EPISODES / WEEKLY COMMENTARY

Zombie Company Apocalypse

EPISODES / WEEKLY COMMENTARY
Weekly Commentary • Jan 11 2023
Zombie Company Apocalypse
David McAlvany Posted on January 11, 2023
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  • Almost One In Four Russell 3000 Companies Cannot Pay Interest On Debt
  • Margin Debt On Stocks Still 5% Higher Than Before The 2008 Crash
  • World Economic Forum Promotes Insects As Great Replacement Protein… Yum

Zombie Company Apocalypse
January 11, 2023

“There is a misconception about lower prices necessarily representing an opportunity. Price is what you pay and value is what you get. Is it possible that a world that looks cheap today is still overvalued? 2023 might well be the year that investors learn that valuations are moving targets like so many things in life.” — David McAlvany

Kevin: Welcome to the McAlvany Weekly Commentary. I’m Kevin Orrick, along with David McAlvany. 

David, sometimes I think we should question why we do the things we do. So, I’m going to throw this out, and many people know this story, but what if I said that the ends of the ham have to be specifically 1/16th of the total weight of the ham? And you’d say, “Well, what are you talking about?” And I’d say, well, you remember the story when the daughter wanted to have her mother and her grandmother and all the family over for their first Christmas meal? First time she was cooking a Christmas meal. And she cooks the ham, and both ends of the ham are cut off. And someone says, “Why do you cut the ends of your ham off?” And she says, “Well, because that’s what my mom did.”

David: That’s what they do.

Kevin: And so, the daughter said, “Well mom, why do you cut the ends of the ham off?” Well, grandma happened to be there. And she said, “The only reason I ever cut the ends of my ham off was because I had too small a pot.” And the reason I bring that story up is, how often, Dave, do we measure and weigh the ends of the ham, cut them off because that’s the way we thought it was always supposed to be done? And actually the origin of the story had nothing to do with why we’re pursuing it now. I think about that for markets. I think about that for religion. We were talking last night, what if we could question those things and actually see the origins of why we think the way we do?

David: Yeah, we take a lot of things for granted. It’s a pattern of behavior. And so, we operate with that as a view towards what is normal and what we can expect next.

Kevin: Yeah. Well, let’s take the markets as an example. There are things that we can watch in the markets that would determine what we would think would be an indication of whether we’re in a bull market, a bear market. I think of margin debt as one of those things. That’s a nice indicator of the direction of a market. But it’s not always completely accurate, is it?

David: Right. It’s one of those things that is coincidental and is helpful as an indicator of where you’re at. It may not be causal in terms of where you’re going, but margin debt through November of 2022 had dropped by roughly 35% from its October 2021 peak. It got up to a trillion dollars.

Kevin: Yeah, I remember that.

David: Stock market peaked two months after margin debt did. And we’ve often noted that the two move in lockstep. That’s an expression of investor confidence, and it shows you how much speculation there is in the market. If you’re so confident to place your stock market bets and to then reinforce those bets by using someone else’s money to enhance returns, again, it’s an extra level, or an extra measure, of confidence—or speculation. So, the bubble bursting in equities is aggravated by this because you then have the forced liquidations of positions that were funded with the house’s money. 

And so, again, 35% decline from October 2021, took about a year to get there. If we have another 5% reduction in that margin debt, that gets us to the previous peak levels in July of 2007. Let that sink in. There’s still a lot of risk being taken in the form of borrowed money for trading. And we’re still above the March 2000 levels, still above the July 2007 market peaks. 

When an analyst like Mike Wilson of Morgan Stanley suggests that we could have additional downside in the equities market likely in 2023, let’s say in the neighborhood of 20, 23—I think he said 22% was his number. I don’t know how he arrives at 22. I’m just going to call it 20. There are justifications for that. There is supporting evidence for that suggestion. But I would argue this is one of those things that is supportive. 

Sentiment towards the decline this last year has not been overly negative. Retail investors particularly have been willing to buy the debt—buy it all the way down. And it seems the drama as they have, the temporary result of Fed tightening due to a mostly transitory inflation problem, has them only too eager to get the party started again. So, time will tell how high rates must go, and the corollary of that: how low stock and bond prices will travel as a result. But this issue of margin debt is I think worth remembering.

Kevin: Yeah, but you’re not saying it’s necessarily the cause. It may just be, like you said, maybe something that you can watch to see where we are in the cycle maybe.

David: That’s right. It’s not a primary cause of market troubles, but it’s an indicator of where we are in a cycle. So, we’ve gone farther than we’ve ever gone before, getting to a trillion dollars, and that marks sentiment at extreme levels. And it serves as a reminder of what is next when margin debt begins to shrink. Of course, you have a selloff in the equities market, that’s no surprise. 

There is a partial causal factor I guess you could say. As you look at the market moving up and down, of course, it’s driven by the flows of capital coming and going. And so, in the case of margin debt, you do end up with an exaggerated move higher or an exaggerated move lower when you’re dealing with a capital base that exceeds the savings of investors. So, it’s money that was borrowed from the house, more than the savings that was available to invest in equities, and it pushes things farther than they could have ever gone before because of that extra boost in liquidity. 

In the end, I think we’ll see the 8%, the 19%, the 33% declines. This has to do with the Dow, the S&P, and the NASDAQ for 2022. We’ll see that as the easy phase of the bear market, the phase where speculation was moderated, but where speculation was not shattered. And the price paid by speculators so far has been really at the extreme, and at the periphery of quality. You look at the non-fungible tokens, you look at the special purpose acquisition companies, the SPACs, the blank check companies as they’re called. You look at the cryptocurrencies, even the late cycle, speaking of this credit cycle, the late cycle technology darlings like the electric vehicle folks, the Teslas, the Rivians, and a half a dozen other names, the pain was most concentrated in companies that didn’t make any money. Even if someday they might.

Kevin: Don’t they call companies that cannot make their interest payments zombie companies? I mean, how many of those are out there right now?

David: That number keeps on growing. So, 24% of the Russell 3000, these companies in the Russell 3000 Index, 24% of them are categorically zombie entities as of 2023. Zombie companies, you mentioned, are counted and defined by the Leuthold Group as companies that are unable to cover the interest on their debt through operating revenue. Kind of a tough position to be in. 24% of the 3000 companies in the index. The previous peak for zombie companies was 20-odd years ago, 2002, in the aftermath of the dot-com bust. The high water mark was 16%.

Kevin: Wow. So, one in four. One in four right now of the companies in the, what’d you say, which index was it? The Russell 3000?

David: The Russell 3000.

Kevin: Yeah. So, one in four. If you had, of those 3000 companies, a quarter of them literally cannot make the payments on the interest on their debt.

David: The interest. That’s right. No, I mean they’re betting on the right market environment in order to succeed. So, a key difference between then and now, I think, is that complacency over the quantities of debt accumulated—and this is going back over the last five to 10 years. Interest rates have been declining. Folks in the C-suites looked at this as an opportunity to fuel growth and to fund the marketing machines with ever-cheaper money. So, if they had access to cheap money, they absolutely lined up for it. 

2023 is an interesting year. It’s the year of the rollover. It’s the year of the rollover. Rolling over a certain quantity of debt will see the interest component rise on that debt that’s rolled over. The interest component will be up two times or three times or even five times off of very low levels established during the zero rate era.

Kevin: That’s incredible. So, the zombie companies, already one in four roughly of the Russell 3000 companies, they’re already zombie companies with the lower interest rates. But what you’re saying is their debt will roll over, and of course it’s going to be at much higher interest.

David: Yeah. So, what does the remainder of the year hold? To me, this is a swelling of the ranks in some corporate zombie apocalypse. Of course, you could have an extinction of those early zombies, as bankruptcy relief serves as the only cure. Because what they’re dealing with is a multi-crisis. Too much debt is a part of the problem. And then, to the degree that we have a recession in 2023, a downturn in the business cycle when you’re carrying too much debt on the balance sheet, that’s the kiss of death.

Kevin: So, what we’re looking for now is who’s going to be the savior this time? Is it going to be the government? Is it going to be central banks? People are always looking for a savior. We can’t have this multi-crisis, can we?

David: Well, that’s the discussion, isn’t it, of multi-crisis? If you go to the OECD, if you go to the Paris Peace Forum, if you go to the World Economic Forum, they combine these concerns. Most of the concerns are what you might describe as external or exogenous. War that somebody brings to your door. COVID-19. Climate change for developing countries. And that’s really where the focus is because it helps with that notion of redistribution. They’re said to be paying the existential price for the successes of the developed world. Said to be. 

When multiple issues converge at a point in time, who will save the day? In the past, it’s been governments. In the past, it’s been large treasuries, except that we start 2023 with a unique set of backdrop circumstances, impaired balance sheets, global inflation problems, a credit cycle. We’re talking about cheap money having gotten cheaper for all those years. It’s ended. 

So, those are external problems. Then you’ve got the endogenous problems like debt, deficit spending, balance sheet impairment, housing affordability, that are also in play in this context. And it’s fascinating. We watch the world’s elite soliciting permission to unscramble our eggs, as if such a thing were possible from them.

Kevin: You know what, it reminds me of? Humpty Dumpty. Sometimes you have to go back to these old nursery rhymes to see if this can be done. You talked about unscrambling. But Humpty Dumpty, if I remember right, was an egg and he sat on a wall. He had a great fall. But here’s the biggie. All the kings’ horses and all the king’s men could not put Humpty back together again. I don’t know that the elites, the elites with their king’s horses and their king’s men, can they unscramble this?

David: Well, capability is different than what is promised on the front end. And I think when you see uncertainty and the growing social anxieties grow, not only here in the US but globally, around these both exogenous and endogenous problems, it promotes an acceptance of that global mode of operation to unscramble. Somebody’s got to be able to do something. Please tell me. And again, we’re looking for the answer. And the more our anxiety grows, the more desperately we’ll listen to someone who says, “Yeah, no problem, I’ve got this.” And so, regardless of the cost to freedoms and the sacrifice of the primacy of individual rights, we have collectivists entering 2023 with confidence that they can solve collective problems, though, by their own admission, may have to break a few more eggs to get the job done right.

Kevin: I don’t know if you want to use eggs right now as a metaphor. My wife would get upset because she’s now paying $10 to $12 for a dozen eggs. Of course, these are the organic eggs, but still, $10 to $12, and they’re limiting here in Durango right now purchases of eggs to two dozen per customer. So, I just wonder if eggs are the right analogy right now. I don’t know that we can afford to use them.

David: I think that sounds like your eggs are coming from a golden goose. When we reference inflation receding from peak levels—and of course we have the CPI, Consumer Price Index, print this week—it seems that some of those items are stubbornly high, maybe even going higher. And statisticians will tell you perhaps that eggs are meaningless. It’s not the real big input, and the cost increases—I mean, for you and me, maybe it was from $2 to $6 or $7, or if you’re getting the golden goose eggs, it’s $10, $11, $12—but it’s not a problem because those bean counters have the ability to substitute and shift in statistical weighting any particular element in the CPI. And so, I wonder if these folks could, well maybe in fact they have, allayed their fears by downloading the World Economic Forum’s recommendations on protein. We move away from animals, we move away from eggs, and we end up with something else on the plate. Insects.

Kevin: Well, there you have it.

David: It reminds me of Dr. Seuss, Dr. Seuss for the modern age. This is the sanctified WF version of Dr. Seuss. I do not like them, Sam-I-Am, I do not like green eggs—made of, whatever they’re made of—and ham—and I’m not sure what the ham would be made of. But we’re changing that to, You do not like them, so you say? Try them, try them, and you may. Try them and you may, I say.

Kevin: So, the World Economic Forum wants to tell my wife that when she gets a salad with an insect in it not to send it back anymore, because that’s happened. Don’t send the salad back.

David: No, it’s better than the eggs in terms of protein per ounce, you’re going to be served that much better. 

Honestly, this week, inflation is expected to recede as it’s reflected in the CPI. And that’s I think maybe the difference between your wife at the grocery store and the CPI calculators. This is a measure of inflation, perhaps not the best measure of inflation, but the statistic is expected to recede further. 

The current challenge with that is that the market—both the equity and bond markets—and market speculators see receding inflation as a reason for the Fed to lighten its touch in the realm of quantitative tightening and their efforts here recently to contain inflation. So thus a reduction in rates and an easing of financial conditions is expected. And what does that translate into? If you’re following the domino effect, it translates into, “go out and buy stocks, go out and buy bonds.” So, inflation recedes a little bit in the CPI number this week, and chances are you’ve got a free-for-all in the allocation process. 2023 might be 2022 in reverse. So goes the thinking, and so goes the allocating.

Kevin: So, the eye is brightened. Every time it looks like CPI is going to drop, the eyes brighten and they’re thinking, “Yo, we’re going to have our bull market back again. Remember the everything bubble? It’s coming back the way it used to feel.”

David: But this loosening of financial conditions in an attempt to front-run the Fed, that aggravates the Fed. And seeing the incitement to speculate come roaring back just even in the last few days of trading here in 2023, and as we read the recent Fed minutes, we are going to have higher rates for longer. That’s going to be required. And part of this is a response to, again, the animal spirits coming back into the market so quickly. Of course, the leveraged equity player says, “Pish posh.” The typical contempt that they have for restraint, and this belief that now is the best time to be buying stocks. In fact, there’s never been a better time to buy stocks than now. That’s what the Fed’s facing is this issue of, if they relent at all, it just promotes more speculation.

Kevin: But, Dave, not everybody’s saying that, right? Didn’t you say that a well-respected analyst, what was his name? Mike Wilson? Felt like there was going to be a 22% downturn this year as well. That doesn’t sound like a bull market.

David: No, I mean, and if you turn the clock back, you’ve got Jeremy Grantham just at the beginning of 2022, who said, “Buckle up for a 50% decline. We’re in a super bear.” And by that categorization, there’s only been two other super bears in the last 100 years. This takes us back to the 1930s, and it takes us back to the major debacle that we had around the year 2000. 

So, Grantham, was he wrong? Are we done? The worst is behind us and we’ve got an all-clear to go forward. Is Wilson smoking the wrong kind of cigarettes? Maybe he’s just a little too concerned. 

If you look around Wall Street, there is a lot of analysts who look at 2023 as an immense opportunity. December 8th Bloomberg headline read, “Analyst see S&P at 5,000 in a new bull cycle.” It was only a few days later, December 16th, Market Watch ran a headline, “Here is how stocks could rally 20% next year,” says a veteran analyst. Seeking Alpha, a hodgepodge of writers, on December 20th ran a headline, “A new bull market is likely to start in 2023.”

Kevin: Isn’t it interesting that they’re both focusing on 20% roughly? One person says 20% up this year, another person says 20% down this year. There’s hardly agreement right now. And I know there’s analysts that are always disagreeing with each other. There’s however many billion people on earth, and no one agrees completely. But in this particular case, there doesn’t seem to be any clear direction at all.

David: No, and to me, when you have analysts very vigorously agreeing on one side, and another analyst very vigorously disagreeing, taking it the other direction, 20% up. Or as Mike Wilson says, 20% down. Analysts always disagree, as you said, but this symmetry suggests you’ve got strong minds not creating compelling enough probabilities to step out and take a lot of market risk. If I’m talking about my money, and I’m talking about my money, and you’ve got smart people on both sides of an argument and they both stack up, but yeah, we should see a 20% upside, and the other side, yeah, we should see 20% downside. We’re just stuck. Basically, we’re stuck in the middle. 

You need compelling probabilities. Your best-value purchases are not in the limbo land of maybe 20% up or maybe 20% down. The best time to sell is when the consensus is that stocks can only go higher. And I know that sounds backwards, but you’ve got to think like a contrarian. If everybody’s on one side of the boat, we’re only going higher, then we probably already put in the highs. And the best time to buy is when the consensus is that a particular asset class needs to be left for dead. It has no future. The probabilities are uniformly negative. That’s probably when the last bit of risk has been wrung out of it, and you’re talking about an absolute bottom.

Kevin: This is when you have to almost be a psychologist because we’ve seen how the market is moved by perception. If the perception of the market changes, and let’s say everybody becomes very, very bullish, or everyone becomes very, very bearish, that has a huge impact as well. It’s not just the margin debt, it’s not just the possibility of the Fed lowering rates or raising rates. Don’t you think that psychology plays one of the biggest roles at this time when there’s so much disagreement?

David: Well, it’s the driving force of markets on any given day. Markets are driven off as psychology, and your indicators of where the psychology of the markets rests is critical. So, if we emphasize margin debt, it’s because it tells you something about risk-taking, or, on the other side of the equation, risk aversion. Risk-taking is most bold and the rejiggering of probabilities, in people’s minds, the reconfiguration of probabilities becomes more uniformly positive at market peaks. Flip side’s also true, and this is— People cannot help themselves. People are people. Pretending to be rational is one of the highest human art forms, but in the end, it’s pretend, right? 

So, we all fit on an emotional spectrum, and there are a variety of internal and external factors that drive us to feel what we feel. And then, on top of that, we create this structure of rationalization. We rationalize those emotions. And you see this with engineers and accountants and professors as easily as you do street fighters, artists, and blue-collar builders. It doesn’t matter what your profession, what your educational background, or if you perceive yourself to be someone who is carefully thinking. The reality is, underneath the veneer of rationality is this bucket full of mush. It’s a mess. It’s emotional.

Kevin: Yeah, you’re talking about the rationalizations. Remember how we started, when I was talking about weighing the ends of the ham and thinking that you’re doing the right thing. And then the reality is, the only reason the ends of the ham were ever cut off in the first place was grandma didn’t have a pot big enough for the ham. And so, these rationalizations, we have to watch ourselves, don’t we?

David: Yeah. I encountered a situation this last week, and this is slightly different, but a highly rational, structured thinker was expressing opinions which really revealed a common human story different than appearances. So, on the one hand, there’s this very rational presentation of “the facts,” and the reality is very different than that appearance. So, although we pretend to have it all together, we operate and we navigate life through the lens of, well, through the lens of our insecurities, through sometimes our subconscious but always present fears. And frequently, those things are unknown to us. Sometimes it’s even a reflection of personal wounds and traumas, and we pretend it’s not so. We appear to be something that we’re not. We appear to have it together to have a rational line of thinking, right? 

And this person I’m thinking of, practiced in the art of public presentation, convinced of being a clear thinker with objective insight. And I took the idea that was presented, and I spent hours one evening this last week engaged with an idea that had been presented, and actually presented it to a friend of mine. We debated and discussed it. An idea that dates back thousands of years, and I wanted to gain a little bit more context. So, I rediscovered in this process the degree to which seemingly objective thought so often rests in subjective confusion. 

This took me back to F.C. Copleston’s History of Philosophy and it took me back to Jaroslav Pelikan’s five-volume series on The Christian Tradition: A History of the Development of Doctrine. And Copleston—like, if you don’t know those series, I highly recommend them. Pelikan is from Yale, and one of the brightest theological documentarians, if you will, of the last 100 years. F.C. Copleston delivered the Gifford Lectures. Oxford educated, one of the brightest historians of philosophy ever. 

Sometimes it’s helpful to know the genesis of a debate-worthy concept. Where are you in the dialogue of an idea? What has already been said? What problems have already been solved? On what basis do you draw your conclusions? Whether we’re talking about philosophy, politics, economics, history, we operate very confidently, and sometimes also very ignorantly. 

And that’s one of the things that we wanted to draw out as we talk to our friend in England, discussing the story of Russia to say, “Is there something about the context of this current conflict that might help us have a better insight because we think we know what’s going on, we’ve come to certain conclusions and yet do we have any basis for that? What is the basis of the conclusions that we’ve come to?”

Kevin: Grandma, why do you cut off the ends of the ham? Really, that’s a question, that is a life question, if applied. Think about the data that we follow, Dave. And I think of GDP and how much that changes. I think of CPI and how much that can be changed. There are so many things that we count on as clear data that are really just ways of cutting the ends of the ham off, and it may not make any real impact.

David: Well, and I think these are the things that we console ourselves with. It’s the collection of data that we’re convinced by some probability. We give ourselves the trappings of a rational or scientific or logical— The same is true with, as we look at the market, we figure out what we think is going on and we don’t realize that perhaps this problem has been solved, or an idea is very relevant here that’s not even included in the conversation. If you look at market histories, they’re really the same from the beginning of time through the present. The pendulum swings from greed to fear. And we’re somewhere on that pendulum. And so, do we have sufficient objectivity to make the proper market call and know where we’re at on the continuum?

Kevin: It really reminds me, how often do we see a stock that’s way down and are convinced it couldn’t go any further. I’ll use the dollar as an example. When we show the dollar chart for the last 100 years, but actually really since 1971 when we went off the gold standard. The dollar’s lost over 90% of its value. But what a lot of times people don’t realize is it can lose another 90%. It doesn’t mean we’re going to lose the last 10%. It means we could lose another 90%, or another 90 after that. Question would come, stocks like Tesla. Is it low or high right now?

David: Yeah, sure. Well, there’s a lot of other examples. If the ARK innovation fund, Cathie Woods’s invention of the brave new future of technology, is down 81% from its peak, are we looking at a compelling value proposition? If Tesla is at its worst, off 74%, maybe it’s 78% from its peak, isn’t it time to buy? Apple shed a trillion dollars from its market cap, and is still the highest-valued company of all time. Well, I guess it shifts back and forth here recently between number one and number two with Saudi Aramco, but it’s up there. It sure is cheap. Again, if we’re talking about relative to peak pricing, a trillion dollars cheaper is cheaper. You look at its cash position. 

We can create these justifications for why it makes sense. Amazon’s given up $850 billion in market cap in the last 12 months. It’s off 50%. Similarly, Nvidia is down 50%. And that’s only a loss of 400 billion. But Nvidia is interesting because they’re not only selling technology that goes into gaming consoles, but they’re also selling the technology that goes into the hardware used by crypto miners. Right? So, what about crypto? Off 60%, 80%, 90% losses in crypto land. The buying opportunities have unfolded incrementally throughout 2022. So, you could argue, and the numbers would say, “This is a time you got to step in,” except that the buyer of the dip so far is probably not very liquid right now, having bought all the way down. And this is what you have to wrestle with. Relative to peak prices, things are cheap—or are they?

Kevin: This goes back to what you’ve pointed out for many years and that is, the price of something’s not as important as the value of something. Will it be valuable going forward? Not will it be higher in price. Will it be valuable? We just assumed, Dave, when something gets low, we’re going to cycle back up.

David: And that’s not always the case.

Kevin: Yeah, the US stock market has, through the years, gone back and taken out old highs, but sometimes it takes 20, 30, 40 years. Look at the Japanese.

David: Well, even look at the US markets. When we had our 80%, almost 90% decline—89%, to be precise—in the early ’30s, it wasn’t until 1953 that the 1920s speculator was back to break even. It took not just a couple of years, not just a couple of quarters, but it took a couple of decades to get back. 

Japanese stocks peaked in 1989 and they’re still today 1/3 lower than those peak levels three decades later. Intel. Technology has come roaring back. Intel peaked during the dot-com era with a market cap near $500 billion. Since then, it has only reached half that level, and today sits at a 75% to 80% discount to those levels. And here we are two decades later. 

So, there is a misconception about lower prices necessarily representing an opportunity. We’ve said this before, somebody once saying, “Price is what you pay and value is what you get.” Is it possible that a world looks cheap today, is still overvalued? So, value is what you get. 2023 might well be the year that investors learn that valuations are moving targets, like so many things in life. Cheap. Well, on what basis? On what basis do you draw your conclusions? It’s one thing to declare something. It’s quite another to defend it.

Kevin: And you talked about psychology being the driver of the market, so you’d have to probably say a close second to that is liquidity. If there’s a lot of money flowing, that also ultimately gets speculation going, doesn’t it?

David: Yeah, absolutely. Absolutely. I’m not defending the view that markets remain overvalued simply on the basis of margin debt levels remaining high. That, as I said earlier, is just a measure of where we’re at on the continuum of prices, and it shows you how much ample liquidity still exists in the system. Ample liquidity equals ample pricing. Limited liquidity represents the limits to the upside, and potentially a catalyst to the downside, in pricing. 

So, where do we go from here? Do we see a radical increase in margin debt—again, just as an indication of the speculative juices flowing, a reinvigoration of risk-taking. Will that be accommodated, and on what terms? This is where some of the structural factors of an increase in cost—maybe even the cost of capital, interest rates rising—may put a dampening effect on that.

Kevin: Well, to your point, the Russell 3000, those companies, if a quarter of them, roughly, are zombie companies that cannot make the interest on their debt at the low rates that they were at in 2022, then what does that look like when that rolls over? I have to figure that’s going to affect liquidity.

David: Yeah, we have to think of things in terms of ebbs and flows. Bear markets have come in waves. There’s reprieve along the way. Past periods of inflation have come in waves. It’s not a constant unrelenting push, but it’s breaking into new territory, almost a two steps forward, one-step back motion. War and conflict come in waves. Varied defenses. Even if you’re talking about— we’ve spent a little time talking about psychology today. Depression and the mind comes in waves, depressive episodes. 

The ebb and flow is what I’m talking about. We’re not speculating about whether we did or did not have a bear market in ’22, because in 2022 we did. There is no guesswork there. We uniquely saw it cross into virtually every asset class, and uniquely had both equities and bonds down in the same year—a once in a century event. 

The consideration today is whether the worst is behind us or still ahead of us, and this I think is where history has something of a helpful indicator. A second year of decline is not unheard of in the context of a market dislocation. The psychology involved in a second year’s decline is harder than the first because you are talking about giving up on hope. When you talk about capitulation, that is typically what you see at the very end of a bear market. And we did not see capitulation at the end of 2022. 

So, we look at the psychological factors, we look at margin debt, valuations suggest a greater correction is still on the horizon. Margin debt levels suggest a greater decline is still on the horizon as well. We talked about recession and the factors which might impair earnings for companies, and of course, we’ve covered this multiple times, my colleague in Hard Asset Insights does, and I’d suggest that you read the last couple of weeks there, but suffice it to say, the pendulum’s in motion. If we’ve determined where we’re at in the continuum, then I think risks and opportunities become clarified. Our choices become a little bit more clear.

Kevin: Yeah, it just catches my attention how vulnerable I am to past bias. Again, I keep thinking of that analogy with the ham. I can get pretty set in my ways, and this is a period of time where I think we have to have very flexible thought. As we meet on Monday nights and share a Talisker and talk about what’s going on over the week, it’s not that we’re talking with certainty of knowing what’s going on. It’s as if we’re coming to the table going, “I really would like to know what is going on.” And that seems to be probably a safer attitude right now than being absolutely convinced of a bias that might be just cutting ends of the ham off.

David: We live our lives as individuals largely in the first person, and the danger is that we do slip into individualism and are disconnected from a larger group of people. We convince ourselves of being rational creatures, but we can’t ever fully account for the biases that direct our thinking and lead us to various conclusions. And the value of that communal touch point—I think of the team dynamics that we have in our Wealth Management Group. Objectivity is a more likely outcome in the context of free thought and inquiry, within the context of debate and community-driven exchange. There is where we have a chance to see things as they truly are.

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, M-C-A-L-V-A-N-Y.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.

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