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The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

November 28, 2018

Kevin:It’s that time of year again, Dave. Every year we have asked for questions from our listeners, and they have responded. So we are asking our listeners today to send us any questions you would like to have answered in the next few weeks to

David:We’re looking forward to them. We always do. This is one of our favorite things to do each year, engaging with you directly, and points of curiosity, whether it is technical to the markets or theoretical to economics or very practical to your particular portfolio concerns, we will do our best to take all those in stride. And where we don’t have answers we will certainly seek them out for you.

Kevin:Again, that is

*     *     *

The S&P and the Dow – they are down, less than 2% for the year. They gave up all their gains from earlier. The NASDAQ 100 is still positive by 2%. It has given up a lot. It has given up 20% plus, and all of that since the beginning of October! So only now – only now – is there some concern among the major investment houses that this may turn into a protracted bear market.”

– David McAlvany

Kevin:Boy, another year is over. Thanksgiving is over, and you just got back from your in-laws down in Texas. You have some family traditions that you do every year – looking for the walking staff is one of them. Tell the listeners a little bit about what you do when you go down to the ranch in Houston.

David:Out at the ranch there is fishing, there is hunting, there is hiking, and there is, as you mention, an ironwood tree. We are always looking for the perfect Shillelagh, or walking stick. We do a variety of things. This year I did spend a good bit of time with my daughter, teaching her how to shoot a .22.

Kevin:Each of your kids have learned to shoot on that property, haven’t they? You shoot .22s at targets that are set up? You have enough room to do that?

David:Yes, that’s right.

Kevin:And this time it was your youngest daughter.

David:Yes, it’s a good time for them to spend with grandparents. Each of them have a calf or two which is being raised on the ranch, so they always want to go out and see the calves and see how they have grown and if they are pregnant and going to have another calf in the future. All of that is their soft approach to ranching.

Kevin:It is one of the many ways, though, that you are teaching them about business. I think about business versus productivity, like having a cow, raising it, seeing how that works, selling it and taking that money and putting it elsewhere. I think of that as a good business practice.

But Dave, look back at last year at this time. We were talking about the craze, the rage, what looked like tulip bulb mania that was going on in the cryptocurrencies. Remember what bitcoin was doing this time last year?

David:I can’t help but think of the fascination there is with cycles and sometimes the dumbfoundedness there is with a complete cycle. I took my four-year-old to the boneyard. We’re out on a ranch, and animals live and animals die. This is the full cycle of life. It does happen. He just couldn’t believe that two mules had died and there were the bones from a number of cows. It was overwhelming to him and he came back and said, “Have you seen the dead animals?” And of course, my mother-in-law was thinking, “What are you talking about? Who has died?”

Kevin:But when you are four, this is your first exposure to that.

David:First exposure to the full cycle of life. There is the full cycle of any asset class, and certainly Solomon was keen in reminding us that there are these cycles. Things rise, things fall, and there is a time for everything under the sun.

Kevin:Honestly, Dave, there may be a place for blockchain technology, but what was going on last year was typical of almost any cycle that had gotten out of hand.

David:It has been a while since we have discussed cryptocurrencies. Just a quick score card – bitcoin is still the largest, making up about 53% of the known cryptocurrency universe. It is down 71.6% since January 1st,, so year-to-date, down 72% roughly, and over 80% from its peak in December of 2017. In the last week, the decline from $5500 t0 $3700 has been quite swift, and remember, the peak was $19,000 last December, so from $19,000 to $3700. Again, we’re kind of dealing with the life cycle of an asset class.

Kevin:How about Ripple? Remember when Bernanke was talking about how Ripple was his pick?

David:I think for good reason, there is an interesting element to the technology. It is now the second-largest, but that hasn’t prevented it from being in decline, down 84% from January 1, and down 90% from its peak valuation. Ethereum is kind of the third heavy-hitter. It is down 86% since January 1stand 92% from its all-time highs. This is more than a bear market decline, and I would say that, at least in terms of the numbers, it looks like capitulation. But it is fascinating, as I talk to folks in the cryptocurrency space or those who still own it, they are unflappable in their views of where the cryptocurrency markets are going. I noted that the CEO of is in the process of selling his retail business or the retail business that he leads.

Kevin:We interviewed him ten years ago.

David:That’s right. And he is launching a cryptocurrency alternative, so it is not as if the theme is over. Again, there is a life cycle and I don’t know where exactly we are in the life cycle, but at least for the true believers, it is far from dead.

Kevin:What I sense from people who are buying cryptocurrencies is that there are a number of them that do it for an ideology because there is this burning need to have something like what gold has been through the years, something that is outside of a manipulated and controlled system. So there probably is a place for cryptocurrencies if the individual was allowed to be the individual. But let me ask you, will the people who control the people with currency, controlling the markets, what have you – do you think they are really going to give up that control?

David:This is an interesting point because I don’t think anything has changed in my view of the future utility of the blockchain. or certain iterations of it that we call cryptocurrencies. But following our conversation with Oscar Gandy last week, I’m not sure that the greatest value in the cryptocurrencies isn’t also, at some point, a menace to privacy and freedom. I guess this is in their future and final iteration.

I admit, I may have an overactive and overly suspicious imagination, but what are they, in essence? They are a simple ledger system, a database, with a record of transactions, which is difficult to change or manipulate, and as time goes on, almost impossible to change. I realize the current iterations offer privacy of some sort, but I think it is naïve to think of them long-term. Let’s face it, privacy in 2018 is really not possible. Privacy in the year 2018, let alone 2020 or 2030 – it is only possibly if you are talking about a remote, uninhabited island in the Pacific.

Kevin:Think about it, Dave. If, honestly, you were looking to peacefully keep the peace but control the people, you are going to want them to believe that they have freedom and independence in a period of time when they don’t. That’s what we talked about with The Panoptic Sortlast week. The panopticon, when you go back and look at the design of that prison, it actually looked like it was giving prisoners more freedom, but in reality they were being observed at different times and it changed their behavior.

So what we see with cryptocurrencies, again, this zeal, and I think sometimes people can transfer an idea of a good idea into – “Oh, this means the price is going to go up.” But that’s not always the case. You can have a good idea and not know, necessarily, what the future is. Let’s face it, last year when it hit $19,000, at that time it was overpriced. This year proves that.

David:Oscar’s discussion of TGI, which was his acronym for Transaction-Generated Identity, the characterization of individuals in order to better understand their behavior patterns, their buying patterns, and predictably come up with what they will do under certain circumstances – correcting behavior if need be, controlling choices, or, from a marketer’s perspective, just putting the most appetizing piece of cheese in front of the right mouse. This is really what we’re talking about. It is already on display. We see that in venues like Facebook and Google. I think what blockchain enhances is the immutable nature of data. That is essentially what blockchain does.

Kevin:You brought up last week, isn’t it good to sometimes forget?

David:(laughs) Again, this is maybe me being suspicious, or having an overactive imagination, but there is a value in being able to forget. There are times when forgetting is very helpful. We have that in our bankruptcy code which allows for a different version of risk-taking in America than any other place in the world, because there is an official erasure of data, that is, the forgetting of a past failure so that you can move on and create a new business venture.

That black mark is never off of you if you start a business in Europe. If you fail, you are never given an opportunity to succeed again, which changes, again, that dynamic, the motivating factor to be a risk-taker, to be an innovator. So I like what we have and I think there are multiple variations of the value of forgetting.

Kevin:Let me ask, then, technology itself is not good or evil. Technology is just technology. In fact, blockchain technology is fascinating. So let’s talk about that because I think sometimes people look at technology and they say, “Oh my gosh, that’s horrible.”

David:Right, so that can be determined by personality, where in some instances people are looking for how it can be abused, and yet other people, based on their personality, will see the ways in which it enhances life and brings greater things.

Kevin:So it is sort of neutral.

David:It reminds me, I just had this discussion with my oldest son last week, talking about Frederic Bastiat’s, The Law. The case that Bastiat makes for the law is that the law is neutral, and it depends on whose hands you put it into. It can be something that serves the progress of mankind or it can be used in the abuse of mankind. It depends on how the law is wielded. If you have never read the book The Lawby Frederic Bastiat, it is a must read. But I think that is a common theme with technology. It depends on how it is used. It is neutral in and of itself. It could be good, could be bad, and we should just be mindful of both eventualities.

Kevin:So it’s not that you don’t trust technology, it’s that you just don’t trust men with technology.

David:Which is one of the reasons why I continue to like gold as an asset class, and gold as a form of money, because it is, as Jim Grant says, kind of the opposite of the Ph.D. standard. It is the automatic rebalancing system within the monetary universe, and was for a long, long time. So I remain kind of skeptical that cryptocurrencies will meaningfully replace gold as a store of value, or as a representation of intergenerational wealth. The blockchain is a record-keeping device, it has many applications, they are disruptive, yes, and potentially that is positive to the economy and the financial system.

For instance, I think, particularly, of the transactional efficiency of Ripple. I could see the SWIFT system that we use today for international wires and transfer of money from one financial institution to another – I could see that being thrown out completely in the years ahead, and Ripple taking its place. The cost of transaction, the speed of transaction, is dramatically different than what we have with SWIFT, and is a dramatic improvement.

Kevin:Wouldn’t that be something, too? Because SWIFT is used, actually, as a political tool. We have seen that over and over and over with the U.S. Treasury. Ripple, if it was put in place correctly, would give independence to that international transfer system.

David:There are areas where I remain hopeful on the utility of at least a handful of those cryptos. We mentioned Patrick Byrne. He is launching a new crypto and they continue to proliferate now, over 2,000 of them.

Kevin:Didn’t Paris Hilton release her own crypto at one point?

David:Of course, it’s the latest thing, it’s the latest fad.


David:There are less ICOs, that is, Initial Coin Offerings, since the crash has gained momentum on the downside, and most of them are very, very small – a few million dollars in total value. But how and when these blockchain applications take hold will define the market dynamics going forward. So we have had the initial mania and after any mania the question is then, “What is the utility?” So we had the mania which gave us via WorldCom – WorldCom owned 90% of the Internet backbone, they had more fiber and controlled more fiber globally than any other company in the world. And if you wanted to go back even further, you go back to the railroads. It comes to mind the 1840s in Britain and the 1880s here in the United States.

Kevin:We’re a railroad town here in Durango. It was the 1880s that built Durango.

David:That’s right. So you have the mania which is really the idea of something, and then the mania ends. Fortunes are made and lost in that cycle. And then, ultimately, real businesses can emerge, where real profits are made, and that is after the speculation phase. That speculation phase is more concerned with the sizzle than the steak, and it is not that there is not a steak involved, but be aware of where you are in terms of the cycle. We’ve been through the sizzle stage and now I think we get to see some maturity take place in the blockchain space.

Kevin:You always have to ask, “Who is it that I am fighting, and can I win?”

David:And that is why in the currency space I don’t think that cryptocurrencies take much of a role because again, as currencies, I cannot imagine the monopoly powers of the world’s central banks going quietly into the night. It’s control them, or kill them. That’s the currency reality for the cryptos. If they are going to exist as a currency it is going to be because central banks have stepped in to complement their monopoly powers. But they do not stand for competition, not in the least. Control or kill – that is the reality for the cryptos as they relate to the central bank community.

Kevin:Dave, I’ve told you, and we have mentioned this gentleman on the Commentary before, but I have to give him kudos. He was in technology. He lives in Colorado. He said, “You know what? I like the idea of bitcoin, I’m going to go ahead and get in.” This was a few years ago. And he rode this thing all the way to the top, and he called me in January. He said, “Kevin, it’s time to move to silver.” I said, “Well, okay.” He said, “I think it’s over for cryptos, at least for the mania part. I’m going to go ahead and move to silver and I’m going to play the silver-gold ratio,” which is exactly what he is waiting for now.

This is a guy who saw what was coming, he capitalized on it, even though not for a minute did he think it was reality for the long run, and then he turned it into silver. There are people in history who have done that in the past. I think back during the days of John Law, you had winners and losers during the Mississippi bubble.

David:I happened to be reading the biography of Richard Cantillon. It is the best I’ve found on Cantillon. I do find some similarities in the psychology of the market within the cryptos over the last 18-24 months compared to what was going on in the timeframe of the Mississippi bubble. Cantillon was an Irish Catholic immigrant to France. He went from wartime goods trading – call it profiteering – to Parisian banking. He became a banker in Paris in the 1710s. There is an interesting story here because most of his insights, and what gave him the ability to not only profit from the Mississippi bubble, but avoid, as our client had, the demise within the cryptocurrency space.

For Cantillon, it was the hard lessons of life. In one generation before him, 1500 acres of family property had been seized. They came over to the island and seized it, held it for 500 years, and then it was seized from them. So it forced Catholics to get very creative in terms of how they were going to make a living. And they started exporting illegally, black market trading with the continent. They created all these contacts with continental traders who were importing and exporting goods back to Ireland, and from Ireland to the continent.

And, actually, those trading contacts ended up being the very contacts that allowed for him to become a banker. There was a mass exodus of Irish from Ireland, and where did they go? They went to Paris, and they went to France where it was a little friendlier for the Catholics at that point in time.

Kevin:I don’t want to chase a rabbit here, but isn’t it interesting how the free market always finds a way somehow, and what you are talking about is Richard Cantillon. Obviously, he was a victim to a circumstance that turned into a market opportunity.

David:Right. I think there are as many differences between the 1720s and now as there are similarities. But the period was most notable for the activities of another man, John Law. He was a Scotsman, brought onto a position the equivalent of Prime Minister there in France. So imagine that. Just in and of itself that is a fascinating turn of events on its own. It’s not the topic for today, but Law used – this is really where it got interesting and I think there are some similarities to, not only the central bank policy-making that we have today, but also the dynamics of mania.

Law used the issuance of company shares to solve a national debt problem, and he involved the public’s appetite for growth and the allure of riches – quick riches – to create artificial demand for government bonds. So to buy shares in the Mississippi Company and its ancillary ventures you made payment for them in the form of treasury notes. This created an artificial demand for government notes and drove interest costs on the national debt down considerably, which was one of Law’s objectives. Again, he is toggling back and forth between monetary policy and fiscal policy. Deal with a debt problem unconventionally – that’s exactly what he did.

Kevin:We talked earlier about knowing who your enemies are. If you look at John Law, he actually was solving the government’s problem as well as solving the greed problem of the people. So that worked. He wasn’t introducing something that was fighting the bankers.

David:We read about John Law and it explains where Keynes borrowed some of his most potent ideas. Keynesianism, as an economic system, is almost directly borrowed or stolen from John Law.

Kevin:So the Mississippi bubblism (laughs).

David:Well, in fact, yes, because the top-down management of fiscal and monetary matters to promote full employment and economic growth comes from Law. So again, it’s not Keynesian economics if you are looking at the source of the ideas. It comes from John Law’s playbook. So you have Cantillon who is an Irish banker in France, and he was not merely an observer of the Mississippi bubble, he was an early participant in the bubble. He rode the first leg of it up. He was also a business partner with Law in a number of property deals in Louisiana. Cantillon actually made two fortunes from the Mississippi scheme.

To me, Cantillon, because he is a man of the world and a man of letters, as well, he reminded me a little bit of Alex Pollock, our recent guest on the Commentary, in this way – not as a war profiteer, obviously, but using a combination of banking experience and economic theory to make critical judgment calls about what was true, about what had enduring value, and ultimately about what was sustainable, because he began to see Law make certain decisions and he said, “Oh, that’s not going to end well. That cannot end well. It’s time to exit.”

And when he exited, guess what he did? He exited not only the market, he exited the country, because he knew that there was going to be political fallout from the catastrophe within the economy and within the monetary system, and that people were going to be hung. Heads were going to roll. And Cantillon had enough street sense to say, “Not only am I going to take my profits, but I’m going to move to Italy, and I’m not coming back.” So again, there is more to learn from Cantillon’s life, and we will maybe look at that another time. But suffice it to say, bubbles share certain common characteristics.

Kevin:This is what Pollock was trying to tell us. Economic history is not taught to the financial world. You talked about street sense for Cantillon. I’ll bet you Cantillon had read a little bit of history. You understand that you need to leave the city, the state, the country, whatever it is, when you understand history. It is the same thing when we see these bubbles. You’re talking about bubbles sharing certain characteristics. We can’t know what the next bubble will be, but we can know what the outcome will be in the long run.

David:That’s right, and if you are among the class of people – let’s say, circa 2020 – who are going through the gyrations of a wicked bear market in stocks and bonds, and yet someone out there is succeeding, someone is profiting, or has profited, even as you have lost, your pain, being disproportionate and on the opposite end of the spectrum from their success, means that you will have the same mentality of those in France in the 1720s, and ultimately, we saw it again in the 1790s, which is “Hang ’em high. Heads are going to roll.” There is zero tolerance policy for success versus failure. If everyone fails, that’s fine. But if anyone succeeds in the context of aggregate failure (laughs), that’s when there are pitchforks.

Kevin:Isn’t there a common denominator? The common denominator at the end, you are right, is anger. But the common denominator at the beginning is debt and credit.

David:That’s right. You’re exactly right. I need to be brought back on track. Creativity with the ideas of money and credit, that is behind the scenes driving most bubbles throughout financial history. It is creativity with the ideas of money and credit and then all of a sudden you have particular asset bubbles which are merely being symptomatic of the changes within the financial system’s liquidity.

We have the cryptocurrency bubble of the early 21stcentury, and it’s one of the history book’s great examples. It broke all past records in terms of asset price appreciation from pennies to $19,000, the percentage gains were astronomical. And it is, in my view, symptomatic of the credit bubble of our day. It complements the imprudent ideas of easy money, and it complements the ideas that you can get rich in a very condensed and short period of time. It’s just not the way history is written.

Kevin:But we saw this back 10-15 years ago with the mortgage-backed securities. So we have seen this before. The ramifications with real estate collapsing were huge. We still haven’t gotten over it, we’ve just painted over it. What are the ramifications of the crypto space?

David:I think it’s pretty minimal because you look at the mortgage-backed finance bubble and it sent tentacles through the domestic and international financial universe, so there was nothing – no bank here or abroad left without some scars from that period. And if you roll back the clock a little bit, it was more of a domestic equity issue when the tech bubble burst there in the late 1990s, so again, kind of contained to our borders. When you look at the impact from the cryptocurrency bubble bursting, who is impacted? It didn’t integrate sufficiently into the larger economy or have enough adopters to have a real economic impact on the downside.

So we are concerned with the problem that John Law was trying to solve, and that is, then, as now, we have too much government debt. And it is a big issue. It is a grave issue in our day, and this move from 2008/2009 to the present, the last ten years, has been a migration from private sector liabilities – that was the concern ten years ago – now to public sector liabilities. The implications here are pretty interesting because you look at how currency values are impacted when the national account goes upside down. Or, I guess a better way of saying that is, when confidence is lost in our currency because it doesn’t look like there is enough income to meet the obligations.

And this is where the French were in the 1720s, it is where we are today, although we very effectively navigated just as Law did, through an increase in debt, and we have in the process over the last ten years, pushed the interest cost down because we have sat on top of interest rates. We’ve forced them lower. Our negative interest policy, our low interest rate policy by the ECB, the Bank of Japan and the Fed has done a wonderful job of making the decisions of too much debt becoming even more debt. It has made it seem sustainable because they have controlled the interest variable – the interest cost.

Kevin:You’re talking about too much government debt. I’ve grown up hearing that, Dave. I’m 55 years old and I haven’t really seen any of the ramifications of too much government debt. Not here. It’s like, “Oh, well, we’re America. We can just continue to grow, and grow, and grow forever.” But you named France. After John Law and the collapse in France, there was starvation. We go to Germany back in the 1920s. They were navigating too much government debt – using your words, navigating, successfully. That’s what they thought. But there was starvation when it collapsed. We have Venezuela. They were navigating too much government debt, and right now in Venezuela there is starvation. There is a price to be paid for too much government debt.

David:Right, and I guess what we are really talking about is not the come-uppance in the debt markets as of yet. That may come two years from now or 20 years from now. The greatest point to be made here is that a spirit of speculation is pervasive in one timeframe, and it expresses itself in various forms and in various asset classes with an enthusiasm that seems boundless. You have the justifications which in that moment are obvious, they are rational, they are definite, they are easy to come by – the rationalizations and justifications for why an asset class is doing what it is doing.

My interest at present in the crypto market runs in a parallel track with the stock market as a whole because of this pervasive spirit of speculation. Again, what is the sentiment driving prices, and has it turned? Has it changed? Because there are a serious number of ramifications as and when that shift occurs?

Kevin:So has it occurred?

David:In the crypto space, obviously, I believe it has. The numbers we mentioned earlier suggest that it will take a real effort to revive the enthusiasm in cryptocurrencies which was up until December of 2017, just a year ago, cruising unstoppably like a freight train.

Kevin:There are two types of fears. You have brought this out before. There is the fear of missing out, and then there is the fear of not being about to get out.

David:Right, so FOMO [fear of missing out] switches to just the fear factor (laughs) and the phases of euphoric investment are driven by a positive belief, and as you say, a fear of missing out. When that sentiment shifts, the momentum which pushed prices higher becomes, ultimately, an equal and opposite momentum moving the other direction. Missing out recedes and fear converts the spirit of speculation to something that is pure negativity – pure negativity. 2018 was the year that witnessed a shift in sentiment, certainly in the cryptos, and as I would like to suggest, it may have in other significant areas of the U.S stock market, as well.

Kevin:One of my favorite market commentators for decades, and now works for you on the short fund, Doug Noland, has talked recently about how this sentiment shift is actually going to come from the periphery and collapse to the core. You are seeing that sentiment shift at this point.

David:That’s right, so the risk-off moving from periphery to core, you see that with the outer edge of speculation – taking a hit, the riskiest of the risky assets beginning to see an initial decline, and then those price declines moving from the outer edge inward. High yield bonds, other marginal credit markets, are showing stress at this point, and we have seen at the same time a reigning in of risk in the emerging markets. We have seen selling of assets and a decline in price in the emerging market space here in 2018. It has not been a great year there, either.

Pressure remains in Europe. Italy, specifically, remains under pressure. You even have the folks here in the U.S. and globally running hedge funds – hundreds of billions of dollars in what is called a risk parity trade where you are an owner of stocks and an owner of bonds in a leveraged offset to where if you see any decline in the value of your stocks, you should see an offsetting increase in your bond portfolio.

And 2018 has been a wicked backdrop for them, as well, because the Fed has been raising rates, the value of bonds has been dropping, and twice this year, both January and October, we have seen a decline in stocks at the same time. So instead of winning on one side while you are losing on the other, it has been a double negative.

Kevin:Wasn’t it just two or three months ago that we were speaking weekly about these five stocks that were pulling the index up for everybody else. Most of the stocks already were lagging, and you had five stocks that were actually pulling the index up. Now the opposite has occurred.

David:Right, so this is where we see, again, the migration from periphery to core where the U.S. stock market is showing weakness, and it is the leaders now – the leaders that were are driving prices higher – those names which led on the upside are giving up considerable ground. The leadership issue is a big issue. Think about this. You have the semiconductors which are often at the front edge of a market rise, and also at the front edge of a market decline. They have given up the ghost here recently, along with smaller cap stocks. If you want to look at your S&P 400 or your Russell 2000, again, greater weakness there than in your broader indexes. Financials have been weak, as well. All those sectors have been weaker than the broader markets.

Kevin:Yes, but look at the FAANGs right now.

David:Yes. Facebook down 39.5% from its peak, Amazon down 26.7% from its peak. Apple just shy of 24% off of its peak. Google 20% off of its peak – 20.7. Netflix down 37.4 from its peak. So the FAANGs have lost 633 billion dollars in market cap. You might ask, “Was that a big deal? You throw around a big number, is that a big deal.” We have to qualify every big number we use these days because how often do we hear hundreds of billions or trillions thrown around? I don’t think we even appreciate what those numbers mean anymore? So quick note – yes, that’s a big deal, 633 billion dollars in market cap erased in less than 60 days? Yes, I’d say that’s a big deal.

Kevin:Alan Newman has been banging the drum, saying, “We’ve never seen this kind of bullishness ever.

David:(laughs) So you transition from 2017 to 2018, you see some rockiness there in the first quarter, and the unflappable bulls, the investment advisors who are just saying, “Look, this is the greatest thing since sliced bread. You have to buy on the dip. Alan Newman measures sentiment along these lines, and you have investment advisor sentiment now three standard deviations above the norm. That accounts for 99.73% of all data. In other words, there is less than half of one percent of all time (laughs) where there has been greater bullish sentiment. So that is how we come into the September/October timeframe. In other words, just to boil this down, rarely in financial history has there been more bullishness coming into October of this year, which has been a rough, rough season.

Kevin:Okay, but I’m going to sit across the table from you and play the other side and say, “You know what? Even with those losses, is it really that bad for 2018?”

David:No, it’s not a big deal, because even with those declines most of those companies are still in positive territory. They are still showing green on your portfolio. So the rate at which their share prices rose earlier in the year was reflective of a speculative migration. From the periphery to the core, speculation was moving in, the indexes were rising, driven by, on a cap-weighted basis, just those few names. So what we saw as a risk-off in terms of cryptocurrencies giving up ground in December of last year, that has continued. That has become a concern as we have migrated through 2018, as more investors have said, “Well, is this going to last?”

So concern in the equity space is not yet acute, and I think a part of that is because we may not be knee-deep in clover, but if you are looking at the U.S. equity markets, we are still ankle-deep in clover and we are not in a position where people are panicking. Leadership is failing, weakness has, indeed, moved from the peripheral high risk to those areas that people believe to be impervious to decline. And the saving grace of the equity markets is that the year-to-date results in those major indexes are not that bad.

Kevin:So when people get their statement at the end of the year, if they haven’t been watching the market and the volatility in the market, they will say, “Ah, it’s not too bad,”

David:Right. So it’s marginally positive, marginally negative, depending on the index in question. The S&P and the Dow are down less than 2% for the year. They gave up all their gains from earlier. The NASDAQ 100 is still positive by 2%. Now, it has given a lot. It has given up 20% plus, and all of that since the beginning of October! So only now – only now – is there some concern among the major investment houses that this may turn into a protracted bear market.

Kevin:You mean the guys who always told us to just buy the dip? “Buy the dip, buy the dip. Anytime it falls, buy the dip. It always works.”

David:Yes, the 16-year trend of buying the dip might be dead. That’s what Morgan Stanley is saying. To quote: “For the first time in 16 years, it’s not working.”

Kevin:But they’re not nervous yet.

David:No, and that’s worth repeating. Concern is not acute. You have no idea what selling looks like. (laughs) Year-to-date gains in the major indexes are still intact. There is no panic in the air. What I am trying to say is that just as all markets were on the rise in 2017, most have hit significant speed bumps in 2018, with implications for sentiment in those sectors. What do you think has been happening in the oil market? That is not a supply issue, that is a demand issue. At least, that is our interpretation of what is happening in terms of a global economy weakening, and the implications of that for major markets, including oil.

Kevin:I’m going to turn this thing around a little bit because Roosevelt said, “The only thing we have to fear is fear itself. But actually, the only thing the markets really do have to fear at this point is fear itself. Now, look at your grandma’s stock. Everybody’s grandma wants to have the bluest of blue of blue chip stocks. I’m thinking General Electric here. General Electric built up tremendous debt – huge, huge debt. But why not? They had all these different business ventures. There was absolutely no way to fail. Now, look at your grandma’s stock.

David:I think the better grandma’s stock would be AT&T. But GE is that hyper-cyclical stock which, at least 20 years ago, represented a go-to mutual fund. Before the proliferation of index funds you could buy GE, and it was an index fund. It represented technology, it represented the industrials, it represented finance. It was a smattering of everything. The next leg lower, should we get one, I think is going to reveal what Alex Pollock discussed a few weeks ago. Asset prices fluctuate while debt is permanent. So when assets decline enough, then debt on the balance sheet begins to look uglier and uglier, and GE is a case in point. AT&T is a case in point. To me it is almost inconceivable that GE is moving into a category of near-extinction, the only company that exists today that was originally in the Dow-Jones Industrial Average over a 100 years ago.

Kevin:Back around 1896.

David:And today it is similarly priced as it was in 2008, just after it gave up 85% of its market cap from the 2000-2001 peak. It gave up 85% of its market cap. It went from $60 a share to $6.66 cents, I think, it’s all-time low (laughs) – no significance there. But we are less than a dollar away from there. You are talking about nickels and dimes away from those levels. Here in recent weeks they have cut the dividend to a penny a share from what was 12 cents per share per quarter, what previously had been 24 cents a share. Again, if you include the unfunded pension liabilities at GE the total liabilities are 263 billion dollars on a shrinking equity base. Not good. Not good.

Kevin:Doesn’t AT&T have about that same amount of debt?

David:Same amount of debt. Less cyclical in terms of the business, probably a better bet on that basis. There are massive liabilities to shoulder on a diminished base of equity, and more importantly, especially for GE, on rapidly declining revenue. So GE, I will say one more time, is the more cyclically vulnerable of the two, but people are slow to worry and slow to change their minds, slow to change their vision of what the future entails for them. I should say they are slow to change their feelings on the market, but when they do, they don’t seem to do it alone, and they do it very quickly.

I look at GM and the executive decision here this last week to aggressively reduce head count and start closing plants. I think it reflects weakness in demand in China. If you look at the auto sector and auto demand off huge double-digits there in China, and they are the largest consumer of automobiles in the world today, and perhaps General Motors is anticipating what Goldman-Sachs has now begun to discuss – the economic outcome for 2019. They are anticipating the U.S. economy sliding from 2.5% growth rates to 1.8% in the 3rdquarter, declining even further to 1.6% by year-end 2019.

Oh yeah, and as of November 21st, last week, Goldman-Sachs is also now suggesting that equity investors should be boosting cash. Thanks for that. Wish it had been September 21stwhen the market was peaking and not 8%, 10%, 15%, 20% lower, depending on the asset that you owned.

Kevin:You said earlier that people are slow to change, but when they do, they don’t do it alone. You’re a diver. I was diving with my son in Cabo. It was an amazing scene because we were down with a single sea lion. We looked above us at swirls of tens of thousands of little fish. That was the food. The sea lion was down there and we were sitting next to him. Really, it was amazing as it swirled. But when he decided to go for a fish, you can imagine, that hypnotic swirl where everybody was just calm turned into an immediate scatter. That is exactly what happens in the market.

David:Markets move like swarms of birds, they move like swarms of fish. All participants act, and they act on the basis of the actors, and of the movements in price that are right next to them. It becomes self-reinforcing. You have the swarm effect on the upside, you have the swarm effect on the downside. We watched this on the way up – we may get to see it on the way down as well. We now have two episodes in a calendar year after having zero volatility in 2017, massive volatility returns in the January/February period of this calendar year, and October the correction has been on. Central planners are failing to manage the markets toward perpetual bliss, and yet people still have faith in the positive outcomes of central bank activity.

Kevin:Pollock told us, being a banker – you asked him, will the central banks be able to keep control? He said, “Absolutely not.” Now, I asked you this last night, Dave, when we were meeting. Have we, as a society, been desensitized, however, to loss? Because the central bank – we have the plunge protection team, it comes in and buys whenever it drops. You have artificially low interest rates, so why not just take out more debt? Things have been smoothed out to the point – I talked about the hypnosis of the swirling fish – what if the sea lion is eating fish and the swirl never changes?

David:(laughs) Right, well, I think this may go back to a difference we have talked about, somebody else’s crisis versus your crisis. My dad happens to love Chai tea from Starbucks. So if a Starbucks were to close – any Starbucks – it’s not a big deal to him. But if it’s “my Starbucks” then it’s a very big deal. It’s about proximity, and if those numbers are very remote, it doesn’t really matter. It only comes home when people feel it. This is why the pocketbook and politics are inextricably linked. It is the economy stupid, over and over again, because when people feel it, that’s when they get frustrated and angry. Central banks – I think what they have attempted to do is short-wire the communication mechanisms. You have that hive, or the swarm so to say, and they have attempted to short-wire the communication mechanisms within that swarm, that’s for sure.

Even when the market begins to signal that decline is imminent, that something is weak, that a particular company, a particular sector, is on the rocks, you have the equivalent of algorithmic muting of the signal which occurs, and calm returns almost immediately. Calm remains within the market, panic is abated. It’s notable that the power to mute the signal seems to be running into problems this year.

Kevin:So I guess the big question is, do people see this year as a turning point, or as just another step in an upward direction of the market?

David:Right. That’s the issue. Have we seen the correction already, or are we in a multi-step sequence lower? Picture this. Picture a bowling ball slowly moving to the edge of a step and then kachunk! And then there is greater stability and calm, and then kachunk again, as the ball glides to the next edge and the next step lower. There is a threshold where individual investors who were stung by the losses of the last financial crisis are going to move to protect as many of their assets as possible. We have just seen one or two of those kachunks where the ball falls and moves to a new lower level.

I would guess that the threshold for individual investors in U.S. equities coincides with the 50-day moving average slipping below the 200-day moving average. That is not an event that has occurred, but I think that is an event that will occur as and when the Dow slips an extra 1,000 points. So 23,500 on the Dow. We could pick the equivalent in terms of percentage declines for the S&P, but I think you slip an extra 1,000 points from here, 23,500. And if we can avoid that level we can likely avoid panic selling from the man-in-the-street. Breaching 23,500, I think that opens up some very interesting opportunities on the short side (laughs) and some very interesting sort of pain threshold measurements from there.

*     *     *

Kevin:It’s that time of year. We talked about this time of year last year, but we have done this every year since we have started the Commentary. We want to ask our listeners for questions. We are going to be doing several question and answer programs, so please send your questions to us at We try to answer just about everything that comes in, or at least combine questions that are the same and answer those questions. Again, that is

Dave, before we wrap up, not only can people send in their questions, but they are looking at the end of the year, and oftentimes, for the person who is not actively changing their portfolio all the time, the end of the year is the time to say, “What does 2019 look like? How do I re-organize? What would be the winning trade for 2019 without taking too much risk?

David:The Vaulted program that we launched in this last year, some of the marketing materials that we put together for that included charts and research relating to the perfect allocation between equities and gold. That is why I mention it here – 75% equities, 25% gold, in a growth portfolio, is an interesting mix, and it maximizes growth on the upside in equities, which I think is very limited at this point and I’m not recommending a 75% allocation to stocks. But the numbers bear out over a 50-year, 100-year, 200-year period, that a mix of 75/25 mutes the downside losses that you have in equities by having something that appreciates in that context, namely gold.

So I think the winning trades for 2019 – underappreciated is the cash category. Listeners to the Commentary for any amount of time have heard me say that for 6, 12, 18 months. Treasuries, preferably – floating rate treasuries. Also interesting – gold and silver, and I think the relating shares. If equity markets continue to encounter headwinds, or if we see, really, the gale-force squalls that epitomize a really chaotic bear market, this is a defensive posture likely to do well.

And I think you need to be thinking defensively. I am not at all perturbed by what is on the horizon for 2019 because I think there is a level of engagement, certainly with our listeners and with our clients, and they could be described as the forewarned and forearmed category of people.

But Kevin, as you mentioned, the Q&A is coming up. We would love to be challenged by your questions and engage with them as much as we are able to, as much as our capacity will enable us to. And by the way, know that if we are unable to answer your questions, A) we can acknowledge it, and B) we will pursue guests on the program for 2019 that will bring the insights you are looking for.

So that is the goal with the Weekly Commentary, to continue to bring fresh insights to you and hopefully, a thoughtful appraisal of the markets that will allow you to make better decisions related to your portfolios.

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