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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“On today’s program, what is the real value of anything? Actually, listening to Jim Grant, he would say, ‘For 2018 gold outperforms bitcoin.’ That’s the prediction. By definition, that’s a contrarian call, actually, a double contrarian call.’”
– Kevin Orrick
“Somebody sees something on the horizon and they’re positioning ahead of time. You don’t position today for today, you position today for 18-24 months from now. And I think what investors are looking at, in the German context, and the European context, and the Asian context is for something that is on the horizon. We can’t get our nose out of today. That’s all we care about here in the United States.”
– David McAlvany
Kevin: Dave, last week we talked about rate of change. It is amazing to see what we’ve seen in the stock market over the last year. I think we have just seen the fastest 1000-point rise in history, haven’t we?
David: Well, that’s right. And what we’re seeing in terms of what some are calling synchronized global growth is really, I think, you could call synchronized global speculation. What we don’t know is how 2018 ends. We certainly know, in retrospect, how 2016 began, which was fairly tumultuous, and it ended very well. So how things begin and how they end can often be quite different. But this issue of synchronized global speculation Doug Noland mentions in his Credit Bubble Bulletin this last weekend, and looks at Italian stocks, which just since the beginning of the year are up 7.2%, French up 3.9%, Spanish up 4.2%, German 2.5%, Portuguese up 4%, Belgian up 4.7%, the Austrian market up 5%, the Greek market up 6%, the Icelandic market up 4%. It just goes on and on and on.
It doesn’t matter if it is Asia or Europe or the U.S., everything is moving into a full-fledged speculative bubble. So for those of you who are interested in joining the Tactical Short Quarterly Conference Call, that is this Thursday afternoon, and please register ahead of time so that you can be on that call and you will get a link, an email confirmation, which will take you to that call. So, if you have questions on what the tactical short is, and specifically, what Doug Noland is doing with McAlvany Wealth Management, please join us for that call on Thursday.
Kevin: Who needs cryptocurrencies and the gains that they bring when you can possibly buy Icelandic stocks or Italian stocks? Let’s face it.
David: (laughs) Well, the point we made last week about the rate of change is an important one. We noted that as markets progress in a bullish trend they rapidly accelerate into what is ultimately an unsustainable push to a top in the market. So we went from 24,000 on the Dow to 25,000, and it took a matter of 23 days.
Kevin: That is that 1,000-point rise. That is amazing.
David: And then in about nine days of trading activity, we covered a 1,000-point move in the Dow, 12 days total, the span between when we started at 25,000 and moved to 26,000. And as you mentioned, it is the fastest 1000-point rise in Dow history.
Kevin: Okay, so the last two 1000-point rises – one was 23 days, the other was 12 days. This is remarkable.
David: The speed has become staggering. We talked about uniformity last week. The rise continues with maybe the Dow-Jones utilities the only market which is in sell-off mode. But 26,000 on the Dow is not the novelty. Of course, it is a record, but it is the rate of change which is more worthy of note. We can go to 30,000 on this rise. Anything is possible, at least for a moment, or the moment. And when that moment is past, then you have the reverse dynamic of, just like we have too many buyers in the market today, or an abundance, I should say, of buyers, having an abundance of sellers is the other side of the equation.
Kevin: And when you have people indiscriminately buying, and everyone – you talked last week that over 95% of the stock analysts were bullish – when you have that many indiscriminate buyers, you have that same amount of indiscriminate sellers all at once when things reverse.
David: And the indiscriminate buyer, of course, has been popular, particular in the ETF space, the Exchange-Traded Funds space, where you have an aggregation of a purchase. You’re not buying an individual stock, you’re buying a whole sector, and it doesn’t matter which is better, good or best in that mix, it is indiscriminate because of the packaging.
Kevin: Speaking of the packaging, this is what makes it so difficult to be a manger of money, because ETFs and these funds, they’re like fruitcake, Dave. You may not like cherries or pineapple or the nuts in it, but when a piece of fruitcake is sliced you get a little of everything. These ETFs – when the indiscriminate sellers come in, you’re going to have good stocks selling away just as much as you have bad stocks selling away.
David: I think there is a window here between 2018 and 2020 where we see the indiscriminate buying shift to indiscriminate selling, and that shift can happen in the blink of an eye. And that is where I think the opportunity for the discerning asset manager is going to be very big indeed. Because again, what you are going to see is everything being sold just as everything was purchased, and that allows for someone to step in and say, “On the merits of the company, on the merits of the management, on the merits of the growth profile, on the merits of organic growth, we choose this company, not the whole universe,” as you mentioned in the slice of the fruitcake.
Kevin: What we are talking about here is not mathematics, we’re talking about raw emotion – raw, exposed emotion. Math goes out the window at that time.
David: That’s right. Emotions are fickle. And we know that, when you just reflect on your own life and your own cycles, if you will. The time it takes to go from content and calm to stressed and full of anxiety – you can measure that in nanoseconds. I think sometimes we forget that it is emotions which drive purchasing habits far more than any thoughtful or methodical processes. And we are fascinated by this in our own business where if we’re sitting down with an engineer, for instance, who is generally given to a process and to decision-making, the reality is, we watch, in the process of selling a product, that actually the process goes out the window. Actually, in the end, to buy something or sell something is absolutely an emotional decision, even for the most in-tune and intellectually precise engineer type.
Kevin: We all think down deep inside we’re engineers, Dave, but there is an enthusiasm today in the market that could turn into disbelief tomorrow just on the turn of a pen.
David: The general public is engaged today. And again, what we see is something of an emotional coin toss. We’re engaged today – how does the coin flip tomorrow? Engagement today is disengagement tomorrow. Enthusiasm today is disdain and disbelief tomorrow. Wondering how a market turns as fast as it does is forgetting what drove it there in the first place, because again, it is not a rational process, but it is a rationalizing. Really, that is the basis of a buttressing an emotional appeal. You come up with reasons to justify the way you feel and what your inclination is, but those reasons are actually – again, it’s not a rational process. Do you see the difference between a rational process and rationalizing?
Kevin: How many records did we set just over the last year? We had record closes numerous times. I know it was more than 10-15 times.
David: The race to 26,000 on the Dow has had over 75 record closes. And that is in less than a year. We passed no less than five 1,000-point markers in the last year. That is more milestones in a single year than in any other year of the 120 years of Dow history.
Kevin: Do you think we’re going to get that in 2018?
David: Again, anything is possible because we’re not dealing with a rational function here, but if we repeated in 2018 what we saw in 2017 that would take us well past 30,000. Given that this is the longest string of gains – I’m thinking of the NASDAQ here – the longest string of gains in 37 years, another 12-month push seems unlikely, but again, that is my reflection made with reason tied to it. And as we have just acknowledged, this is an emotional move more than a rational move.
So give the markets the benefit of the doubt. I think as we watch them go, give them the benefit of the doubt. Manic moves can continue through 2018, but as we reflected, quite frankly, it merely and meanly – in a very mean way – sets you up for a decade to follow with negative returns. This goes back to our discussions with Andrew Smithers, and the idea that when you buy something that is overvalued, you pay the price for it over the next years, and even up to a decade.
Kevin: It is sort of like a form of debt, isn’t it? When you have these parabolic moves to the upside you pay that back later with losses, and sometimes that is over an extension of many years.
David: I think our last conversation was late 2015 or early 2016 with Andrew Smithers just before he retired from his column with The Financial Times. It was interesting because at the time – again, roll the clock back a number of years – he said, “Look, we’re now at the point where investing in the stock market today might give you 1-2% annual returns over the next decade.” Well, look, the Dow has moved up considerably, all the financial markets have moved up considerably since then, and what that implies, again, is that over the next 10 sequential years you will have an average return which is in negative territory.
Kevin: You talked about engineers. They do like to analyze the numbers, but in the end when they’re making a buying decision they are still as emotional as anyone else. If I were to go get an education right now in investing, it doesn’t sound to me like mathematics, engineering, statistics or any of those matters. It sounds like it is more of an emotional education, or a sociological education that I should probably study.
David: Yes, and I’m loving the point you made earlier because it reminds me, too, of our debt obligations. Get what you can get now, right? We have a debt problem because we have a whole generation of people who are happy to put it on the credit card or mortgage it, and basically hope that the future takes care of the present. They are consuming today rather than putting off consumption today for tomorrow. We don’t have that mindset. Get what you can get now, let the future take care of itself. Debts are mounting and the modern man or woman agrees, the concerns are not in the present moment so why worry about them? You can accrue as much debt as you want. Again, it is the same idea or emotional structure that goes into the stock buyer today saying, “Hey, we have positive returns today, who cares about tomorrow?” But the math is, 10 sequential years of negative returns, on average – that’s what you get when you buy an over-priced market, and we are more over-priced now than at our last conversation with Andrew Smithers when he basically said, “I just prefer sitting in cash. This is not the timeframe to be going long equities.”
Kevin: That was two years ago.
David: Investing remains, I think, one of the greatest fields for the individual that values the liberal arts, that is interested in a variety of fields of study. When you pick up the Wall Street Journal, when you look at The Economist, when you look at some of these things that show up as price action, appreciate that there is more going on than meets the eye. This is not just a matter of plusses and minuses in a particular column. It is more than accounting. What you have are aspects of sociology, and of psychology, and of history, and of economics, and of finance. You can even see written into those price movements biochemistry and brain science.
I guess what I would suggest is that a liberal arts education is really perfect preparation for a career in investing, whether you are a professional or someone who is doing it on your own, precisely because you are sitting at the intersection of a dozen disciplines and you get to see what is happening on a daily basis from a multi-perspectival vantage point.
Kevin: You brought up economics as part of that, and I would almost disagree at this point, Dave. Economics really is measuring the value of something, and when there is no cost – we live in a day and age right now where everybody is making money in virtually everything, from cryptocurrencies, to stocks, to bonds, to ETFs – you name it. Money is free at this point. When there is no cost to capital, how do you have economics?
David: That’s right, because when you start tinkering with the cost of capital, really what you are tinkering with is the realities of pricing of any assets.
Kevin: Right, so what is anything worth?
David: Yes, my response to the markets and their current meteoric rise still goes back to that question. Can you tell me what anything is worth? In a period of time where the cost of capital has been reduced to almost zero, in a world built on debt and the creation of infinite fiat currency, can you tie valuation down? Can you relate it to anything concrete? Can you tell me, for instance, right now why European debt is priced more conservatively than U.S. debt? This is what we talked about last week, if you remember. Can you tell me why last week saw the largest inflows into junk bonds since December of 2016?
Kevin: Oh, it’s because they’re such a value, Dave.
David: That’s right. Is that it? Or is it simply more yield-chasing, ignorant of the impact that may be tied to two, or three, or four rate rises which will come across the fixed income universe in 2018? That is the speculation, that the Fed is going to raise rates two, three, four times, and yet people are moving headlong into junk debt as if there is no implication.
Kevin: Well, there is no risk these days. There is no risk. In fact, you don’t even have to earn a profit. Look at Tesla. We talked last week about the dotcom craze back in the late 1990s. Those companies didn’t have to have a profit, they just had to have dotcom behind their name. Tesla, at this point, still isn’t turning any kind of profit.
David: So what is the company worth? What is Tesla worth? What is Amazon worth? What is J.P. Morgan worth? What is bitcoin worth? I can tell you, and you can tell me, what they are trading for. That’s the price. But that is a different frame-up. If we say, “Tesla’s current market cap is, say, 56 billion dollars, and you still can’t give me a PE ratio because they don’t have any earnings – positive earnings, that is (laughs). Without debt, without a massive stock offering every year – and of course, don’t forget government subsidies – Elon Musk’s enterprise would be a fraction of its current price. So again, this difference between current price and trying to assess the value of something, and the reality is everyone gets a free pass, if the value of what they have today is tied to an idea and that idea locks you into an imaginative journey which takes you from here to infinity?
Kevin: Dave, let’s just go back and look at basic economics here. Let’s say that I buy a hot dog stand from you that is earning $100,000 a year. You say, “Kevin, I’m going to sell that to you for a million bucks.” What that means is that I’m paying about ten years’ worth of earnings to own that hot dog stand, right?
David: You have to be connected to this hot dog stand for the next ten years. You have to see that either you are going to trim the fat, maybe shrink the size of the dog. What are you going to do to make it more profitable, improve the bottom line, and maybe shrink the timeframe?
Kevin: But that may still not be a bad investment because you’re still earning $100,000 a year. Now look at Amazon. How many years would you have to own Amazon for the dividends, just the earnings, to pay it off?
David: That’s right. Dividends don’t exist. That’s the question, maybe they should be paying dividends. But Amazon has a market cap of 630 billion dollars, and it trades for the equivalent of 330 years’ worth of earnings.
Kevin: So if I were to buy Amazon today I could expect to break even in 330 years.
David: (laughs) So it’s a bargain for the long-term investor as long as the long-term stretch is beyond ten generations.
Kevin: (laughs) You’d better be buying longevity drug companies. I’m thinking that is probably more important.
David: And at the rate Amazon hires and sees its employees quit, you have to appreciate why that company is interested in robotics, why they are interested in artificial intelligence, because it has to be central to Amazon’s future. I had no idea working for Amazon you would be considered a senior level employee if you could stay past 18 months, but I spent some time with a gentleman this weekend who was a previous employee, and he was a senior guy at 16 months. He was more senior than over 60% of the entire Amazon workforce. That is just amazing. What Bezos has is an organization that is operating like a work camp. Fortunately, people can leave when they want to so there is a difference (laughs).
But again, what is it worth? We know what the price is, but what is it worth? And as long as you can tie imagination to the equation, as long as you’re playing with an idea rather than the realities of cash flow, current and perhaps future, you can price it to whatever you want it to be. $1300 is not the limit for Amazon. Maybe it’s $5,000, maybe it’s $50,000. Maybe it’s bitcoin to infinity and beyond.
Kevin: Yes, but if you’re talking about things being over-valued, people would probably tell you they’re going to be worth more because of the tax cut. There are beneficiaries to this new tax cut, are there not? Especially the ones that have been chosen for being beneficiaries in the past, as well.
David: Absolutely. J.P. Morgan, as my colleague Dave Burgess just point out in the market recap on our Wealth Management website – if you look at how that stock has performed, it has received the benefit of the tax cuts, not once, but maybe two or three times. And it is as if investors have forgotten why they pushed the price up in 2016, why they pushed the price up in 2017, why they are pushing up the price now (laughs)? There is this disconnect between the current price and what the company is worth. That continues to diverge. And of course, there are all these little justifications as the earnings reports come out because they are helped by a reduction in loan loss reserves, and they are helped by these little things along the way. But we’re at a point where, again, valuation is so ridiculously secondary, it’s a little scary.
Kevin: Dave, last April I decided to buy more bitcoin just for the fact that I really didn’t understand, necessarily, where the value was coming from. I wasn’t really speculating in price as much as being able to just have an intelligent conversation with people who are operating in that area. And Dave, even after the experience, even though it has come up eight or nine-fold over this year, I still don’t really understand the valuation of bitcoin. But I have this suspicion.
We were talking last night about a guy that we would like to have on the Commentary, Ken Rogoff. He is a grand master chess champion. He also is very much part of the strategy to reduce and remove cash from our system – to go to a cashless system. We’ve talked to his co-author, Carmen Reinhart, and talked about that closing of the system. But if you were Ken Rogoff right now, and you were looking at this cryptocurrency threat to the monopoly of the currency system that the government has right now, how would you play this game? Let’s say you have your queen that is blocked by a bishop, or what have you? How would you play this game so that the government wins in the end, while bitcoin owners still believe that they are the ones who are winning?
David: I think it is fascinating that what Rogoff is after in his book, The Curse of Cash, is a system which is closed. But you need a better accounting for all the transactions which happen within a closed system than exists today. So very interestingly, what you have with blockchain is a perfect accounting of what happens – who, when, where, what, why.
Kevin: With the perception of anonymity.
David: That’s the issue. Today, there is the belief, and perhaps there still is the reality of anonymity. But the nature of cryptocurrencies is that they will grow in price until they represent a threat to the existing the money-creating franchises. And then I think ink and blood flow at the same time, whether it is legislative ink, and of course, the blood of the investors who have been investing into those things thinking that they are part of our brave new world. Rogoff said it best. He said, “The long history of currency tells us that what the private sector innovates, the state eventually regulates and appropriates.”
Kevin: So what you’re saying is, we may still see significantly higher prices, but at some point the government is going to co-opt that.
David: That’s right, because you’re talking about a very important privilege, the creation of fiat money. And that has been a very well-guarded monopoly for a long, long time. Here in the United States – for those of you have not read The Creature of Jekyll Island, it is worth reading it – this is the third iteration of our central bank. The first and second mandates were allowed to expire and they were closed down. So the current federal reserve system that we have as our central bank is the third U.S. central bank.
And all that we see implemented in the early years of the 20th century here in the U.S. was borrowed from the central bank playbook in Sweden, and in England, and in the Netherlands. These places had already perfected the central planning model using monetary policy throughout the 17th, 18th and 19th centuries.
Kevin: We talk about looking back at history and saying that this is what Sweden did, what England did, what the Netherlands did. We have analogy. But with this blockchain technology we really don’t have analogy because it is not only money, it is a record-keeping system, like you said. I just currently invested in another side blockchain currency that you could only buy with bitcoin. It was interesting, you could not buy this with dollars. So it sounds a little seedy to me, or at least deep-seeded.
But blockchain is different because the second blockchain that I bought, they were advertising it as something that not only will monitor inventories of liquor stores across America, but would also help machinery keep temperature records of meat that is being kept frozen in trucks that are carrying it all across America. This is a strange thing where we have money that also has a useful purpose in the form of record-keeping.
David: Right, so let’s not forget that. As the blockchain is further developed, and the blockchain has a very long future ahead of it, there are hundreds, or even thousands, of unanticipated applications which are likely to be foundational to 21st century financial markets and capital flows, but the merits that are being sold – monitoring, tracking, recording – again, you are talking about things that in the world of anarchists are fine because nobody is in control, and nobody is telling you what to do, and no one is, in a centralized fashion, actually aggregating the monitored, tracked and recorded information.
Kevin: Yes, so full disclosure is the selling point of a blockchain currency, and then for the person who wants to believe they’re anonymous, anonymity is the selling point for the blockchain currency. It sounds ironic, or at least, it sounds paradoxical to me.
David: Right, and it’s just a question of how long it remains the case that it is decentralized versus centralized. And so, as to any one of those currencies in the crypto universe – how it fares, I think it is impossible to say. And at present, I think it is more determined by the speculative flows than actual innovative application. But going back to Ken Rogoff’s comment, ultimately, the trajectory of any or all of those cryptocurrencies will be determined by the permissions granted from the central planning community. I think that goes without saying. When and how that happens – I think that’s what you have to watch for.
Kevin: I asked you this last night, Dave, as we were talking about the program. If you really look at what is going on, the old wise counsel is not what is being sought right now. It is actually the younger generation, anyone below 30. How often have we seen someone who is a grandparent or a parent going to their less than 30-year-old son or daughter and saying, “Hey, tell me about bitcoin. How do I buy bitcoin?”
I asked you last night, “In history, when we go back and look, when the youth is the only generation consulted, or understands what is actually going on in a society, what are the ramifications of that?” You brought up the 1960s. I thought that was interesting – Flower Power, and the hippies, and how that generation, at that time, was idealistic and they had a very youthful way that the world was going to change. And yet now, we have 40 years of experience looking back in the rear-view mirror and it has been a debt-driven society that they thought they were fighting off in the beginning.
David: I think when they graduated from Kent State and decided to get jobs, they realized they had to be something more than idealists, and they starting for the man, and they ultimately became the man. The rebellious hippies of the 1960s are the generation that oversaw the 40-year record expansion in debt, they oversaw the unhinging of the currency markets from gold, and they created, or allowed for, massive expansion of the state apparatus, which ironically, again, the 1960s hippies and the Flower Power movement were so suspicious of at the outset.
Kevin: So talking to people who are absolutely almost religious about blockchain technology, a lot of times they are almost anarchists against the Federal Reserve, against centralized money. Do you think possibly we could see the same type of co-opting with that generation, as well?
David: So wouldn’t it be funny, wouldn’t it be ironic, if the digital anarchist crowd found themselves tomorrow in the halls of bureaucracy as the only ones who knew how to manage big data, and what would then be the evolved uses of blockchain for 100% transparent financial activity, which is the opposite of the stated and intended communal goal of the crypto crowd today, which, of course, is non-transparency and decentralization? Think about it. Decentralized, transformed into the net for centralized control – a perfect record is precisely what the blockchain provides.
I know this is merely food for thought, but if permissions are granted, and this is, I think, what we should watch for in legislative halls around the world, whether it is China, South Korea, or the U.S., if permissions are granted by the central planners, and the co-opting, as Rogoff suggests, does occur, you know that the identity piece, which is supposed to be private today – that’s been solved, and anonymity has been eliminated. So, within the larger context of big data, the appropriation will already have occurred.
So again, I look for the central planners, once they are on board, you know that this is no longer them holding on to the tiger’s tail, they have complete control. And the take-away is that I think we need to observe how government engages via regulation and control. And I think Rogoff will ultimately be right.
Kevin: So even if he is right, we still have the question of, what is the value of something? Because things continue to climb, and actually, some of the cryptocurrencies have really taken it on the chin over the last week or so, they have been going down. But I think it is interesting that you go back and look at old literature from before the Depression. The old saying was, “If the shoeshine boy is giving you stock advice, you know that you’re at the top of the market.” And if you look at the press right now, the newspapers have been continually printing cryptocurrency news. It’s almost like it’s time now. They’re almost the shoeshine boy of the 21st century. I’m wondering if we’re not seeing something getting toppy in that area, too.
David: As we ended 2017, I look at the newspapers. The increased frequency of press coverage on the cryptocurrencies was matching the impressive rise in price. The reality is that by the time the news media outlets have the boldness to put something on the front cover, the trend is already extended, and likely counting down to reversal.
Kevin: Look at The Economist. It put the almighty dollar, George Washington with the muscle-bound look, and it was going to be the mighty dollar. The dollar lost 11% this last year. It’s like making the front of Sports Illustrated. It’s almost the death knell.
David: It’s one of the most fascinating aspects of Robert Prechter’s works in socioeconomics here he looks at social trend and social mood, and a reflection of what is bubbling up from the inside, again, from an emotional aspect, where things are being expressed and people don’t necessarily know why they are finding expression in pop culture, but it’s telling you what you want to know. You’re right, last year’s Economist magazine – one of them had George Washington, and the title was “The Mighty Dollar.” It coincided nicely with 2017 being one of the worst years for dollar performance in recent memory, down over 11%.
So, if you’re looking for clues in the media, look for unqualified statements of enthusiasm or despair, either end of the extremes. And again, in the news media what you have is the psychological market dynamics summarized neatly for you in the form of a headline. You might argue, “Well, but data is data.” I would respond that there is a lot of data that never sees the light of day. Why is the data presented considered to be prescient? So, you have an editorial staff that is responding, needs to sell rags – they need to sell this paper – and something has to determine the relevance.
Kevin: I’ve got a lot of hope for gold, then, because nary a word about gold is being spoken, even though gold actually had a pretty good year last year. So, thinking like a contrarian, if the press isn’t paying any attention to gold, it might be time to actually buy. Remember when Barron’s really did like gold?
David: And that was at the end of a 20-year period, a two-decade period, when they had nothing nice to say about it. Exactly, they ran positive articles on gold in 2012 as gold was reaching a peak. Media reflects the market undercurrent. It does not lead. It does not inform it. So after a decade of averaging 12% returns, and after refusing to say anything positive about gold, Barron’s finally writes something positive. Journalism is designed to sell into the sweet spot, which requires getting a beat on what people want to hear, what they want to read, and then producing material to reflect it.
Kevin: And that’s usually late in the market cycle.
David: That’s late in the market cycle. Mainstream media has its own sociologically driven pro-cyclicality. In other words, they will create their own trend. The news lines feed the enthusiasm, the enthusiasm is buttressed by the news headlines, there are more news headlines that feed the enthusiasm, and again, it feeds on itself.
Kevin: And now the algorithms are actually programmed to read the news without a person involved. They can just read the news and buy or sell something based on the algorithm.
David: That’s right, and that’s absolutely fascinating to watch – algorithm trading where mindless computers comb the headlines and they initiate trades on the basis of what a few words insinuate. I think sometimes speed offers no advantage at all. We’re enamored with how fast things happen. Actually, there are times at which speed puts you at a disadvantage, and I think this is one of those times. I think of that time a person needs to process the headlines and determine fact from opinion, to sort out bias from intent in the message. And algorithms sweep right past that. They jump to conclusions on the basis of syntax and word choice.
And I think of the speed at which, in a different category altogether, you look at your cell phone, you look at your smartphone, and I think of the speed at which texts and tweets can be hammered out without giving a second thought to them. And honestly, I view that as a scourge on civility. I look at that as a complete reversal of meaningful communication. Meaningful communication requires time and reflection to encapsulate an idea or a feeling. Maybe that’s for precision, maybe that’s for elegance, but that is completely lacking in today’s communication, and again, it’s because it’s instant.
Kevin: Then when you have algorithms analyzing the news, and buying and selling, it’s a little bit like Siri. When you’re talking to Siri on your phone, granted, she can help you with your GPS to get you somewhere, but to have a meaningful conversation with Siri, she has absolutely no idea what you’re saying to her. And to have buying and selling back and forth with this computer, what do we have? High frequency trading is over 70% on average. Is that not the case?
David: Yes, that’s correct. It reminds me of a conversation I had with a gentleman sitting on a plane ride from Austin to Durango – Austin to Dallas, and then Dallas to Durango. The gentleman had sold his technology to Google and managed, personally, multiple super-computers around the world and was trading the market every day, and was in and out of the market between 50 and 100 times per day. That technology of managing stocks on the basis of an algorithm that read headlines worked very well for him. I think to myself, what is the world of tomorrow in the world of finance where you can create your own headlines, you can create your own senses of urgency. What’s trending? You can influence what is trending. And then actually determine the course of pricing in a particular asset class.
You have Jack Ma, one of the primary owners of Ali Baba in China, and he also runs a massive financial company, which up until this last year was doing debt deals. He did 37 billion dollars in debt deals last year. And I think to myself, what does 2018 through 2020 look like for Google? Perhaps one of the evolutions in the financial markets, now that we’ve seen the ETFs become this homogenous place to invest, now the question is, how do you trade what has been homogenized? And it may be that Google financial – I don’t know that that even exists – but that may be the wave of the future. I don’t know that that is necessarily good, but again, on the basis of being able to almost create and fulfill a prophecy. Does that make any sense at all?
Kevin: It does, but I’m sitting here thinking none of this would be possible if we didn’t have the Federal Reserve, and the European Central Bank, and the Bank of Japan, fueling free money. We talked about the cost of capital. If capital cost money then people would have to make good economic decisions. Remember, Dave, before we had the last financial collapse, Alan Greenspan, who had actually created a big part of the mess that we were in with the debt, came out and said, “You know, the debt is getting a little bit too high and I’m retiring, by the way.” And so Ben Bernanke came in, and of course, we had the crash right after that. It’s almost like he saw something coming. Bill Dudley is doing the same thing right now.
David: Leaving the New York Fed. You’re right, because we can talk about the influence of technology in the world of the markets when we’re talking about over-liquid markets and misallocation of capital, because all of that works. It doesn’t matter how capital is allocated when it’s done and driven by technology, or done on the basis of there being too much liquidity and credit in the marketplace, but there is a variety of factors which can make liquidity and an abundance of credit secondary. You think about what is being initiated with the trade discussions north/south with NAFTA. That’s a potential trigger for market, royally. Then you have the trade discussions east/west with China, where we may get very mean and nasty.
And there are, again, potential triggers for market reappraisal. Bill Dudley, as you mentioned, is leaving on a sour note, although asset markets are performing better than ever. Now he is saying, “Look, debt is an issue, and the costs associated with it, if you’re going to have rising rates that could be a critical issue.” Plus look at what we’re doing with tax cuts and other things, 2018 could be a blowout year in terms of deficit spending. How does that end up being, as you circle back around to the end of 2018, absolutely crippling to the financial markets? I always love when the financial guys are leaving, the Fed guys are leaving, it’s almost like a mea culpa. “I don’t have to feel guilty about what happens. I participated, but now I’m saying I’m sorry, and please be careful.” And somehow, that absolves them from any of their previous sins.
Kevin: Well, they want to leave with their reputations intact. You’ve been talking about tightening. The European central banks are saying that they’re going to start tightening and not buying as many assets. The Federal Reserve has already said that they would do that. I thought it was interesting that Kuroda came out and said, “Oh, no, no. We’re going to absolutely stimulate like we have been. There is going to be no backing away.”
But it seems like three balls have continually been in the air since 2009-2010. You either have the Federal Reserve quantitative easing ball in the air, or you have the European Central Bank quantitative easing ball in the air. Now we have the Japanese. But when those guys at some point start to tighten – I’m wondering if that’s not what is going on with Dudley. Dudley is probably stepping aside before he knows that this asset boom is going to end.
David: With Dudley leaving I think it is also interesting to see how the New York Times has framed – this is Benjamin Applebaum last week in the New York Times suggesting a brand new approach to economic management by the Fed. And it is as if there is an anticipation, whether it is new ideas being hatched in the ivory tower, or the Fed basing new tools as they engage the market based on the latest economic theories, restructuring itself as an organization for relevance and greater effect through its monetary policy tools.
What does that look like exactly? Are they going to bump up the inflation target? Do they explore the zero bound in the context of eliminating cash a la the Rogoff and Michael Woodford approach in a neo-Keynesian Wicksellian model? It’s just fascinating, there are things in flux, and there will be a reaction in the marketplace to any new regime.
Kevin: We’ve looked in the past and usually those types of changes can only come when people cry out after a financial collapse. Do you think, actually, they will see those changes come in before – we live in a day and age — remember, the Wall Street Journal said back on January 8th, “Many investors have decided that spending money to hedge against big declines is a waste of money.” Right now the mindset is that there can be no downturn. Do you think these changes at the Fed would come before or after a downturn?
David: Right, so you have the Wall Street Journal highlighting investor enthusiasm and saying, “Look, big investors, money is being made so easily right now, why take the time?” In fact, the words used were, “Why waste the money to hedge against big declines.” And they’re saying that with the Dow at 26,000. It’s remarkable. Bloomberg says the most hated rally this is not. Equity euphoria has gripped most of the world to kick off 2018. Reflecting on Morgan Stanley and their U.S. equity strategist, he says, “Now we’ve seen a total reversal, with people having a hard time even imagining how the market could decline. We must admit, the speed and relentlessness of the move is a bit troubling.”
I go back to saying, this remind me, Kevin, of the inverse of 2016. We started very rocky. Awful January. GDP figures for the fourth quarter came out and they were stunningly low. And all of a sudden there was a reappraisal, instantly positive sentiment in the market in November and December all of a sudden turned to this catastrophic 30 days of terror. But that’s not how 2016 finished, of course. Now we have the exact opposite where it’s just like, “Who is going to take us off this trajectory? It is from here to 30,000, 40,000, 50,000. The fix is in.”
Kevin: Okay, but we’ve talked about paper assets, especially paper assets, including the digital assets like the cryptocurrencies, being ridiculously over-valued. In fact, the question has come up throughout the program – what is the value of anything? But really, if you look at commodities, which are real things, commodities right now are the cheapest in 60 years. So could that be the real value play at this point?
David: It’s funny, because they are the cheapest in 60 years compared to stocks. And of course the mainstream media will tell you that stocks are cheap compared to bonds. And you could now say that bonds are cheap compared to cryptocurrencies. And I don’t know where you go from there because I don’t know what is cheap relative to cryptocurrencies.
Kevin: Well, cryptocurrencies are still cheap relative to wooly mammoth meat. Let’s just go ahead and put it that way.
David: Yes, because that is scarce, and you can’t be forked when you’re dealing with – well, I guess you could be forked if you’re talking about wooly mammoth meat. But the number of cryptos is approaching 1400 – 1400 different cryptocurrencies. I was very amused in the last month or so to see a cigar manufacturer announce on the wire that they were going to start mining bitcoins, and their publicly traded stock went from three cents to $1.50 (laughs) before settling down in recent weeks to about 30 cents. But it’s just fascinating. You mentioned the gold market, you mentioned the commodities market. Commodities are cheap. We’ve seen a tick-up in oil, natural gas. Copper had a great year. Last year, palladium. And we had massive buying in the global exchange-traded funds for gold, mostly in Europe and in Asia. But 445 tons of buying last year, second only to the record year in 2009, and again, that was 50% higher still. But this is following 2016, which was not a shabby year either.
Kevin: So gold is being accumulated.
David: It’s being accumulated, but nobody in America knows or cares. The World Gold Council reported that Germans were the largest per capital gold buyers last year. So again, somebody sees something on the horizon, and they’re positioning ahead of time. You don’t position today for today, you position today for 18-24 months from now. And I think what investors are looking at in the German context, and the European context, and the Asian context, is for something that is on the horizon. We can’t get our nose out of today. That’s all we care about here in the United States.
Kevin: Dave, there is a man that you go to see often in New York. You go to his conferences. It costs several thousand dollars a year to read his letter – Jim Grant. One of the things that these guys – Jim Grant is included in that – these guys who supposedly predict the markets, are oftentimes asked, “Well, go ahead and tell me about 2018.” I was amused, and actually interested, to see what Jim Grant prophesied or predicted for 2018. I think he’s rolling the dice big time, but he may just be right.
David: The definition of a contrarian call is to look at the general trend, both price and enthusiasm, and move in the opposite direction. So the fact that cryptocurrencies had an amazing year – we’re talking about a 12 times increase in bitcoin, and I think closer to a 28 times increase or more in ethereum. I don’t even remember. But massive, massive increases. Grant says gold will outperform bitcoin in 2018.
Kevin: That’s pretty strong.
David: Well, it’s doubly contrarian. Not that gold underperformed in 2017, but it was off the radar, and nobody particular cares about it.
Kevin: It went up 13%.
David: Yes, but again, no one really cares about it. So the contrarians would say, “Look, things have gone so well, perhaps you should hedge your bets. And to reflect back on the Wall Street Journal article, January 8th, “Many investors have decided that spending money to hedge against big declines is a waste of money,” the contrarian will say, “Many investors are usually wrong.” The majority is always wrong. If most people today think that it doesn’t make sense to hedge, this is probably the best time to consider it. Again, maybe that is merely a contrarian play, but I think that is where some of your smart money is going to end up. Whether it is gold, or short the market, you will find that. So, as a reminder, join us for the last quarter’s call, a Tactical Short Quarterly Conference Call, this week.
Kevin: That’s on Thursday.
David: That’s correct. Join us on Thursday for that.
Something to consider – maybe the best move is to look at how this year ends, instead of how it began.