Podcast: Play in new window
- When FOMO Becomes POMO
- Panic Of Missing Out Signals Most Market Tops
- China In Its 4th Year Of Trying To Manage Market Meltdown
“Mexico, for the first time in two decades, has surpassed China as the leading source of goods imported into the US. And for the full year 2023, 475 billion from Mexico—that’s up 5%, versus the Chinese imports, which fell 20% to 427 billion. So we have trade diminishing and a relationship being put under pressure—that’s characteristic of the US and China. We have trade improving and, frankly, a relationship with Mexico that is improving.” –David McAlvany
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany.
David, we’re so entrenched on inflation. It’s really all I’ve ever experienced in my lifetime here in America. We sometimes forget that deflation can actually happen in some sectors, and the Great Depression in the early 1930s, that was a deflationary depression. And of course the dollar was backed by gold back then, and the dollar bought more and more and more, because also it was just a receipt for gold. What does inflation versus deflation look like right now? And I’m thinking about China because China’s starting to show deflationary characteristics.
David: Well, I think it’s very important to get a clear picture on what we’re talking about. In the 1930s, the deflation was an asset deflation. So prices had gone up considerably through the Roaring ’20s, and then those same asset prices collapsed in the 1930s. That asset deflation caused a tremendous amount of chaos in the banking system, and caused a tremendous number of bankruptcies, and the Federal Reserve has ever since then considered deflation to be one of the greatest evils and hardest things to deal with, and they’ll avoid it at all costs.
But just in the decades prior to that, there was another form of deflation which was highly productive. And that’s where innovation and change and growth in the business, technological advancement and improvements in productivity, lower the costs of goods and services, and you have price deflation. Price deflation, not asset deflation, and price deflation is like a bonus to consumers.
So we look at China today and they’ve got price deflation in real estate. They’ve got price deflation in stocks. They’ve got price deflation— We talked about Evergrande and many of these other big builders whose bonds now trade for one penny or less.
Kevin: Right.
David: And so—
Kevin: And that’s a lost penny, by the way.
David: That is, and that is asset deflation. But we also have statistics coming out of China which show price deflation, and that is consumer goods and services coming down. And somehow there’s concern about that, when historically price deflation, distinct from asset deflation, is actually a bonus for the consumer.
What a mashup, we’ve got credit growth characteristics of a boom-bust cycle, desperately being forestalled by more credit, by more of what has created the problem in the first place. You’ve got real estate that remains under intense pressure in China. You’ve got equities that remain in an intractable bear market. You’ve got credit growth in China, aggregate financing, which is going bonkers, hit a record 904 billion. That’s in January, and as my colleague Doug Noland points out, that’s 16% above estimates and 8% above January 2023 numbers. So your 12-month growth in that same figure—again, aggregate financing—exceeded $5 trillion for the first time in a 12-month period of time, 5 trillion.
There is so much credit being pumped into the system to maintain the status quo, and it’s not working. Austrian economic theory is keen to note that credit expands until the system strains and can’t take it anymore. So a boom-to-bust cycle is a business cycle driven by credit, and it requires an ever-increasing amount of credit to keep the cycle expanding and going beyond a natural endpoint.
Chinese theater is what we have today. Chinese theater is what the PBOC is promoting. Chinese theater is what you see as the cycle has already turned for both real estate and equity. So we are talking about an asset deflation, and yet the CCP believes that it can force a different outcome or forestall the bust side of the credit equation.
Kevin: I was at the Durango Coffee Company yesterday afternoon before meeting with you. Every Monday, we meet in the evenings and I try to study beforehand, and I was reading a book. There’s an author coming up that you’re going to be interviewing in the next month or so, and I was reading his book on interest rates and economic booms and busts, the history of how that all works. And as I was reading, I was listening to a table of college students. They had all gathered, I think they only had enough money to buy one cup of coffee so that they could have a meeting place. The rest of them—there was probably eight or 10 of them, but one of them said, “I just paid a hundred bucks for a bag of groceries,” and another person started talking about it. And I was listening to this inflationary discussion.
It was far more of an economic education, honestly, than reading the book. I just paused and listened to the conversation, and one of them just said, “How can you live month to month?” Because he was talking about what he made versus what he needed to eat. And it was like, how do you stay alive? So inflation is a very real thing here. All of these students would’ve loved the good kind of consumer deflation.
David: That’s right, and I found it intriguing that Bloomberg was fixated last week on China’s consumer deflation. This is price deflation, again, for consumer goods, arguably a positive for consumers. In the same context, you’ve got asset deflation, which remains the real game changer for Chinese households, for businesses, for the economy as a whole. It’s a collapse of value. It’s an undoing, an unhinging of the banking system. So just remember the good deflation, things being cheaper as a result of productivity improvements. It’s a natural experience in a growing and innovative economy. Yes, a good deflation does exist, but the CPI dropping the most since 2009—this is in China—is understood as a negative.
Kevin: You talk about the central banks and how they’re continually trying to make an inflation target as if that’s a good thing. Okay, but actually, even if they hit their target, if you’re losing 2% every year, that’s their target. That seems to me like I’m still losing 2% a year.
David: Well, this is a really critical point. Central banks want to bring inflation down, but they don’t want deflation. They want inflation. They just want it at a low level. So the central bank obsession with inflation targeting, it’s a global obsession, but it is a new obsession, and it’s one that is without strong academic justification. It’s not like there was some seminal work on inflation targeting written which was adopted amongst professional academic economists. No, in fact, it would’ve been considered absurd prior to this broad and blind adoption in the 1990s. First it was, I think it was New Zealand, and then it was a Nordic country, and all of a sudden it became the world. But price stability, at one time, was a flat-line experience.
Now, price stability is defined as a steady but persistent increase. That’s hard to fathom. A steady but persistent increase—at a low level, of course, at a low level, of course. But this is where the interests of the general public and the interests of central banks are now completely at odds with each other. It’s been this way for 20 years, but it’s become acute. It is what you described. It’s the student at the coffee— What they haven’t figured out, those students, and they will next time they go in, is you buy one cup of coffee for three bucks and then you go back for your 50-cent refills for everybody else at the table.
Kevin: Yeah, and maybe they were doing that. It is interesting, though, because you’re talking about a steady but persistent increase. What if that applied to your body? Okay, let’s say that you had a disease and they said, “Well, we don’t really want to eradicate it. We just want a steady and persistent continuation of it.”
David: Well, it’s shocking for central banks, for that whole community, to see a decline in price, versus the balderdash that we celebrate, right?, if we have a decline in the increase of prices. Think about that.
What we’re hoping for this week, and the US CPI figure did not decline as much as hoped for by the markets, but think about what we’re looking for. We want a decline in the increase. We don’t want a decline in the price. Does that make any sense? But that’s the whole central bank community. You still want an increase in price. You just don’t want it at a level that you can’t control. So you want a decline in the increase, but you don’t actually want a decline in the price.
Consumers want a decline in price. Consumers don’t want to pay four stupid whatever dollars for a loaf of wonder bread. It’s ridiculous. We want to see $3, we want to see $2. We don’t want to see a decline in the price from four— The rate of change is essentially what they’re after, and they’re assuming that this is tolerable. It’s not. It’s not tolerable.
So yeah, the US CPI didn’t decline as much as hoped for by the markets or by the political class that, frankly, at this point needs to sell the public on the vast economic improvement during their tenure. And so what did we have earlier this week? Tantrums in tech, all the assets that have assumed that the inevitability of interest rate cuts in 2024—five. First it was seven, straight out of the gates. Seven cuts in interest rates, even though the Fed only said three, and they said, “All right, well, maybe it’ll just be five.” Okay, I’m digressing. The topic is China.
Kevin: Okay. But the topic is China, and it is possible that they’re starting to experience the kind of deflation that we’re talking about. As many trillions as have been thrown into the market to try to beat— Again, let’s differentiate the two. There is asset price deflation, which is when a stock market or a real estate market, just tumbles—
David: And consumer price deflation.
Kevin: And consumer, but it ends up costing the consumers to try to beat the asset price deflation because they’ve been spending trillions to try to keep the meltdown from turning into a worse meltdown.
David: Yeah. And that’s a challenge that they’ll have to negotiate down the line, where the amount of liquidity that they’re pumping into the system can—usually does—have an effect on the consumer prices down the line. They’re managing a market meltdown. This is a market meltdown now in its fourth year, and it’s taking more resources. It’s taking more muscular enforcement. The light estimates are five trillion in losses. I’ve read as much as seven trillion now, and this is in the world’s second-largest market for shares, for equities.
We’re not even talking about the debt in the real estate markets. That’s not included in that $7 trillion in losses. Asset deflation is what the world’s central bankers fear. Broad-based asset deflation is precisely what you have in China.
Now, consumer price deflation, you’ve got a little bit of that as an indication in the most recent Chinese CPI numbers, and it should be welcomed. Asset deflation is the stuff of the 1930s here in the US, where you had— On the front edge it was very positive—leveraged growth, financed growth. But ultimately it was unsustainable growth, and it collapsed on itself and you had a lot of debt to pay, and that created insolvencies. Right? So shifts— I think this is what it comes down to. If you think about what happens in China stays in China. No, no, no, no, no. Shifts in financial market liquidity rarely remain siloed. Difficult to see a massive asset deflation in the world’s second-largest economy not send ripples across the pond.
You see it first, I think, in Germany. Under pressure already. They are in recession as China is in recession, and in Germany you’re already seeing residential real estate—of course here in the US we’ve got commercial real estate as sort of the first layer of the leveraged onion—but residential real estate in Germany, that’s in free fall. This, I think, is directly tied to the weakness in China. And so can we expect to see an unwind in China remain siloed?
Kevin: Well, and that’s what I’m wondering because you talked about how no country is an island, and China especially, it’s the second-largest economy in the world, and a lot of liquidity has come from China. Well, since the 1970s we had that symbiotic relationship where we bought about 400 billion extra from them and they had 400 billion in extra Treasurys that they would buy from us, basically. They turned that cash back around, and that became an amazing boom for China. You talk about deflation, a lot of things were a lot cheaper for us because of that symbiotic relationship. Now that’s really broken down at this point. So my question would be, is China a potential trigger for the rest of the world?
David: Yeah. If you look back in time, we know that from the ’70s to the 2000s we had the petrodollar recycling, and then, as you just described, we moved to trade dollar recycling. And it’s with the same benefits, where we could live beyond our means and finance our deficits through the cash— It was landing on foreign shores, whether it’s the Saudis and OPEC, or China and Japan more recently. China presents itself, if you look at the scenario we have in front of us, it’s a very reasonable candidate as a trigger for a larger global financial contraction, and time will tell how this plays out. But you now have asset managers en masse advising that the country—that is, China—is uninvestable. And is that because of the current market conditions where, frankly, negativity gets to its nadir? And that’s what you see.
The worse things get, the more panic and concern there is. This is where the Rothschilds would’ve said, you buy when there’s blood in the streets. The contrarian would say the worse things get, the more attractive they become, right? So on the one hand, market conditions are deteriorating there and maybe setting up for a once-in-a-decade trade, maybe once-in-a-generation trade, or rather, like Russia two years ago, is China becoming a place where capital goes in but cannot come out based on sanctions, based on capital controls? And this is a critical determination because their foreign policy, the domestic policies will drive the capital flows going forward.
Kevin: We look at the emerging markets, and China sometimes is considered still an emerging market, even though it’s a very large economy. What percentage does China make up, if you were to compare it to the other countries around them?
David: This is one of the arguments for why the dollar should die as the world’s reserve currency because, as a percentage of global GDP and global trade activity, it is small compared to China and the rest of the world. If you look at indexes of emerging markets and things like that, you can see that China has taken on a huge role, number two economy in the world. It should. Like the MSCI All Country World Index, and then they also have the MSCI Emerging Markets Index. Those indices both had, this week, 66 Chinese company names cut from them. Maybe that’s a cap-weighted decision. We talked about this being a four-year unfolding crisis. China’s been a drag on those MSCI indices for several years, helping drive developed world relative outperformance, developing world underperformance. At its peak, China was 43% of that Emerging Market Index. Now it’s down to under 24%, and that’s, again, an indication of tremendous pressure on the assets. This is an asset deflation in China, the likes of which you only see once in 100 years.
Kevin: Okay. So let’s play a thought experiment here. Let’s take geopolitics out of it completely. Let’s just isolate it for a moment and say, all right, would Warren Buffett buy China if the geopolitical concerns were not present?
David: If it was down to the numbers, if it was down to the statistics, yes. If it’s down to the state and a determination of rule of law and property rights, that’s a very good question because again, the mash-up here is, like the Buffett ratio here in the US, market cap to GDP in China has declined from a peak of 121% back in 2007 to its current level, 61%.
Kevin: So it would be a buy if you took geopolitics out of it.
David: Again, that’s in China. In the US, we are today at 181%.
Kevin: Yeah. We’re no bargain right now.
David: We were at 60% at the bottom of the global financial crisis in 2009. So from 60% to 181. Now, at 181, we’re inches from the all-time high—the everything bubble high, the peak that we hit, 200%, in late 2021. If you could rely on or have confidence in the CCP, the shift out of US equities to Chinese equities would be now. The math is compelling, except that your policy risk and your geopolitical risk, those are unmeasurable. They’re unmeasurable. So for the risk-aware, the risk-conscientious, this is where Dr. Fred Schwarz’s 1965 title You Can Trust the Communists (to be Communists)—
Kevin: You got to read the whole title there, too. Yeah.
David: He had the last part in parentheses.
Kevin: But communists, also, that’s command and control economy. And so there’s an awful lot of strong-arming and arm twisting and, I don’t know, executions here, or there in China, making sure that the too-big-to-fail companies don’t fail. What does that do for the other companies?
David: Well, I think by that you mean corporate executions, because the dollars are flowing to the big boys. Large caps are getting a small reprieve in China as interventions increase. You’ve got the short selling restrictions, those intensify. You’ve got the forced allocations for asset managers and insurance companies, where it’s not a literal gun, but it might as well be. And they said, “You go out, you buy these exchange funds, you buy these mutual funds, you buy these companies.” Right now, that’s not enough to save the small caps. And so equity performance in China has been horrible on a broad base. And then there’s pockets where it’s not just horrible. It’s awful. And if you look at the investor class today, real estate’s fallen out of favor. It was the only moves in one direction, everyone always wins, just buy more real estate trade. And that’s gone. That’s fallen out of favor. Equities have also fallen out of favor. So guess what young people in China have gravitated towards?
Kevin: Gold?
David: That’s right. So Chinese New Year is here. We generally see an uptick in demand leading towards it, and then it gets a little soft. The market can get soft after that. Chinese New Year is here, at least for the equities market. This is the one-week market holiday, which frankly has been more effective than the direct interventions of the People’s Bank of China in preventing a cratering of stock prices. You just shut it down for a week. “All right, we’re going to take a break. Everyone go on vacation.” Their 300 is like our large cap index. Their CSI 1000 is more like our Russell 2000, small caps, off 27% year-to-date. We’re not even two months in, here. 27%, that’s the small cap index trading at 2018 levels. And so I read one Shanghai hedge fund manager describing being forced, in the first few weeks of January, to cut his stock positions just to survive. He said, “You must lose an arm for survival.”
Kevin: So stocks are very different there than they are here. But you talked about gold, and it’s interesting because the Western investor isn’t really participating in gold. But the East is just devouring it right now.
David: Yeah. Another round of gold purchases by the Central Bank of China. Bloomberg reports January purchases—15th, 15th consecutive month of buying—that is, ounces of gold—by the PBOC. 320,000 ounces. 320,000 ounces. And so de-dollarization, reserve diversification, that is a contrast to the motives which the Chinese public have, seeking security, and perhaps they want performance, but more than anything they need control. As the state gets more desperate, they’re reverting to—and I think this is very critical, and maybe this is a lesson that we can learn from them. As the state gets more desperate, they’re reverting to the non-hackable, the non-trackable form of wealth preservation. That’s what’s coming back into the limelight in China.
Kevin: If I was Chinese, that’s what I would be doing, too, just because, also, they watch everything that you do. But I’m thinking this through though. We had this relationship with China for decades, where, I was talking about the symbiotic relationship where we bought their goods and they took their dollars and recycled it back to us. China’s been the number one exporter to America for years.
David: Not anymore. Yeah. Mexico for the first time in two decades has surpassed China as the leading source of goods imported into the US for the full year 2023. 475 billion from Mexico, that’s up 5%, versus the Chinese imports, which fell 20% to 427 billion according to the Associated Press.
Kevin: So Mexico has surpassed China?
David: Yep.
Kevin: Wow.
David: I would say trade and relationships go hand in hand, right? So we have trade diminishing and a relationship being put under pressure, that’s characteristic of the US and China. We have trade improving, and frankly a relationship with Mexico that is improving. And of course, there’s the election year hullabaloo about the border, which is a very big deal. But we are doing more business and there is more free trade with Mexico than any time in US-Mexican history. It’s amazing. It’s amazing. So trade and relationships go hand in hand. While the RMB—or the yuan, whichever you want to reference—in China and the yen are frankly collapse candidates in the event that those respective monetary authorities lose credibility, the peso is a growth candidate in 2024.
Kevin: That is amazing to me because you talk about the yen being a collapse candidate. The peso all my life has been a collapse candidate. When would you ever just go by pesos as a currency play—long-term secure currency play? What you’re saying right now is the peso is replacing the RMB, the yen.
David: No, just to be clear, on the yen, there’s some ambiguity because the yen to the US dollar went past 150 on the stronger than expected—
Kevin: So what does that mean?
David: Therefore, disappointing US CPI number this week.
Kevin: the Okay. Okay.
David: So the exchange rate shows dollar strength, yen weakness. And we’re getting to a point—again, we’ve talked about the 150, 151 range for the yen being the point where it could break down. Again, collapse. On the edge of a free fall. But ironically, if you look at the broader picture in Japan, particularly with Bank of Japan policy shifts on the horizon, the yen’s ironically poised to rally. Of course, it depends on those Bank of Japan policy shifts. April may bring a reversal in monetary policy in Japan. Really, you’re only talking about going from stupid loose and accommodative to just loose and accommodative.
Kevin: Oh, so finally, the Bank of Japan is trying to get in line with the other central bankers, at least the perception of tightening?
David: And keep in mind, getting in line with them comes at a cost. Because they’ve been buying so much of their own debt, and a bump in interest rates is going to be a material loss in terms of a balance sheet hit for the Bank of Japan. So if a form of monetary tightening occurs, JGBs, Japanese government bonds, are vulnerable again on a yen rebound. They’re in that catch-22, do they want to help their currency? If they help their currency, they hurt their bond market, and that may have consequences for them.
Kevin: Which is what we saw here.
David: That’s exactly right. So yeah, getting in line, it may not be ultimately that appealing. Okay, so this is not a Bank of Japan initiative, what happened in 2023, but it is worth noting that with higher US interest rates, global investors took notice of the US Treasury market, and Japanese investors in particular. Bloomberg reported that Japanese investor appetite for Treasurys broke all your previous records. This is again, last year, 121 billion in Treasury purchases by Japanese investors. This is not the Bank of Japan, and that supports the US dollar. That supports the US debt markets.
Through the years, the idea has been that ultimately the dollar capitulates when a major decline ensues if your two big creditors, the Japanese and Chinese, exit their Treasury positions. And I don’t remember if it was Minxin Pei— Our conversation with Minxin Pei, I think he made clear that the purchase of Treasurys is not economic in nature. They would do that on a strategic basis.
Kevin: That’s political.
David: Exactly. There’s a deeper policy frame, a more intriguing policy frame. So I think for US investors and maybe for those who are concerned about dollar stability, they assume that the “Sayonara” or the “Zàijiàn” will be the last sounds that you hear as the dollar makes its way to the currency graveyard. And yet here we have last year, case in point, 121 billion in Treasury purchases from people who are interested in higher interest rates. A large pool of savings saying, about the dollar, “Not yet. Not yet.” This is a large pool of savings seeking yield, seeking security, and it’s still flowing to US dollar assets.
Kevin: So this is the positive of higher interest rates, as far as support for the currency, because I think of that movie back in the 1970s with Jane Fonda, Rollover. And the whole movie was based on the Saudis not rolling over—for political reasons—their Treasury debt. And what you’re saying is, interest is a strong temptation, even if you’re not necessarily wanting to buy that currency. It’s like, you know what? Really? You’re going to pay me 5% on US Treasurys right now?
David: It’s a pretty thick pasting of lipstick on the dollar pig.
Kevin: Okay. Well, let’s talk about thick, though. We’ve had, what, 21, 22 reportings of— We bring up the economic leading indicator index and it has said recession, recession, recession. But the US economic data, it’s looking pretty positive right now, isn’t it?
David: I like the US dollar. This is straight out of Monty Python. We’re not dead yet.
Kevin: “He’s not dead.”
David: The leading economic indicators are saying, “You are doomed, and you will die.” And maybe that’s just the case because on a long enough time horizon, we all do die.
Kevin: Well, and he did want him to take him anyway because he was going to be dead by Thursday.
David: By Thursday.
Kevin: Remember that?
David: Yeah. But he wasn’t going to be coming back through town. So yeah, this is it. If you just set aside the CPI stats for a moment, US economic data continues to be positive. Last week’s ISM metrics, that’s a decent start. This week, we’ve got mortgage applications, retail sales figures which are expected to be positive on the ISM. You did have prices paid. The prices paid for materials, they are back on the increase. It would appear that shipping delays and rerouting traffic to avoid hotspots like the Red Sea, starting to show up.
Although, you look at energy prices and they’re still pretty tame. That in our mind is a factor to keep your eye on. A move higher in energy would destroy the dovish stance that Powell has taken. It would put the Fed on its heels. It would force a sobering up in both the US equity and bond markets. Energy hasn’t moved yet, but conspiring towards higher prices if you wanted to make the case for higher prices and ultimately that input feeding into the inflation statistics. Conspiring towards higher prices in oil you’ve got shale decline rates, you’ve got an uptick in demand in the emerging markets, ex-China. Commodity prices, you can’t really paint them with the same product brush. Commodity prices are incredibly idiosyncratic. At present. You get industrial metals, which are mixed to down. You’ve got ag prices broadly lower. That helps.
But again, this is where you’d say, “Okay, but if ag prices are lower, why isn’t my box of cereal lower?” Welcome to Corporate America. The exceptions in the commodity space, cocoa’s at the highest level since 1977. Oil, again, flat. Natural gas, it’s below two bucks. Under two bucks. That’s something that is a long-term investment you should be considering. But what can be said goes back to Richard Cantillon. It goes back to the experience of excess money and credit in the French system hundreds of years ago. That is that credit inflation first impacts assets and then migrates out to price inflation chronologically, the Cantillon effect. So the greater the proliferation of credit and the more broadly speaking leverage as it expands in the financial system, the more you can expect wave two of a larger and longer price inflation problem.
Kevin: You know, Dave, the complaint yesterday when I was at the coffee shop was not that nobody had a job. Everybody probably had a job. That’s not the issue right now. The complaint was that the bag of groceries was $100, and so the jobs aren’t really keeping up when you’re college age. The jobs aren’t keeping up with the prices. Unemployment is a really strange thing right now because there’s no lack of jobs. I have to take a side note though. You said cocoa is at the highest level since 1977?
David: Yeah. And frankly, what you should remember from 1977 is it is the best year for port probably ever.
Kevin: Okay. Again, this is a distraction, but downtown, and it was chocolate factory, they have a cocoa drink that is Mesoamerican. In other words, it has no sugar in it. It’s very, very unique, but it gives you sort of like a caffeine tingle without the caffeine. Have you tried that? It’s just pure cocoa. They heat the water. They make it with cocoa and no sugar. It’s not necessarily— If you’ve got a sweet tooth, it’s not going to satisfy it. It’s not a cup of hot chocolate.
David: I’m just wondering if there’s anything more Mesoamerican in that chocolate. Is this like—
Kevin: No.
David: —a hot Hiawatha chocolate?
Kevin: There’s a lot of that type of stuff all around town. Yeah. They’ve got green signs. But let’s go back to unemployment because we really do have strong employment.
David: Yeah. And that’s the good data part, right? Initial claims data for unemployment continues to drop. Very positive for the labor market. Things remain tight. The flip side is tight labor means pressure on wages, and that inflation component from that, right?
Kevin: Right.
David: So there’s good and bad. The conference board measure of CEO confidence turned positive for the first time in two years. That’s great. So marginally, it’s optimistic as the measure hits 53. If you cross the 50 level, that’s kind of the demarcation for optimism versus pessimism. So we’re just over the line at 53. It’s not wildly optimistic, but say something good if you can. Bloomberg reports that CEOs are certainly feeling better about the economy, but cautious about the risks ahead. So in the here and now, we’re good. Still cautious about the risks ahead, and I think that’s consistent with the LEIs. As you look farther onto the horizon, there are unknowns and a series of Gordian knots which are going to be difficult for the market to untie.
Kevin: It sure doesn’t hurt though that the stock market is still melting up, right?
David: And it certainly affects everything, right? Because if a CEO is looking at refinancing debt, now’s a good time to do it. There’s appetite for debt, both investment grade and high yield. Ample risks to be mindful of, though. And I think the mindfulness that comes with attention to risk, sometimes that’s absent when a market begins to melt up, right? So maybe it’s the market melt up that is feeding the CEO confidence. You understand? You get access to capital. If you need to raise money in the debt markets, you can do it quite easily. It’s on better terms than it was six, eight, 12 months ago. And yet, if you’re looking at markets melting up—
I mentioned the Buffett ratio. And Buffett, as a human being, as an asset allocator, it’s an environment where Buffett builds cash, and I think we need to remember that. For all the positivity and for the CEOs to be given two thumbs up, that’s great. They’re doing it along with the hedge fund managers and retail investors. It’s two thumbs up. But on the valuation front, you’ve got to kind of let some of these things sink in. The Mag5, just five companies in the NASDAQ-100, or they also are in the S&P 500, Mag5, not even the Mag7, they have a greater market capitalization than all Chinese listed companies combined.
Kevin: You bring up China—
David: And that’s the second-largest stock market in the world.
Kevin: Yeah. Okay. But look at their valuation and how tied in and how vulnerable they are to China and Taiwan. If something happens over there with microchips, all five of those companies, I can’t remember what the percentage is, but I think one fifth of their revenue comes in from things that are dependent on microchips. Statistically, it’s amazing to watch the entire S&P 500 pulled up by those five companies, but still, people have this fear of missing out at this point. Morgan actually has brought up that it’s beyond the fear of missing out. It’s the panic of missing out. So FOMO to POMO.
David: Yeah. Of these indices here in the US, we talked about five companies having a greater market capitalization than the entire collection of Chinese equities. That’s every index.
Kevin: Really? That includes everything?
David: That’s everything.
Kevin: Wow.
David: That’s Shanghai, that’s Shenzhen, it’s everything. If you’re a listed company in China, put them all in one bowl and you still don’t reach the same level as the Mag5. It’s pretty amazing. And there’s so much enthusiasm around it. Again, the fear of missing out becomes the panic of missing out. And I think David Einhorn can bring some balance to that sort of current market excess. He’s 55 years old, has managed the hedge fund very successfully. One of the brighter guys back in New York managing money. “I view the markets as fundamentally broken.” So Kevin, you and I, or maybe the average investor is thinking, “We’ve never had it so good. This is beautiful.”
As this plays out, let’s extrapolate. We just made 100% in X amount of time. We had one semiconductor stock this week, who in a two-day period was up 100%, 99%, 95%. It was virtually 100% in two days. As things accelerate, we’ve talked about this many times, but it’s the rate of change which becomes unsustainable. When you go vertical, your parabolic charts resolve themselves. They don’t maintain that verticality. And so David Einhorn’s comment is, I think, important. “I view the markets as fundamentally broken. Passive investors have no opinion about value. They’re going to assume everybody else has done the work. Quants base their trades on short-term price moves rather than a company’s actual worth.” Kevin, in essence, he might suggest that the US markets are uninvestable. We talked about China earlier for other reasons, but when you get to periods of market excess in 1929, 1968—
Kevin: 1999.
David: —2000, 2007, 2021. You can say when you get to these periods of peak valuation that those markets are uninvestable. Excess valuations lead to years of underperformance. So you’ve got a hedge fund hand like Einhorn keeping company with Jeremy Grantham, who at those critical points in 2000, 2007, and even at present, would say it’s time. It’s time. As an investor, you need to periodically step aside. It’s time.
Kevin: I want to pause and think about what he said, though, about no opinion about value. Brings up a conversation I have with my wife. We’ve been talking to people that we know that— In politics right now, Dave, it’s the strangest thing. When you have a conversation with people, you can’t talk about issues anymore. There’s either this hatred for one candidate or hatred for another, and really issue is no longer a part of the discussion at all. And in a way, people have no opinion about issues. They just have opinions about the political— whoever the candidate’s going to be. And what he’s saying is, that’s the same thing with no opinion about value in the markets.
David: You’re not engaged with reality.
Kevin: Yeah.
David: You’re allowing other people to do your thinking for you.
Kevin: Yeah.
David: It’s not a thoughtful engagement. And with the markets, you’re no longer thoughtfully engaging with them. It’s the danger zone. It’s the hella-fun zone. People are making money hand over fist, and that’s why you go from FOMO to POMO. Everybody loves it, but—
Kevin: But Dave, because of what’s going on in China, those people are thinking again about value. You talked about the gold purchases in China relative to the Western purchases.
David: Yeah. Western investors still fail to see the relevance of gold and silver. It’s the Chinese Central Bank demand in January of 320,000 ounces. It’s the December deliveries off the Shanghai Exchange of 271 tons. It’s the December retail gold purchases in China at a six-year-high. What you see so often informs how you act. We see a trade, a short-term trade. The Chinese see a trend, thinking of gold in particular. And I think some in China hope that it continues towards a tectonic shift. It probably needed to draw the distinction between the PBOC, CCP, that side of the equation, their designs on a de-dollarized world with a sort of ante that simply wants for her family, for her progeny to preserve wealth. And in Chinese real estate, it’s out. In Chinese stocks, it’s out. Gold is in. In the US, real estate is still in. Stocks are in. Gold is out. This is so fascinating. I love this. But for how long?
Kevin: Mm-hmm.
David: For how long? Not that long. Credit excess has and always will run its course, and then the true price discovery process begins.
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Kevin: You’ve been listening to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. You can find us at McAlvany.com. And you can call us at (800) 525-9556.
This has been the McAlvany Weekly Commentary. The views expressed should not be 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.
