Podcast: Play in new window
This week Alan Newman of Cross-Currents.net joins the McAlvany Weekly Commentary to discuss how the stock market is poised for an even larger correction than the 2008 stock market crash. CLICK HERE TO VISIT ALAN NEWMAN’S WEBSITE
- DOW $14,000 And Gold $5,000? The Numbers To Look For
- Gold Is & Will Continue As The Currency Of Last Resort
- Central Banks Cannot Promise Unlimited Gains In Stocks Forever
The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“I think that the central ba
nks have manipulated a bit too much over the last 15-20 years. I don’t know that they can do that going forward, and this is one of the reasons why I’m such a tremendous gold bug. To me, gold is the currency of last resort. So it’s very easy to see, at some point, we’re all depending upon gold, and that’s how we base every other currency.”
– Alan Newman
Kevin: Our guest today – Alan Newman. We promised that last week. Dave, I just have to go back and look at a memory here, because we are in this amazing period of time where the stock market continues to rise, just unstoppably, and we haven’t even had a correction of more than 3% in the last year. We have margin debt hitting highs like we did back in 2000, we have Bitcoin, inexplicably, just continuing to go through the roof. It feels very much like that period of time right after we didn’t have Y2K and we went January, February, and then finally a crash in March.
I remember this man that we read on a regular basis, Alan Newman, on February 28, 2000, when everything seemed like it would never go down, he said, Within six weeks we’re going to see this market crash at least 35%. And nobody was saying that at the time, and sure enough, just a few days later it crashed and Alan Newman was found to be right. There are so many things we could say, Dave, but I think it’s important that we look at the context of the market, don’t you?
David: Absolutely, context is important. At a market bottom you see high yields, lots of stress, and valuations which are compelling, but relatively uninteresting due to the dominant feeling in the marketplace, which is dominated by fear, so people are generally ignoring opportunities at a market low. And that is in contrast with what we see today. You have very low yields. Notably, this last week we had the Greek ten-year treasury dip below 5% for the first time since 2009. You can go back in time and you remember the magic 5%. You used to get that in a conservatively rated bank CD. Now you have to go to the almost bankrupt isles of Greece for it. I think Icarus would be looking at this and laughing. Today the fear that is in the marketplace is interesting. You can put it in an acronym – FOMO – the fear of missing out. The spirit of the age is greed and that’s what dominates today.
Alan Newman, you are back on the program with us. You have been a newsletter writer for 28 years, a market observer for more than five decades, so there are some similarities and differences, I’m sure, between what you see now and what you’ve seen in the past. Seventy-seven years old – when I think of a doctor, doctors perform hundreds or even thousands of the same procedures and they see every permutation possible and they get a real sense of what is in front of them. Part of that is because they are connecting dots, and a part of it is at a more intuitional level where they are probably still connecting dots, but maybe it is just subconscious. What is your sense – if we shift this to “Dr. Newman” (laughs) – what is your sense of the markets today? As you connect the dots, what are you intuiting?
Alan: I’ve actually seen instances like this before. You made a very good point about market bottoms where the market is just ruled by fear. And you have the complete opposite. You don’t have it as often because fear is more often in the market than greed. But you have instances like you had in 1929 – the roaring ’20s – that you had in 1972 with the nifty-fifty, that you have had in 2000 with the tech stocks, and in 2007 with a dual double, stocks and housing, and you’re having the same thing today. This is a very rare occasion where greed just completely overtakes fear. It’s like the surgeon who is looking at the patient, who shouldn’t be alive, but he is. He’s not only alive, he’s running around the track.
There is something very mysterious going on here. It’s going to end very poorly, as it did in 2007, as it did in 2000, as it did in 1972, as it did in 1929. There is just no way to pin it down and say, “Okay, this is the peak. Today is it. We’re going to crash from here.” But from what I see over five decades plus of experience, we have entered that window where I’m not just looking at the possibility of a bear market ahead, I’m looking at the possibility of another halving in prices at some point.
Looking at valuation measures like Shiller’s cyclically adjusted price range ratio – it’s called CAPE. That’s over 31, and it has only been there once before, and that was in 2000 with the tech bubble. It got close in 2007, it got close in 1929. But believe it or not, it is higher than it was in 1929. If you take the mean or the median for CAPE, we’re going to be down about 48%. So, all right, that’s close enough to a halving in price. The technical work that I do for a couple of years now has pointed to 14,719 on the Dow, and I’ve always wondered about that. That number is now over 40% down. So, I’m pretty certain this is going to happen, I just can’t tell you when. But I think it’s going to happen in the Trump administration.
David: You and I operate with a sense of history, and frankly, from 2009 to the present we have had records of all sorts which have been taken out. And so, you look at the young market practitioners today and history is fading in terms of its significance. Did we get to the end of history without getting the memo?
Alan: I think what you have is a period where whoever is going into stocks is more or less just relying on the indexes. They are going into ETFs. And what happens in a situation like that, the ETF doesn’t care how their constituents are valued. It just buys every single one of them. So we’re in a period where valuations are bogus. They’re not real. So you have stocks like Amazon, which I think is grossly over-valued, and you have other stocks that are grossly under-valued because they are not bought because they have a good outlook, they’re bought because they’re in the index. That’s it. That’s the only reason they’re bought. It’s bad for investors over the long term.
David: Let’s look at the role of leverage in this cycle. How significant has leverage been in levitating equity prices since 2008-2009?
Alan: I did a lot of research back in the mid 1960s. My dad had some stock. He had been a broker in 1929 and he just threw it in a vault after the crash and it was my job to take everything out and take a look at it. I was down at the business library in Brooklyn every single day for about six hours, and I went through a lot of books, and I found statistics from the New York Stock Exchange about margin debt going back as far as about 1926. And I was blown away. Unfortunately, I can’t find that information again – I did have it – but margin debt was about 11% of total market cap in those days. It was just a mind-boggling figure. It’s worse than what tulip mania was in 1636. So that record is never going to be broken.
But what we have seen since is a gigantic record in over-leverage, excess leverage, in 2000 with the tech bubble, again in 2007, and again now. And each one of those excessive peaks in leverage has been far worse than the one before it. We’re at a point where – the way I calculate it is I take total margin debt, which includes NASD besides the NYSE, and I subtract absolute levels of mutual fund cash. I come up with a number of about minus 275 billion dollars. That is what I think right now is net demand.
Now, if net demand it actually negative by minus 275 billion, why are we still going up? It’s just that type of a crazy period. It’s a mania. There is really no way to call a top. The only thing you know going forward is, when that peak happens, the denouement is just going to be ridiculous. It’s going to be the kind of situation where you go out to the bathroom, you come back and – what? We’re 2,000 points lower? How did that happen? I’ve seen it before, and I’m pretty sure we’re going to see it again.
David: You have the last 12 months where we’re not seeing intra-day declines of greater than 3%. Volatility has largely been vanquished. And you factor in margin debt – margin debt as a percentage of GDP. Couldn’t you argue that the central bankers/central planners have changed the markets and have just promised us a brave new world where it only goes up?
Alan: Absolutely, they certainly have. But it’s a bogus theory. You can’t do that. You can’t promise it will always go up, because what you’re doing is, you’re corrupting any semblance of value, and in the end you have to have value. You have to have something that you’re paying for that makes sense, that is logically. And, I’m sorry, Netflix is not logical. Neither is Amazon. There are quite a few stocks like that. Neither is Facebook.
David: Coming back to market dynamics associated with periods of rising leverage, this has been pretty awesome to witness prices increasing as they have. The unwind of leverage – can you tell us a little bit about how that dynamic looks? Two steps forward, one step back, or is it a little bit more vicious than that?
Alan: We’re in a period of what I term groupthink. I learn more by reading David Dreman’s book, Psychology and the Stock Market, which he wrote in, I think, 1975, showing how groupthink overtook money managers in 1971 and 1972 at the nifty-fifty. You have a similar situation now where it’s momentum, and the momentum is, “I’m doing so well, and I’m now embarrassing you as a money manager, and you have to go in and buy Netflix and Amazon so you can keep up the chatter with me.”
So this spreads from you to another guy, to Joe, then to Charlie. And then everybody is buying the same stocks at ridiculous multiples. The company’s outlook cannot possibly justify the price. Not only do you buy it, you’re now going to be even more courageous and you’re going to buy it on margin. So that’s how it builds. And it just crescendos to a point at which there is no way it can be supported and the bottom drops out. It kind of happened in 1987. It was slightly different then, but 1987 did show us how fast prices can decline.
David: In the fixed income market you have an artificial buyer in the form of central banks. Within the stock market, outside of the NIKKEI, where, obviously, the Bank of Japan is actively participating, but in the U.S. stock markets, you do have something that looks like an artificial buyer, that is, companies buying back their own shares. What can you tell us about that and its role in driving prices higher?
Alan: That may have ended. There has been a big bulge in stock buy-backs from corporations, and we got up to about a net 12-month rolling total of 590 billion dollars. It’s down to 500 billion. So that’s a significant decline, and if that continues down, that’s one of the biggest sources of demand for stocks. It’s about the same size as margin debt. Right now margin debt is 608 billion, so if you have gone from a net positive 590 billion in stock buy-backs to 500, you’re taking, if not the biggest, the second-biggest source of demand away.
I also think that corporations are flush now with their own shares. There really is no reason for them to continue buying back stocks. They are aware of price earnings multiples. They are aware of over-valuation. Maybe they could make a case for it a year ago at lower multiples. They can’t possibly make a case for it now.
David: We talked about leverage. Can you also share with us your thoughts on liquidity? It is generally believed that the investment public has been on the sidelines. There are trillions that could come into the market. We just talked about the corporate buy-backs being a source of liquidity and that may be going away. Mutual funds, low levels of liquidity – what do you see from the standpoint of liquidity?
Alan: What’s happened in the ETF era is that people have been liquidating mutual funds as much now as ever. We’re averaging for domestic funds about 20 billion dollars exiting mutual funds, maybe a little more than that. And I don’t think you quite have the same inflow for ETFs. So over time the little guy has been pulling out of the market, and this is quite understandable after being absolutely savaged from the result of the tech mania, and then being savaged again in 2008 and 2009. If people are going to put money in stocks, they’re just going to put in little monthly payments to ETFs, which again, overvalues a lot of stocks. Over time this is a very bad procedure.
We now have, the way I calculate it, which is total margin debt minus absolute cash levels of mutual funds minus 275 billion in demand, it was as bad as minus 290. We’re not that far away. We’re still at terrible, terrible levels. We’re lower, much lower, than we were in 2000, much lower than were in 2007. Basically, you have four downturns – real huge downturns. There was one in 2000 that was historic, then the one in 2007 that was even much more historic, and then in 2015 which resulted in about a 16% or 17% correction. That’s all.
But now the bottom that we have is just beyond anything that I ever thought was possible. But it’s there, and it’s telling you the same thing. There is just tremendous excess leverage that is driving stocks, and when this reverses, it always reverses very quickly. It can’t reverse slowly, because if I’m buying stocks on margin, if I’m down 10% I’m actually down 20% because I’m buying on 50% margin. If I’m down 50% I’ve lost everything. So you have to get out very quickly. And everybody just follows one another and it’s like lemmings jumping off the cliff, and prices go down very rapidly.
David: When you see something at a generational low like your volatility indicators, or on the other extreme, you see things at generational highs like FANG stocks – Facebook, Amazon, Netflix[, Google] – and they begin to make the nifty-fifty mania look mild by comparison, what do you do?
Alan: You always want to take the opposite tack, so when you see a period of tremendous complacency like this – obviously this complacency is the overall driver right now – you want to be very concerned. When there’s a lot of fear, like in March 2009, then you want to be a buyer. And I was one of the biggest bears around, but even in March 2009 I could see that prices had gone down too much. It was the time to buy. When everybody is buying, that’s the time you want to be very fearful.
So right now we’re seeing as much complacency as I have seen in over 50 years, and you see it in the volatility. There is almost a complete lack of volatility, which is a complete lack of concern. The players don’t care. They will buy, they will actually stick it out for a minor decline. Right now that strategy is working. It won’t work very soon.
David: You mentioned the bear market target for the Dow Jones Industrial average of 14,719. Can you give us some insight as to how you arrive at that number?
Alan: Yes, it’s a support level. I did the same thing way back when – I gave a speech to the International Federation of Technical Analysts many years ago. I offered to them a long-term bear market target of Dow 6400, STX 680, NASDAQ 1000. And it’s just working on support levels, what I determined to be long-term support levels drawn from charts. And it took a long time for those levels to be achieved. It didn’t happen until 2008 and 2009, but they were achieved almost exactly. We got down to 6469 on the Dow, so I was 69 points off. We got down to 666, I think, on the S&P – I was off 16 points there. I messed up on NASDAQ, we only got down to about 1250 and I was calling for 1000.
But when you make forecasts like this you have to have some certainty. It’s almost impossible to predict time and price together. Anybody who does it is going to wind up on the wrong side of the eight ball at some point. It’s better if you just predict price because you know it’s going to happen eventually. Here, I have been wondering for a long time, for actually a couple of years, why I have the 14,719 target when I’m looking for 40-50% down on the Dow. When we were back at 17,000 or 18,000 that’s just a correction, 14,179. Now, it’s that 40% down. And it is taken from old Dow charts where I’m finding supports and resistances and coming up with what I think is the most likely target. I don’t expect it to be achieved exactly, but we will be in that neighborhood at some point.
David: So, considering the ratio of the Dow to gold, what does experience tell you we are likely to see in that ratio, and maybe even in the price of the now only occasionally shiny metal?
Alan: You made a point a couple of months ago about the biggest asset reallocation of all time. That is exactly what I expect. I think that’s a lot of what us gold bugs are looking for at some point. Gold is a currency. Right now we are undergoing a very long consolidation, but when you look at what gold did, it went from $265 up to over $1900 an ounce in a relatively short period of time, you would expect a long-term consolidation. So, I’m not troubled by gold’s action here. I’ve been looking for a consolidation range that gets us as high as 20.5 or 21 ratio for Dow-to-gold. I think we’re at about 19 now.
So we could actually go a little lower, or the Dow could go a little higher, but I think that’s about it, and I think at some point next year we’re going to see gold start to run toward what I believe is an equitable Dow-to-gold target ratio of between 5 and 6-to-1. That gets you up to, oh my gosh, close to $5,000 an ounce. And I never thought I would see that. For years I have been saying $3,000 an ounce and I was wondering how people were coming up with a $5,000 an ounce target. Now I know. It’s there because stocks went a little crazy.
David: And it’s not likely that stocks are going to give it all back, but they might give 40-50% of it back. What does the metal look like in other currencies, and therefore, in the minds of other investor bases elsewhere in the world?
Alan: That’s the funny thing, because you’re looking at it in dollars – this thing has done nothing, it doesn’t look good – but if you look at it in terms of the euro and the yen, it’s fine. We’re still in bull trends. The euro is kind of testing the support for the up-trend right now, but the yen looks fine. And it’s only the dollar and that’s because the dollar has not been that good lately. But I think you have to measure gold by a wide variety of currencies to see how potential is, and as far as I’m concerned, it looks fine. It’s just this very long consolidation mode. And in terms of the yen, oh my gosh, we’re like 5% away from a new high. That’s not much at all. It could be there in a few days.
David: Yes, you get to Asia and it’s a very different perspective, isn’t it? Speaking of Asia, Bank of Japan captures everyone’s imagination as to what you can do next, but activism among central bankers has been a dominant theme since 2009. Now you have a number of those bankers talking about normalizing interests rates and reducing their balance sheets. Do you think that is just talk? And what would the consequences be if, in fact, they follow through?
Alan: I think it’s just talk because we’re in such an unusual period that it is very hard to know how they can react going forward. What if we do have some type of financial cataclysm à la 2008 where they do have to step in and save the entire financial system? They can do it once or twice, they can’t do it forever. I think that the central banks have manipulated a bit too much over the last 15-20 years. I don’t know that they can do that going forward, and this is one of the reasons why I’m such a tremendous gold bug. To me, gold is the currency of last resort. So it is very easy to see, at some point, we’re all depending upon gold and that’s how we base every other currency.
David: When we look at things from an emotional perspective – we’ve talked about markets, we’ve talked about them perhaps getting into a manic phase, what do you see as an indicator which would say, yes, things are just way overdone? Bulls versus bears, Rydex assets, Investors Intelligence, even the Michigan indicators if you’re looking at more of an economic versus a market indicator in terms of just consumer sentiment. On a scale of 1-10 where are we in terms of emotional-based indicators?
Alan: I started to keep a 0-10 scale some months back. I had it at 9 not long ago. I kept on saying to myself, “It’s got to be so extraordinary for me to move this up to 10.” And guess what? A couple of months ago I did move it up to 10. And I feel firmly convinced that that 10 is an accurate reflection. You mentioned Investors Intelligence. I think that is an excellent tally to look at. It’s a poll of investment letter writers such as myself, and recently we had 64% bulls. Frankly, I don’t think I’ve ever seen that. My data doesn’t go back far enough, but I can’t remember seeing it that high. Average bears for quite some time has been around 15%. That’s extraordinarily low. So you have a ratio of over 4-to-1. That’s extraordinary.
Again, what it tells you is, not only are there too many bulls, there are too few bears and there is way too much complacency in the market. Another indicator I like to look at is the Rydex ratio where you take the assets in Rydex bull and sector funds and divide it by assets in the bear funds. The assets in the bear funds have just been dwindling each and every month. People don’t want to put money to protect the downside anymore, so they’re not, and the ratio has gone up as high as 30-to-1. I’ve never seen that before – never.
So I’m seeing extremes everywhere I look. I’m seeing it in leverage, I’m seeing it in bullishness, I’m seeing it in bearishness, I’m seeing it in complacency. I’m seeing it in the prices, the PE ratios, I’m seeing in valuations. What does it tell me? We’re going to have one heck of a bear market.
David: I don’t know if you know this, but this last year we partnered with Doug Noland who managed the Prudent Bear Mutual Funds for about 16, almost 20 years. To me, as a manager of a wealth management organization, this is to me one of those amazing value plays. When you have a 30-to-1 ratio of people investing on bullish trends versus bearish trends and you’ve never seen this kind of lopsided, everyone shift to one side of the boat, to me, this is the story for 2017 and 2018. Are there other pockets of value in a world which is priced for perfection?
Alan: Yes. When you talk about the greatest asset re-allocation, I certainly see tremendous value in gold stocks, if we’re correct, and we’re going to see an extraordinary move in gold at some point, and gold is looked at as the currency of last resort. You have gold miners that are presenting tremendous value. I’m not telling you that they’re doing particularly well at this point, but I’ve had a base position in Newmont for many, many years, and in Gold Corp. I’ve traded some in and out as time has gone on, but I have those base positions.
Although Gold Corp looks terrible right now I’m tempted to buy more – that’s GG on the New York Exchange. I have had a nice position in IAMGOLD – IAG – that also trades on New York for a long time. It’s a very speculative play, but I think it’s an attractive speculation. Newmont, of course, is the diamond of the gold stocks, as it were. It’s probably the best managed company of the bunch. At one point when gold was forging way ahead they had a dividend yield of over 7%, so I got some money back that way. It was a good investment then, I think it’s a good investment now. So I think you see value in the gold stocks. I’m sure there are silver stocks and other precious metal stocks or maybe lithium at this point. I just don’t specialize in them. I like gold. I stick with gold.
David: Alan, my dad tells me of a number of companies that he owned in the 1970s and 1980s, South African miners. The dividends that he received from them were greater than his original cost basis – 100% return of capital just in dividends. I don’t think investors have an imagination for what happens when you have a tremendous amount of wealth drop to the bottom line because your costs are relatively fixed – not completely, but relatively fixed. And with an inelastic asset like gold all of a sudden no one has the imagination for it.
I know you’re speaking to a blind audience here – you don’t know them – but could you advise the audience as if you needed to share a very meaningful insight, let’s say, with a grandson. This is a crazy world we live in. In trying to get perspective on where we are and where we’re going, what is your sober advice to a family member about where we are and where we’re going, and how they should proceed?
Alan: I’ll say exactly what I have told people for 30-40 years – do your own homework, do your own research. Just listening to one other person may not get you where you want to go, but if you can do your own research and do your own homework, you will probably form opinions that you will have a lot more confidence in and you will be able to act and react a lot better than you would otherwise. That’s the best advice – do your own homework, do your own research. It’s not that difficult.
David: You have seen some of the grand old men who have written the greatest commentary of the last 50-60 years – Alan Abelson had been on our program a number of times. Unfortunately he is no longer with us. Richard Russell, Joe Granville, Sy Harding, a number of people who have brought so much insight into the world of finance. My question is this. Where would you go for that kind of wisdom, in a world where a lot of the experience isn’t around anymore? I can’t ask Richard Russell a question anymore. I can’t call Westchester and dial up Alan Abelson and ask him a question anymore. Where do I go for something that is beyond the time that I’m stuck in, the age that I’m stuck in, the perspective that I’m stuck in, for someone who has been around and done that and brings a different perspective?
Alan: I’ll tell you what. You’re not paying me to do this, but I would say, go to David McAlvany’s site, because you have a lot of readers already, and obviously, they’re there because they’re getting something of value. So, I don’t even know that you want to go to my website anymore. I’ll give you the web address. It’s www.cross-currents.net. I’ve been kind of inactive lately. I don’t know what I’m going to be doing going forward, and the reason is, I’m an old codger, I’m 77. I do this as a labor of love. I expect to continue in some capacity. But if you’re asking where to go, you’re site is as good an answer as anybody is ever going to have. Like I say, you have a tremendous number of readers and there is a reason why, because you have been giving them good information all along.
David: Alan, that’s very kind. I would say, Cross-Currents, as a labor of love, is something that is of huge value to us, of huge value to your readers, and I understand mixed priorities of personal life and family dynamics, and at 77 – but I also want to encourage you, if there are months where you feel like you are not getting the feedback that you need, I’m constantly asking my assistant, “Did Alan publish yet? Did he publish it? When is it out?” And we look with anticipation for that. I have a tremendous amount of respect for your work and there are fewer and fewer people who bring solid technical analysis, with a fundamental overlay, to the market. We need your insights, and I would encourage you to keep them coming, but I understand, if things change, things change. But by all means, cross-currents.net would be a great place to visit.
Any final words of wisdom for us, Alan?
Alan: Be careful. I could have said the same thing at the exact top in 2007. I’m sure I did because I called several tops in 2007. I know I said it on February 28th of 2000 because I wrote that newsletter and that was my headline, and I said NASDAQ is going to crash. By April I expected it to be down 35%. Well, it went up another 500 points before it started its crash. But sure enough, it was down in six weeks 33%. So I’ve seen this before and I feel exactly the same way. Just be careful.
David: We go back to an earlier comment, a doctor who does thousands of procedures knows what he knows, in part, because there are the logical inferences that are made. And so you have numbers and charts and things like that, but I’m also interested in your reflections, your intuitions, because there is nothing that can replace experience – nothing that can replace experience. So, at 77, and 53 years – is that right, 53 years market experience?
Alan: Yes, 1964 was when I started. I was 24 years old.
David: You are building on what was conversed about at dinner table conversations because of your dad being stockbroker through the 1929 crash. Be careful – as simple as that is, there is some added power in it because it is you who is saying it.
Alan: When you think about it, he was 30 years old in 1929 and he and his dad had accumulated a decent amount of stock. What caused them to take all these certificates and lock them away in a safe deposit box and keep them there until 1964? What? How does anybody do that? That’s how bad that crash was, that people thought it was never, ever, going to come back. “Okay, we’ll take the paper, we’ll lock it away.” And it never saw the light of day for 35 years.
In fact, I’ll tell you a very interesting story. One of the stocks I took out of there was Amerex Corp. It was Chase National. And on the back of the certificate it said Amerex Corp. What the heck is this? It took me a while to find out it was the forerunner of American Express. He had $20,000 of American Express stock, $4,000 in dividends that he had no idea he owned because it wasn’t on the journal that I kept. It was only the Chase National shares. I actually gave this little vignette to Nelson DeMille. He used it in his book, Gold Coast, on page 46. That was my story (laughs).
David: Fascinating. (laughs) Well, Alan, thanks for joining us. Great to have you on the line again, and hopefully, we can circle back around and have another conversation in 2018.
Alan: Love to.
