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“On a trade basis, short-term pressure, but as that pressure is relieved and the trade shifts, I think you’re talking about resumption of trend, a very significant trend. Year-end performance for the metals could very well astound.
It seems we are at the end of a long-term cycle for financial assets, and that trend is playing out as spasmodically as you’d expect. But at the same time, we’re just entering into a period of growth for hard assets. I think to see it unfold is going to take poise and patience. Both are required.” —David McAlvany
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany.
Sometimes people just don’t want to be confused by the facts, Dave. I know sometimes I even fall into that category. We’re watching the market hit all-time highs right now, and there’s a lot of hope in a system that’s had a lot of hopelessness over the last three or four years. Is that factual? Is it following the facts? Or is it emotional? Is it following the madness of the crowd?
David: Well, I don’t know if I can answer the question. I think we can just reflect on it, and say, we find the information we want to find. That’s the nature of confirmation bias. Once you hear something that resonates, you think that’s got to be true because it’s what you want to be true.
Kevin: Well, what does the group say? I mean, what’s Doug Noland saying right now?
David: Thursday, the 25th, Doug and I will have our quarterly call for the Tactical Short. We are going to start an hour early this time. 3:00 PM Eastern is the start time for this quarterly call. It’s always a great macro overview, and we’ll have a look at how the market’s closed out Q4. Of course that represents the end of the year, too.
The preview of our conversation on Thursday— The analysis is never simple. You’ve got financial markets which have traded as a unified theme for some time, and, at least in the last week or two, they’re showing a bit of differentiation again. Emerging markets are weakening, small caps are falling behind the pace of gains in the NASDAQ 100, and the key currencies are back on the ropes. The yen’s headed back to the danger zone. The RMB, it’s currently being very well defended by policymakers, but it’s vulnerable, and you can see the Chinese financial markets under acute stress.
The authorities are finding it very difficult to halt the rout in Chinese equities. In fact, you have to wonder if you aren’t seeing the liquidation there in the Chinese markets of long interests and long-held hopes that China would be the leader in the 21st century, because frankly we may be at the end of a period of glasnost, that opening and transparency which has been there for several decades.
You see that because foreign direct investment has reversed. After decades of billions pouring into China, you’re seeing for the first time in decades negative numbers in terms of FDI, foreign direct investment. It’s worth considering that China, like Russia—today anyways, is becoming uninvestable.
You look at things, and if you take geopolitics out of the mix, you’re quickly approaching a compelling buying opportunity in China. Keep geopolitics and the Chinese Communist Party in the mix in risks, therefore in focus, and you’re playing with fire. Let that be a warning to all those burnt bandaged fingers out there.
Kevin: Geopolitics. Geopolitics. I told you I don’t want you to confuse me with the facts. That’s overseas. How about here?
David: The numbers out last week in the US, exceptional to say the least. This is the point. This makes the analysis difficult. The data in the rearview, looking back, is positive—in contrast with the look ahead. That’s with those leading economic indicators which remain negative yet again.
Kevin: What is that? 22 now, 22 months?
David: I think 21, painting a less sanguine picture if you’re looking ahead. The only longer stretch of negative readings on the leading economic indicators came in advance of the Lehman Brothers crisis.
Kevin: I got to admit though, I don’t mind. Actually, I’m joking here because I do see the facts and I’m concerned, but my mom put her house on the market. She’s downsizing. She lives down in Arizona. I was concerned about the tightening conditions, and now, my gosh, it looks like mortgages are back on the bandwagon and hopefully my mom’s going to be able to sell her house and get something smaller without having to miss a beat.
David: Yeah, on that positive note, if you sample from Doug’s Credit Bubble Bulletin, and he’ll cover some of this in the Thursday call as well, December retail sales were strong. They were stronger than expected. You’ve got weekly mortgage applications strongest since last July. You’ve got weekly initial jobless claims, 187,000, unexpectedly dropped to levels last seen in September. You’ve got the National Association of Home Builders. Their index jumped seven points to 44. And you’ve got a 12-point surge in the expected sales component, the largest increase since June of 2020. There is good news if you’re looking on the domestic economic front.
You also have the notable upsurge in consumer confidence, 78.8. Preliminary January UMich numbers, the University of Michigan Consumer Confidence, they blew away expectations. Doug says consumer sentiment surged nine points to the high since July of 2021, a report which also preceded a major stock market rally.
So people are feeling good. The current conditions component in the consumer confidence number jumped 10 points. Expectations rose 8.5 points. Those are both highest since July of 2021. And as you mentioned a moment ago, financial conditions have loosened considerably, not just because interest rates are lower.
There is a wealth effect, there’s a positive net worth effect, and of course you get the benefit of an extra two, two and a half trillion dollars in deficit spending, which is being plugged in, well, was plugged in 2023. And you’re on track for another 2.2 trillion in deficit spending this year. Highly stimulative to say the least.
Kevin: Well, and you talk about stimulation on the economy. Yeah, don’t confuse me with the facts, but sometimes the facts don’t really add up. I think there is an ebb and flow, Dave. Anybody who’s worked at a restaurant, which you have, remember the ebb and flow of customer rushes versus everybody just goes away and it’s like, well, how do you make rhyme or reason of some of that?
After doing this for 37 years, I can just tell you sometimes people get tired of being tired. That’s what I’m feeling right now. What I’m feeling is, even with my clients that have purchased gold and held it, they see the facts for what they are, if there are debts that they’re wanting to pay off or things that they need to take care of, right now, a lot of them are saying, “Hey Kev, I’m going to sell a little bit of gold back. I’m going to go ahead and pay a debt off” because they’re tired of being tired. They’re tired of waiting. It’s like it’s time. Let’s clean the garage.
David: Just going back to the UMich numbers, July 2021 is when the University of Michigan numbers were at their last peak in sentiment, before the markets raised even higher. So again, sentiment was strong, and then the stock market takes off and we start putting in those interim peaks. This is back to the everything bubble Q3, Q4 of 2021. That was it.
Then came 2022.
Kevin: Which was nasty.
David: Yeah, it’s sort of like, looking back, you’ve got confirming data that says we’re all clear. Looking ahead, you’ve got leading economic indicators which say “not quite so fast.” On the bright side you’ve got melt up dynamics, which were a real possibility in the stock market. Valuations can get far more stretched, and leveraged speculation has room to increase.
Kevin: Isn’t the downturn the next time the one everybody should be concerned about?
David: What we’re talking about is a blow-off top, not a new bull market. The downside is not that of a normal market correction after blow-off top like the one we’re talking about, but of a more extreme second test of lower levels.
Kevin: It’s that nasty second test.
David: Yeah. In a major market top, there is the initial decline, followed by a significant rally. That’s if you want to say patterned or textbook or whatever. It’s the secondary decline, not the first one. It’s the secondary decline that does most of the damage. That secondary decline is a high probability here in 2024. Perhaps we’ve got the election chicanery and so it’s a post-election that we see turmoil and chaos, early 2025, maybe just after November.
We’ll talk some with the Elliott Wave guys here in a couple of weeks to explore what they think about the markets, and if they think the markets can hold up that long—all through 2024 into 2025.
Kevin: Let’s go back to that second downturn, that second decline, because we can go back and we can say, “Okay, well, the big crash that everybody hears about in history is 1929.” That second decline, I mean that just ate up everything, didn’t it?
David: Yeah, ’29, ’68, 2000, those all come to mind, so 1929, 1968, the year 2000. In 1929, the initial decline was in ’29. It was followed by a four-month rally. It was November through April. Then came 1930, 1931. The initial decline was 30-something percent.
Kevin: That was like 1987. We had about a 30% decline.
David: Boom, pops by 20%, you’ve got a rally, then the 85% bruiser. 1968 to ’82, that bear market was an inflationary, not a deflationary, bear market. And so value destruction took on a different quality. The value destruction was masked by nominal pricing. Over the period, you had significant declines, not quite as bad as the 1930s, but you factored in inflation over that period and it was not constructive, not healthy. The initial decline was 1966, and you had a complete recovery into 1968.
All right. The worst is behind us. Then you’ve got the 1968 to 1970 decline, which was worse, but then the recovery off of the 1970 lows was nothing short of spectacular. It actually put in new all-time highs. And you’d think to yourself, well, clearly we’re out of a bear market. No, the bear market began in ’66. You didn’t emerge until ’82, but you had multiple opportunities to see forward momentum, positive price action, and the perception shift of “baby, we’re back. Look at us go.”
So the 1970s low, then you increase new all-time highs by December of ’72. That is, if you’re not factoring in inflation. And then you’ve got the second recession of the decade. The second recession of the decade of the ’70s overlapped my birth year.
Kevin: So you were a recession baby, 1974.
David: I was. ’74 was unpleasant to say the least.
Kevin: Except for your birthday.
David: Well, of course, what a blessing. Stepping back for perspective, you essentially were in a sideways grind for 16 years, with the price cap of 1,000 points on the Dow Jones Industrial Average, which kept in place. On the downside, you’d give up 30 to 40%. And throughout the period inflation was working its dark magic. Real returns for the period were quietly catching down to the 1930s’ catastrophic 89% nominal decline.
Kevin: You had a different perspective back in the year 2000. I remember, Dave, you and I, remember, we would have afternoon conversations. I’d be sitting here in Durango. We’d talk about books or whatever. And you were sitting over at Morgan Stanley. You were actually going through one of those eras where we had the NASDAQ, the tech stock bubble peak, and then we had it pop and then rally and then pop again. I remember those conversations. Do you remember those right before you’d go to lunch there at Morgan Stanley or right after?
David: Yeah, there was always not only our conversations that were fascinating, but because my dad’s been around the world of finance so long, talking to some of his old friends, there were always insights and perspectives that were very unique.
I remember a gentleman who had been working on Wall Street for 40 years, finally walked away, owned a number of nightclubs in Miami. I think I was talking to him when he was in his late 90s. His fascination was with Gann lines and Fibonacci retracements and technical analysis. Every once in a while he would dabble with Elliott Wave Theory and their wave counts, but he just loved the minutia of the markets.
The year 2000 was fascinating. I had a front row seat to that decline. What you really had was a period of distribution where you’re putting in a major market top. And the topping process began in 1999 and continued for a number of years. It was not a point in time where you had a sharp turn. May of ’99 to May of 2001 was the distribution phase for stocks.
If you want to contrast the accumulation phase in the early stages of a bull market with the distribution phase where constructive interests are exiting positions and selling into strength. By that I mean—the distribution phase—a top was being put in, advances were met with selling, long-term owners were gradually exiting the market. I’m still just talking about the Dow here.
The drama on the downside was a little bit later. The distribution is May to May, ’99 to ’01, and then you see the real drama May to September of ’01. But the selling had already been happening. Large interests had been exiting the market for two years. I think that’s very similar to today. The initial peak was mid-year 2021. Depending on the index you’re looking at, it was either mid-year 2021 or the very end, sort of November, of 2021, maybe even first couple of weeks into 2022 when you’re putting in the price peak.
Kevin: You were talking about the Dow back in 2000, 2001. But, as you know, the NASDAQ lost more than half of its value and it took 15 years to come back to the level it had fallen from. But if I recall right, they also finally declared that there was a recession there about that time, too. You remember that?
David: Yeah. People are quick to set aside what they know, leaders to laggards. What was helping on the upside becomes the albatross on the downside. Going back to 2000, a recession was ultimately assigned. Of course, they backdate these things. It was seven months of leading economic indicators giving warning signals throughout the year 2000. Once we’re in the recession, it goes unacknowledged. And then finally they backdate it to March of 2001.
It was actually almost over by the time the official designation was agreed to. October sort of marked the end of the recession, March to October. They’re in the fall by the time they announce it. We’ve been here for a while.
The declines in equities, if you recall, they extended another year into September of 2002. So the recession’s over, but the malaise is not. That lingers because you’re dealing with the psychology of the market. You’re dealing with the psychology of investors whose expectations have not been met. They went to Vegas to win, and now they’re nursing losses and coming to grips with their expectations not panning out, their dreams not panning out, their retirement expectations and plans fizzling.
Kevin: That takes us back to the NASDAQ because it feels today very similar to NASDAQ stock gaming and playing back in the late 1990s.
David: Well, as time goes on, you find a more selective interest by the markets—the NASDAQ a very dramatic illustration of valuation excess, 2000, 2001, price absurdity. And you see that to some degree today with the Mag 7.
There’s a consistency through time, and it’s that investors feel like they’re on the cutting edge, and that the decision-making process has become simplified because of how clear and compelling the offerings are. What you lose track of is that it’s the same story, it’s just a different set of names each time it’s told. So today it’s the Mag 7, or if you want to just focus on NVIDIA and Microsoft.
Kevin: The Mag 2.
David: The Mag 2. But we had the Nifty 50, the popular one decision stocks of the ’60s and ’70s, which were largely the underperformers of the ’80s and ’90s, underperformers of the ’80s and ’90s. The one decision stock was that you were deciding to be, in that moment, locked into underperformance for several decades.
The tech stocks of the 2000s—and you mentioned just a moment ago—15 years of working your way back to break-even. The upside action was concentrated in a few names. The downside pain was certainly more intensified. That’s a consequence. That’s the consequence, not just of a tech stock, but you could generalize this to any asset class.
When any asset class becomes over-owned—
David: Over-owned becomes overhang in the marketplace in terms of a supply that wants to be brought to the market to cash in.
Kevin: Why is that? Because you need a buyer, right? I mean if it’s over-owned, it means everybody owns it.
David: And who’s going to keep on driving the price up?
David: That overhang of supply becomes an issue. A larger group looking to cash in, that’s kind of what you get when it’s over-owned, more sellers aggregated around what turns out in retrospect to be an impulsive purchase. And now you’ve got this large cohort of people interested in selling. Sometimes if the market has already turned, even desperate to sell if their expectations are already being disappointed.
It’s fascinating how the most popular names, the leaders become the laggards. A part of that is because the liquidity dynamics change. Liquidity dynamics are always different when you’re selling into weakness. This is one of those tried and true adages. Goes way back to Mayer Amschel Rothschild.
Large owners of stock tap into the wisdom of it, sell too soon. The primary reason large owners of stock must sell too soon is because for the liquidity dynamic to accommodate the quantity of shares they own, there has to be a crescendo of interest that allows them to exit while the masses step in.
Kevin: Well, and since you’ve worked for a large brokerage firm, you also understand that— I can’t help but think, speaking of restaurants, the old adage, “push the fish, it’s starting to smell.”
David: But this is classic. I mean 2001, and remember the meeting where the word went out, here’s what we’re moving, it’s the fish. Only in this case it was technology shares.
Kevin: We need bag holders. We need bag holders to hold the bag because we’ve got a lot of this.
David: And that mutual fund, which was newly issued at $10 a share, within six months was selling at $2 a share. And so, accommodate large holders needing to exit, and you create products that require the bag holder to step in.
Kevin: Over-ownership, let’s go back to over-ownership because over-ownership means that you’ve got a lot of something that may be very, very valuable at the time, but you better sell it before it doesn’t have that same value.
David: Yeah. Even the dynamics can shift. Let’s say it doesn’t appear over-owned at a particular point in time, and then you move into a post-recession disappointment. Growth rates are not the same. The distribution of a product or a service is not quite as ubiquitous as anticipated because the economy is not accommodating anymore. You can’t sort of gin up expectations there.
A sentiment shift occurs, exuberance turns to despondency. And again, oversupply, you don’t have to have a recession to have a bear market in equities, but when you have negative economic factors driving a liquidation cycle, it can be to excessively low valuations.
This was the beauty of being an agnostic investor. You’re now at the opposite end of the spectrum of the sell-too-soon dictum. It’s “buy when there’s blood in the streets.” And may I say, may I say, 2022 lows were not excessively low. There was no blood in the streets. There was merely a correction off of a high point—of what was a three standard deviation valuation, and it corrected to a mere two standard deviation above the mean, still excessive, still overpriced.
Kevin: Let’s talk about pricing because when a person says, “Well, how in the world do I know if it’s overpriced?” we look at the Shiller PE. If you go back and look at the Shiller 10-year adjusted price earnings ratio of these companies, it follows a very, very regular pattern with the pricing in the stock market over time.
David: I would encourage any listener to go back to the archives where we talk about the Q ratio and we talk about the Shiller PE as the two most reliable metrics for market valuation. Just look for Andrew Smithers because it gives a significant explanation and the science or the math behind it, if you will.
Yeah, the reference point on that two standard deviation or three standard deviation excess evaluation, and obviously we’ve come up from where we were off the 2022 lows, the reference point is the PE 10 or the Shiller PE. We’re at 31 and a half. That’s the current number.
Kevin: And the average is what? About 15? 14, 15?
David: 17.4 is the average for the Shiller PE. We’re not at a bargain. 31-1/2, no bargain. Clearly it’s not back to the 2021 levels of 38. So on a relative basis, it’s cheaper than peak valuations.
I guess what I’m saying is if the average is 17 and you’re currently at 31, and you’ve declined off of 38, maybe you should be cautious, cautious in how you allocate assets. That’s not how the operators in the stock market are behaving today. Last week we were not talking about the 10-year rolling average PE. We were talking about Apple and we were talking about Microsoft and we were talking about the fact that they were selling also at twice their average price:earnings multiple.
That’s a suggestion that companies that are very popular today are very expensive, and you rarely make money on an investment when you overpay for it. Those names, along with the whole market, are pricey.
Kevin: When you were younger, you were studying philosophy and working for large brokerage firms. When I was younger, before I started here, I was a toy store manager. I remember the mid-’80s, Coleco came up with this brilliant idea to make dolls that look like people’s little girls, Cabbage Patch Kids.
What they also brilliantly figured out was that they would control the supply and not produce enough the first year, and they didn’t. And so people would come in and they’d say, “Well, I need a blonde one with blue eyes.” And as a toy store manager, I would say, “Well, you should have been here last week” because they were always gone instantly when the truck would get there. In fact, these people were violent with each other, these people who were trying to buy the right doll for their kids.
Where I’m going with this is this, the first year it was a rage, the second year it was a little slower, but by the third year you could not give a Cabbage Patch doll away. I had top stock in the store everywhere of Cabbage Patch Kids. They did the same thing with laser tag the next year for a little boys. Okay, so Coleco had figured out, okay, control the supply, cause a mania, and then try to sell the heck out of them. We couldn’t give them away.
This is probably what happens to shares when you’re paying two, three times the price for what they should actually be. Your neighbor’s buying it. It’s like, hey, I got to go get one. Blonde hair, blue eyes. Let me have that stock. Let me have Microsoft. But in the end, how do you move that to the next person?
David: Yeah, too expensive doesn’t stay too expensive, and too cheap doesn’t stay too cheap.
Kevin: Time changes things, doesn’t it?
David: Time does. Maybe if you’re the loser in that equation, you’ve paid too much. You might even think that time heals all things.
But back to last week’s contrast between the manic and the depressive. People don’t usually consider manic behavior to be a negative thing. If you put it on a Gaussian curve, the fat tails on either side, the bell curve issue, it’s acceptable as long as prices are on the high side. It fits the category of making money. So what is too high, really? Only imagination limits what we consider to be too high.
So here we are. Does it come as a surprise that margin debt remains 700 billion? Stands as an expression of investor confidence in the market moving higher still. For comparison’s sake, the peak in margin debt was over a trillion, so that coincided with the 2021 market highs.
Here we haven’t overtaken the everything bubble. We don’t have the same level of exuberance that we had then. In this case, the advance has not been broad based. It’s not the everything bubble, it’s the twofer bubble. It’s the seven name bubble, seven names out of 500 in the S&P, just a handful of names in the Dow as well.
Kevin: When you as the listener may have a stock portfolio and you’re going, “Gosh, it’s just not showing the numbers that they keep publishing for these all-time highs,” it may be that you don’t own the two stocks that are actually pushing those things up.
David: Yeah, year to date, it’s not the magic seven. Year to date, it’s just two—
Kevin: Just two.
David: —that are driving results. Going back to this notion that everything bubble is behind us and we’re dealing now with a more concentrated investment thematic, real estate is not universally higher, as it was in 2021. Bonds are still a shadow of their former selves, given that the 10-year has risen from half a percent to over 4% and prices have dropped commensurately.
Cryptocurrencies traded at a steep discount to their peak values set in 2021. Non-financial tokens, NFTs, just rallied something like 60% and are still down 80% from their peak. SPACs are all but extinct, those blank check companies. And we have indeed moderated the universal excess of 2021, and are finding that it’s focused in just a few channels.
Kevin, that’s not uncommon in a bear market rally.
Kevin: Which is what you’re saying we’re in.
David: Yeah, the bull market energy has largely dissipated. It’s no longer touching everything, but is still finding an avenue for positive expression. But as the list narrows, so does the increased likelihood of a significant decline.
Kevin: Okay, so you’re a political analyst at this point, and you’re basically giving advice, and you say, “Okay, we need to pull out the fiscal spending.” Right now we’ve got exuberance in the markets, we’ve got a couple of stocks that are just leading everything, but you’ve got to still get to know November, Dave. What does that look like?
David: It’s a great question because, I mean, at this point, market analysis and political analysis, those waters are a bit muddied. Nobody likes low prices. We talked about the Gaussian curve a minute ago, and then the manic and the depressive. The manic, we love, the depressive, we don’t. Low prices, depressive, losing money, the other side of the bell curve, that requires intervention, that requires stimulus.
Kevin: Do you think that’s going to happen?
David: Well, we had it last year. We had the SVB debacle, and very quickly the market was given what they needed. Likely to have that again. Makes this look and feel like the ’68 to ’82 period.
Kevin: Which had inflation built into it as well.
David: Yeah, because any weakness in equities brings out the monetary policy big guns. In an election year, any weakness brings out the fiscal policy big guns. What you’re talking about doing is revitalizing the inflation issue and extending a longer-term sideways chop in the financial markets while the real returns are getting uglier and uglier as time goes on, our ’66 to ’82.
Kevin: We talk about pricing, and we don’t just look at the Q ratio—Smithers, Andrew Smithers—or the Shiller PE. Warren Buffett, that’s a name everybody knows, has his own indexes and ways of gauging. We’re not quite at the peak that the Buffett ratio peaked at, but it’s still high.
David: Actually, it’s not his index as much as it is something that he popularized because he said, “Here’s your best way of telling when things are cheap and when things are expensive.” Look at the economy.
Kevin: Somebody else named it.
David: It’s become known as the Buffett ratio. If you look at the economy, the total measure of the economy, GDP, an imperfect measure but a good gauge, GDP, and you divide that into the current capitalization of all publicly traded stocks.
We’re not at a peak anymore. It was 216, 216%. Now we’re at 168%. That’s where it is today. And that’s exactly where we were in the year 2000 at that market peak. And so the 216, it should be noted, was something of an anomaly. The GDP denominator collapsed during COVID. And so the way you do that math, again, denominator into the numerator, we got a spike in the ratio, which is just corporate market capitalization divided by GDP.
Nevertheless, market historians would agree, today’s price structure is a premium price structure. We’re not at record levels of excess, but we’re nowhere near a bargain.
Kevin: Well, and if you smooth off the rough edge, that’s really an interesting point, Dave. I hadn’t really even thought of that. When the Buffett ratio was at 216%, it was because of a collapse, a temporary collapse in GDP. So, in a way, if you smooth that out, this is just like the Shiller 10-year PE. If you just look at PE without smoothing it out, you don’t understand it.
David: That’s right. There’s noise in some of those numbers, which is why the PE ratio done Shiller’s way on a 10-year rolling average is so much more effective.
Kevin: Right. Okay. We’ve talked about the two stocks that are really performing, but, I mean, the overall market’s made of a lot of other stuff like small caps.
David: You look at all of the indices, the Dow Industrials have gotten to new highs. The S&P 500 has gotten to new highs. The NASDAQ 100 has gotten to new highs. The NASDAQ, the broader measure of tech, has not. So again, it kind of shows the importance of those few names.
I mentioned this earlier, but the small caps, they’re not cooperating. The utilities, they’re not cooperating. The material sector, not cooperating.
Kevin: How about the transportations? Remember?
David: Well, you’ve got consumer staples not cooperating. Consumer discretionary weaker.
David: And your point, yeah, the notable one is the transport average.
Kevin: That was Richard Russell’s favorite confirmation.
David: He’s been a long-term influence on my thinking. 25 years ago, I’d read the Dow Theory Letters every time it was published. When the transportation average does not confirm, moving the same direction as the industrials, or vice-versa, you’re looking at a counter-trend move, so it gives you data that you need, transport’s weakness is thus today flying in the face of the industrials making an advance. That non-confirmation casts a shadow over the tech-driven leadership that’s currently dragging the main indices higher.
The history on this, Charles Dow, we talk about the Dow Jones Industrial Average, where’d it come from? Charles Dow, the original writer of the Wall Street Journal. So he’s making all these observations, begins theorizing about the market and the behaviors which he sees on a daily basis, publishes them to the Wall Street Journal.
And then you come along later, people are mining the insights, and you’ve got Hamilton and you’ve got Robert Rhea and you’ve got Richard Russell, who take and create generalities out of Charles Dow’s observations. Thus, we have what we call Dow Theory. One of the tenets of Dow Theory is this non-confirmation—or the confirmation priority of the Dow transports and the industrials moving in lockstep.
Richard Russell, not only did he refine some of Dow’s theories, but he developed his own proprietary index. It’s called the PTI, the Primary Trend Index. It’s a bull-bear measure, if you will. That index is positive, points to further advance in prices. And yet we have the non-confirmation of those old averages, raising questions as to what the future of the advance will amount to.
It comes back to our original, call it a discrepancy if you will, or disagreement, or conversation, where, if you’re talking about the macro picture, the analysis is never simple. You’ve got things that you can look at in the here and now and which reflect the most recent recorded economic activity, so kind of rearview mirror, which would suggest all is clear, economy’s good, employment’s good, housing’s good, we’re good.
Yet the leading economic indicators and a variety of non-confirmations would suggest not all is well, the future holds something different than the present and certainly what we’ve had in the past. You might want to be careful.
It doesn’t take a rocket scientist to say, yes, if you’re going long the market at 31-1/2 PEs, your odds of success over the next 10 years are fairly narrow. Whereas if you’re investing in going long equities and the PE is 17 or closer to 12, your odds of success are that much greater. That’s basically what Smithers was saying when he was arguing on the basis of Tobin’s Q: where you put money to work matters. If you’re putting money to work at elevated levels, good luck to you. You’re going to see low single digit returns, if not negative returns on average every year for a decade or more.
So your starting point absolutely matters, and you can’t really argue with 31.5. You can’t really argue with the Buffett ratio of 168% over. What you can say is that things can get even crazier from here because people do crazy things with their money. Doesn’t make it sustainable, doesn’t make it a winning proposition long-term any more than tech stocks in late 2000/early 2001 was ultimately a winning proposition. As a day trade maybe, but if you were a long-term investor, you learned a thing or two.
Kevin: Dave, I want to go back to Richard Russell before we finish up because he was somebody that I also read every day. One of the things that I liked was he respected— Well, first of all, okay, when you read the Bible, you read generation after generation. He was the son of so-and-so, who was the son of so-and-so, who was the son of so-and-so. That can be very helpful because you actually see what family they came from.
Well, this whole Dow Theory thing was similar to that. Charles Dow started it out and then it was handed to Hamilton and he used those same systems and analyzed it and played the stock market, or actually invested wisely in the stock market using it. And then Rhea and then ultimately Richard Russell.
It was like handing a baton off. They respected the strategy, they respected the numbers, but they also—especially Richard Russell—he would have arguments with himself right in his own newsletter. He’d say, “Well, my Primary Trend Index right now is saying that it’s bullish, but the transportations are not confirming.” This is also a man— How many ounces of gold did he say everybody should try to work toward by the end of their life?
David: Family of means he said, should always have 3,000 ounces of gold.
Kevin: Yeah. He was a gold guy too.
David: No, I mean, I read that when gold was $250 an ounce. As time has progressed, and as you look at the last 25 years, you actually have on an annualized basis an outperformance of gold versus the S&P. This has not been a shabby 25-year stretch.
Yes, you would’ve made money in equities. Yes, you would’ve had plenty of volatility. There’s gold as a representation of enduring wealth—
Kevin: That was his foundation.
David: —as an aspirational goal. Maybe your goal is different. Maybe it’s 1,000, maybe it’s 100. Whatever it is, I think that’s interesting, setting a goal. It’s something that I mentioned in the book Intentional Legacy, where I give each of my kids a cigar box and they fill it with treasure. And as time goes on, they fill the box and they need a bigger box. I’m motivated by getting to a bigger box. So decide what your ounce goal is and shoot for it.
Kevin: Yeah. Okay. Richard Russell is a World War II veteran. If I remember right, he was either a pilot or a bombardier on bombers in Europe.
David: He was in a bomber and he was a navigator.
Kevin: He was a navigator. Okay, well, that makes sense because this is similar to navigation. He would tell you, Dave, analysis is never easy. You don’t want to become a slave to any one program.
David: Yeah, it’s not easy. And there is good news. There is the not-so-good news. Frankly, where you train your eye will determine your next steps. Are the circumstances that are right under your nose, does that represent a trade and a trade higher? Does it represent a trend, a long-term trend that is investable for a longer period of time? If you can’t determine the difference between a trade and a trend, if there’s doubts that are emerging, then you can always move to the sidelines.
We talked about gold last week at length. We talked about the COTs, the Commitment of Trader reports, and what they suggest—as we discussed last week—on a trade basis, short-term pressure. But as that pressure is relieved and the trade shifts, I think you’re talking about resumption of trend—a very significant trend. Year-end performance for the metals could very well astound.
I don’t want to rehash last week’s comments, but it seems we are at the end of a long-term cycle for financial assets, and that trend is playing out as spasmodically you’d expect. But at the same time, we’re just entering into a period of growth for hard assets. I think to see it unfold, it’s going to take poise and patience. Both are required.
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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.