The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David, Bill King is with us today. I love it when Bill King gets on. His brain operates like a pinball machine that is just going crazy. It’s like you’re getting bonus points here, bonus points there. But what he says is really very concise. He is wrapping the world up into just a few statements. I want to hear what he has to say about quantitative easing, because it looks like they are not going to be able to quantitatively ease.
David: We have an economy that is a wreck, and we’ve been able to paper over that with a variety of tools issued from the Treasury and the Fed, and the perception in the marketplace today is that things are getting better, we’re in recovery, and the shock will be, for the vast majority of people, that it could not be farther from the truth.
We are in a deteriorating economic and market situation, and just because you see higher prices, that does not mean that what you have supporting you is anything of a sustainable nature. I think it’s important, not only to look at things from a market technical perspective, but also from a broad economic perspective. Not to harp just on fundamentals, but there is a combination of: What is in play, what does Wall Street see, what are the Titans of Wall Street doing with their own money – in contrast to what they are telling others to do, by the way – and what do we see, again, from an economic standpoint? Like Vallejo, California, we’re broke. We know that. Everyone knows that. What are we doing about it? And that’s what we have, the political sphere is not doing anything, which leads us to one thing.
Kevin: You bring up the politics. Bill King has used the same cycle that you’ve talked about for many years, the financial transferring to the economic to the political, then the geopolitical.
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David: Bill, it’s great to have you back on the program with us. When we look at the economy, we know that economic growth relies on growth in the labor force. We haven’t had much of that. In fact, growth has been in decline for some time. Increases in income are another source of economic growth, and we actually don’t really have good news on that side, either. But the third variable that can drive economic growth is credit growth. Where are we going to get our growth, moving into 2014 and 2015?
Bill King: That’s the question everybody’s searching around for. Who is going to be the golden goose here? And it’s not just here, it’s globally. Part of this whole rally in the first part of this year is because of “Abenomics.” He said Japan was going to print their way out. That’s a novel concept, right? We’re going to print our way out of an economic problem. And it’s not working. It’s just not working, and that’s a separate issue to talk about later.
But then it was, well, Europe’s going to get better. Well, how’s it going to get better? On what basis? Because they’re going to raise taxes in France? Because their going to create more social nets? The big picture, and I think we mentioned this months ago, because it’s been going on for years, is the collapse of the Western welfare states, and that includes Japan, which is their model. It’s collapsing. And that’s the problem everybody’s facing here. Because of the ascent of China and other developing nations, it has accelerated the decline in living standards in the West that has been going on for decades.
That massive transfer of wealth to the BRIC countries and other developing nations has just devastated the Western and Japanese economies. Of course, it worked out worse with the 2008 crisis because the governments went all-out Keynesian and monetarist to save their big banks, and in the process they’ve bankrupted themselves further.
So the big banks, as we see, whether it’s Europe, whether it’s the U.S., the big banks are joined at the hip with the sovereigns and that’s the problem now, because everybody recognized that they’re pushing up to thresholds on debt that are unsustainable. That is what we’ve done. We stopped the global depression two ways, by having this enormous QE that is global. It’s Japan, it’s China, it’s Europe, the ECB, the U.S. You can go through the list, which is unprecedented in human history.
The second thing they did is they fired up the Keynesian engine by creating all these bailout programs, by TARP, by all the entitlements which we see in the United States, whether it’s food stamps, disability, you name it, they’re just going berserk to the upside. But in the process, you’re killing the sovereign governments. They’re running out of room to do things, they’re running out of maneuverability. And there’s no light, however many decades, six, seven, or eight decades, of this thought that the government can always create demand.
To a Keynesian, when demand is soft, government will make up for it. The problem is, for eight years government has had an increasing share of the economy. The original Keynesian concept you could argue was true. When demand falls, government jumps in. But it’s implicit that when demand picks up the government should jump out. That has not happened. The government just kept getting more and more voracious and more rapacious, just taking over more and more of the economy, and in the process now it’s being bankrupted, bankrupting nations.
So, now you have this problem where you need organic growth, but you can’t get it, because most economic growth comes from small companies. They’re the innovators, they’re the people who hire. They don’t manage for cash flow, they manage because they have ideas, they have vision, and that is being destroyed by politics and other factors.
We saw an article in The Economist magazine a week or two ago that said this precisely, that for decades, the economic studies showed that small businesses create 70% of the job growth. Of course in the 1980s and 1990s it was even more than that, because the big companies were all downsizing, downsizing and going global. That was the big thing in the 1980s. Downsizing because they didn’t want to get the corporaiders like Icahn to come in and greenmail them, so they downsized.
And then as we moved into the 1990s what we had was this technology boom in the internet where people started replacing labor, especially manufacturing, with technology. But the good news was, you still had this nascent internet that was creating more and more jobs. Now, what has happened over the last 10-12 years is that we are at the point of the technology cycle where technology destroys more jobs than it creates.
The point being, in the 1990s you were destroying manufacturing jobs, you were destroying jobs in publishing, in printing, in typing, mail delivery. You can just list all the things that technology was taking over, research, on and on, but you were creating jobs, as these economies in the internet, and all the ancillary services and products were expanding.
Now we are at the point where we have all these technological efficiencies and wonders in the market, but you aren’t creating a new technology. What has Apple created that’s new? Well, they’ve improved the iPod. There are no ground-breaking new technology devices or software.
So consequently, this still goes through the marketplace, it kills jobs in other industries, but the technology industry is not creating new jobs, and that’s clear when you look at any of the data, whether it’s the BLS or other foreign countries, technology and information jobs have been declining for a number of years, now. And where is the job growth? The cheap, easy, low-paying gigs. Retail, leisure, health care, business services, temps, on and on.
And of course, with Obamacare, that’s a factor. Tax hikes this year, that’s a factor. Unless you can find a magic lamp with a genie, or the golden goose, good luck trying to find organic growth somewhere. It’s just not happening.
David: It looks like the Fed’s strategy has been to create a wealth effect. Put QE in place and push up the stock market, push up real estate, and get people spending so that there is job creation. That’s the strategy. QE has pushed up the stock market. The question is, would more QE do the same? Are there limits?
Bill: Yes, more QE will push up stocks, there’s no question. But what they’re confronted with now, and the media hid it, at Jackson Hole in August there were three academic research pieces that said, “You guys are wrong. This wealth effect is not working.” But that’s all they had. You’re right. Everything is based on the wealth effect and the QE, and that’s not working. It’s enriching somewhere between 1% or 0.5% of the population. It’s just not helping.
And in the meantime, as I wrote recently, you’re deflating everybody’s income. You’re taking anybody that has a bank account, money market, a bond, a CD, and you’ve taken their income and given it to the big banks, and to people that are big in the stock market. And that kills people, because the average person wants a steady, reliable stream of interest income, and the retirees aren’t going to be dependent on the stock market. They’re not going to be, they’re just not. You don’t want to dip into your capital. You want to have that string of income that you know is there, and you’ve destroyed it. You’ve crushed it.
And you’ve forced these people to do two things, speculate, or go take night jobs at Walmart. And that’s what they’ve done to people. Go to grocery stores, go to stores where you used to see high school people, or young adults, manning cash registers, or sweeping floors, or being customer service reps. Now, it is very clear, that people from 55-75 are taking those jobs. The only demographic of job growth over the last year or so is 55-64 and 65-74. I think those are the brackets that the BLS uses. That’s the only people showing job growth.
There is a reason, because people cannot retire, because you’ve killed their interest income, you’ve killed the pensions, and it’s very deflationary. People think QE is inflationary. No, that’s one of the reasons Japan has not gotten out of their hole. It was a nation of savers, and you killed their investment and interest income. You’re doing the same thing in the U.S. Who benefits? Less than 1%. And the idiots at the Fed can’t see that they’re producing deflation, because you’re killing income.
The U.S. economy is the consumer. The U.S. consumer is their income and their household liquidity, meaning what your jobs and your income produce, plus what you have saved up so that you get an income, especially for retirees, or people who are working part time, or are semi-retired. You have a nice income stream coming in, so you take a part-time job.
Now it’s the opposite. You’re just getting crushed, so you want to be retired, but you take a part-time job. And it’s all because of the Fed, but they cannot admit that they’re wrong because it’s their life’s work. It’s decades of saying this was going to work, even though there’s no evidence it ever has worked. And in fact, the evidence is that Japan is making their deflation worse.
And that’s the other thing they don’t want to talk about, and I’ve mentioned this for years, that when QE doesn’t work, just like in the 1930s when the Fed pumped money like crazy, when you point that out to people, they say, “Well, they didn’t do enough.” Just like Japan. Japan went to a zero interest rate policy in April of 1995. How’s that working out? “Well, they didn’t do enough.” That’s what Bernanke says, “Well, they didn’t do enough, they should have done quantitative easing.” “Well they did do that.” “Well, they didn’t do enough.”
So Abenomics is saying, “You know what? We’re going to do enough. We’re going to do a mind-boggling amount.” And that’s not working out for them. And that’s what is scaring the Fed now. People have missed the real story. They say the Fed is saying they’re not going to taper QE because the economy is soft. Wait a minute. You guys are missing it, that at the end of last year at Jackson Hole the Fed said, “We’re going to do QE3.” And then a couple of months later they said, “We’re going to do QE to infinity.”
And then you had Abenomics and the global economy is not responding. In fact, it’s rolling over in the U.S. So what if you don’t taper? This is like, “You know what? We’re giving you these drugs. We think you’re going to get better, so we’re going to take the drugs away. Oh, you know what? You’re not, you’re getting worse. So we’re not going to take the drugs away.” That’s good news? The drugs aren’t working.
So now the problem with the Fed is that it’s not working. We know it’s not working, the model doesn’t work, and you’re seeing Abenomics failing, just what you’re saying, the wealth effect model doesn’t work, it’s busted. So now, what does the Fed do? “Okay, we won’t taper.” But if the economy rolls over, as it is, what do you do? Are you going to do more? Why? Your model doesn’t work. So now you have to find a model that works? There is no evidence that this works? How much would be enough? How much QE would be enough?
This is the point you were making. Can they do more? Sure, they can do more. But will it work? Again, you normally would go to your model. That’s what Bernanke came up with when they said, “Why are you doing 600 billion of QE the first time?” He said, “Well, we equate that to a 50 basis point rate cut.” So what are you going to do this time? You’re doing 85 billion a month, that’s almost a trillion a year. What are you going to do, 2 trillion a year?
And then understand you’ve reached a threshold, where you bubble the stock market, where you bubble select real estate markets, and then it all crashes because they always do crash. It’s unsustainable. You create bigger problems, and then you can’t print your way out of that. So it’s a very difficult environment. It’s difficult for everybody to navigate. The problem is, we have academics running the Fed instead of bankers. This has been my theme for a long time, that we are now letting academics – this is like the Houston Astros down there. “You know what? They’ve just been so bad, we can go and get a bunch of academics to come in and run the team. And they’ll give us all of their theories.” That’s not what you would do. You’d find good baseball people and you’d bring them in.
But that’s the problem with our Fed. We have academics that have little or no banking experience or real experience. Volcker was the last banker that had real experience. The academics have stolen the Fed and they’re trying out theories. Good luck with that. That’s another problem we’re having here.
David: Yes, we look at the market and we’ve got momentum to the upside, that’s the current picture in equities. What do you see happening now? We have a constructive picture, according to the media, but arguably, risks are multiplying. What do you see?
Bill: The risks are going through the roof. That’s why the volume is collapsing. That’s why Carl Icahn sold off half of his Netflix. That’s why he’s on Twitter yesterday and today, why he’s out on CNBC pounding Apple. He’s trying to get Apple to take him out. He’s clear. He wants Cook to buy his position. Why? You didn’t see him do that with Netflix, did you? You just let the market work.
But that’s what these people don’t understand. When you see these activist investors, as they are called, whether it’s the hedge funds, when they go public, and they’re tweeting, Bill Gross, when they’re talking their book, they’re nervous. They want somebody to take them out, because the market is not taking them out the way they wanted to be taken out. So they’re trying to create something. But the volume is not here.
Anybody who works in this industry, and sits here every day and has clients, the volume is horrible, and on top of that, it’s mostly high-frequency trading, hedge funds, and professional traders. The institutions are just sitting around. I’ve had some very insightful conversations with some top money managers that were having outstanding, just ridiculous performance, because they’ve been in the right stocks and the right groups that are going berserk. And they’re trying to tell their clients, “Look guys, we are so far above norms of performance, we know this can’t continue.”
In fact, Bill Miller just did this recently, right? He came out and said, “I’ve done so well in the last four to five years, I’m not going to do this in the future.” You just can’t do it. But what is alarming them is, with this unbelievable performance over the last couple or three years, virtually all their asset growth is coming from the stocks’ appreciation, which means they’re not getting new money in. Normally, as you know, when you perform well, money comes after you very hard. It’s not happening, because it’s not there.
The big pensions are being squeezed in states. The individual people aren’t putting money in, as much. In fact, they’re depleting their 401(k)s and IRAs and pensions. That’s a dynamic that the Street doesn’t want to talk about, that even the people with great performance are having difficulty getting money coming in to them.
That’s why the volume is abysmal. That’s why you see these layoffs starting to show up more and more on Wall Street. A lot of it’s the mortgage and re-fi area, but that still has an effect going through the trading desk and everything else – the mortgage trading and the bond trading, etc. And nobody trusts the markets. It’s all the Fed, centrally planned markets, and that’s another way Bernanke is killing employment, with centrally planned markets, people leave the industry.
You have stocks at all-time highs, the Street is angry, it’s upset, nobody’s happy. You’ve got volume going down and people understand that this whole game is, “The economy is getting bad, buy stocks because we’re going to keep doing QE, or increase it.” That’s an extremely, extremely dangerous environment.
David: We look at the markets from a monetary backdrop, talking about volume bringing in a bit of the structure of the market. Maybe you can speak a little more to the technical backdrop that you see.
Bill: Recently, we were doing one of these ascending wedges, which used to be a rare pattern. But we’ve done it a lot over the last three to four years. What that is, is that you go up and down, and as you are going up and down, on an upward by upward-sloping bias, the pullbacks are getting narrower and narrower, so that wedge on the left hand side is quite large, and then it keeps narrowing down. Now, as you are getting more current in history, why this is dangerous is that one of two things happens. You break the bottom band, the bottom, which is the support trend line, and you usually get a hellacious collapse. You can google “rising wedge,” and there are a lot of charts showing that.
David: And you’ll see this most clearly if you’re looking at the S&P 500 for the last 12-18 months, that kind of a time frame. This is the chart pattern that you’re seeing in the S&P 500.
Bill: Yes, exactly. And it takes a while. And what is happening is, part of the psychology is that people are getting more and more bullish, and they’re buying dips more and more. The other thing that tends to happen is that you have decreasing volume. You tend to break down, and break down severely; however, one of the other things that occurs is that you break out to the upside, above the upper trend line, and you tend to go parabolic. That’s why this is a dangerous formation, is that there is normally a very volatile move coming up or down.
What you’re trying to do, now, the stocks have to rally robustly. You have to break the surly bands of market gravity to get this thing going parabolic. The traders are trying to do what they do to stocks like Google, and Tesla, the trading sardines, what they had done to Netflix, which is just to push these things straight up and just jam all the shorts and run them up there. And then, of course, what happens, just like Tesla or Netflix, some event shows up and they just get cratered. Netflix trades up to 389 on great earnings, and the next thing, the aftermarket is trading 314, because Icahn sold half of his six million share stake. Tesla, same thing, going berserk, and then they have a little problem here with the battery thing, or the fire, whatever it is.
And that’s where you’re at. It’s a very, very dangerous backdrop for structure of the market. That’s what’s going on. You saw in Japan, it went straight up on the Abenomics, and then it just went straight down. Boom! And that’s what we’re doing here with the market because the traders come in, they race it, they push it. There’s no value investing here. This is market impact. This is momentum. This is the the algos which are just programmed to do this without thinking. They see a headline in a program, “Weak Economy, Buy Gold.” And it goes boom! And they do it, without thinking, until it starts blowing up and then somebody will reprogram that algorithm.
That’s, again, why this is dangerous. In 1987 we had the mindless computer-type investing and program trading and portfolio insurance, and at that time it was about 22% of rallies, 500 points in the Dow, all based on these shenanigans, and then when the computers went the other way we had the 1987 crash. That a tea party compared to what’s going on now. It’s not even close.
David: Bill, you mentioned market impact.
Bill: Right. What we have now is just so much faster and more devastating. The reason that market that didn’t crater further in 1987 was that you couldn’t talk to your broker, you couldn’t enter orders. As I tell people, at that time, because I was sitting there, I was there when this was happening, even though they showed that screen that shows Dow Jones is now 508, that’s not the truth. The problem was, the S&P futures and the OEX options were trading, they should have been down another 50%, and if the screen had said down 750, it wouldn’t have been down 750, it would have been down 2000. Because at that point everybody’s busted everywhere. The market was inefficient enough that things weren’t in line.
I’m telling you from firsthand experience, you couldn’t enter orders. You couldn’t get brokers to pick up your phone call, whether you were calling the New York Stock Exchange floor or people were calling their stock brokers, you couldn’t contact your mutual fund. There was a safety net built in, communication inefficiencies and technology inefficiencies. Now, how many people can just zip into their own accounts and do transactions? You couldn’t do that in 1987.
David: So today we have circuit breakers and the potential for firms to step in and cancel trades. Let’s say you were actually short the market, benefit, and they can cancel the trade, or you have a buy order in at a low price and you buy the shares, but the trade can still be canceled. There is a sense in which there is more than just the bond market, which is a rigged game today. When you look at Wall Street and the way the equity markets trade, you have to know that there are rules that can change in the middle of play and how do you address that?
Bill: Well, you can’t, because this is the market structure they gave you. So almost daily, we see individual stocks crash, because all of a sudden there’s a bunch of orders in there. You can imagine what happens when there are a bunch of real institutional sellers. The problem is, we see this when we trade, we have one big institution that comes in and we know we’re getting a program, and that means they’re giving out others. Just that one guy will change the whole flow of the market until they’re done. And that’s just one. Because there are so many algorithms out there, and they’re looking for a disturbance in the market, and all of a sudden they see an abnormal amount of buy or sell orders, whatever side the program is on, and they immediately go into that mode. They start buying S&P futures, or ETFs, or the industry that they start seeing the disturbance.
You can imagine what’s going to happen if a half-dozen, or 8-10, major institutions decide they need to sell stocks. Those algorithms are just going to go berserk. And you’re not going to be able to hide it. Again, in 1987 the circuit breakers were the inefficiencies in communication technology. Now, we’re light years more efficient in communication technology, and order delivery systems, so that you can do things in nanoseconds, and heaven help you. And there are no specialist stops. Specialists in the past would stop trading. They would buy, they would sell, they would hold things. You don’t have that anymore. It’s just computer stocks in the computers for the most part now.
David: So what do you do? Preserving wealth today – what does that require?
Bill: It requires you to vigilantly look at your portfolio, make sure you have a well diversified – I hate to say well-diversified because well-diversified means a nice basket of stocks. I don’t mean that, I mean asset class diversification, with a healthy cash hoard somewhere, depending on what your circumstances are.
That’s the problem, you can’t just give out general information, because it depends on what your income stream is, it depends on your asset stream. Do you own property? How many? Is it rental? Is it vacation? Is it primary residence? So essentially what you need is a cash reserve, and on the other side, what the whole world is in search of is a vehicle that will preserve the purchasing power of your cash, because of all the QE and all the government problems that are going on in the world. That’s what you’re looking at.
Also, some of these big, important people – look at Warren Buffett, he has a record amount of cash. What is it, 58 billion? And there’s a reason he’s doing that, because he’s not comfortable with what is going on. But you can look at a lot of other big billionaire-type people. They have a nice reserve of cash, they have some gold, they will have some real estate, they will have some art, a whole mix, some diamonds, whatever it is.
David: Real stuff.
Bill: Things can move very quickly right now when you can’t move. That’s why you see so many people that have large amounts of cash now, because they recognize that developments in news can occur so quickly now that you don’t have time to move. That’s why I just keep recommending, if you have portfolios and holdings you have to look at them and make sure that you’ve weeded out any possible problems, you’re as low on debt as you can be, you have a nice cash reserve, and you have a hedge on your purchasing power. The whole world is looking for a medium of exchange that is reliable, because there is so much currency debasement going on.
That’s why stocks have played up. What is interesting to me, and you know it because it’s in the letter, and I’ll be highlighting it tomorrow, because of what is happening now, where you are getting economic weakness and there is not going to be a tapering and some people are trying to make the case that you should do more, more liquidity, that gold is all of a sudden trading in concert with stocks.
Now, we all know in February commodities fell apart. Part of that was China stopping the commodity financing. There were other things going on, the higher taxes in the U.S., the amount of money that came in at the end of 2012 to beat the tax hikes. You have a lower budget deficit. There were a lot of things. India tried to stop the inflow of gold into their country. They were worried about a bubble. There were a lot of things going on that wrecked not only gold, but commodities.
You saw copper, all these things peaked mid February, and then they just went to hell. And the thought also was of the tapering. But now that’s off the table. And, of course, China was also tightening, if you remember back then. They were tightening to try to stop the property bubble, etc. So you had this huge whack in gold, and stocks recovered more quickly and they went up.
But now if you’re watching, just like today, you had soft U.S. economic data, principally, the market PMI was much softer than expected, as was the EU, services and manufacturing were softer than expected. So that’s why we’re up, and gold is up, and copper is down, because, “Oh no, the economy is weak, more QE, or at least they’re not going to taper QE.” So it’s a knee-jerk algorithm reaction. But that, I think, is very important now is that gold is trading in concert with stocks.
And you see it with the gold stocks, also getting bids, so now we might get back to where we were a couple of years ago, where gold and gold stocks will outperform the S&P 500 and the Russell 2000 because we’re at a point where there is going to be little economic growth, and you might play the funny money longer than people expect it. So there’s a market adjustment going on here.
David: Just in a few weeks, mid November, same time-frame, I’ll see you up in Chicago, we’ve got China’s Third Plenum in Congress, and it’s a very good time for them to lay out a clear path toward economic rebalancing. It happened in 1978. I think it happened again in 1984, where the Third Plenum was a big deal. You roll out the implementation strategies. It’s not like the five-year plan, but now let’s get into the nitty-gritty of how we’re going to get this done. We know that rebalancing in China is treasury-negative, in large part because they are moving away from their tradable goods sector, and less deficits here mean less surpluses there, mean less need to be buying treasuries in the first place. How do we then finance our deficits? That’s a part of the question.
Bill: That’s what the QE is. There’s only a handful of beneficiaries. The big banks, as you can see what has happened with their earnings and the reserves that they’ve piled up. The second one is government. We did QE during World War II to finance what was uncontrollable spending. That’s what’s going on now. The biggest beneficiary of QE is the federal government because they are paying very little in interest. If you went to regular market rates, they couldn’t service the debt, and that’s what has happened. Japan quit buying in 2005-2006, and that’s when the Chinese accelerated their buying, and now the Chinese have stopped. As you can see with the TIC flows, they’re weaker than expected, just what you’re saying. But who stepped into that? The Fed. The Fed’s balance sheets, it’s ridiculous, it’s going to be four trillion dollars by the end of the year.
David: They can continue to do QE and cover over issues in the treasury market for some time. Is the canary really the U.S. dollar, on the cusp of breaking technical support right now?
Bill: You’re absolutely right, and as you know, that’s what we’ve warned in the last couple of weeks, is to get your dollar chart out. It’s in collapse. And it’s right near the low that we had in February. And if you remember, that was the peak in the commodities this year, and then they all went to hell in the middle of February, and that was because of the tapering talk in China, etc., and then the dollar strengthened. If you start taking these lows out, you’ve got a little room, but then you start taking out 2011, and you can look at the chart, you’ve got a real problem developing.
And part of this is Janet Yellen coming in, everybody expects her to be an über-dove, maybe even more so than Bernanke, and she’s going to have a real problem when she comes in here. Because she comes in and the expectation is, it’s like a teacher coming in and you say, “The substitute teacher, we know who she is, she’s really easy, we can railroad her.” And now she’s going to be made principal, and so everybody’s thinking about how they’re going to abuse this person. That’s what is going on here.
She’s going to have a very interesting start. If she rolls over like they thought, then she’ll never get in front of the market. The market will never respect her unless she goes Volcker on them, and we know if that happens, it’s Armageddon. So to me, I think she’s going to come in and have to do something very tough-minded in the beginning, or to disabuse the market that she is this easy pushover, that they’ll keep playing the financial terrorism card and she’ll keep accommodating them. Or if she doesn’t, you’re right, the dollar’s going to go to hell, and anybody who was around in the 1970s, you realize when you had those squishy Fed CEOs, they never got ahead of the curve. They always said, “Well, we’ll hike rates another 25,” and because you’re behind a curve, you just make things worse. Then Volcker came in and said, “I know how to stop this. Watch this. No, I don’t care where rates go. I’m not raising rates. I’m just slowing the growth of the reserves down. The rates are going to go where they’re going to go.” And he did it.
So, it’s going to be interesting to see how she comes in. If she comes in the wrong way, again, just think of some substitute teacher who has a real squishy reputation, and you’re making her the Dean of Discipline, or the Principal, and everybody’s expecting that they’re just going to roll her as want. She’s going to have a problem when she comes in, and right in the very beginning of her term. It’s going to be real interesting.
David: We had a similar conversation to this back in mid-2008 and there was probably more concern in your tone, and in the content of our conversation, than I had heard and read in your report in a long time. It’s a challenging circumstance when a cash hoard is attractive, and yet the cash hoard may go through the meat grinder, and be turned into some sort of sausage. But that’s a better alternative than being long the equity market 100%. So this cash hoard, with the world still looking for a reliable medium of exchange, it seems like you could simplify and just say, “Okay, well, don’t call this genius, but if you had a third of your assets in gold, a third of your assets in stocks, a third of your assets in cash, and then you just get down on your knees and pray.”
Bill: Well, something similar, that whole mix of stocks and gold, I think you should have some type of gold in there, because some of the very smart people, some of the captains of industry that I know have that position, some gold, but they also have diamonds, they have art, a store of value.
So what I’m saying is that they have a diversified portfolio, but it’s not what you would think, where Wall Street would sit you down with their wealth manager, and almost all these guys now have a computer program that the firm hands out to them, because they don’t want to be sued. And it’s like, based on your circumstances, you should have this amount in stock fund, and then they’ll even break that down into emerging market, growth, value, and then this amount in bonds, and they’ll subdivide that, maybe some percent in commodities, and some percent cash.
But what the other people are doing is, and the question really is now, because people don’t want to hold long-term bonds, they might hold something short, as a diversification, a year or two. They’re basically a substitute for cash. But basically, it’s cash, and what is my hedge against that? The wealthier you are, the more you have the propensity to buy diamonds.
David: The other thing about real things is that it’s quiet wealth.
Bill: Yes, it is. A lot of people aren’t really trying to make money at this point. Those that have the money are trying to preserve it, because they don’t see the opportunities. That’s why you see share buy-backs and all this other. You see Icahn fooling around, forcing people to take positions, using the social media and the media to push it up and then unload that stuff. He’s not restructuring companies or creating jobs or creating new industries. That’s kind of the deal, he sees a chance to make money, but where is he preserving his money? And that is globally, where do you hide? You’d better be liquid. You’d better be able to meet your obligations, but you’d better have some real asset hedge against your cash.
And the key question: Not too long ago I sat down with one of the biggest names in private equities, and everybody knows the name, it is very recognizable, and his question was, “Who wins, inflation or deflation?” I said, “I don’t know, I think we get both.” And he said, “Yeah, yeah, that’s kind of how it looks.” And that’s the fight. You have systemic deflation, and you have government and central banks trying to inflate our way out. And that’s why you don’t know who’s going to win this thing right now. So you’d better be able to go quickly when it goes, but you’d also better be in a position that when it starts happening, you’re not going to get wiped out.
And along those lines, the problem isn’t owning businesses right now. In fact, a good business that is going to generate cash no matter what happens is a great investment. The problem, as you mentioned, is that the stock market, because people are looking for this they’ve grossly over-valued companies that have that propensity. I know some very smart guys and what they’re doing is they’re buying individual auto body shops, because that’s going to be here no matter what happens, on a micro-level, on a smaller level. And on a bigger level, you see people buying Walgreens or the CVS. These guys, no matter what happens, inflation, they’re going to be here. Deflation? They’re going to be here. They’re going to generate cash. Certainly, industrial types of companies that have products.
I think one of the reasons the State of Texas is doing so well is because of the energy. Certain parts of Canada, and in your area, Dave, we have energy, even though when you look up, you see, gee, oil isn’t really doing anything, in fact it’s kind of going down. But you see investment, you see growth, you see things happening. You see jobs, you see people investing money, that type of situation. And that’s kind of what the big picture play is.
The stock market is really a sucker’s game right now. It’s professionals, it’s algorithms, it’s people that have to play, it’s money managers that have to meet their benchmarks, they have to do these things. There are a lot of people who make opinions, but the proof is in the volume, and also that the best performing money managers are not able to attract money right now, because it’s just not there.
David: Something you mentioned earlier is that government has an increasing share of the economy. We have government that is attempting to manage the economy, as a whole, via the Fed and the Treasury, maybe a few Wall Street pimps throwing in their two bits. But do we assume a further slide toward a command economy? We went through that in the 1940s, and really didn’t emerge with an all-clear signal until about 1949. The market basically protested. You’re right, if you had a private business, and it had cash flow generation, you just continued to either find comparable businesses and buy them, or sit on cash.
Can we assume that there will be constructive change over a series of election cycles, or, in your opinion, is this the point where you have to go the full cycle, collapse of Western welfare state includes the desperate attempts to prop up the system, maybe that’s health care, maybe that’s everything coming under one roof in terms of control and influence. Is there a way out or are we on an inevitable track?
Bill: Great question. I mean, that is the question. And it’s very clear. Everybody with half a brain, and this is reflected in all the polling, most of the country is on the worst path. It’s reflected in the opinions of the politicians, and business and Wall Street. It’s on an unsustainable path. We all know that. The debt is unsustainable.
The problem is, and again you have alluded to this, the people dependent on this, especially the politicians, this is their power, this is what they’ve known their whole lives, are going to fight not to give it up. And the central bankers are going to fight not to give it up. But it’s going to blow up. So the Fed, as we know it, is no longer going to exist. I envision it going back to bankers, real bankers and business people, back to the original role, which is the lender of last resort, and not somebody in the marketplace every day, facilitating Wall Street, so they can speculate. And I think the big blowup is going to be political.
Now, what’s interesting, what you’re saying is, my view, around 2009-2010 I was getting more optimistic and not thinking about moving money out of the country because of this Tea-Party revolution, in that I thought Middle America was revolting. Not the Tea Party, per se, but the people in the middle, which is America, which distinguishes America from other countries, the middle, has woken up and realizes this is an unsustainable welfare state, and it’s going to explode. It’s clear. The math is clear that this is unsustainable and it’s going to implode, and they want to do something before it comes to that. So I thought, “You know, this might work out. Maybe America’s going to do the right thing.”
As opposed to Europe and other countries who are so vested, and they’re so socialistic that they’re just going to let it go, they’re going to do like Greece, they’re just going to let it all fall apart. But now we look like we’re going with everybody else, that we’re just going to get more and more socialistic until is just blows up, more and more welfare and entitlements until it just blows up.
And I do think the model is Vallejo, California. I remember this very clearly, because it blew up in early 2008 before the financial crisis, and everybody knew they were bankrupt, and one of the major publications, and I can’t recall whether it was the New York Times, or the Wall Street Journal, or whomever, sent a reporter out to talk to the city manager, and the reporter said, “You’re going bankrupt.” And the guy said, “Yeah, that’s right.” Like it’s Puddy on Seinfeld. And the reporter said, “Well, what are you going to do about it?” And the city manager said, “Well, what do you want me to do?” “Well, pretty easy, right? You’ve got to rein in spending, and you have to raise some revenue, taxes, sell assets, whatever.” And the manager said, “Well, I can’t do that.” And the reporter said, “Well, why not?” “Well, if I do that, I’m out of a job, and the politicians will be voted out.” “Well, what are you going to do?” “Well, we’ll just let this run its course and someday a bankruptcy judge will sort this all out.”
That’s what’s happening. There is nobody that’s going to stand up and say, “Oh, let’s stop this debt growth.” No, in fact you’re going to demonize the other people because you’re a threat to their system, you’re a threat to their existence, you’re a threat to their power. This is what this is all about, as our founders knew, the bigger the government, the less liberty, the more power. And we know what the whole thing is.
But we also know from history that they’re going to fight desperately to maintain this socio-political economic system that’s been cobbled together for eight years that’s no longer sustainable. That’s what going on now. That’s why all of the country is so divided. There’s a reason for that. Because it’s clear what’s going on and what’s going to happen, but the people with the vested interests are not giving it up. The people that eat at the government trough, and that’s everybody from people on entitlements, the big business and defense contractors, and the politicians, are not giving this up, and that’s the problem, and you’re right. So now, I just think this thing is going to have to blow up.
Now, what’s interesting, and where I think the U.S. is at a better advantage than others, is that we’re not as homogenous as other countries, so you have pockets of this country, and you could call it the blue state, red states, where Texas is doing very well, and there are certain areas that are doing well, where there’s energy, where there’s some tech industry, etc. Look at California. Northern California is talking about seceding because they’re doing so well. There are a couple of states talking about that. Part of Colorado, right? They’re talking about creating their own state. I think that’s the answer in farm areas, certain other areas where you are getting demographic movement. There’s a reason why the SEC is so great in football for a decade, because that’s what the demographics are showing. That’s where it’s going.
So I think that’s the one interesting thing about the United States, is that if you look at it as one homogenous entity, you’re wrong. I think, much like we say with stocks, you have to look at individual groups in stocks. But I think in the United States it’s the same way. To give you an idea, I have a fraternity brother who is an executive at a major company, an industrial company, a Dow company. They spun off a division that he was president of to a private equity, and he was here in Illinois, I just ran into him at a football game recently, and he’s moving to Texas because he can’t take the higher taxes and the nonsense of Illinois, and he’s moving, that’s it, he’s packing up.
Some of the people will transfer, those retiring, and those looking for jobs, and the State of Texas is highly accommodating, you can get whatever you want, whatever you need. Somewhere around the Dallas area and Ft. Worth area, he’s taking that division. Of course, he has the blessing from the private equity people, and that’s happening more and more.
We see this in the State of Illinois, you’re getting population down, businesses down, etc. That’s what’s happening within the U.S. Of course, people don’t want to talk about that, but that is probably one of the redeeming things that we have. If you’re in France, there’s not a lot of safe places to go, Greece, Ireland, Italy, you go through the list. But in the United States, there are still some safe places to go. Canada, to me, looks like a very safe place. The energy, minerals. We’ve always looked at them as being a kind of socialist country and they feed off of us, we take care of their defense spending, and on and on. But there’s a book out recently, There is a Quiet Revolution Going on in Canada. I tried to get it but they won’t sell it outside of Canada. And it’s because of all this boom in energy out in the Western provinces and you have a lot of immigrants and people coming in from the U.S. and elsewhere, but their coming in to work. They’re coming in because of the energy, and they are turning the political mix of Canada to a more conservative, more centrist view.
So when you look at the Canadian banks, which were the strongest banks after the crisis because they didn’t play the games with the subprime and they demand higher down payments on housing. Their bubble in housing debt ensued because Canada was safe, people flocked into Toronto and Vancouver. The Chinese and Asians were pouring into Vancouver. Those two markets have blown up, they got too hot.
But the rest of Canada is in a transformation. So there are some opportunities there, I think, if you’re looking to hide money or have investment money or some other things. It’s hard to find a safe place around the globe, but I think if you look within the U.S. in certain areas, even certain areas of Canada, there are some pretty good places to hide.
David: Well, it is interesting, we’re at a point in time, a point in history, where that is a part of the conversation, and not, “Here’s a place to put money to work and see capital formation.” Capitalism is building on opportunities, and yes, there is an element of creative destruction, but there’s less creative and more destruction in the equation today.
David: So, the word hide is a part of the equation, a part of survive.
Bill: Oh, it’s the operative word right now, absolutely, it’s how to survive what’s coming. We know. You look out and you see the weather conditions, whether it’s a hurricane, a tornado, or a major snowstorm, and you know what that’s going to bring. And you don’t say, “Oh, you know what? I’m going to go out and do… no, I’m going to survive this, and then afterward, we’ll worry about what we are going to do.” And I think we have a major, major conflagration, storm, whatever, coming and you’d better survive it. And if you do survive, guess what? You win.
David: This is the impossible question, and maybe any answer is imprudent, but when you put a time frame to this, it seems like the old saw, “How did you go bankrupt?” “Well, it was slowly, and then all at once.”
David: Is this five years, is this ten years? Is this 24 months? At an instinctive level.
Bill: Yes. Again, getting back to talking to guys who run these big hedge funds and private equities, and everybody would know their names, they don’t know, and nobody knows. But the way you prefaced your question is actually the answer. What we know historically is that even though these things are obvious, they tend to take longer, even the start of a bull market, like gold. It was obvious that gold was undervalued in the late 1990s and early 2000. It was clear. But it takes longer for these things to develop and hit a critical mass. But when they do, they go very quickly.
Now, one of my first jobs on LaSalle Street was in gold, in 1975, and they got absolutely crushed. And then people keep thinking about, “Look at silver in 1979-1980.” Yes, that’s right!
David: Were you there in 1975 and 1976?
Bill: Well, it was not good. After they cut it loose, gold went to $195 and then it fell down to breach $100 on one day, and then it came back above it. But people look at the chart, and it goes very slowly, very slowly. Just like gold here, we saw gold go up and then all of a sudden it goes to $1900 and blows out. And that’s what gold did, and silver, especially, because it was obviously more speculative than the gold, with the Hunt brothers back in 1979-1980, go look at the chart. That all occurred in a very brief period.
And so, your point, in the preface to your question is, yes, these things take longer to materialize, to come to fruition, but when they do, it goes faster than anybody can realize.
David: It sounds like a little patience is necessary.
Bill: Yes, it’s a difficult environment. Everybody understands that. I can tell you just from watching people that I’ve talked to for years and they are slowly, slowly dropping out of business, slowly people losing their jobs. I’m talking money managers, hedge funds, advisories. Just slow, slowly, more and more attrition. And that’s telling you, this is speaking very loudly, with stocks at all-time highs. That does not compute. Something is seriously wrong. Only a miniscule amount of people are getting this wealth effect benefit, and the rest are suffering, and they’re having a slow degeneration of income and reserves, and living standards.
David: Well, we look forward to continuing the conversation. Hopefully 2014 brings a few rays of sunshine.
Bill: Well, it will be an election year, and it will be very interesting.
David: It will. And as always, we appreciate your contribution, your thoughts, and we look forward to seeing you in Chicago in a few weeks.
Bill: Terrific! Sounds good.
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Kevin: Well, as promised, Bill did deliver again. I thought it was interesting that he talked about gold and gold stocks now might actually out-perform the SP 500, because the S&P 500 is getting all of the benefit right now of quantitative easing. It looks like gold might be doing the same thing.
David: I think it’s very important to remember the game that is in play, and to be cautious with the way we live our lives, with the way we allocate our assets, and understand that, as Bill pointed out, there is a threat to power, and that is in play. There is a threat to the status quo, which is no longer sustainable, and the fight that is likely to be witnessed in that context will be nothing short of brutal.
And so, the notion of having part of your assets in quiet places, in real things, in things that you control, in things that are in other parts of the world, this becomes very relevant, and perhaps this is what many investors don’t realize, is that these are not normal times. If you listen to the mass media, these are beyond normal times, these are improving times, these are times that require you to buy stocks, and buy a house, and get a rental property, and do things that would be a normal investment process, or decision-making process, in normal times.
Kevin: Well, and he said, have real things. You had brought up a great point in the conversation. That’s quiet wealth, but it’s also preservation wealth.
David: And too important to overlook, the issue of cash, and this is what’s fascinating to me. As often as we move to cash in our managed money portfolios, guess what happens? That cash disappears. People cannot sit in cash. They look at it as a non-investment. They don’t see its optionality.
Kevin: Burns a hole in their pocket.
David: They must do something with it. “Why aren’t you doing anything with it? Why aren’t you investing it?” I think that’s one of the most important elements. We’ve viewed it that way for years now, and have increased our cash allocations, decreased our cash allocations, and are now in the process of doing that same thing again, with a focus on cash, with a focus on real things, with a focus on equities that are geared toward a very challenging environment. It’s really important that people assume, actually, the worst. Assume the worst, and prepare accordingly. That’s the unfortunate state that we find ourselves in today.