if there was even more benevolence from the Economic Steering Committee, that is, the Federal Open Markets Committee, the FOMC at the Fed.
Kevin: You talked about something going on in the background. We’ve talked before, could it be Deutsche Bank that is the black hole that is sucking liquidity? All crisis, every time, is a lack of liquidity, right? That’s what financial crisis always is. So what do you do? You just create out of thin air the liquidity. But what bothers me, Dave, is we’re not talking about side joint kinds of countries. We’re talking about the two most powerful countries in the world. The United States and China right now are scrambling to provide enough liquidity.
David: And there wasn’t a huge move by the Chinese this week, but they did cut short-term funding rates for the first time since 2015, 5 basis points, not a very big deal, but they are also involved in their own repo and reverse repo market. I just think it is fascinating that you have the two largest contributors to global GDP, the U.S. and China. They are both actively influencing the credit markets and they want to facilitate calm, and if you move beyond the treasury purchases – you remember we had Charles Goodhart on the program a couple of years ago.
Kevin: He is a central banker.
David: He was very dismissive about the expansion of a balance sheet of the central bank saying that you can sterilize those things. Sterilize – whatever that means. Actually, sterilization was a theme that was talked about and developed late 1970s, early 1980s, and I don’t think anything was sterilized to the degree that you didn’t end up with inflation eventually. But again, this idea that we’re just going to do this stuff and there are going to be no future market implications.
Kevin: In the past, the Federal Reserve has talked about intervention where they come in where they need to, fill in the gap a little bit. It seems to me like they are taking over everything. The keys to the farm have been handed over.
David: As Karen Petrou pointed out in the Financial Times about ten days ago – fascinating article – the Fed is on track to commit 11.5 trillion dollars in gross cumulative support to the repo market through the end of January. As she points out, the Fed did not stabilize the repo market, now it is the repo market.
Kevin: The keys to the kingdom.
David: And Karen describes it as de facto nationalization. Here is the point. As far as the Fed is concerned, no matter, just move along. Because the last thing the Fed wants is for investors to stop, for investors to gaze, for investors to observe or to judge the signs of the times. Think of it like a traffic accident. The Fed is trying to prevent rubber-necking. Do you know what I’m talking about? That tendency to kind of slow down and stare. You’re not implicated in the accident, but you have to see what happened. Is anybody hurt? What’s going on?
Kevin: They’re saying, “Move along citizen, nothing to see here.”
David: That’s right, fly down the road at 70 mph, ignore what just happened. So whether it is 60 billion dollars a month in QE which is not QE, or that 11.5 trillion dollar de facto nationalization of a part of the lending markets, we’re coming up to what I would describe as the price for oblivion.
Kevin: Oblivion, or oblivious?
David: Oblivion is defined as the state of being unaware or unconscious of what is happening, and that is precisely the state which is being funded by the Fed. What is the price of oblivion? $183 per person, per day.
Kevin: And that is the 60 billion plus the repo interventions that you’re talking about right now. Or is that just the 60 billion.
David: That’s just the 60 billion.
Kevin: Oh, my gosh, you’re kidding me! 60 billion a month – I’m paying $183. And the reason I say I’m paying it, Dave, is that you don’t print money out of thin air without the cost of losing value of that money down the road. There is no such thing as just doing that.
David: That’s why I say, at some point in the future, what are we talking about? It is merely going to be the cost of a cup of coffee – 183 bucks.
Kevin: It’s as if these Fed chairmen are drunken bankers. It’s as if it is a drunken party and they are just basically saying, “Hey it’s the punch bowl.” Remember, they used to call it the punchbowl. Didn’t the punchbowl terminology come from the mid 1950s by the Fed chairman at that time?
David: Exactly. It wasn’t like you were supposed to support the party. William McChesney Martin suggested you were supposed to take away the punchbowl before the party got started. You weren’t supposed to let things get out of hand. Now it’s that you can’t let the buzz go away. We talked about that before. But again, we’re not talking the Fed alone here. This is the Bank of Japan, the European Central Bank, the Bank of England, the People’s Bank of China, and this is precisely the state being funded by the Fed. It’s oblivion. They want a state of being unaware, or being unconscious of what is happening.
Jim Grant describes the Fed’s behavior, particularly as it relates to the repo market. He said, “It’s a little bit like a bank president who drives his Cadillac into the country club swimming pool.” He says, “The repo market is showing a whole new personality.” (laughs)
Kevin: Wow. You wonder, let’s face it, the stock market is hitting all-time highs. It must be working, right? If a person doesn’t dig any deeper, it’s a little bit like going on vacation with a broke person who has a credit card. You think you’re paying for stuff. You’re really not, you’re borrowing, right?
David: Yes, it’s fascinating to see a resurgence in popularity in the financial community. You go back to 2008-2009 and there was this resurgence of popularity with an economist that most investors have never heard of – Hyman Minsky.
Kevin: The Minsky Moment, right?
David: Yes. In a search for clarity and a search for understanding for what had just occurred, people dusted off the Minsky instability thesis, which simply states a paradox, that stability begets instability. I think it was Mohamed El-Erian at the time, working alongside Bill Gross at PIMCO, who first described it as a Minsky Moment back in 2008. Actually it was not, it was the CEO at PIMCO. It was Paul McCulley. He had kind of a knack for phrasing things. The Minsky Moment, that’s what it was called. Traders, frankly, don’t often get lost in the weeds in economic theory.
Kevin: They’re busy with the day, or the moment, actually. They’re just trading on the moment, they’re not looking at long-term economics, any more than an algorithm would.
David: When you’re success or failure is marked to market on a second-by-second, day-by-day basis, and at the end of the day you look at your P&L to see the nature of the daily and the short-term trading trends and how it treated you, that tends to ingrain a certain pragmatism that can be devoid of philosophical or theoretical reflection. So when you think of theory, and like Minsky’s theory, it is unusual to see that operative in people’s mindsets. It is usually a discussion during a market post mortem.
Kevin: After doing this for 32 years and seeing three major crashes, 1987, 2000, 2008, they call them Black Swans, and the people in the post mortem analysis say, “Well, we really didn’t see it coming.”
David: Right. So you get into trouble, the search for a coherent explanation – in some instances it is just a search for an excuse – that begins in earnest, but it is kind of after the fact. So the most reflective moments for most traders are those moments where a portfolio has just been gutted.
Kevin: I read a great autobiography years ago by Chuck Yeager, and he was part of the investigation when the Challenger blew up. Chuck Yeager was a P51 pilot in World War II. And then of course, he went on to break the sound barrier. I believe it was in 1947 with the X1. But he was a man who could take that plane apart and put it back together. Every plane he flew he could take apart and put back together.
One of the things he said when he was part of the Challenger incident team was, “We’ve reached a point where you have a million working parts, and you have specialists in each of the areas of the shuttle.” The danger to these men who were flying this particular machine, it was so sophisticated. And you talked about stability. It is so incredibly stable almost all of the time that is almost impossible for them to realize that a frozen O ring or something simple like that would be a reason not to fly.
David: And I guess that is the point of the Minsky Instability Thesis, that it is stability which tends to lead us to lower our guard. We have stability, we have a normalized yield curve – no concerns about recession on the horizon according to that – and we have the VIX, the measure of puts and calls, the Volatility Index, which indicates a level of concern in the market, or lack thereof, and today it is now in the low, low double digits – twelve and change.
Kevin: So it’s snoozing.
David: Yes, and single digits are like the bell-ringer on the VIX – total complacency, disproportionate bullishness, high spirits, a bell-ringer in the sense that, like clockwork, you get to a single-digit VIX – you don’t always have to go that low, but you get to single-digit VIX and that precedes every major period of volatility. Again, stability begets instability. The long average for the VIX is a touch over 19, sitting at 12 today, but like any free-wielding price, averages are made up of the extremes, highs and lows, and so from a single-digit level you are basically marking the extreme low. You frequently, from that level, see the VIX triple, occasionally, even quadruple or quintuple.
Kevin: Stability in all of life causes us to sometimes doze off. Sometimes when I am driving I will appear somewhere, Dave, and not remember the drive because my mind was elsewhere. Now, I’m certainly hoping that I was driving safely the whole time, I think I probably was, but it is because it was an uneventful drive. Now, that’s fine if I’m actually still observing and maybe reacting to that because I’ve done that for so long. But what if somebody actually was creating a stability in a time that maybe I was in crisis. Let’s say that instead of me thinking that I’m going 65 mph, I’m actually going 120 mph, but somebody, namely the Fed because of interventions, negative interest rates, pumping of money, $183 a day, has reached over from behind and turned my speedometer down to 65 mph. Now the danger at 65 versus 120 mph is quite different, but what if I’m unaware?
David: Yes, I experienced a different version of that this weekend. I was headed out to St. George, Utah and Zion National Park to do some training. You’re cruising down the freeway at 70 mph, or maybe 80.
Kevin: Don’t say that on the air.
David: I never speed. I’m not impatient.
Kevin: It was just you and dog, right?
David: That’s right. And so, you have this reminder of being on course, and then of course, they have rumble strips on either side of you. So if you start veering off course at all you hear that sound. And it’s a wake-up call that you’re not actually going straight. And so the reminder is important. One of the things that we look at in the Credit Bubble Bulletin is that we explore the why – why this is the case.
Kevin: Something Doug Noland has been doing for decades.
David: That’s right. The Credit Bubble Bulletin each week – why it is the case that stability begets instability. And he looks at our credit trends and how the looseness of credit, which appears as stability and encourages greater risk-taking at the same time, is encouraging a less thoughtful allocation of capital. In the end, you get to a point where the allocation is reckless, a reckless allocation of capital all based on the assumption of financial conditions remaining the same, very supportive, and what looks to be stable.
So you end up with a misallocation of capital and a seemingly inevitable last series of steps toward instability which occur without there being, really, any negative effect. Because again, if you allow there to be enough liquidity in the markets, it is like taking away the rumble strips. You really don’t know how close you are to the edge of the road, and if you hit the edge of the road going at a high speed you can end up in a real bit of trouble. That is why the rumble strips are there. Liquidity kind of takes away that signaling in the marketplace. Prices jump higher and higher, momentum takes on a life of its own.
Kevin: Look at the stock market. All-time highs, every day, [unclear].
David: Short positions have to be closed out. That is a new form of buying in the marketplace. And the characteristics there, for us – again, Doug is giving you the why. Stability begets instability. But you look to the internals of the market and you can begin to see some unhealthy characteristics, the late cycle boom in asset prices is accompanied with divergences. And those divergences are key to clue into.
Those are the indicators that suggest that something is not quite right, something is off. Just an example – lower, or progressively lower volumes. There are less people participating in the stock market even as prices are hitting higher and higher levels. That is a sort of divergence.
Kevin: You said boom. That is a four-letter B word. Well, there is another four-letter B word that you can almost always fill in after boom. It’s bust. Boom-to-bust cycles. But when you look at that – you talked about volatility, Dave. When volatility is low, which means people are not nervous, the VIX, the Volatility Index, that almost always means that stocks are going to go higher.
David: Back to VIX. It’s almost counter-intuitive at this point, but when you have lower VIX quotes, that is married to higher stock prices, and the fact that they move opposite each other is helpful, because we don’t know how high assets prices can go. The NIKKEI reached 40,000 before it went screaming lower to 7,000. But in its ascent to 40,000 no one thought it was possible to exceed 20, or 30, and then by the time you get to 40, everyone starts thinking 50, 60 and 70 are reasonable. We don’t know how high asset prices can go. But we do know how low the VIX can go. So the closer you get to zero on the VIX, the closer you are to, let’s call it, Turkey Day.
Kevin: We were talking about post mortem. Some day we will have a post mortem. When this market crashes, whenever it happens, we will be sitting around and saying, “We saw it coming, but here are the reasons for the trigger. Now to be fair, I talked about Black Swan. A guy named Nassim Taleb wrote Black Swan. Actually, it could have been called Black Turkey because one of the examples he uses is coming up. Thanksgiving is coming up. And he uses this as an example.
David: That’s right. He writes that the happiest day in a turkey’s life is the day he is being stuffed and fed, and it is preparatory to an event that he is mindless of, he is clueless about. It is the next day. It is the slaughter. So, too, with the markets, because our happiest days are the days of capital gains. And far out on the horizon there is the reality, getting closer to that Minsky moment day. But the bird gets stuffed, the bird gets cooked, and I think when you look at the market today we have a lot of turkeys running around, a lot of turkeys on Wall Street. What do they feed a good turkey?
Kevin: Okay, so I’m using my Apple iPhone. I’m using my Apple iPad. I’m probably going to have to get a new Apple iPhone about the time that they tell me I have to have my new Apple iPhone. If we can look forward and say, “What a good company. Why would we even worry and not just buy what looks like it is going to be a good idea?”
David: Okay, so try this on for size. What do these numbers all share in common? Let’s see if you have any sort of numerology background. 62, 45 – this is not Bingo but just play with me. What do these numbers share in common? 62, 45, 32, and 40.
Kevin: 42 is the meaning of the universe, we just don’t know the question, right? That’s Hitchhiker’s Guide.
Kevin: So give me those numbers again.
David: 62, 45, 32, and 40.
Kevin: Well, I don’t know.
David: Those are the amounts that Apple shares declined, in percentage terms, following a vertical ascent. We have a vertical ascent with Apple shares right now. Carl Swenlen is a technical analyst. He has been doing it for decades – 4, 5, 6 decades – and he didn’t start as a toddler. He suggested that we are months away from a vertical blow-off in Apple shares coming to a halt, and then begins the shedding of tears.
The average decline for Apple shares is, basically, 45% following a major blow-off like we have now. Again, 62% negative, 45% negative, 32, 40. These are big numbers, folks, and this is an example of a stock which everyone owns, which is why I would suggest that Apple is exactly what the turkeys are being fed. It is an example of a stock that everyone owns, whether it is hedge funds or mutual funds or ETFs, or even Warren Buffet, that is a lot of fat and happy birds. Everybody owns it.
Would it be a shock to you to see a 45% decline in Apple shares? Not to me. And would that be alongside a general market decline? Not necessarily, because Apple can enter its own sort of maelstromic vortex on its own. It doesn’t need to get pulled down by the market, but it can hardly avoid a wider vortex, in which it is one of the most heavily owned and broadly distributed shares of all time, currently at a 1.2 trillion dollar market cap. (laughs) Every bird is stuffed with this.
Kevin: But could that possibly be why Trump invited Powell to the oval office a couple of days ago? Could it be that if, indeed, we are going to see the end of some of these meteoric rises, you don’t want to have it happen before the election if you’re Trump.
David: Again, I don’t know that, at least in terms of Swenlen’s view, this is months away, not years. And do those months stretch out to 9, 10, 12 months, does it get us to the election? I don’t know.
Kevin: But that’s Apple. You have mentioned Berkshire Hathaway. We’re talking about the greatest investor from Nebraska of all time.
David: Warren Buffet has taken a big bite out of Apple, and would it shock you to see a slide in Berkshire Hathaway shares, alongside a general market decline? We said 62, 45, 32, 40 – Berkshire Hathaway, arguably one of the best investors in the world, and we could get into that, but what are these numbers – 49 and 54?
Kevin: I think you’ve already telegraphed that.
David: Percentages. That’s how much Berkshire shares fall in line with a market correction. So there is nowhere to hide when the market slides. Selling is indiscriminate. It doesn’t matter if you are Berkshire Hathaway or a small cap company. What is the solution? You hedge accordingly, whether it is Tactical Short, or like what we have offered in the marketplace or the physical metals exposure. Let me tell you a sad truth. Turkeys don’t hedge. They feast.
Kevin: Yes, but there is pressure, Dave. I was talking to a broker, a guy who has been a professional for many, many years, and I just asked him how he feels about the stock market at these levels. He knows good and well that the price earnings ratio is over 30, because we talked about it.
David: At least, the cyclically adjusted price earnings ratio.
Kevin: Right, the Shiller cyclically adjusted. So being over 30, he understands that it always comes back down. And it usually comes back down to 14 or less. So that is more than half on the stock market, if it were to fall. I just said, “What is your feeling?” He sort of laughed and said, “You know, Trump is going to win the election, the economy is doing just fine, and granted, the Fed has their back.” There was this level of confidence that just bothered me, Dave, because this is man in his 70s, he has been through a number of crashes, and I think he is going to go through another.
David: Yes, well, this is the beauty of Wall Street and most investors. The two constant themes are the shortness of memory, and the short and quick return of greed.
Kevin: “We could have never seen it coming.” That’s what they say. “We never saw it coming.”
David: So when we talk about turkeys not hedging, where you generally see a popular transition, whether it is to an investor buying a short product like Tactical Short – we call it tactical because it is flexibly, or tactically, reducing a short exposure. If the market is moving higher and against us we eliminate the risk and get out of the way to a degree. Or toward gold, something like that. Frankly, people only move there after the bloodletting has already begun, or is largely done.
It’s like Chicken Little. Chicken Little doesn’t get along well in the turkey pen. The turkey is a big bird and a chicken, according to a turkey, is barely a bird, right? I might be getting carried away with the analogy here, but I think you get the point. Defense is an afterthought. Preparation requires too much of us as individuals, investors. Think of it as voluntary cognitive dissonance where you live in a normal world, you make normal decisions, you dream normal dreams, but you have a plan B.
Kevin: But that’s where the pressure comes in, because this is a broker who right now has to satisfy his clients, and his clients are watching all their friends making money in a stock market that is hitting all-time highs.
David: That’s right, so any money that you take out of that, either to divert toward metals or a short position, or just sitting in cash, that’s fine, too.
Kevin: You might lose your clients or your job.
David: Well, you have to be creating a certain amount of income, and if you’re taking money off the table then it is no longer a productive asset. If you ask Warren Buffet he would say gold is an absurdity, he’d never own it, only things with cash flow. Well, investors have the same rigorous expectation, and you’re right, there are investment managers who refuse to take anything off the table because they fear that existential threat of, “You’re fired.”
Kevin: So using the stuffed turkey analogy, they don’t have a plan B.
David: Turkeys don’t take time for plan B. There is a humorous movie, if you want to watch it with your kids or grandkids. They did a series of these – Wallace and Gromit movies. I think this was released about 20 years ago, a clay animation movie called Chicken Run. If you can imagine blending Steve McQueen and The Great Escape – you’ve got that picture in mind – blend that with a clay-animated contrarian chicken, who is dead set on avoiding being turned into a pie.
That’s the movie to watch. It’s a fun movie, and frankly, I think the guy in the story who is turning the poultry into the pies, looks a lot like Hank Paulson.
Kevin: And that couldn’t have been planned, right?
David: No, no, no, no, no, because Paulson came a little bit later. He was Treasury Secretary in 2008. I think he was with Goldman-Sachs in 2000.
Kevin: Going back to what we were talking about, if I’m paying $183 a day, and paying may be the wrong word, if I’m borrowing $183 a day, to keep this economy going – we’re talking about stuffing the turkey – that stuffing is coming from borrowed money. How much money is being borrowed to make this thing look the way it looks?
David: We’re criticizing one 60-billion dollar monthly imitative, but the feeding of the big birds, you could go to a Reuter’s article this last week. Bank of America Merrill Lynch calculated that since the collapse of Lehman Brothers, governments have borrowed 30 trillion dollars (laughs).
Kevin: 30 trillion.
David: Governments of the world since the collapse of Lehman have borrowed 30 trillion. Companies have borrowed 25 trillion dollars.
Kevin: This is in the last 11 years.
David: Households have borrowed 9 trillion dollars, and banks have borrowed 2 trillion dollars since the collapse of Lehman. So by year-end global debt will top 255 trillion dollars. That is three times global economic output. And here is a complicating factor. When we had a debt crisis, going back to 2008 and 2009, when we had too much debt and too much creative finance, and the numbers were a lot smaller than they are today, we did have a concentration of that in the financial sector, and within specific financial products, mortgage-backed security related.
The new complicating factor in terms of bailouts and in terms of political bargains is that according to the Bank of International Settlements and the International Monetary Fund, you look at this 255 trillion dollars in debt, 190 trillion of that is outside the financial sector. Yes, but it is worse for having the ability to actually get in and do something about it. At least with the mortgage debacle, you knew where to find the problems and you knew which entities to bail out because you could connect the dots and know where the exposures were. This time it is a little bit like a cancerous root system buried in every crack and crevice throughout the global economy.
Kevin: But trying to time this thing is almost impossible because the debt has been working. Let’s face it, so far, worldwide, we have been able to borrow just about as much as we want, without much consequence. It has been 11 years since the last crisis. Why in the world would we have another?
David: Powell, last week, one of the truer things he commented on is that our debt situation is unsustainable. He said at some point the interest component on our debt is going to be too much. It is going to require too much of tax revenues. A truer thing has never been spoken by Jerome Powell. But speaking of Treasury secretaries, and not, this time, of the guy who looks like the clay-animated poultry farmer (laughs) in Chicken Run, Hank Paulson, Steve Mnuchin – I just want to do a 9-12 month retrospective, because here in this period of time starting January of 2019, the vertical ascent in stocks has matched promises to pay and credit provided to the markets in an uncanny way. The vertical ascent in stocks and the new highs that we see day after day are predicated on access to credit. That remains the case today. It is financial conditions which are loose – very, very loose.
Kevin: What a difference a year makes. Do you remember last year at this time they had talked about maybe tightening up a little bit.
David: We were in the process of tightening
Kevin: Yes, and things were going terrible for the stock market.
David: That’s right, exactly. And yet, two days before Christmas – going back to Mnuchin – two days before Christmas of last year (laughs), folks this is not an eternity ago, but last year, 2018, Mnuchin was on the phone two days before Christmas to the six largest banks, assuring them that they had access to ample credit. You might well recall that that Q4 period, the 2018 Q4, the 4th quarter, was a disaster in the stock market. So it’s the ease of credit which has propelled stocks to all-time highs. It is not earnings reaching the stratosphere which is dragging stocks higher.
Kevin: Have you ever heard of the love languages? There are people who say, “Well, my love language is this, that or the other.” But it looks to me like the love language of the Treasury and the Federal Reserve is liquidity.
David: Oh, absolutely!
David: Yes, Mnuchin was talking to the street, and you’re right, he picked up on the love language, the language of liquidity, and the promise of liquidity in any amounts needed. So earnings, 3rd quarter this year, we were finishing up 2019, 92% of companies in the S&P have reported for the quarter. Zero hedge reports that you have a blended earnings decline for the index, the S&P 500, for the 3rd quarter of -2.3%.
Kevin: So they aren’t earning money, it’s negative, as a whole.
David: Earnings growth is declining. So meanwhile you have Q4, the next quarter, we’re in it now. Earnings per share is now projected to be negative, as the S&P is now knee-deep in an earnings recession. That’s where we are. Earnings are already sending you a signal, which to us suggests that the markets are deeply addicted to “hopium.”
Kevin: Hope – hopium that is fueled by the love language of liquidity.
David: Right, or other various credit injections. I wanted to point something out from Grant’s Interest Rate Observer because he commented on this recently. You have the U.S. PMI, Purchasing Manager’s Index. This is apropos for us in many ways because we manage assets at McAlvany Wealth Management and we actually have an interest in this particular niche. When the U.S. PMI falls below 48, as it did in September of this year – 47.8 was the reading – Morgan Stanley observes the S&P metals and mining sector has tended to out-perform the S&P by an average of 12 percentage points in the follow year if a recession materializes. So again, a declining PMI, and you have the S&P metals and mining sector outperforming the S&P 500 by 12 percentage points in the following year if a recession materializes.
Kevin: Well, that’s if we have a recession. But what if we don’t have a recession?
David: Morgan Stanley points to the out-performance by 96 percentage points if it does not.
Kevin: Wow. So either way it’s going up. Once that index falls – what was the index again? The S&P 500.
David: Yes, so the small component S&P metals and mining sector tends to outperform when the US PMIs move negative – move below 48. So what are we saying here? Yes, I maintain the view that indiscriminate selling can hit even undeserving companies. Maybe Berkshire Hathaway is undeserving, but it can still decline 40-50% in a market decline.
David: Apple – again, 60, 30, 40, 50, an average of 45%. You have companies that can sell out hard, but there are carve-outs nonetheless. And that is, there are areas that make more sense than others. So yes, a hedge makes sense. And yes, a contrarian mindset which adjusts positioning to sectors less vulnerable also tends to make some sense.
Kevin: So what you are saying is, have some gold, and if you have stocks and you have to have stocks – a lot of the people listening to this program have to maintain a stock portfolio, Dave, because they are professionals and they have certain requirements. You need to have a hedge if you have to own stocks during this period of time, and that could be the Tactical Short, as well.
David: Right. I’m never opposed to cash. I think cash makes a lot of sense, and having up to 20-25% of a portfolio as a minimum cash position today, I think, does make sense. But here is a present tense reality. It’s simple. The markets are on a tear higher, so we have, as we described earlier, a form of stability
Kevin: No matter what it costs.
David: And I just would remind you of Minsky, at this particular moment in time.
Kevin: Stability breeds instability.
David: Right. I would remind you of Minsky so you don’t have to blindly go to the financial slaughter when instability becomes a reality of the moment, and I think that moment is not far from now.