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- 90 Chinese Military Aircraft Enter Taiwan Territory
- Stock Prices So High It Would Take Till 2060 For Earnings To Catch Up
- Because Gold Video – vaulted.gold
“The inflation target is close, but we’re not there yet. And it’s not as if we’ve had any form of deflation where we’ve seen a decrease in prices, so the fact of the matter is we’re just maintaining an elevated level, and we’re talking about households that are not seeing any relief. The tourniquet isn’t getting turned any tighter, but neither is it loosening at all.” —David McAlvany
Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany.
David, I was laying in bed and I was just thinking about you guys, because twice a year your entire family goes with four other families to Moab. You guys go to the desert and you ride mountain bikes, you talk, you have campfires. I just see how rejuvenated you are when you get back. But I was laying in bed and I was thinking, it’s sort of lamenting this time because I knew you were gone this weekend. I knew the families were getting together, but I also knew your eldest son. This is his first year in college, and I was thinking, “Gosh, I wonder how they’re doing. I wonder how he’s doing missing that weekend for the first time in, what, 12, 13, 14 years?
David: Yeah, about 14 years. So I mean, whether it’s rappelling or canyoneering or rafting, we were always out there once in the spring, once in the fall.
Kevin: So twice a year you guys do this.
David: And it’s an amazing adventure. We see all these little kids and they used to be knee-high to nothing.
Kevin: Now they’re going to college.
David: Right. So he’s not going to make it home for Thanksgiving and he’s not going to make it home for Moab. But we created a little surprise for my wife.
Kevin: That’s what you said. I just heard that—
David: He flew in to Denver and then he drove down from there.
Kevin: He came in. Oh, that’s so good. So he was there. What a surprise for your wife.
David: It was amazing. It was absolutely amazing.
Kevin: Don’t you love those events in life where it’s like a little bonus. Tolkien, J.R.R. Tolkien, used to call that a eucatastrophe where you create a good catastrophe in the story. Just at the very moment when everything seems like it’s going to fall apart, you have something dive in and completely change the narrative.
David: And I think none of us really like market surprises if it is a loss or if it is a catastrophe. But we love surprise if it’s a gain. Oh, wow. Check that out.
Kevin: I’m going to shift gears here because you just talked about market surprises and every year you typically would go to the Grant’s conference and Druckenmiller, from what I understand, was talking at the Grant’s conference this year. Is that correct?
David: Yeah, and always a host of interesting characters with varied experiences, various points of insight into the market, some fixed income, others trading volatility, others currencies, equities. But Grant’s is really about interest rates and a dialogue around money, the cost of money, and what moves markets. So he brings in this wide array of people, and it’s always super, super exciting and insightful.
Kevin: Well, and the reason I bring that up is because it’s either a catastrophe or a eucatastrophe depending on what side of the market you were trading on. I think it would be worth you retelling the story of how Druckenmiller made his name with Soros, and how they broke the pound—his pretty heavy duty bet. And it worked for them. It didn’t work for everybody.
David: No, that’s right. If you’re on the other side of the bet, it was painful. The other people on the other side of the bet were the Bank of England, and four times in Stanley’s life, he’s lost a billion dollars in a day.
Kevin: Wow.
David: In a day.
Kevin: He’d lost, four times.
David: Correct.
Kevin: That’s called a catastrophe, not a eucatastrophe.
David: That’s right. But he’s never had a losing year in his 45 years of trading.
Kevin: Huh.
David: And part of that is risk management. If you don’t pay attention to risk management and knowing when to cut losses, knowing how to mitigate them, and when to put a trade back on the other side— He’s very practical when it comes to those things. And he came in with what he thought was a winning trade, betting against the British pound, looking at the fiscal situation, and in the relationship between the pound sterling and the German mark.
Kevin: This is in the early ’90s.
David: That’s right.
Kevin: I’ll never forget it.
David: Yeah, and so he was willing to bet 100% of his portfolio against the British pound, and Soros chastised him immediately and said, “That’s absolutely ridiculous. When you see a trade like that, you don’t bet 100%. You bet 200%.”
Kevin: Wow.
David: And so they doubled up. We’re 100% short on top of all of their capital, and they made a billion dollars in a day.
Kevin: Made a billion in a day.
David: Correct.
Kevin: But you’ve got to admit, they had enough to actually manipulate the market. Now, I’m going to shift to today because, yeah, they broke the pound. They made a billion dollars in a day. Right now, China is trying to do the same thing on the other side, try to save their economy. Is it working? I mean this stimulus, we’re talking about it weekly now.
David: Yeah, and I think it’s worth keeping in mind that the unthinkable happened with the Bank of England, and the most unthinkable, in my mind, would be breaking of the buck. And we’ve talked about that in terms of money market funds and the $1 denomination that a money market fund has. You buy it at a dollar, you sell it at a dollar. It’s always the same price.
Kevin: Always a dollar. Always a dollar.
David: But if it “breaks the buck” and trades at less than a dollar, something went wrong. When I think of breaking the buck, I think of the US dollar being the same position—or a comparable position. Different circumstances, but under pressure nonetheless. And could we eventually be at a point where there’s so much pressure that the dollar declines in a similar fashion? You could bet against the dollar and win as Druckenmiller and Soros bet against the pound and won.
Kevin: And wasn’t Druckenmiller asked in the meeting, is there another trade out there like that where it’s almost a sure bet? What did he say?
David: A shortest bet, not 100% percent short. It’s certainly not 200% short but it sounded like his shortest bet was US debt. And so you think about the direction of interest rates, and that seems like a fool’s errand. The Fed is lowering rates and it seems like a given that bond prices should be going up as yields come down. He’s taking the other side of that and saying, no. I think quite the opposite. Going short, the US Treasury market makes the most sense.
Kevin: So long bond.
David: That’s right. With yields destined to move higher and prices lower. So it’s an interesting thing. You’ve got some smart people out there looking at things from a standpoint of perhaps sustainability and viability. I don’t think we’re quite at the point where we can think of breaking the buck, but, again, the unthinkable becomes the thinkable once it happens.
Kevin: Well, so if the Fed continues to lower rates and the bond vigilantes continue to see those longer rates go up, what they’re basically doing is, like you’ve said over the last two weeks, they are not buying what the Fed is trying to serve right now.
David: Well, that’s right. And we’ve seen the Treasury market move higher, and that’s across the curve. Twos, 5s, 10, 30s, these are all bond yields that have moved up almost as much as the Fed funds rate moved down. So the Fed says down 50, and the bond market says no, up 50. And so the question is who’s getting it right? The PhDs at the Fed or the bond market? And again, we said this last week as well, perhaps this is a short-term anomaly and it means nothing in the end, or perhaps it is the beginning of the great question in credibility with the Federal Reserve.
Kevin: Well, and I’m going to want to bring up China again here because China, the stimulation right now, the stimulus that they’re throwing at the economy, had a tremendous effect on their stock market. What’d it go up? Like 34, 35%? And now some of that’s been lost.
David: Yeah, and the stimulus remains adequate but not impressive. Last week, we were up to 283 billion. Over the weekend, they revised it higher to 315 billion, US. That was on Saturday. So the CSI 300, this is the 300 largest companies in Shanghai that trade on the Shenzhen Exchange, up 34% between September 13th and October 8th. A very nice move in anticipation of stimulus, which was— There were rumblings of it at that point, and it has now sold off 9.4% since then. So kind of a buy the rumor, sell the news cycle. Alternatively, you could just say expectations of the fiscal stimulus were pitched way too high, and so expectations have not been met. I would just add one very important word: yet.
I think the fiscal stimulus expectations are actually spot on. They’re not pitched too high. The situation is, within China, within the Chinese economy, a few clicks shy of desperate. I would agree with my colleague Doug Noland that the stimulus will ultimately have to be real shock and awe because that’s how bad things are from an economic standpoint.
So what are they doing currently? There’s a measured dissemination of commitments. That seems to be the strategy to avoid radical market moves. Not like the 34% gain in equities, it wasn’t radical. I mean, that was within a few days. And we’ve had a ramp up in margin debt in the Chinese equity markets at the same time. But there are bigger concerns in my mind as I think about China, and it’s not with the amount of stimulus or lack thereof within a short time frame.
The bigger concern is in the geopolitical sphere, and more on that in a minute. But as long as Chinese economic growth remains suspect in this interim period, you’re going to have economically sensitive commodities which are going to underperform. They’ll be in a performance slump. Watch them come out like a cannonball from a cannon once the variables shift and it’s no longer sort of economic malaise in China, but it’s inflation 2.0 which is obvious.
Kevin: Well, and when you take economics, you have supply side economics, you have demand side economics. And you have to understand, pricing sometimes is affected by supply, sometimes it’s affected by demand. If China is in a malaise, it’s not going to buy a lot of oil.
David: That’s right.
Kevin: I’m shifting gears here to the Middle East, because their demand for oil, there’s not a lot of it right now.
David: I had an interesting interview with Bloomberg last week, and it went something like this. Your past prognostications on the price of oil are for higher prices, but it seems like you’re not quite as strong on that call today. Can you explain? I said it’s really about China. Global oil markets remain soft. Demand weakness in China has and will remain the market’s primary consideration for oil, and frankly for other industrial metals. Add to that the pessimistic outlook in China that is an optimistic outlook on Israel. What I mean by that is they’re not planning on hitting energy targets. Oil, gas, nuclear.
Kevin: And that’s the supply side.
David: Yep, exactly. And so they’re focusing strictly on military targets. And so, between China and weakness in demand and sort of an easing of concerns on the supply side, oil continues to soften.
Again, maybe this is cynical me. It looks like a Netanyahu-Biden gentleman’s agreement to not upset the oil markets prior to the election. Action prior to the election is expected. That’s going to happen. That’s already been forecast, but it needs to be military targets and nothing that would impact the oil market.
Kevin: Doesn’t China get a lot of their oil from Iran, and that’s where that could change things?
David: Yeah. New York Times last week had a fascinating discussion on that. China imports 3/4 of its daily oil needs, and Iran sells 90% of their exports to China. So on the export side from Iran, it’s 90%. That reaches approximately 15%, if you’re tallying it, 15% of Chinese imports are coming from Iran. So the economics of Israel’s Iranian strike are relevant both to the US presidential election on the one hand, and to Xi Jinping’s attempt to keep the Chinese economy moving towards the 5% growth target as well. You think about the impact of Chinese demand, if it can’t get access to that 15% of below-market Iranian oil, and I mean by below market, they’re paying a discount. It is the same as the Russian oil where India is buying a lot of Russian oil and they’re doing it at below a Brent price.
There’s a penalty in the market, and the Indian government says, “Yeah. We’ll take the discount. Thank you.” Well, China’s doing the same with Iran. But imagine if that Chinese demand seeking the 15% from the global oil markets, if that steps into frame. China’s economy is still a concern. If they can’t buy their oil at a discount from Iran, and they have to enter the Brent crude market, with a whale of a bid, energy inflation is back overnight, inflation is back overnight. So we look at this and say, Israel’s decisions are central to global energy market stability, and there is a knock-on effect to global economic stability.
Kevin: And you think about the economics of Israel’s, what their strike’s going to be into Iran, but think about the economics of what China’s doing right now in Taiwan. Everything doesn’t always play to the best economics, does it? I’m talking about the military ramp-up that we’re seeing right now.
David: And I think that’s my bigger concern. Again, within the geopolitical sphere, a geostrategic consideration. You’ve got a soft blockade of Taiwan as of Monday. Largest ever deployment of warplanes according to the Financial Times writer who’s in Taipei, 125 military aircraft in the air this Monday, participating in operation “Joint Sword 2024B.” So I guess part A was when the new president was elected and they wanted a show of force to say, “We don’t like this and we don’t like him.” And now part B is, “We don’t like you 2.0.”
Kevin: Maybe part B is be invaded.
David: Yeah. Well, 90 of those aircraft, of the 125 entered Taiwan territory, 17 warships, 17 Chinese Coast Guard vessels in what I think is reasonable to describe as a huge escalation.
Kevin: This goes back to what you said last week. It’s not if, but when.
David: Yeah. And of course we had no way of knowing that they would bring that— I mean it’s just, day-by-day it’s become unsurprising. It was 35 last week, it’s 45 this week, it’s 50 this week. I mean, they continue to sort of stretch what they can, and they’re normalizing the behavior within the coastal waters and in the air. When, not if. Xi has committed to this publicly, unification will occur, which translates to either invasion on the one hand, or a modern version of siege warfare, cutting the island off from the outside world. And I’d like to think that we would be in support of Taiwan. We’ve certainly expressed that, not formally, but I see US duplicity as something that knows no limits.
Loyalty is limited to self-interested considerations. And if we’re going to buy chips for everything we need to run our 21st century economy, do we care who we’re buying them from? So we buy them from Xi and company instead of Taiwan Semiconductors currently headed by C.C. Wei, the current CEO of Taiwan semiconductors. So who’s in charge of the company? Is it Xi Jinping or is it C.C. Wei? Why? I don’t know that the US really cares. I’m not sure we care. I’d like to believe that our word is our bond, but I’m no longer sure, and time will tell.
Kevin: What I’d like to do, Dave, because we can go back 70 or 80 years to World War II and we can say, “Well, who was tied to whom?” Or you could go back further, and go back to World War I and say, “Who was tied to whom?” And we talked a little bit about this over the last few weeks, but let’s just think about this for a moment. We’re talking about Iran possibly being struck by Israel soon. Their connection to Russia is through drones, drone sales. They make drones for the Russian side. You’ve got China, who in the past has been a distant supporter of North Korea, and Zelenskyy right now in Ukraine is talking about North Koreans actually in the fight. Is there any reality to that?
David: Yeah, I don’t know. Claims from Zelenskyy that they’re routinely encountering North Korean troops on the battlefield. Troubling to say the least. We know that munitions have been flowing, but troops would represent another form of escalation, an escalation in that conflict. So you had the Washington Post, Al Jazeera, and The Guardian out of the UK all suggesting that the troop casualty reports confirm that assertion, that North Koreans are being provided as fodder in the war, as if losing Russians was not bad enough. So maybe Zelenskyy is fabricating a pressure point to open the minds of the US and European military leadership to the use of bigger and more devastating hardware. I don’t know. In either case, the war is not cooling off. We’re not moving towards anything conciliatory. There are hypothetically two major conflicts we could be, as the US, directly involved in.
Kevin: And we’re sending our own troops already to one of them.
David: Well, that’s right. Last week, 100-troop contingent to Israel to operate our THAAD missile defense system. That’s a defensive system to complement the Iron Dome. And I think back in the concerns over World War III—I can’t tell you how many times I’ve encountered them. World War III has always discussed among doomsdayers as an inevitable next step, not appreciating that there is real power in diplomacy. There’s real power in conversation. There’s real power in creating economic alliances. But I would say right now, onlookers had better not underestimate the power of complexity. Global conflict is at a dangerous inflection point. Kevin, you reminded us of Sarajevo and Franz Ferdinand last week. Is there a modern day Black Hand that would like to see conflict erupt? Where would that be, and towards what end? I have no idea.
Kevin: And I wonder, Dave, because there’s such a dichotomy right now. We’ve got the US equities trading at all time highs. You’ve got the Federal Reserve lowering interest rates, even though inflation is increasing, yet you’ve got the bond market saying, “You know what? I don’t buy this.” And interest rates are going up on the long bonds. So you’ve got this dichotomy between the stock market and the Federal Reserve acting like everything’s fine. And then you’ve got the bond market going, “No. No, everything’s not fine. We’re going to have higher rates.” Who’s right?
David: We don’t know what they don’t buy. There’s something in the mix that is not quite right. Certainly, as you point out, US equities trading at all time highs with the exception of NASDAQ. It’s as if traders believe that a single factor—loose financial conditions complements of the central bank community—as if that one thing determines the course we’re on and we are safe in that assumption. My view is that that’s myopic at best. Myopia is that condition where you can see what’s in front of you, but anything in the distance is blurred.
So your equity traders look at it and say, “This is what we’ve got today. Who cares about tomorrow? The money’s flowing. The Fed’s accommodating. All’s good.” So it’s myopic at best. It’s naive and dangerous at worst. It’s this weird combination of overestimating corporate stability while at the same time underestimating the cost of conflict—maybe this generation’s reminder of the importance of history. The importance of factors not generally discussed in a corporate quarterly report or on CNBC as the breaking news of the moment. We just beat expectations by a penny. Wow. Isn’t that exciting?
Kevin: Well, and you talk about the power of diplomacy, and actually we forget that the power of diplomacy worked from the 1870s until about 1914. But then, what is interesting about looking at world wars, because you’re right, doomsayers are always saying World War III, but to be honest with you, World War I and World War II were something you really don’t want to repeat. They were painful. And what seemed to happen, when you really study, if you say, “Hey, why did World War I happen?” If you were to ask a guy in the trenches, most of them really didn’t understand why they were there fighting, but they were trapped, Dave.
They were trapped by a series of connections like what we were talking about. In this particular case, China consuming, 90% of Iran’s oil. That’s a big connection. Russia using Iranian drones, and we could go on and on. Israel and the connections that we have there. Taiwan, the semiconductors. There’s a point where you get yourself into a place where you really can’t go right, you can’t go left, you can’t go up, you can’t go down, you just have to get into the fight.
David: A few years back, I was reading Thomas Schelling’s book, The Strategy of Conflict, and I always wanted him to be a guest on the Commentary, and I think I started reading his books too late. He died in recent years at age 95, taught at Harvard, and he opened people’s minds to the importance of game theory and to dealing with the psychological aspects of warfare. It’s not just math, it’s not just statistics, you’re dealing with human beings and the psychology, sometimes even a psychosis, which is anything but rational.
The Strategy of Conflict was a good read for me. But you see that there is more to diplomacy than just two people. Ultimately being able to walk away with a handshake. There is a psychological aspect to it. There is a communications aspect, which sometimes is genuine and sometimes is totally disingenuous, to move the needle a particular direction.
Kevin: Well, when you have interpersonal disagreements, you want to keep your options open. There are times when you have an interpersonal disagreement where both parties just walk away or get into a fist fight.
David: I want to stretch an analogy, if I can. We spent the weekend mountain biking at a place called Dead Horse Point.
Kevin: I know the point. Yep. But it’s beautiful. I mean, this is Moab. It’s beautiful.
David: Yeah. The name comes from— As legend has it, the cowboys would round up wild horses on something like an inverse box canyon. Okay? So just flip it upside down. A narrow mesa that drops off on all sides with sheer cliffs. There’s no surviving the terrain without access to water, which does not exist on the Mesa, even though it is abundant 2,000 feet below.
Yeah, you can see that river winding way, way down.
It’s the Colorado River. So trapped, your choices are not great. As I look at the Wall Street bulls today, I think they’re looking more and more like trapped stallions, potentially dead horses. Liquidity taps, if they’re turned off, these beasts are dead. The wild mustangs of Wall Street, they are dependent on the Fed cowboys for their survival. Traders are already trapped. They just don’t know it.
But in some sense, and this, maybe the analogy breaks down, I think the Fed cowboys are trapped too. Liquidity abundance is required by everyone, and we’ve got some things that are heating up. Access to market liquidity can evaporate for a variety of reasons. You’ve got market internals, we mentioned the geopolitical externals, you name it. There can be a variety of reasons why what you have today, in the blink of an eye, just disappears in terms of liquidity.
Kevin: You talk about siege warfare. I thought that was interesting when you brought up Taiwan and saying it’s almost like a preview of siege warfare. And siege warfare, of course, is where your enemy surrounds your city and they limit what comes in. And what you’re saying from a Wall Street perspective, if that liquidity doesn’t get there, just like those horses couldn’t get water on dead horse point.
David: That’s right. So I’d encourage you to— A couple of things. I forgot to mention this earlier. We started a Vaulted campaign. This is our financial FinTech solution for bank savings. And if you want to have, or the equivalent of bank savings in ounces, vaulted.com. In the show notes, you can look at our current advertising campaign, if you will. It’s really fun. Take a look at it. If you like it, forward it onto your friends and family members. I think they’ll get a kick out of it. And it’s because gold. Why do you want? Because gold. Gold speaks for itself. So I wanted to mention that. See what you can do to push that out to friends and family members. I’d appreciate it.
I would also encourage you to read Hard Asset Insights from this past weekend. And I think when you do, you’ll see the trap clearly, this trap I’m describing where, yes, the wild mustangs of Wall Street are trapped. They’re out on that dead horse point, and the Fed cowboys don’t know it, but they’re just as much stuck as those stallions. Morgan argues, I think very persuasively, that choices are limited, and each one of the choices that are now optional are highly consequential. Fiscal issues have driven us to the edge. We can see— From this vantage point we can see liquidity, which is like an eternal spring of hope for the speculator. But if by contour and geography we are cut off from it, then the speculative trade dies, and you’ve got something of a significant correction to the mean, if you will.
Kevin: Consider this just for a second, I’m sure you did this weekend. What would it be like to die of dehydration in sight of water the whole time?
David: Right. We have ample liquidity, but the cost of providing it is something that has to be considered at this point.
Kevin: And we’re talking about interest rate costs. We’re talking about deficits.
David: Right. The interest on US debt has increased 34% year over year. So the interest on the US debt, what we paid a year ago is higher this year by 34%. We can’t afford higher rates from the standpoint of interest expense. And we’ve noted three weeks in a row, the Fed has moved to bring rates lower, and bond market participants have pushed them higher instead. Is that an anomaly or is the Fed trapped too? The Fed is not able to increase rates without triggering a debt death spiral. So there is some question as to why they would lower rates at all since the economic statistics are very supportive of a reasonable economy, certainly not an economy in dire straits.
And so why are they lowering rates 50 basis points? Well, they are proving it’s difficult to keep them at a higher level because the interest expense is eating their lunch. It’s very curious that the bond market MOVE Index has been showing signs of stress in recent weeks, the highest level since January. Not what I would expect following a Fed interest rate accommodation of 50 basis points. What was their stated goal of loosening financial conditions? If you don’t know, the MOVE Index is to bonds what the VIX index is to stocks. It’s a measure of volatility within the bond market. So the fact that over the last three to four weeks we’ve seen an increase in bond market volatility, even while the Fed is accommodating with easier monetary policy, what do bond investors see that stock investors are not even paying attention to?
Kevin: And that goes back to your average household. You’ve got the guy who’s, let’s say in his fifties, he’s got his 401k, he’s looking ahead. He knows how much money he needs to make by the time he gets to 65 for retirement. A lot of these people are just not paying attention to the fact that the stock market— What’s the price:earnings ratio right now, Dave? How far out of whack is it? As far as being too high?
David: Again, spending time in the desert focuses your attention on water. You can live without food for a long time. You can’t live water for more than a few hours. String that into a day or two max, and then you’re dead. And there’s a book written about the Grand Canyon and all the casualties within the Grand Canyon. And by far the greatest number of casualties come from people who go out and they think they have enough, and they don’t. And they run out and they die. Dehydration.
Kevin: I don’t mean to divert here for a second, but you’re just blowing my mind. I picked up some hitchhikers who had been in the mountains for, oh, I don’t know, two weeks. And a lot of times out here in Colorado, these guys will come out onto the road just knowing that a Coloradan is going to probably pick them up and take them where they need to be. They’ll do long trails. But as we were sitting and talking in the car, my hitchhikers that I had picked up, this lady was sort of shy and embarrassed. She said, “I like reading some pretty dark things.” And they were talking about in the Grand Canyon, down all the way at the bottom at Phantom Ranch, they stayed a few days, and they have that book there at Phantom Ranch, and she was just enamored by it. She said, “It’s amazing how people die in the desert.” We hadn’t even talked about that.
David: The greatest— Number one is water, if I’m recalling correctly. Number two is from plane crashes. And it’s because you had two planes collide. I forget. This is several decades ago. So your casualty rate, I mean, how many people die in plane crashes? It’s not like every private pilot dies that goes into the Grand Canyon. It happened to be two commercial flights that collided. And so the numbers, the body count was huge.
Kevin: It’s just random that you’ve read that same book. That’s amazing to me.
David: Well, households are enthusiastic about equity ownership. No one’s feeling the thirst for liquidity. Liquidity seems close at hand. They have all they need. You look at something like the cyclically adjusted price earnings ratio at 36.7. People feel like, “Hey, this is fine. We’re good. We have what we need.” Apple topped three and a half trillion market cap. No growth in two years, and yet they’re still at a three and a half trillion market cap. They’re trading in line with the S&P. So the S&P I’m referencing, CAPE, cyclically adjusted price earnings ratio, this is just a regular PE. For Apple, it’s trading at 35.22. Not cyclically adjusted. Microsoft sits at 3.2 trillion in capitalization, sports a PE of 35 and a half. These are investors who are saying, “No, I’m fine. I have what I need. We’re good going forward.”
Kevin: That’s right. And actually, if I was buying this company, let’s say I was buying Microsoft or Apple, I’d be saying, “Well, I know I’m not going to break even for 35 more years.”
David: Well, and so the experience of these statistics is a little bit grating, but no one is concerned about further access to liquidity. Further upside, further growth, that’s the given. So maybe think of it this way. I turn 50 soon. Birthday is just around the corner. So if I buy these companies today, at age 50, I’m finally getting my money back from annual earnings on my 85th birthday.
Kevin: How excited are you for that? Buy the stock today, break even because of earnings by the time you’re 85.
David: Just so that the statistics aren’t totally boring to you, if I’m buying Apple at 35.2 or Microsoft at 35.5 in terms of the price:earnings ratio, that’s me buying those companies and finally getting my money back from earnings when I’m 85. 85.
Kevin: Yeah. Will you still need me, will you still feed me when I’m 85? But that’s not all companies. I mean, you guys have been looking at energy companies that were just single digit on the price:earnings ratio just recently.
David: As recently as 2022, your major energy companies were trading in the single digits, PEs. And they’re still in the low double digits now. Some not even into the teens. Well below the historic averages of all stocks across all time, which is 16, sometimes people will stretch that to 18. But in that range of the teens still. That’s a reasonable valuation. You’re not buying things cheap, and you’re not overpaying for them. And a lot of your energy companies are well below that, so you don’t have to chase 35 years worth of getting your money back. There are more reasonable value propositions in the market today.
Kevin: Yeah, but we’re in dead horse territory for the ones that are up at 35 or 30 times. 36 times earnings.
David: Yeah. Run wild, run free. Households are allocating more to stocks than ever before. And to me that is an expression of running wild, running free. No liquidity issues here. Price to sales for the S&P 500 were back to January 2022 levels. Anyone recall the market in 2022? It was a breakeven year for us. No. Great thing to get super excited about.
Kevin: Yeah. Well, the management team didn’t lose money. They didn’t make money that year.
David: Dow was off 16%. The S&P was off 19%, NASDAQ was down 30%. I don’t know if the markets break down prior to year-end, if they break down after. This is a tricky year. We’ve got an election year. We’ve got the Fed that’s trapped. We’ve got QE, which, if necessary, the Fed will get cranked in a heartbeat to support the bond market, to support equities.
None of that is far off, but people need to pay more attention to the risk side. And it seems like all they see is the reward side. And when you’re only looking at rewards and ignoring risks, that’s when bad things happen. And again, you walk an hour, two hours through the desert, and you can be completely taken in by the beauty, the novelty of desert beauty, and forget that you need to pay attention to clues.
You’ve done this before where you’ve said, look, if I had not paid attention to where I was, and this is you down in Chaco Canyon, you go in and you don’t come out. You have to pay attention. You can’t just pay attention to what is the beatific moment. If it’s aesthetic, it’s one thing. If it’s monetary, it’s kind of the same thing. You’re just enjoying the ride.
Kevin: Well, and trails in a desert are really interesting. Since we live so near desert, people build cairns, these little rock piles, and you learn to make sure that you don’t lose sight of the cairn behind you while you’re looking for the cairn in front because if you lose sight of the one behind you, you’re lost if you can’t find the one in front. So that’s a great analogy, but let’s go ahead and reverse it here a little bit because it might take you 35 years based on earnings to buy the S&P 500 or Microsoft or Apple. But when you get to a market low, if you understand this, you can have dividend yields that are almost the equivalent of the earnings of the company.
David: Well, that’s right. So I like your analogy or your description of looking back at the cairns and looking forward and making sure you understand where you’re at in between. At a market low, that’s exactly right. You can find a dividend yield almost replicating the price earnings ratio in the single digits. So you’re talking about PEs of 6, 7, 8, dividend yields of 6, 7, 8% versus less than 2%, which we mentioned last week. We are at the opposite end of the spectrum now, closing in on 40:1 on the price earnings ratio. It matters because when investors get used to overpaying for stock, they’re setting themselves up for disappointment, not recognizing where they’re at. They have no appreciation for what’s in front of them and certainly don’t recognize what’s already behind them.
Kevin: I’m going to change the analogy. The other day, my wife and I were in the car and we saw this bicycle, a road bike flew past us. I don’t know how fast that thing was moving. But he was just in a normal bike helmet, his little bike clothes. And I told my wife, I said, the popularity of e-bikes, electronic bikes that are almost like little motorcycles, people don’t really realize the speed they’re going, Dave. They’re still dressing up in this thin bike clothes cloth, putting their little bike helmet on, and then they’re going motorcycle speeds, race bike speeds. I’m sure a lot of the listeners have experienced this where it’s like, wait a second, is that a bicycle, on flat ground, going 55 miles an hour?
David: It’s crazy. Well, coincidentally, speed was a part of the weekend. Maybe that doesn’t surprise you. We’re on mountain bikes, we’re covering as much ground as we can.
Kevin: This weekend.
David: A little slow with my 10-year-old. It’s not easy terrain. But day two, we did a couple of loops in the morning, and the Department of Transportation was doing research studies on the usage of trails and creating access to national parks. So one of the things that they’re monitoring is e-bikes.
Kevin: ‘Cause that does introduce a change into how you climb everything.
David: The first day we’re out there, I mean we’re out on a great pyramid and doing this loop, and these two guys come motoring by. 75 might be generous. They could have been pressing 80 years old. My first impression was, old, haggard, and oh my gosh, they’re out mountain biking? That is so awesome. I hope when I am old and haggard, I am out there skiing and mountain biking. So actually—
Kevin: It does introduce an opportunity for older people who could not have done it.
David: That’s right. And they’re not out there to break the land speed record. They’re just to be out there, and they need a little help. So we did that. We participated in the DOT study, and we had e-bikes the latter half of the second day of riding, which was a godsend because our legs were shot. Totally shot.
Kevin: What was that like?
David: To barely put out any effort and to be flying over intermediate and advanced terrain?
Kevin: Yeah.
David: It was amazing. It was really fun. And also really dangerous at times because on more advanced terrain, it’s all technical, and speed does not help you. Speed creates problems. I encountered a few of those.
Kevin: Yeah, so let’s just make sure that we’re keeping the analogy for the listener who thinks we just shifted to a mountain biking/e-bike podcast. No, the analogy is that speed can kill.
David: Well, over the weekend, as I mentioned, camping in Moab, mountain biking, hiking, it’s just beautiful. Campfire stories one night included our greatest loves, skiing for one and high speed records on the ski slopes. And the conversation got sobering when one of the college students who was with us mentioned a good friend who had spent four months being put back together after pinballing off of three pine trees. Just shattered his body. Broke his jaw, broke almost every bone in his body. So 60 miles an hour is something remarkable on a set of skis. Really quite something special to experience until you lose control. And the markets are in that high speed moment where conditions need to be just right and the edges need to hold. Conditions matter, and I’ll be frank, it doesn’t matter if you’re a novice or an expert, the conditions matter.
Kevin: So the Federal Reserve, they may be caught, they may be in a dead horse point kind of moment, but inflation, which they claim to be fighting, is actually rising.
David: Well, I mean it’s not moving by much, but the market’s making the assumption that the Fed has done their job, and they already took the victory lap, so let’s just get on board, and get long risk assets, and everything’s going to be fine. So CPI was hotter than expected by a tenth of 1%. So 2.4 versus 2.3, which was the expected number.
Kevin: Didn’t they revise August, though, too?
David: Well for PPI, yes.
Kevin: Okay.
David: PPI was flat month over month, but two tenths higher year over year. And August was revised higher by two tenths. The inflation target is close, but we’re not there yet. And it’s not as if we’ve had any form of deflation where we’ve seen a decrease in prices. So the fact of the matter is we’re just maintaining an elevated level and we’re talking about households that are not seeing any relief. The tourniquet isn’t getting turned any tighter, but neither is it loosening at all.
Kevin: But bond prices, let’s go back to bond prices. Are they telling us the truth?
David: Well, I think there’s indications all over the place. University of Michigan sentiment, it slipped. Current conditions declined. Inflation expectations increased. And as we’ve noted sort of ad nauseam, bond prices are moving the wrong direction. The implied rate for the Fed funds end of 2024 and end of 2025, again, this is fed funds, they’re creeping up. The assumption was, back in September, like 18th to the 20th, that time frame, 195 basis points. So they were going to see almost two percentage points decline. Now it’s 149 basis points of decline. So again, those expectations are returning to higher levels. Mortgage rates slightly higher week over week.
So, the bond market is saying something very different, that inflation is not dead. And maybe this is wrong of us to assume we know what it means in terms of what bond market is telling us. It’s just telling us something. And we mentioned this last week, the fact that the bond market is telling us something, we’re not clear exactly what it’s telling us, but the gold market is telling us something as well. That’s where you see the need to pay attention. These are two signals that don’t always match up. That they do is worth paying attention to.
Kevin: So does that force the Fed ultimately to have to reverse course and start raising rates again?
David: I think that we will see that. Is that six weeks from now, is that six months from now, the Fed being forced to hike in the face of a second inflation wave? What that does is stock investors will then begin to appreciate being stuck on the mesa without any good options because they’ve assumed that liquidity is ample and they have no worries.
But if the Fed is forced to hike rates in the face of a second inflationary wave, your equity investor will then appreciate that they’re in a bad place. They don’t have what they need. They’re not going to have the supplies that they thought were available to them. Bonds in that moment, parallel to stocks, may be the short of a lifetime. If you’re talking about making money as prices go down. We’re setting up for what could be another round, just like we had in 2022, of 60/40 carnage, people allocate 60% to equities, 40% to bonds, or vice versa depending on your age. And both of those asset classes are in a high risk category.
I think yields in that event, much higher. The Fed, in deep trouble, with their credibility having been crushed. QE comes back onto the table in sort of a Hail Mary fashion, and who knows, the dollar may or may not be interesting to foreign investors at that point, which really does redefine the course of gold and other hard assets going forward.
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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 adviser to assess your suitability for risk and investment. Join us again next week for a new edition of the McAlvany Weekly Commentary.
