The Exhaustion Of Sellers Is The Birthplace of Bull Markets

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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

“What happens when the anchor is released? Again, if they have been anchoring rates, what happens when rates are unanchored? Listen, I think monetary policy alone makes this one of the most fascinating years as an investor in a long time. That may sound like the observation of a dork, but monetary policy is going to be very interesting in its impact into the financial markets for 2018.”

– David McAlvany

Kevin: Last night, Dave, when we were sitting and talking, we were talking about navigation and how important it is as human beings to be navigators, to know where we are, know where we’re going. I brought up to you that I had read a fascinating study that neuroscientists have found that we have something called grid cells and the same thing that allows us to navigate, either in the ocean or across the city, those same brain cells are the same cells that we use when we remember where we are in life and memories from the past. The study was basically bringing out the danger of just using GPS and turning those cells off, because it is actually affecting our memory.

David: It is interesting, the U.S. Naval Academy, back in 2015, as you have told me, is back to teaching celestial navigation. There was a ten-year gap where they thought that electric navigation was all they needed. All the electronics and the GPS was what they had so they quit in 2005, preferring the more modern contemporary. And lo and behold, 2015 rolls around and they need the people who are piloting our ships to know how to find a course in open water using celestial navigation.

Kevin: How often have you and I been travelling and we have needed to use GPS. I remember when we were in Zurich, Switzerland. Without a GPS I have no idea how anybody gets around, but I can tell you, I really don’t know my sense of direction. The cities where I rely on GPS, if I were placed there without the GPS I wouldn’t really understand where I have been.

David: The reality is, you could have finished that sentenced differently and said, “You realize the number of places we have traveled and I’ve been taking sun shots so that I could practice my own celestial navigation.”

Kevin: (laughs)

David: Because you are one of the few people that I know who uses a sextant on a regular basis.

Kevin: And I was doing that this weekend while you were actually doing another sense of direction for people. I was taking sun shots and working out the math just because I think it’s almost like magic. I told my wife, “It’s just like magic to be able to take two sun shots with a sextant and then go and do the math and draw it out on a map and know exactly where you are.

You were talking to students, I think mainly Korean students, this weekend in San Diego about the same type of thing, but it was more about life. These are highly educated Korean students that you were trying to teach also that you have to have a sense of perspective. You have to not just have knowledge or facts like a GPS would give you, but you also have to have a sense of perspective as to where you are and where you are going.

David: You are right, I spent the weekend with a group of Korean students in San Diego, and the conversation started with, “We’re going on an expedition, and as we go on an expedition we have to consider where we are, and where we are going, who we are in the process, what resources we have, what skills we have, and if you wanted to think in terms of double column accounting, if you wanted to think of an audit of everything that you have, what are you going to need on this expedition? A pair of boots, a backpack, water, enough food – how long are you going to be on the trip? So everything is dependent on the scope of the expedition.

Kevin: One of the things that separates, sometimes, the East from the West, is the emphasis in the Korean culture of education and hard work. This is not a group of people that necessarily is lazy about their learning.

David: Not at all. In fact, that is a huge highlight, and I think a huge relative advantage to a lot of U.S. students. The Korean culture has a major emphasis on education and hard work. It was interesting, I sat next to a UCSD, University of California San Diego, graduate faculty member on the plane ride out to San Diego. His view of higher education was carefully worded, but one thing was clear, that critical thinking and logical analysis are not a part of the modern educational framework. At least, that is his experience working in the graduate faculty.

Back to the group of Koreans, because that doesn’t necessarily apply to them, but I see these things like education and hard work being a cultural norm. Entrepreneurship is not as common in the Korean culture, with a lot of financial resources tied up in just a few conglomerate companies, but education is emphasized as a way forward. Net-net, you have students that are prepared for college, they choose majors with rigor. There were a lot of engineering, math and science degrees in the room. And they are a very tight-knit community, whether they stay in the U.S. for employment or head back to South Korea to pursue job prospects there.

I would encourage any student in this day and age to balance credentials with job experience. A degree anymore is a dime a dozen, even from a very good school, and that was echoed by the gentleman I sat with from UCSD and the graduate faculty. He said, “Look, we get a lot of people who apply to our programs, and they’re coming from Harvard and Princeton and Yale to do graduate work with us. We have a very specialized program, and I can tell you, even coming from the Ivy League, critical thinking is lacking.”

Kevin: Dave, look at how you, yourself, hire. Education is important, but that’s not the first thing that you look at.

David: It’s very important, and continuing education is obviously something we care a great deal about. What stands out is someone that has know-how, that has problem solving ability, that has experience, and is not afraid of hard work. That, anymore, is a rare commodity. And I think someone who can communicate well, too, whether it is in written form or verbally.

Kevin: Dave, there have been people who have applied to work here, and obviously, we won’t name names, but they had sort of a sense of entitlement based on the degree that they had, and by the college that they had gotten it from.

David: But fascinatingly, some of those graduates from state universities – not this weekend, mind you – that we have had the opportunity to interview, can’t read or write at a high school graduate’s level, and yet they have degrees from a university. So the degree factories are not just an Internet phenomenon. When I’m hiring, I look for experience and proof that someone is eager to make a contribution, that they are eager to engage, that they are eager to learn. Because frankly, there is nothing more professionally appalling that having to sit by someone’s side, working with them every day, who thinks they know everything when they don’t, and is unwilling and unable to grow on the job and continue to learn.

So I think many of the themes that we discussed this weekend dealt with identity, and dealt with accounting for strengths and weaknesses. Because again, it’s a question of trajectory – life trajectory and that idea of an expedition – knowing where you are going is certainly helpful if you know what you’re capable of doing and who you are, that certainly is a part of that original accounting function.

Kevin: Also, Dave, with your thrust and focus on legacy, a big part of legacy is gifting your skills and your resources to someone else. A giving spirit – it’s an amazing thing – an educated person who is a hard worker, who also can give to the community or to the business or to his family – that’s what builds legacy.

David: Right. And I think the guy that coordinated this event, this group, was very solid. He is a molecular biologist who is investing so much back into his community. That was, frankly, really challenging to me this weekend. I had to ask myself if I’m doing enough of that. I appreciated the holistic approach that he has taken over the years of encouraging the comprehensive growth and development with these students. I know there will be some rising stars from that group – one, based on the raw talent and the hard work that they have put in – two, their education, and of course, their aspirations from here, but also, based on the guidance and mentorship that he is providing. He left me inspired, and the whole weekend reminded me that our little ecosystems, wherever you live or whatever community you are in, are better or worse based on your willingness to make that investment in others.

Kevin: Dave, we know that hard work, education, a giving personality, a legacy mindset, identity – all those things that you talk about – that is really the road to success. But in a way, we have cheated. Sometimes you can conjure a genie and you can say, “Well, I don’t want to do that, I just want my wishes to come true.” I think about the way the economy has worked over the last 20, 30, 40 years. It has been based on debt that we know that we can’t pay. After the financial crisis we could have had a cleanout and a restart of hard work, but instead we had quantitative easing – just printing money out of thin air. That makes us not feel the pain now, but sometimes the pain is what inspires you to move out of the fire.

David: The conversation that I have had with both my three-year-old and six-year-old in the last few days has been about removing limitations. We think about wishes, and there being three wishes and the genie in the bottle. Well, they have figured out that if one of your three wishes is an infinite number of wishes then you can have whatever you want, and there is no cost to it. And I think they are actually borrowing from the current Fed playbook.

Kevin: That’s the quantitative easing of the wish list.

David: That’s exactly right. Who needs limitations? Who said three was an arbitrary number?

Kevin: Yes, but something is lost, Dave, when you do that. If you think that you’re going to get a wish without actually having worked for it, you’re robbing something – you’re robbing Peter to pay Paul.

David: The old quote, “If wishes were horses, beggars would ride.” I think Stephanie Pomboy commented this last week about QE and how it has robbed a generation of their retirement. She went on to say that now they’re taking all the jobs away from new entrants. We have the labor force participation of 20-to-24-year-olds – this is very apropos to the group that I just spoke to – labor force participation of this group of 20-to-24-year-olds is the lowest in 45 years, and if you’re looking at those numbers for 18-to-19-year-olds it’s stuck at its lowest levels in history.

That is not meant to be a downer for young listeners, but a very strong reminder of the importance of internships and of job experience because no one pays you to be you when you graduate. You have to prove you can do stuff, and you have to do it well. What you know, in terms of head knowledge, that’s all well and good, I’m all for a broad-based education, I’m a liberal arts guy, myself, but a career is game time for the doers. In the next ten years, I think, if you are lazy, you are toast. But there is always opportunity for the hard-working. There is always hiring, even in a declining economy, for those that aren’t afraid to work.

Kevin: It reminds me – who are the people that we actually look up to? Inspiration is the word that I come up with – someone who inspires you. It’s not inspiring to have somebody who just feels that they deserve it, but inspiration usually is something that shows up when a person actually has to face adversity to get to the place that they are looking to.

David: Yes, and I know there is discussion this weekend with Trump playing hardball through the weekend, coming away with a victory, at least for this round, on the DACA and the government – it won’t be on furlough until February 8^th. But I think about folks coming into the United States and what they are willing to put in, and I was absolutely inspired by one young gentleman that I met this weekend. He started his business eight years ago, and he runs a very successful business – a very successful business. Now, he is 22 years old, and he is working this year on moving from electrical contracting, just on a commercial and residential basis, to getting contracts with the navy. He finished his college degree this year. He is applying to study international business.

And I just thought to myself how I marvel at the nature of this country. This is a great place. You come here, you invest deeply, you work hard, and anything is possible. I was sitting there talking with a living example – a 22-year-old who is a “make it happen” guy. He is a “roll up your sleeves and get it done” guy. At times I feel cynical about the direction of our country, and then at times I look and I say, “It’s as good as it’s ever been because there is still opportunity, and there is still people taking it, and there is still people doing something with it. And they are writing their own tickets. Nobody is giving them anything. They’re willing to work for it. And this 22-year-old – do the math – who started his business eight years earlier – yes, that means he was not even in high school and he was starting in the electrical contracting business. Amazing! I love it.

Kevin: And see, that’s inspirational. That’s not falsifying success. Now, I look at the opposite side. I’m not trying to draw it back to the negative, but the Federal Reserve is finalizing the loosening of capital requirements for banks, which means they are encouraging more debt, more leverage, at a period of time when we are really hitting historic highs as far as the leverage and margin accounts go.

David: It’s curious that leverage is being increased for banks at this point in the cycle. The Fed is arguing that this should happen, and they are trying to make it happen, much to the chagrin of the FDIC. The FDIC, of course, is not in agreement because they are the ones with the first dollar at risk. I guess I did not use the singular accidentally. They lose the first dollar. We already know the second verse of that song. The U.S. taxpayers, baby, we pick up the tab.

Think about the context. The markets are over-heating, we are at full employment, the Fed is satisfied with our economic growth, we are very near the 2% target rate for inflation that the Fed has put out there, and we need more leverage in the banking system now? That’s really puzzling to me, it’s almost as if they’re not making decisions contextually, by maybe if you fast forward to the end of 2018 we know from the tax cuts, and several other reasons, we’ll be running a very significant deficit this year. Maybe loosening leverage with the banks is a way to accommodate more treasury purchases as we head into 2018 – Deficitlandia.

Kevin: Isn’t this exactly what happens at the end of every cycle? Instead of tightening things up you actually loosen things up because it can only get better?

David: Treasury yields moved past Bill Gross’s demarcation line this last week of 2.5%. We finished at 2.66% on the ten-year. And in his humble opinion, that line of demarcation marks the end of a 30-year bond bull market, with yields falling and prices rising in fits and starts during that entire time. Is it possible that the winds are changing?

Kevin: Well, they’re talking about normalizing, which means raising rates. That is what the Federal Reserve has begun to do. What happens when we normalize?

David: That’s right, so we start with normalization. Is that the first release for bond yield suppression, for them to follow, that is, rates, a more natural course, and seek a natural level? We have Carmen Reinhart talking about finally seeking the natural rate of interest, what she calls the R-star. And the reality is, if you do that in certain parts of the world, it is going to have massive consequences.

Germans need to normalize. Why? Because they’re below 4% on their unemployment and they want to make a decision. They’re pressuring the ECB to make a decision that represents responsible decision-making as far as the German universe is concerned. But you have EU unemployment that still hovers around 9%. And so what happens when you start raising interest rates in Europe? The ECB does that simply by stepping away from their bond purchase program. And now you’re talking about the interest coverage ratios in a lot of your peripheral European countries which can go haywire.

Kevin: Right, when Germany sneezes, Spain goes into pneumonia.

David: Just watching in reverse, what got the problem in Europe started, and led to the worst of the crisis by 2010-2011, which was lowering rates, and everyone across Europe getting the benefit of being treated like a German credit.

Kevin: This is the opposite of that.

David: Exactly. But you have rates rising, and it will have its ramifications across that universe, but without the same economic engine driving the ability to repay interest on the amount of debt that has accrued in the interim. So we talked about the ECB, we talked about the Bank of Japan. There is the Chinese, as well, not that they are necessarily going to restrict credit in 2018 – that remains to be seen. Maybe they will, maybe they won’t. But I’m thinking about the other side of the equation for the U.S. – the Chinese being on the other side of our financing activities. In other words, rates rising without the degree of interventions of the central banks, even as the U.S. marches toward fiscal deficits nearing a trillion dollars, in the environment of the Chinese trimming treasury purchases.

Kevin: Right. You have to get people to loan you that money if you’re going to run a deficit.

David: Yes, so the U.S. Treasury may have to count on the bond market to absorb twice what it did last year as more debt is offered and less debt is taken by the central bank buyers, which have become the buyers of first resort, not the buyers of last resort.

Kevin: Do you think this is why we are starting to see the degradation of the dollar? We lost 9% or 10%, 11% last year on the dollar, and it seems to be continuing into 2018.

David: Yes, and I think whatever happens short-term in a number of asset classes is less relevant to the trends which we’re beginning to see develop. So in a continuation of 2017 we had the “bad for the dollar” scenario where bond prices give up ground, so yields are rising, bond prices dropping. Maybe equity prices suffer at the same time from eroding interests from foreign investors.

Kevin: What does that do to gold?

David: It should continue higher. You have overseas investors who have to weigh potential capital gains in the asset class, whether it is stocks or bonds, what have you. Weigh that against the currency losses that they might get hit with, which serves as a reason to stay away from U.S. equities and bonds. And it seems reasonable to see a continued interest in precious metals in that environment, particularly by overseas buyers. We saw that last year, the dollar was down 11%, and certainly the demand for gold overseas was very robust, even if it was almost non-existent here in the United States. The rest of world buying, non U.S., was the dominant reason – it was the dominant reason – for 2017 gold price increases. And the motivators have likely remained in place for 2018.

Some things to watch – you have the gold-silver ratio which is hanging back, waiting to confirm any real, substantive move higher in U.S. dollar terms for the gold price. And I would expect a move above, say, $1400 an ounce for gold will trigger a silver price catch-up, and that will be the next real shift in that ratio. Currently you are in the high 70s. You could see that ratio well into the 50s. Again, silver has lagged. It lagged last year. I think a break at above $1400 on the gold price, which I would say is not immediate, that is probably summer to fall, would trigger silver leading into the close of 2018 – leading in terms of returns, leading in terms of profits, and ultimately, shrinking that gold-silver ratio.

So I think we have initial springtime volatility, get past the Chinese New Year, and that is going to present an excellent buying opportunity in both the metals and the miners. So the current uptrend – and this is sort of minutiae, maybe it doesn’t even matter to our listeners, but the current uptrend has become very popular in the futures pits. So you’re talking about position traders in futures contracts. You have a high percentage that is rabidly bullish, and that generally is about the time that the market cools off a little bit, which is, again, why I think we cool off into the spring and then start to see things pick up in the summer and fall, maybe look for the big increases in price post Ramadan.

Kevin: From a gold perspective, Dave, it has been a breath of fresh air, actually, to see this sentiment that has been so pervasive, here in America anyway, the last three or four years, to be shifting. What is amazing to me is that in the East, if we were in China, we would have never felt the sentiment change. The buying has been record buying for the last few years. But here in America it is very different. The sentiment has been bearish on gold and silver as it rose.

David: Yes, this is year three of that sentiment shift for the metals. For most people, the asset class was left for dead somewhere between 2014 and 2015. And they’re not following the current stabilization in price. They’re not aware that that stabilization process began December of 2015, and the advances that the metals have made since then. So we are warming up for the good stuff in the gold market later this year, so I would be patient. But be smart, and add to positions on any weakness. That is a strong recommendation.

Kevin: You brought up earlier that the country is going to be going into more debt, and actually worldwide, more debt, and I’m wondering if there is going to be pressure applied. You brought up Carmen Reinhart, and I can’t think of Carmen Reinhart without thinking of Ken Rogoff, and thinking about closing the loop or creating a captive audience. Do you think that these debt markets are going to be pressuring the individual investor to be the buyer since the central bankers are backing away?

David: Yes, I think that is a reality. The Financial Times, this last week, suggested as much, as well. Going back to the debt markets, you have the pressure from governments globally, which will be to finance more debt from private investors rather than through their central banks, so financing more from private investors for the first time in four years. You have private investors who are going to be prodded to do so as the central banks are stepping back. Again, this is stepping back from an environment that has set record low yields in Europe and Japan.

Kevin: Those record low yields came from a guaranteed buyer. The central bankers were coming in and buying virtually all the debt, so of course, the yields could be as low as they wanted to.

David: Exactly, so it’s directly linked to official purchases. Now, you have the ECB purchases for 2018, the year-on-year decline is going to be 222 billion as the estimate for 2018, down from 622 billion last year. Again, the difference – 400 billion of market purchases in European debt. That issuance in the U.S., similarly, as expected by J.P. Morgan, to be 828 billion. That is what is going to need to be financed this year, compared to last year of 357 billion.

Kevin: I’m looking at this as an investor and I’m thinking, if I were to buy sovereign debt right now, am I really making a return? We’re at record lows. Why in the world, other than just simply having liquidity, or having security, why would I buy it?

David: Right. What most people don’t keep in mind when they think about the bond market is how volatile it actually is. In any one year you can have a swing in terms of the yields of 20-40%, particularly, coming off of basic basement level numbers that we see today. You wonder if buying sovereigns isn’t an invitation to immediately give up the equivalent of one, two, three years’ worth of income from that bond price volatility. Is there any rationale for doing this, where the investor says, “Yes, I want to own government debt?” Maybe the hope is that there appreciation in the currency of choice, say, perhaps the euro. And that makes up for the other side of the losses and puts you in the net gain. So for instance, if we have dollar weakness and euro strength, is there a real possibility for 2018 to be a reasonable gamble on euro debt? Does that make sense?

Kevin: Yes, but are you going to touch European debt, Dave?

David: Personally, no, not with a ten-foot pole. The idea of picking up pennies in front of a steamroller comes vividly to mind. Actually, in Europe you have fractions of a penny when you’re talking about real terms. Factor in inflation and it is fractions of a penny. So if the European Central Bank and the Bank of Japan have anchored the global interest rate market and thereby have provided tailwinds to the financial asset market as a whole, you have Bret Barker over at TCW Asset Management who asks, “What happens when the anchor is released?”

Again, if they’ve been anchoring rates, what happens when rates are unanchored? I think monetary policy alone makes this one of the most fascinating years as an investor in a long time. That may sound like the observation of a dork, but monetary policy is going to be very interesting in its impact into the financial markets for 2018.

Kevin: When longer-term trends change you don’t want to be fooled by short-term changes in the motion. We have seen the dollar falling over the last year. It is possible that we could see a bounce in here. Wouldn’t that be technically expected?

David: Yes, so with gold, what we said earlier is that sentiment has changed and this is the third year of there being a positive sentiment. Now, in that three-year period there have been ups and down, and ebbs and flows, and we’re likely to see some more ups and downs, and ebbs and flows, in 2018 for the gold price. But we’re talking about short-term sentiment versus what is being established as a longer-term trend. Charts would suggest that the dollar will likely bounce in the short run, if you’re talking about the days and weeks ahead, and what does that spell for gold? Probably gold dropping back. I don’t know, is that 20 bucks? Is that 50 bucks? Is it 75 bucks? It is still maintaining its 2015 to present uptrend. You have the euro, again, if you’re looking at charts of the euro, technically, the euro temporarily rolls over. In that case, again, you could see dollar strength, gold weakness. Those are just some of the thoughts that are top of mind as we look at the short run.

Kevin: But look toward the end of the year, the longer run.

David: Year-end, I think one of the top performing asset classes will be precious metals miners. We mentioned that Jim Grant, last week, thought gold would outperform bitcoin handily in 2018. I think these are asset classes that you need to pay attention to. These are strong recommendations for 2018. Own your metals, own your metals miners, own enough to make a difference. Silver, too. You want to own enough to make a difference.

And finally, I think one area of overlooked value, and it is idiosyncratic for most people, but sort of directly in our wheelhouse – the U.S. coin market. That is a very semi-esoteric category – the semi-collectible coin market.

Kevin: It is the most neglected market, probably, in the nation right now, Dave.

David: It’s because it saw no traffic in 2017. It sought zero traffic in 2017 and the premiums typical to that space when U.S. buyers are present, have been crushed. So over the last year or two the value has been there. And the value remains there, I think. As a proposition for investors, there is a huge value play there. A break above $1400 on the spot price will bring U.S. buyers back, and these record low premiums will disappear. Again, I view that as another area to dabble in. Even if you’re typically a bullion buyer, you could have outperformance by year-end. That would not surprise me.

Kevin: Drew Crowell has been with the business now for 36 years. Talking about not buying sight unseen, even the ones he sees, it is very hard for us to keep supply of the quality that he likes. That is where the double play comes in. We’ve seen it a number of times, Dave, over the last few decades where this space becomes neglected, and then when the gold price starts to go back up you can’t get these coins anymore and the premiums just go through the roof.

David: Right, because again, it’s a double play on the scarcity, which feeds off of supply and demand, and pushes the premiums in either direction depending on the flow. So the same dynamic that helps you, has in the last five years hurt you. But it also harnesses the gold price move. So what do you have ahead once you’ve gotten to the rock bottom levels? It’s almost like saying, “Where do you think interest rates will be five to ten years from now? Lower from here, or higher from here?” This is not the work of a rocket scientist. Where do you think premiums on these kinds of coins will be five years from now, or maybe even five months from now? Lower or higher? Well, they’ve never been lower.

Kevin: Some of these things become obvious only through a lifetime of watching and talking to people who have lived lifetimes before you. You and I live a short lifetime, but after doing this 20-30 years, you living in a family that has done it 45-46 years, and then talking to people who have done it even longer, we can look at things like platinum and palladium, Dave, and we can say, “Well, you know, platinum and palladium are never at a 1-to-1 ratio for long, and so platinum, right now, is a buy, as well.”

David: Exactly. These are the things that are in our discount column, whether it is silver at a 78-79-to-1 ratio, whether it is the gold and silver miners, whether it is the U.S. coin market, whether it is platinum. Platinum was at extreme discounts.

Kevin: Yes.

David: We talked about this last year and the Wealth Management Group made those purchases for our clients, and I think on the precious metal side you guys did, too. And it has already been a profitable trade. So it seems to me that there is a large part of success in investing which is identifying value, and then secondly, having an adequate timeframe to allow for a market revaluation of the asset class. So again, you’re talking about cycles and trends.

Our wealth management team had to wait a year longer than we wanted to, on our natural gas play, just as an example. But it has worked out as expected, just not when we hoped it would. Dividends are north of 8%, capital gains are accruing, but it took time. So you find value, then you must wait. If you don’t have some of those basic components as an investor, just as a sort of a disposition, you should probably join the Keynesian piper’s call, get in line and start spending everything that you have.

Kevin: Dave, we were talking about a sense of perspective and knowing where you are. I remember reading a book years ago about British special forces going in during the first Iraq war. The practice in British special forces is, when you are dropped in behind enemy lines to do nothing for ten minutes. It’s called “take an appreciation.”

David: Appreciation.

Kevin: We’ve talked about that before. When you’re talking about identifying value, waiting is sometimes the biggest part of investing. You stop, you take an appreciation, and that way, when you do make a move you know that it’s not stupid, and done without any sense of perspective.

David: Right. Al we know is the emotional pendulum swing from over-valued to under-valued, and that happens so routinely, that’s the nature of the markets – over-valuation to under-valuation, to over-valuation to under-valuation.

Kevin: And you can get caught reacting to that instead of pro-acting to it.

David: It’s the pattern of markets, it’s driven by greed and fear, with an occasional dash of hope. And it is happening – the pendulum swing is happening all the time. But rarely do people take the time to ask where they are in the cycle. Investor preference is to discover something, work themselves into an emotional buy point, up to an emotional buy point, and take the plunge. Basically, they feel good based on evidence that they have selectively gathered to support the case for action, meanwhile, ignoring any indicators that might contradict their desires. I say desires because it is, actually, desires that motivate people – desires for security and safety, desires for greater wealth, desires for an avoidance of pain.

Kevin: Look at the emotional feeling right now. A person can be either a liberal or a conservative – it doesn’t matter. There is a general feeling right now that the stock market can only go up.

David: Right, even as the stock market has moved toward an exhaustion top, and this has been a top in the making for the last two years. You have had a 50% gain from the election night Trump victory to the present. Again, that is an accelerating trend which is already in place, and so while you’re moving toward exhaustion in the stock market, you have exhaustion of another kind that is being felt in the metals market. There is an exhaustion of sellers rather than buyers. More on that in a moment.

Back of America, Merrill Lynch, has told their investors that here is what they see – boosting of stock allocations to two-year highs, that’s what everyone is doing on their platforms – and their investors have cut cash to five-year lows on the expectation that the equity bull will carry well into 2019. You have Goldman-Sachs observing this last week in a technical piece, that risk appetite is at its highest level on record. And in the midst of all this enthusiasm comes a sane voice from PIMCO. Joaquin Fells said in a recent Bloomberg interview that the fact that fear is gone is the main reason why we should be worried.

Kevin: Isn’t that the time that you put the hedge on? When the fear is gone, at that point either you bet the other direction, or you at least hedge your bet.

David: Yesterday I spoke with our team about a Kansas City money manager, and the firm owner, personally very wealthy, has hired a short specialist for his own personal account.

Kevin: It sounds like Doug Noland, only it’s a different short specialist.

David: That’s right, but note, it’s not an offering for clients. Smart money sees the bull trend fading, many are not willing to openly speak of it because it would be bad for business. People understand over-valuation. Robert Shiller, who popularized the Cyclically Adjusted Price Earnings Ratio, is out all over the place in the press saying, “This is dangerous. You can’t do this. You have to be very cautious in the markets because the Shiller PE is telling you something. If you’re listening, it’s telling you something. Is anyone listening? And believe it or not, in this period of market topping, no one is listening.

Kevin: The Tactical Short Conference Call last week was probably one of the clearest indicators. People need to pay attention and listen to that. I think we should post that, Dave, it was recorded. For a person who is listening and wants to hear Doug Noland’s most current thoughts, that would probably be the place to go. We can post that here on this particular site.

David: Yes, it’s about an hour if you want to listen to it. If you prefer to read it this week, the transcript should be posted, and I think this is going to be an exciting year for Doug Noland and our team. We hope we can help you hedge exposures. We hope that there is profit in 2018. And yes, that would be on the other side of a market that is seeing more volatility in 2018 than it did in 2017.

Kevin: Dave, it is human nature to look back at history and say, “Oh, my gosh, if I would have just invested with that.” We were talking about Intel and the computer chip, and if we were just to have invested in crypto-currencies or bitcoin at a certain time. Oftentimes those “what ifs” have an awful lot of danger in them. But there are times when you can say, “I can go to the birthplace of a bull market. What if you could go back before personal computers were around and invest in Intel? That would have been a great thing. But the birthplace of bull markets is usually where you find an exhaustion of sellers.

David: You’re right, Kevin, three are so many things that we see in retrospect that we wouldn’t have understood in real time, whether it is the Intel chip in 1978, the 16-bit chip which was invented, or the Windows Operating System in 1985. Who knew, and who cared? And yet, we know the significance of them today in retrospect. One thing we do see, although we can’t necessarily know all of the technological innovations and changes which will define tomorrow, we do know the defining factors in the market which are sentiment. An exhaustion of sellers is the birthplace of a bull market.

Kevin: It’s just so hard to go there because nobody else is there. If you’re buying something where everyone else is just exhausted selling, you look like an idiot.

David: You’re going against the trend, just like the exhaustion of buyers represents the birthplace of a bear market, and a bear market decline. Last week, Wednesday, was an indicator. This is worth thinking about. It’s just a day, and it’s no particular day in the stock market, a mild down day, but last week, Wednesday, was an indicator. A day that, if you’re looking at technical price behavior, suggests that the market participants are growing skeptical about the duration of this move higher in stocks. You have the Dow which opened up very strong in the morning. It went to new highs, took us above 26,000, but closed at a loss for the day.

I just want you to keep that pattern in mind because we’re going to see more days like that in the weeks and months ahead, as sophisticated investors are fishing for a top, they want to call it, they’re beginning to get out of the way of downside. Again, when you have a bull trend it carries through and there is momentum. That kind of a movement, what we saw last Wednesday – you will see it again. You will see it maybe two, three, four, maybe even ten times before the end of this bull run, but it tells you that the smart money is looking for the top.

Kevin: It’s like in sailing, you have that little yarn at the top of the mast, and it’s called a telltale. And you’re starting to see the wind change just a little bit. It’s not quite obvious yet. But we’ve seen bull markets before Dave, and people also look for excuses to keep buying. We’ve looked at how the Federal Reserve is loosening the credit requirements for banks and actually encouraging more debt. Look at IBM. Right now people are looking for an excuse to say, “Yes this is still the beginning of a great bull market.

David: That had to be one of the most inane, or insane, Wall Street calls I’ve seen in, say, five to ten years. IBM takes the cake this time, because yes, IBM revenue increased for the first time in 23 quarters. We have been harping on IBM for a long time.

Kevin: Right, because they kept losing money every quarter.

David: Right, and no one seems to care. The stock price continues to go up, and they’re not really measured on the basis of performance. But IBM revenue increases for the first time in 23 quarters, which is like a modern miracle for the company. You have Barclay’s which comes out and picks it as a top stock for 2018.

Kevin: (laughs)

David: Now, we all know that the Trump tax plan is good for corporate America and big businesses, right? It’s reducing their tax burden. But how you figure IBM is going to win on that one when their effective tax rate for 2017 was 6%?

Kevin: And they were still losing money. Their effective tax rate was 6%, and they were still losing money until this last quarter.

David: That’s right. Call it 12% if you’re looking at discrete tax items. But that tax bracket allowed them to beat earnings expectations by a penny.

Kevin: Right, yet they’re the top stock pick for 2018.

David: By Barclay’s – one of them. Just remember 2018 as the year of pennies and steamrollers.

Kevin: Yes, it’s hard to forget that analogy, Dave. Sometimes you go for those last few pennies just before getting run over by the steamroller.