Podcast: Play in new window
- Stocks Today: Would you buy a business that would take 37 years to break even?
- Treasury Department, FED, FDIC, discuss how to define how to regulate cryptocurrency
- Economist Magazine worried Gov Coins could become panopticons to control citizens
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Biden Budget: $6 Trillion Colossus That Even Bernie Likes
June 1, 2021
“What can the system bear? If we assume complexity and adaptation, what happens when you put policy X, Y, and Z in motion? What thresholds exist where stress can no longer be tolerated? Of course, you’ve got specialists who are going to bless the initiatives and promise that all is going to be well. I would simply implore you to think more broadly. Read more broadly. Read it for yourself, come to your own conclusions, invest accordingly. This is going to be a very interesting period directly ahead.” — David McAlvany
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany.
Last week, we talked a little bit about the regulation of cryptocurrencies. But isn’t it interesting? Right now, since this is such a new thing over the last 13 years, when you’re regulating something, you have to figure out what the heck it is because certain people are going to regulate one thing and other people are going to regulate another. To-may-to, to-mah-to, let’s call the whole thing off. What is a cryptocurrency and who actually will be doing the regulating?
David: Of course, the question is still there. Last week, you had the first interagency meeting on proper oversight and regulation of the cryptocurrencies. So, it included the Office of the Comptroller of the Currency, which is a Treasury Department bureau, the Fed was there, the FDIC was there. The object of the meeting was to create a regulatory perimeter, to use their words, a regulatory perimeter for cryptocurrencies, just like we had regulators playing catch-up during and after the last financial crisis. What you had was financial product engineering, which had outpaced the ability of regulators to track with the innovation and we have the same thing with cryptocurrencies now. They’re in sort of a race, if you will, to catch up. But notably absent from the meeting was the SEC and the CFTC, the Commodity Futures Trading Commission. So, again, I think that points to what it is we’re talking about, the question of what cryptocurrency is while it’s still on the table.
Kevin: Is it a security? Is it a currency? Is it a method of controlling temperature from a distance?
David: Yeah. Well, a currency has one set of regulators, a security has another. So, Gary Gensler, who’s head of the SEC, I think he’ll be included at some point because you’ve got many of the cryptocurrencies which have been securitized by Wall Street for easier sales and distribution, obviously expanding the audience of investors.
Kevin: So, that means it’s a security.
David: Well, that confuses the issue of what the thing is. But I think that the Comptroller of the Currency, Fed, and FDIC were doing these initial meetings, it tells you the direction they lean.
Kevin: Wasn’t Yellen also saying she thinks that they’re used for illicit transactions, though? So, at that point, you’re talking currency.
David: Exactly. You’ve got the Treasury and the Fed focus with the FDIC suggesting that money laundering, transaction reporting for tax purposes is the priority. As you say, Yellen has often mentioned that she believes there’s illicit activities enabled by cryptocurrencies, fearing that bitcoin is often used for illicit finance.
Kevin: So, what’s your guess? What are they going to come down with?
David: Yeah. Well, my guess is that you could still find more instances of cash driving illicit activity than cryptocurrencies. If you’re adding up everything that’s done in US dollars, it’s not as if cryptocurrencies have a monopoly on illicit activity.
Kevin: That’s right. When your landscaper says, “Can you pay me in cash?” Rarely ever, does your landscaper say, “Can you pay me in crypto?”
David: But being paid in cash, it obviously serves a purpose. So, my guess is you could still find those cash-driven activities. But it’s anywhere market opacity exists. Cryptocurrencies, cash. You’ll find a mixture of both legitimate private activities, and illegitimate business activities as well. In some countries and cultures, tax avoidance is a national sport. It’s not something that the US Treasury has a very supporting attitude about. So, it is a focus and treated as a currency. You can see that they’re coming to a conclusion that they need greater and greater regulation.
Kevin: Okay. So, what about taxes? As far as regulations go, one of the things that we talked last week how the government’s hesitant, very hesitant, to give up the monopoly power of printing money and have a competitor there. But they’re also not going to give up that tax base, the ability to tax gains or transactions.
David: Right. So, the first set of regulations will be tax related. Transaction enforcement, compliance measures being handed down. Specifically to the companies that were, under the Trump administration, given national trust charters, and that is they’re providing custody services for the cryptocurrency owner and had to have that trust category, or the trust charter category to do so.
So, obviously you can put the onus on those groups for compliance and know your customer rules, which have become, let’s say, nonexistent five years ago and very present in your crypto exchanges today. But without a complex of rules and regulations for these exchanges, you merely have another version of shadow banks, which is what they’re trying to avoid.
Of course, you’ve got on display here in recent weeks radical leverage applied to an already volatile asset class, to describe cryptocurrencies as volatile. But you’re talking about 50 to one leverage, 100 to one leverage in speculation that holds the potential to spill over into traditional commercial banks and financial firms. Obviously, that becomes more of an issue when your financial firms take an interest and say, “Hey. Wait a minute. The market’s demanding products. We’ll provide the products, we’ll make some money on this ourselves.” Now, all of a sudden, groups like Fidelity, guess what they’ve done? If you invite a catastrophe into the world of cryptocurrencies, because of the amount of leverage and speculation and shadow banking that is occurring, then all of a sudden it’s right to the heart of the financial system as these firms have basically said, “We want to play because the profits are too interesting and attractive. The margin’s wide enough for us to make sense of this in terms of a portfolio allocation.”
Kevin: I remember reading Human Action by Ludwig von Mises and I can admit, I cannot sit down and read the whole thing. It’s a very long book. But the ideas are compelling, and I remember that information gap, as far as understanding what something is, is where the most money can be made. Right now, people are trying to figure out what a cryptocurrency is, how to trade it. You talk to people on the phone and they say, “Well, how exactly do I even buy and sell it?” Well, see, right now, those kinds of gaps, those gaps in information create amazing transaction gaps and a lot of money to be made. Now, as they start to narrow that down and define what it is, that’s probably going to narrow the volatility, will it not?
David: Yeah, absolutely. Obviously, we have an interest in the precious metals, and it’s been interesting to see some of the custodians come to us and say, “Hey. You have these precious metals IRAs. Did you know that you can put cryptocurrencies in them as well?”
Kevin: Which we can.
David: “Oh, by the way. You can charge commissions for those cryptocurrency purchases, as much as 14%.”
Kevin: Wow.
David: This is exactly what you’re talking about.
Kevin: I’m not making enough on gold transactions. I can make 14% just putting people into bitcoin.
David: But this is what you’re talking about. A wideness in pricing given a wideness in information. You don’t have enough clarity. There’s not enough volume of transactions, and there is a huge price to pay, somewhere between 2% or 15%, if you’re talking about an outside number.
Again, that’s not our area of interest. That’s not our area of expertise. It’s not what we do, nor would we recommend that in an IRA. But this is the reality. To your point, information gaps have a significant impact on pricing, and that price structure tells you everything you need to know about the information gap that exists.
So, you had Michael Hsu, head of the OCC, he came in just recently with the Biden administration, and in the article that I read in the Financial Times highlighting this meeting between the Fed, the FDIC, and the Office of the Comptroller of the Currency, he’s now head of the OCC, and one of his concerns was over payment processing, and that’s something that we’ve said over and over again as it relates to when the Chinese finally went after Alipay, there’s a real sensitivity to the issue of payment processing and aspects of fintech and technology platforms—
Kevin: Because Alipay was stepping on the toes of the PBoC.
David: Exactly. It creates a little bit of heartburn for the PBoC, the Chinese regulators, and I thought the Financial Times article highlighted the interagency meeting exploring regulation very well. It sat aside the Economist. This is the May 18th to 14th copy of the Economist, and the cover reads, “Govcoins: The Digital Currencies That Will Transform Finance.” Again, we’re talking about, again, the central bank digital currencies, not the privately created— So, the digital currencies that will transform finance, it’s suggesting that Rogoff’s cycle is very much in process.
Money creation, credit distribution through normal banking channels, it amplifies monetary policy from the central bank. The last thing central banks want to see is that loss of amplification. These are the tools that they need to make monetary policy effective. A world of decentralized finance is not a world that centralized planners relish. So, you can see how there’s something of a libertarian bent, a philosophical predisposition to like cryptocurrencies if decentralization is on your mind. But imagine if you’re a central banker. Imagine not being able to manage the economic cycle. Right? So, now you’re entering the nightmares of the monetary mandarin.
Kevin: You know what it reminds me of, Dave? It reminds me of our deep wish. Okay? Our deep wish is that we would have a gold standard like in the late 1800s. I have to say it. I remember one of the conferences that you talked at, you bought a case of books for everybody at the conference on how to go back to the gold standard.
David: Lewis Lehrman.
Kevin: Yeah.
David: It’s a classic book.
Kevin: But it’s wishful thinking. To be honest with you, it’s wishful thinking. One of our listeners and clients is a senator who put forth a bill for the state that he represented to go on to a gold standard. It’s wishful thinking. Think about it, Dave, just for a second. Let’s play a game. Let’s pretend like the government didn’t care about cryptocurrency. We’d be sitting here going, “Yeah. You need to be investing in this because it does decentralize. It gives a person, like you said, that libertarian freedom.”
David: Yeah. Now, think about what US Secretary of Treasury— Janet Yellen, says. She says, “We need to resolve our inequality and that’s going to require huge amount of fiscal policy to do that.” Okay. So, we’re talking about social issues and social economic disparity and we need fiscal policy to solve this. You realize that wouldn’t be possible if we were on the gold standard because you can’t create an infinite amount of credit. You can’t just create money out of nothing.
Kevin: We’d be healthier if we were. But—
David: But.
Kevin: But. Yeah.
David: This is where, again, you see the political prerogative to tend to the needs of particular constituency groups and that makes it untenable to ever go back.
Kevin: Don’t bet on the government doing the right thing.
David: I think that’s fair. That’s fair. So, the nightmares of the monetary mandarin is that you lose control of managing the economic cycle. Right?
Kevin: Right.
David: So, there, you can see cryptocurrencies infringing upon the official space because you’re basically neutering, you’re taking away the vitality of the central bank power to transmit their policies through the commercial banking system and into the economy.
Kevin: Well, and see, that’s It’s not just central banks. It’s commercial banks. The banks as we know them operate in dollars.
David: I think this is a really fascinating sort of domino effect. If you’re talking about private cryptocurrency creation, and then as Rogoff likes to say, the regulation, the appropriation, as the Economist writes about on the cover and in their articles, I would highly recommend it. May 8th to the 14th copy of the Economist, “Govcoins: The Digital Currencies That Will Transform Finance.”
It’s interesting because now you’re talking about the nightmares of commercial banks as well. The prospects for commercial banks grow dim when you think about, first, decentralized alternatives forcing central banks into a more direct role of lending and credit creation, even deposit taking and cash management with a direct connection to the consumer.
What we’re talking about is, again, being the digital bridge and going ahead and getting rid of currency, moving towards a digital alternative. But if you have govcoins or a central bank digital currency, there is a workaround. You don’t even need the commercial banks anymore. You can directly put money in people’s pockets, as we’ve seen to some degree with what the government is doing today.
Kevin: So, you avoid the middleman. It’s just straight across because it’s all basically in the same system.
David: It’s a marginalized commercial bank environment, which is really fascinating to me. Your new bank account may be with US Bank, not the US Bank of old, but the Bank of the United States.
Kevin: Just one big bank.
David: Right. My imagination moves to the same place as that of the Economist’s editors. If you read that article, I strongly recommend it, I think it’s page 13, they say, “This raises the queasy prospect of bureaucrats influencing credit allocation. Once ascendant, govcoins could become panopticons for the State to control citizens.”
Kevin: That’s interesting that they brought that word up. We brought it up last week, panopticons. Yeah.
David: “Think of instant e-fines for bad behavior. They could alter geopolitics, too, by providing cross-border payments and alternatives to the dollar.” I guess they’re talking about in the case of non-US govcoins or central bank digital currencies, whether it’s the Chinese or Europeans, what have you. “The world’s reserve currency,” they go on to say,” and a linchpin of American influence.” So, these govcoins become a real issue, not only redefining money as we know it, but even redefining commercial banking as we know it, putting a surrogate of government directly in the center of our lives, maybe more than we would actually want.
Kevin: I think sometimes, people mistake our warnings about the government taking over or allocating the resource to themselves. I think they make the mistake of us saying that bitcoin and blockchain and all these things don’t have a use, but they do. They’re interesting technologies that have a future, no matter what. It’s just who controls that future?
David: Yeah. Where my imagination has always skipped ahead three chapters in the book is what’s next? Because if this does represent an infringement upon central planning, the central planners won’t stand for it. People have died over less as it relates to the money monopoly. So, the idea that you can waltz in in sort of a libertarian wild, wild west and define your place in the world without regard to the political implications, regulatory and ultimately confiscatory reach of government, wow. There’s a bit of history you’ve got to review. This is not a neutral environment where you just bring something to market. No, no, no, no. You may have gotten there without preapproval. But you don’t get to stay unless you’re granted permission. Your existence is now contingent on public policy decisions.
Kevin: Yeah. So, buy it with money that you can possibly lose, but don’t buy it blindly, thinking that just because it’s the future, you’re going to be able to participate in the game.
David: The next iteration is the most important iteration, and again, this is, as you say, not just you and me with a particular concern in the back of our mind, some sort of conspiracy theory gnawing at our brains.
Kevin: We’ve just been through a lot of pain watching people try to do something without government regulation or a monopoly.
David: But the Economist nails it. “These govcoins could become panopticons for the State to control citizens. Think of instant e-fines for bad behavior.” One of the things that we’ve talked about is that—
Kevin: Yeah. Sesame credit type of thing.
David: Yeah. Exactly. So, that is on the basis of behavior. What if it’s about motivating the next purchase? What if George Bush had the power after 9/11 to not only encourage you to spend, but force you to spend so that those money hoarders were forced off the sidelines and our US economy, 70% based on consumption—
Kevin: Your patriotic duty. Remember? He said it was your patriotic duty.
David: Your patriotic duty to go buy something. Now we’re going to force patriotism because we can through a govcoin. Are you kidding me? What an opportunity. I’m not saying that. That’s the perspective of the central planner.
Kevin: Boy, does that seem like a long time ago? Remember when we were talking about him sending 100 bucks to everybody?
David: Wow.
Kevin: Wow. Things have changed. They’re sending a lot more, and it is our patriotic duty to go and just run up debt and spend as much as we can. Okay. So, speaking of debt, because I think it’s important to understand, too, when we talk about these things, right now, money’s free. Money’s flowing free, margins going up, people are borrowing. They’re not just taking the money that they’re being sent. But margin debt right now, it’s skyrocketing, Dave. So, any of these changes, these major changes that might be unpopular right now, wait until that debt collapses and they have to do “for emergency measures” what Rahm Emanuel says, which is, “Don’t ever let a good crisis go to waste.”
David: Yeah. Margin debt has increased 77% over the last 13 months and it was already at what you could consider a cycle peak. It was matching everything that you saw.
Kevin: Remember Alan Newman? He was screaming, “This is too high,” two years ago.
David: Right.
Kevin: You’re talking in 13 months, it’s up 77%.
David: And it’s increased every month for the last 13. We’re now at 847 billion. Newman makes the case that additional risk taking has been accommodated by— This is kind of his explanation. Part of it is, I don’t think I was wrong. This is why I was still right. But additional risk taking in equities has been accommodated by the wealth coming out of cryptocurrencies. That’s his view.
Kevin: Do you really think that’s true?
David: I’m not convinced of that yet. I think he’s trying to wrap his mind around numbers and statistics never seen before, like margin compared to market capitalization or margin compared to GDP, which are truly eye-popping. The increase of market values within the cryptocurrency space to over $2 trillion, that fills a gap for him. I think there’s a simpler explanation, which suffices, and it is that speculation creates its own positive reinforcement dynamic.
Kevin: Feedback loop. Yep. Yep.
David: Yeah. So, just as an unwinding market creates its negative reinforcement dynamics, there is excess liquidity in the system, plenty from central banks around the world, into the trillions, don’t need necessarily $1 to $2 trillion extra top-off from the cryptocurrency markets. So, dependent on the digital currency, I think, minimizes the natural forces of a mania, and I do wonder if we’re not, in fact, in line to see one final stage of manic behavior in the US equities markets.
Then this is just a speculation on my part, but I went through Financial Times’ May 28th article titled “Wall Street’s Love Affair with China.” It’s a bit of a digression. But you got Goldman Sachs, J. P. Morgan, and BlackRock entering into partnerships, joint ventures, what have you, whatever you want to call them, with Chinese banks and they get to access 680 million Chinese investors for money that can be diversified outside of China. So, we’re talking about products, ETFs, and mutual fund type products, wealth management products managed by Goldman Sachs, J. P. Morgan, and BlackRock, and there’s a fascinating thing going on behind the scenes here.
This is even a further digression. But you think about how BlackRock votes on behalf of all of the shareholders within their funds and they’re becoming one of the greatest political powers on the planet. Now, you take BlackRock and assume that they now have Chinese investor interests in mind and you wonder what kind of power expression is on display as it relates to either domestic politics, international politics, that you can start driving boardroom decisions when you are the single largest shareholder because you’ve got X, Y, and Z ETFs, and you represent 10% of all outstanding shares, 20% of all outstanding shares.
Kevin: It’s like a different kind of United Nations or IMF, or where we have these super-national types of entities that are actually driving world politics and economics.
David: Well, exactly. So, now you’ve got financial firms, which are gaining enough clout, given the number of shares that they hold on behalf of their investors, but they’re voting as if it’s their shares.
Kevin: It sounds like a sci-fi film.
David: No.
Kevin: It really does.
David: It sounds like corporatism. It sounds like—
Kevin: On a world scale.
David: On a world scale—
Kevin: On a world scale. Yeah.
David: —you’re talking about a few people able to drive corporate agenda and national agendas together. The likes of Larry Fink and you look at the heads of State Street, BlackRock, Fidelity, your big management firms, it’s actually moving to a fairly scary place. Again, I know this is a digression, but they’re in the process of tapping 680 million Chinese investors for money that can be diversified outside of China, and that is money that will own even more shares and give them even more “corporatist power.” I don’t like it. I don’t like it. I don’t know how you get off this train. But this one is running full steam down a set of tracks that seems fairly straight.
Kevin: Well, and I wonder what the train would look like if, actually, we had a return to true value. Like we’ve talked before, everything returns to its intrinsic value at some point. I think about all the government handouts, Dave. I don’t think you’re a gambler. I’m definitely not. When we’ve been in Vegas before, I don’t have any real desire to go down and gamble. It’s just not who I am. That doesn’t make somebody who goes down and does it wrong.
But if the casino, let’s say we’re coming into a conference and the casino said, “Look. I’m going to go ahead and give you the first thousand bucks of chips for free,” well, even a non-gambler at that point, including myself, is going to say, “Well, you know what? Thousand bucks for free? Really? All right. Dave, I’ll be back in a couple of hours. I’m going to go play Blackjack or craps or what have you.” If the chips are free, you’re going to be more likely to gamble. Now, is that happening with the government handouts right now? Are people being retrained to be speculators in a system that cannot survive or cannot sustain itself?
David: Yeah. I think that’s a late cycle dynamic, and I would say that feeds into, again, the natural forces of mania and the dynamics of the markets moving from high to higher to highest, the government handouts post-pandemic are just adding fuel to that fire. You have money being used like so many free chips at the casino, whether it’s to buy AMC or Koss or your various meme stocks. But I think those are evidence, if you will. A lot of the stocks originally had very high short interest, low volume, and once they got moving, they were moving and unstoppable to the upside. Speculation feeds on itself. I guess that’s what I’m saying. Speculation feeds on itself in a psychological sense. Success draws out greater and greater risk taking and things that just simply don’t make sense all of a sudden exist. For instance—
Kevin: Dogecoin.
David: Yeah.
Kevin: Yeah. How’s that?
David: And it’s a joke, but it’s worth $85 billion with a B and it’s still a joke, and yet there’s $85 billion representing people who’ve put in real money into something that has— You tell me what it is. I have not found a single person yet—
Kevin: Elon Musk’s even mocked what it is, and he’s proven that it’s a mockery just by the things you’ve said. But like you said, success breeds greater risk taking. I remember when I was a toy store manager, Dave. I worked all year long for, I think it was like a 12 or $1,500 bonus. I mean, worked really hard just for that. I remember going downtown Denver and buying some options contracts. I think it was on sugar or something like that. Well, I just happened to accidentally hit it right and doubled my money almost overnight. I went back into the broker and I’m like, “This is so easy,” and he suggested a couple of other things. Of course, you know how that goes. Fortunately, I didn’t keep winning, fortunately, because it would have ruined my life.
David: 1,500 to 3,000, 3,000 to zero was a healthy life lesson.
Kevin: Absolutely.
David: Yeah. Well, again, the market prices are being encouraged today by verbal interventions from the Fed, from direct money that’s coming from the government, and I think these are, again, probably better explanations than Newman’s idea that this is all now about cryptocurrency excess.
The sense is that markets only move in one direction, and it’s up. So, we talked about Nasdaq already turning a corner and moving lower, growth already moving the other direction. We’d see a rotation from growth to value stocks, and as inflation over the last month or so has become more of a concern on Wall Street, you’ve got a migration. You’ve got a migration of investors who are looking both for a growth opportunity, but also risk mitigation, moving from sectors of growth towards value.
Money’s moving, and to the degree that inflation remains front of mind, that rotation will continue. But we’re right at the cusp. Are we seeing a continuation of a manic phase? Will it continue? Does it continue if you get the Chinese buying wealth management products from J. P. Morgan, Goldman Sachs, BlackRock, or are we just right at the edge?
Kevin: Well, okay. So, you take the Economist. Remember last year, the Economist had a cover that said the everything bubble?
David: Mm-hmm (affirmative).
Kevin: Everything can move at once, even things that normally would be countercyclical or move opposite each other in this kind of speculation. By the way, all respects to Alan Newman because we love Alan, and even if maybe where that money’s coming from isn’t where you think it is, Alan’s got this thing nailed because he knows that when money moves up together, it can move down together.
David: Well, and I agree with him on that, that manic assets move together, they’re disconnected from fundamentals, they’re tired primarily to speculative energy, and when the energy shifts, it does so across the board, which begs the question, with a 40 to 50% decline in bitcoin, and other speculative darlings seeing similar volatility, we’ve got specs that are no longer moving money and new spec IPOs, which, just launched since the beginning of the year, are down 20 to 50%, does that open the door for further selling in Nasdaq and the beginning of a move lower in the Dow and the S&P 500 stocks as well? Newman’s final words in his letter, and I’m always expecting this letter to be his very last because he said he was going to retire.
Kevin: He always tells us that it’s going to—
David: How many years ago was he retiring?
Kevin: Yeah. Yeah. I know. But I love that he doesn’t. He says, “This is it. I’m going to write one more letter because I just have to.” He’s just got to do it, but he also, what did he say?
David: The last words in his last letter, hopefully not his last, “It’s time to divest.”
Kevin: Oh, you think so?
David: Yeah. So, equity investors, again, maybe rotating and upgrading portfolio composition, as we said, going from growth to value. But it’s fascinating to me, if you’re looking at the broader financial markets, that credit investors have yet to do much of that in terms of improvement of portfolio composition and quality. Peripheral European debt rallied last week. The ECB was out there again, active both verbally and with pen in hand to write a big check, buying more debt. Debt investors, to me, today look like truffle picks, searching for the last tuber on Earth. It’s hidden under the leaves looking for that last basis point. We can get it. Let’s get it.
Kevin: And they might themselves get eaten. Okay. So, all right. Going back to Newman, because one of the things that I like about Newman is he really does watch price earnings. Just to give a— Okay. So, you said truffle picks. Let’s pretend like I own a hot dog stand. All right? And I’m earning 100,000 bucks a year, and I’m doing okay. You come to me and you say, “Kev, I’ll give you 500,000 for that hot dog stand.” Simple terms would be, well, I’m selling it to you for five years of my earnings. A million bucks, 10 years of my earnings. If I sell it to you for 1.4 or 1.5 million, that’s 14 or 15 years. I’d be doing pretty good. That’s where the stock market is usually the happiest. But price earnings right now, it’s more than double that, isn’t it?
David: Yeah, and that’s where Newman’s preference is to look at price earnings on its present value, not its future projected PE. So, on his preferred metric, present PE, the S&P now rests at a lofty 44.58.
Kevin: That’s a record. Didn’t we get to 42 back before the—
David: We might have spiked higher.
Kevin: —tech stock bubble?
David: Yeah. I think we spiked higher. But sort of like that day type of thing.
Kevin: 44 years of earnings is what the stock market is worth on the S&P right now.
David: That’s right, and if you’re looking ahead and saying, “Yeah, but earnings are going to improve,” so based it on the forward PE, then you’re like 25, 26.
Kevin: That’s still 25 or 26 years of earnings.
David: That’s an expensive hot dog stand.
Kevin: That is an expensive hot dog stand.
David: $100,000 and you’re paying two and half million for it?
Kevin: Yeah.
David: That’s interesting.
Kevin: You’re going to stand there the next 25 years selling hot dogs just to break even?
David: It’s time to cash out.
Kevin: Yeah.
David: Yeah. That’s the hot dog stand guy. He would say, “Yeah. Time to cash out.” At 44 times, four and a half million, let’s say four and a half million dollars for a $100,000 hot dog stand, you’d be an idiot not to cash out. So, I prefer the Shiller PE, what I often refer to as the CAPE, cyclically adjusted price earnings, because it takes out some of the gamesmanship from the C-suite. They like to game their earnings so that they can game their options and compensation packages. So, stepping away from PE—
Kevin: So, Shiller flattens that out a little bit.
David: That’s right because you’re taking a 10 year rolling average, and so some of the unnecessary noise comes out, and Shiller PE, or the cyclically adjusted, the PE10 sometimes it’s called, 37.2.
Kevin: Okay. So, that’s the one I was thinking of. Shiller PE got to 42. Right?
David: Yeah. Yeah.
Kevin: It was the Shiller. Yeah.
David: We’re right neck and neck with—
Kevin: Right before the tech stock bubble popped.
David: It’s expensive because if you look at the mean level, whether it’s for your normal PE or for Shiller, it’s between 16 and 17. The mean level. Right? So, we’re not talking about extraordinarily cheap. That can go single digit. But extraordinarily expensive is where we are. It’s expensive. Finding value in the market today is nearly impossible. You look at something like dividend yield for the S&P, the index, just over 1.2%.
Kevin: That used to be why people bought stocks, was the dividend yield.
David: Yeah, and the time has passed since the days of Dow theory. Charles Dow’s early appraisal of when you hold them, when you fold them, what he considered to be a good value, you could step into the index, or step into an individual company, rather, and buy it if the dividend yield was between five and six percent, meaning that the share price was low enough, relative to the dividend return to an investor, to give you a healthy return just in terms of current cash flow or annual expected cash flow from dividends. He would say anything in the 2 to 3% range was, in his mind, way too expensive for an original basis.
Kevin: So, if Charles Dow were writing a letter, a newsletter like Alan Newman, would he say the same thing right now? Time to divest?
David: Yeah. Listening for the ghost of Charles Dow, he would say, “It’s time to divest.” It’s strange to imagine selling when the market is strong.
Kevin: Isn’t that when you do it? Isn’t that when you should do it, is sell into strength?
David: Yes, and typically we see the opposite where liquidations are into weakness. People are in a panic mode, they’ve started to lose money, they don’t think it’s going to be bad, and then all of a sudden, it gets worse than expected, and there’s a psychological flip, and all of a sudden they want out at any price.
But that’s after once prices have already headed lower, and that’s not an ideal strategy. You said it. Always sell into strength. There are two reasons for it. Number one, liquidity is typically not a concern as prices rise. You’re feeding the market’s appetite for the asset in question. Number two, if you do that incrementally, you take out your original invested dollars on a disciplined basis and you still have something invested still in play.
But by selling some, you are doing something that is really good for the mindset of any investor. You’re resisting the temptation to maximize every dollar and divine the perfect timing, which frankly, no one knows until it’s hindsight. You can look back in time and say, “Oh. Well, that was the perfect time to sell.” You don’t get to do that.
Kevin: You know what? I remember back in 1987, my first year here, Robert Prechter hit exactly when to sell the stock market right before the crash. The problem is, he really hasn’t hit much exactly since then. Now, it doesn’t mean he’s not smart. It’s just there’s so many different variables. I think of Solomon in the book of Proverbs. He says there’s wisdom in a multitude of counselors. Wouldn’t you say this period of time, especially with the, you called it noise, you need a multitude of counselors that you can trust, even ones who are maybe dead, but wrote books?
David: Yeah, and I think, to some degree, we’re talking about models that are helpful, but don’t tell us everything. So, in the case of Elliott wave, maybe it’s like a broken clock, right twice a day. Maybe it’s more accurate than that. But there are times when it’s spot on, and there’s times when it’s dead wrong, and it’s a problem with the model. Right? It tells you something, but it doesn’t tell you everything you need to know.
Kevin: That would be omnipotence, and I don’t think we have that.
David: Yeah. I like Charles Dow. He created his own model, Dow Theory. There was a time 20 years ago when studying his proteges, whether it was Robert Rhea or William Hamilton, it was absolutely fascinating for me. It was a little bit like reading philosophy for the first time.
Kevin: That’s your weakness. You love it.
David: It was a fresh perspective, and as time went on, it became clear that there were some gaps left by Dow theory, and some of those gaps were in part due to the further development of the markets between now and then. There’s a way of distributing shareholder value. Shared buybacks are a thing these days. Wasn’t really a thing back in the day. Lots of things have changed in the capital markets from the 19-teens and ’20s to the present.
Kevin: And there’s truisms as well. That’s the thing. You’ve got to learn, you hold fast to that which is good. You test everything, you hold fast to the things that continue to be truisms.
David: Yeah. Just because a system is imperfect doesn’t mean that it’s lacking in value. I know Alan Newman likes Sy Harding. Sy Harding does some seasonal studies. Very helpful. But again, they work until they don’t. Sometimes, they’re very helpful. Sometimes, they’re not. I spent dozens of hours with my dad’s friend in Miami Beach, who was enamored with Gann lines and Fibonacci levels, and gin.
Kevin: And gin?
David: Not that they always go together, unless you’re reading your fans and Ganns and Fibonaccis wrong, and then maybe gin is your only consolation.
Kevin: Well, and you still read Elliot wave.
David: Every week.
Kevin: I don’t want to make it sound like it doesn’t work.
David: No, every week. And every week, we consult with a gentleman on the West Coast that prefers Peter Eliades’ research on cycles. Dr. Lacy Hunt, Jim Bianco, David Rosenberg, Bill King, our own Doug Noland. Back to Peter Eliades, as an aside, Peter made one of those significant market calls right around my birthday, called the exact market low in 1974.
Kevin: Really? That was your birthday?
David: Yeah.
Kevin: And that was the market low?
David: In December of ’74, in that particular cycle. So, he calls that cycle low and now he’s famous for his cycle studies. Whatever. But again, is he always right? No. Is it helpful to be aware of a lot of different things from both a fundamentals perspective as well as a technical perspective? Absolutely.
Kevin: You know, Dave, okay. So, pretend for a second you’re at the Louvre and you’re allowed to walk all the way up to the Mona Lisa. Okay? You’re blindfolded. So, you walk up blindfolded to the Mona Lisa, they take the blindfold off, your nose is pressed against it. You’re not going to see the picture. What you’re going to see is you’re going to see browns and reds and maybe a little bit of blue. How you describe that picture when you’re that close is not going to be how you describe it when you’re 10 feet away.
David: You might see stars because my guess is that security has just tackled you with your nose to the glass.
Kevin: Yeah, and my nose print’s still there, Dave. So, yeah. That’s the example.
David: No, but taken together, some of the signals are mixed and contradictory. If you step back from them, you can see the small pieces that tell a story—
Kevin: Right. You can see the painting.
David: —usually different parts of the same story. Doug likes to describe it as a mosaic, and he has lots of different things that we cover on a weekly basis that go into our asset management focus. If you look at all of these different models, they’re different pieces of the same picture. Occasionally, they seem to contradict until you gain more perspective. You weigh each part with a degree of suspended judgment. You look for the areas of common ground for the significant shifts, and not just with one of the indicators, but with 101 of the indicators, and you develop a feel for it. There is science, there is art, and there is where you have a growing consensus among all of those.
Kevin: Okay. Yeah. So, let me ask you. You just named a bunch of guys. Is there something they would all in one room agree to?
David: Yes, that we’re at the far reaches of the financial market, and the sustainability is certainly in question. Where we go from here, if it is higher, it’s incredibly temporary and a significant decline is likely.
Kevin: What is the significant decline?
David: Not a 20% correction, a 40 to 60% bear market baller. If you wanted to look for consensus, it’s that things are very stretched. Things are not reasonably priced, and they’re here only because you’ve got trillions of dollars artificially infused. The natural level of the market is considerably lower, and we’ve got plumb that depth. Again, markets run in cycles, from undervaluation to overvaluation. It’s not as if prices ever land at their perfect level. So, they’re constantly moving. The question is, where are you at on the movement? Where are you at on the cycle? Are you the upper end? Are you at the lower end? Are you somewhere in between, which is far more ambiguous? The nice thing about this market environment is, it is not ambiguous.
Kevin: It reminds me a little bit of health, Dave. Remember for a few years, you spoke at a conference where they were— It was a great conference, by the way. I won’t name it, but there were a number of great vendors there who, if you did what they said, you would be healthy. But what was amazing was if you did what everybody said all the time, it would kill you. Okay? You have to pick something. Right? From keto to paleo to vegan, you name it, but you got to pick something. So, with health, I just got an ad on my computer a couple of days ago that said, “Do this for the next 24 days and you’ll lose 34 pounds.”
David: Wow.
Kevin: Well, I didn’t click on it. Okay? I don’t want to lose 34 pounds. That would be devastating to me.
David: If I lost 34 pounds, I think I’d be dead.
Kevin: Yeah. Me too. But see, okay. So, that’s the thing. Wisdom in a multitude of counselors.
David: Just before we move off that idea of a major bear market baller, 40 to 60%, keep in mind, the Dow moving to 14,000, which Newman still holds is—
Kevin: Yeah. He’s holding that number, isn’t he?
David: It’s been that way in his mind for three or four years.
Kevin: His chart’s telling that.
David: It may be hard to imagine from this sort of perfect perch, but it’s what bitcoin did from its journey of 64 … Well, 64,000 to 27,000 is exactly what we’re talking about for bitcoin, and we did that in a week. It’s not as if we haven’t seen that in a month in equities. We’ve brought in a new version of volatility where people, I think, sell first, ask questions later.
Kevin: Right. Well, and Newman’s the same guy who also says we’re going to get down to five to one on the Dow with gold. Right?
David: Right.
Kevin: Five to one. Yeah. He still has been calling that. We got down to six to one back in 2008. Yeah. It was 2008. But we didn’t quite hit the five, and he’s holding to that. He says, “No, it’ll be five or less.”
David: I think we’ll see three.
Kevin: Okay.
David: So, off of current levels—
Kevin: Which means three ounces of gold would buy the entire Dow. That’s what we’re talking about.
David: Yeah. If you want to expand your financial footprint, it’s sort of a six times multiple from here. One of the reasons why I like gold as a holding pattern, you get to redeploy at different levels.
Kevin: Because it’s done it before. See, that’s the thing, that you hold fast to those things that seem to repeat.
David: And maybe it’s different this time. Maybe it’s different this time. But we do have a good bit of history on our side on that. So, you bring in health, and I think that’s worth reflecting on. A similar approach to health, people love simple answers. People love definitive advice.
Kevin: And they want to do it in 24 days if they can.
David: Yeah. They don’t like pain. People are looking for the one thing that they like and seems to get it all done. So, you have fad after fad where the world gets simplified into an easy, universally applicable method. So, it might be no red meat or only red meat. It might be no fish, it might be only fish and fowl. It might be vegan. If we want to live to be centenarians, maybe we all need to eat Bulgarian yogurt for breakfast. There’s something that is the magic answer, right?
Kevin: Well, maybe your exercises should turn to yoga, Dave. You’re running yourself silly.
David: That’s interesting because there is something about the parasympathetic nervous system that yoga poses help with and promote, and I can tell you some of the deepest nights of sleep I’ve ever had was after doing yoga. Now, I’ll tell you this. Me doing yoga is pretty funny because I can hardly touch my toes.
Kevin: Okay. So, I think about a good night’s sleep. I also know that you’re a cold shower guy. Okay? It stimulates a little bit. But you taught your kids the same thing.
David: This all factors in, right? Whether it’s breathing techniques or cold water, mitochondrial stimulation, ketogenesis in the improvement of fat metabolism for sustained energy. I met with a trainer here in town who was an Olympic athlete cyclist, and we looked at how to move in the direction of fat metabolism as opposed to just metabolizing carbs because you’ve got basically unlimited stores. I have to say, this may not seem connected, but in our hard asset insights this last week, the most disappointing fact mentioned was the increase in the cost of bacon of 16.3%.
Kevin: Okay. For the listener who has not sat and watched Dave eat breakfast, it’s either a plate full of bacon or a plate full of sausage. Yeah. Yeah.
David: I do like protein, and if it’s fatty, I kind of like it too. Wine’s up 11%. But bacon, for sure. That’s a disappointment. That’s the kind of inflation that is intolerable to me. But again, there are a thousand methods, which, taken together, begin to tell us about how a system works, whether it’s the financial system or our physical bodies, and perhaps our individual system differs from the rest. There’s particular care and attention that you’ve got to give. You’ve got to listen to your body, and yes, I think a customized approach is necessary. What works perfectly for one person is not going to work for another quite as well. Your blood type, environmental factors, all kinds of things.
Kevin: Okay. So, the parallel between what you’re talking with a physical system, you have to customize. You have to find out what works. Napier was saying the same thing three weeks ago. He said, “Look. If you think you got a way with everything for the last 10 years with indexed funds or what have you, you’re going to now need to have specialty picking to be able to make it through this next cycle,” and he said this next cycle might last 20, 25 years, down cycle.
David: But at least a minimum of 12 to 15. So, the parallel between the financial system and our, think of it as a physio/electrical/biochemical system, is that first of all, there’s a lot of complexity. Secondly, there’s constant adaptation occurring within the system, both from outside and inside inputs. Exogenous, endogenous inputs, constant adaptation that’s occurring. So, the financial system is adapting. Our bodies are having to do that as well. The third thing, sort of a parallel between them, is there’s a level of stress that complex systems can handle and there is a point at which it cannot take it any further. A level of stress it just simply won’t take. I think we all have experienced that to some degree. I’m kind of fascinated. One of the reasons why I like doing triathlons is to figure out what that level of stress is. Now, I’m not trying to figure out the DOD, the date of death, prematurely. It’s not that level of stress.
Kevin: You’re on your taper week right now, and you shared with me before we started recording that you’re absolutely nervous because all your body wants to do right now is train. So, you taper for the race.
David: But there’s also interconnections, which are sometimes lost by specialists who see things according to a unique set of parameters. So, you’ve got a health specialist who sees things only according to the gut. You’ve got an economist who sees things only according to monetarism, and it’s super helpful. On the other hand, it’s not the full story. So, you have to listen, take notes, self critique, and make sure that you’re getting a fuller picture.
Kevin: But if I were to play the devil’s advocate and say, “But you know what? The government’s here to help. The government has come up with, what is it, $6 trillion,” is that for economic growth? Is that what that’s designed for? Could we see a flood of dollars come into the economy and actually have it look like growth?
David: Coming out of the weekend, Bloomberg describes the Biden budget, $6 trillion colossus, as being focused on wealth redistribution and not growth.
Kevin: Not growth. Okay. So, redistributing wealth.
David: I think one of the— a budget does not always and exclusively be focused on growth, and I think that’s a part of the conversation we had with our friend who lives in Eastern Europe. Right? Was the chief economic advisor to Václav Havel, and to have a perspective that growth is good, but it’s not ultimately why we exist. We have a more complex reason for existence than just simply growth, and the economy can serve other functions. But what Bloomberg is saying is this is more anti-growth. This is wealth redistribution and not promoting growth. It might promote the opposite. The spending is larger than in past budgets. But they’re arguing, so will be the revenue. At least, that’s the desire. According to their numbers, it should leave us with about a $1.84 trillion deficit for 2022. So, just under $2 trillion deficit, and that’s if tax collection goes as planned. So, if you look back over the last couple of years, 2019’s deficit, $984 billion. The 2020 deficit, 3.1 trillion.
Kevin: COVID. Yeah. Yeah.
David: 2021, on track for 2.3 trillion. 2022, 1.84, again, which assumes an increase in revenue of about $670 billion from 2021. We’ll see. But the four-year total on deficits is on a trajectory of about eight and a quarter trillion. That assumes economy’s still pumping great, we’ll get back on our feet post-COVID. If we did get into a financial or economic crisis, we go to 10 over that same timeframe, four years, almost overnight.
Kevin: Okay. So, let’s put this in perspective. We said this about a month ago. It took from George Washington to Jimmy Carter for us to have a $1 trillion deficit, which you’re telling us now is over the four years that we’re going into, we’re talking eight and a quarter trillion. That’s eight of those 200-year periods all wrapped up into four years.
David: Well, yeah. That’s eight and a quarter. We’ll blow past 10 trillion by the time we— This is, again, not total debt. We’re talking about the upper bounds of the 20s—27, 28 trillion, if you’re talking about aggregate financial debt of the US government. So, of course, this is not long-term liabilities, which pushes you into the $200 trillion range.
Kevin: Wow. So, socialism works as long as there’s other people’s money. Margaret Thatcher said it stops working when you run out of other people’s money.
David: It also stops working when people start asking questions, and that’s one of the things that’s really important about controlling narratives at this point because a real healthy conversation about the unsustainability of what both the Republicans and Democrats have served up in terms of a legacy of debt, you know what that would say? It would say the confidence is not well founded and that it should—
Kevin: This is not partisan, by the way. Yeah.
David: No. No, no.
Kevin: I was driving behind a car yesterday that said Bernie Sanders 2016, but I think Bernie likes this budget, doesn’t he? Hasn’t he already come out and said, “Yeah, thumbs up”?
David: It tells you something. So, Bloomberg says this is about wealth redistribution and not growth, and Bernie Sanders gives two mittens up, and says he likes it. That tells you all you need— That tells you what you need to know. Yes, it’s redistribution.
Kevin: Okay. So, you remember in the 1980s, limited partnerships had great tax status until they went back and grandfathered backwards?
David: Tax liability. Changed the rules and said, “You owe us for past years.”
Kevin: That seems to be on the table again.
David: Oh, yeah. Oh, no. I know people who went bankrupt because of that. But in doing that, at least a part of the proposal is a retroactive capital gains tax to April 2021. That was a bit of a surprise. I think the other surprise in the proposal was Medicare enrollment at age 60 instead of 65.
That’s interesting, because again, long-term budget gap of over 200 trillion, and we come back to this question of complexity, constant adaptation occurring within a system from external and internal inputs, levels of stress that a complex system can handle and where they fold under pressure, and then the interconnectivity. These are things that come to mind for me when I’m asking something as simple as, so does it matter that you change that input from 65 to 60? Again, we’re talking about an aging population given access to Medicare benefits sooner. What does that do to the budget gap, which was already north of 200, $220 trillion?
Kevin: What happens if interest rates go up? Right now, we’re not paying any interest on any of this debt that we’re creating out of thin air.
David: Solvency is not top of mind, nor is the long-term sustainability of our actual debt obligations. With low rates, so the current set of ideas would argue, with low rates, why wouldn’t you increase spending and finance it on very attractive terms? That’s the expert opinion from the President’s counsel of economic advisors. With low rates, why wouldn’t you increase spending and finance it on attractive terms?
What can the system bear? If we assume complexity and adaptation, what happens when you put policy X, Y, and Z in motion? What thresholds exist where stress can no longer be tolerated? Of course, you’ve got specialists who are going to bless the initiatives and promise that all is going to be well. From their narrow areas of expertise, that makes sense. I would simply implore you to think more broadly. Read more broadly. Consider implications beyond the areas which even our counsel of economic advisors are giving us, conclusive to the President. We get conclusive economic assessments just like we get conclusive scientific assessments, and today, I think it’s very important. Read it for yourself. Come to your own conclusions. Invest accordingly. This is going to be a very interesting period directly ahead.
You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. You can find us at mcalvany.com, M-C-A-L-V-A-N-Y, .com, and you can call us at 800-525-9556. The views expressed should not be a considered to be a solicitation or a recommendation for your investment portfolio. You should consult a professional financial advisor to assess your suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary.
