December 14, 2016; Trumpo-Stocko-Mania! Let’s Party like it’s 1929

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick


“Get used to it. We’re not going to have anything like the growth we’ve had in the last 30 or 40 years, in part because we’ve got this massive burden of debt that we’re carrying. And now a new administration that says, ‘The debt? Don’t worry about the debt. I’m a master at the debt. All I do when I have too much debt is default on the debt. It’s no big deal, the debt.’ There are ramifications if you’re a dollar-holder, if we should see a default on the debt. And you and I need to take that more seriously than perhaps the oval office will.”

– David McAlvany


Kevin: David, often when we record this program, we have just come out of a meeting with everyone in the company, and I was interested in the story that you told about your son who is eight years old. He just received $100, and you used that as an exercise to teach him about the theft of inflation.

David: We have a conversation about if someone just came in and lifted that $100 and walked away with it, how would he feel? And he was livid even thinking about it. And I said, “Well, what about $30? Is it still kind of the same thing?”

Kevin: If you stole $30 or took $30?

David: Stealing is stealing. Does it matter if it’s $100, or only $30? And I said, “Well, what if it’s just $2?” And he said, “Well, it’s still mine.” And I said, “That’s right.” That’s what inflation does. That’s what the central bank does. They tell you, and they assume that you don’t understand, “I’m going to pick your pocket to the tune of 2% a year, and I’m stealing from you, and you’re going to be happy. You’ll thank me later because I’m smarter than you, and you should thank me.”

Kevin: And that’s what the Federal Reserve says. That’s their goal. It’s like, “Hey, we’re going to take $2 a year out of your $100, and that’s going to be good for you.”

David: That’s right. It’s stories like that, an occasional little biopic. I read a little thing on John Glenn this last week because although I don’t share his politics or his political persuasion, he was an amazing man.

Kevin: Sure. An American hero.

David: He passed away this last week. Every decade of his life was marked by something monumental, which is rare for an individual to have even one thing in one decade of their life be so monumental. I mention that because occasionally you will see this thing show up either on our blog,, if you’re interested in looking at those kinds of things on a period basic, or, more regularly, we will tweet, so if you like to follow us on Twitter or Facebook, it’s a way, in addition to the comments through the Commentary and the Q&A, a place where you can be more interactive if you enjoy that, with the topics that we’re interested in. Some of them are economic and political and some of them are just off the wall and occasionally just personal.

Kevin: That’s different than which is our main site. is a little more personal when you have an idea, like you said, you wrote about John Glenn. One of the things that we try to do in the Commentary, Dave, is look at people who have led deliberate lives. John Glenn is a man who made it into his 90s, when in reality, he was doing dangerous stuff in the 1950s flying fighter jets. He was the first American who orbited the earth.

From an American point of view, at that time the space program was a very iffy proposal. In fact, I remember the story, when he was in space on this orbital flight the sensors said that his heat shield looked like it had come undone. They didn’t tell him that, they just told him to go ahead and keep his thrusters on and not release them, to hold that heat shield on. They didn’t tell him that his life probably was in dire danger and that he might just burn up as he re-entered.

Now John Glenn is an example, but I even think of some of the people that we’ve interviewed here who have lived deliberately, succeeded in that deliberation. The stock market right now – we look at the stock market, it’s about to break 20,000. People are saying, “Gosh, how high can this go, and should I maybe get involved?” I’m thinking of a guest of ours that probably is one of the foremost experts on valuation of the stock market – he has pretty much written the book – Andrew Smithers.

David: Theoretically, the stock market can go to infinity. And I say that because if you don’t have any grounding for your currency, and you’re pricing things in nominal terms, then you could have Dow 100,000.

Kevin: That’s what happened in Germany during the hyperinflation in the 1920s.

David: Right. You just have to divine what meaning is in that, and that’s why value, and figuring out different kinds of value, is so important. You’re right, in the last few weeks we have revived an older conversation with Andrew Smithers. He researched every value metric for stocks on a comparative basis and reached the conclusion and demonstrates that in his book on Q that Tobin’s Q was the best metric by a country mile.

Kevin: Simply put, Tobin’s Q is the replacement value of the company that you are buying stock in.

David: Basically, a company’s market value relative to its asset replacement costs. That number is running at the equivalent level right now of 1929, and the 1929 mania. Alan Newman, also a former guest of ours – we need to have him back on soon – also a fan of the measure, reminds us that we’re now above the bull market peak of 1968, when you’re looking at Tobin’s Q.

Kevin: That was the top of the market.

David: Yes, and from 1949 to 1968 was one of the great bull markets. It ended in 1968. At present we’re only just below the 2007 peak.

Kevin: Before the global financial crisis.

David: The ratio suggests that it is cheaper to build a company from scratch. You buy the land, you build the infrastructure, you hire the people. It’s cheaper and more attractive to do that than investing in shares of an existing business because of the premium you’re paying for that existing business. Those premiums are now too dear.

Kevin: Another metric that he uses is just the price-to-sales metrics, the profitability of companies whose stock may be rising but the profitability, actually, is falling – the sales of that company.

David: Sales for the last two years have been in decline, 18 months to 24 months. Price-to-sales metrics a few weeks ago were well above any other period in stock market history. There are various metrics, and they each tell a little bit different story.

Kevin: There is weighing of the price versus earnings – overall earnings.

David: And then a more reliable measure than price-to-earnings is CAPE, or the Cyclically Adjusted Price Earnings, which is a ten-year rolling average of a PE, and it takes out some of the quarterly volatility in earnings and gives you a much better picture, smoothing it out a little bit.

Kevin: What is the Shiller PE right now?

David: It’s reaching for the stars at about 28. That measure has been higher, but only higher in the years 2000, 2007, briefly in 1929. So you have to be careful of the company you keep. We are at levels that you would associate with stock market mania. Can things go higher? Oh, sure they can, because that’s the nature of manic buying. You’re not doing it on the basis of either fundamentals – we left those behind some time ago – and you may not even be caring about technicals. It’s just the question of, the price action seems to be positive and I want a little bit more of that between now and the end of the quarter.

Kevin: The question that you asked your son is interesting. How much theft is theft? We should ask a question like that with, how much growth is worth the risk? So the downside – let’s say that we have another 10% rise in the stock market. Let’s say we go to 22,000, something like that. But the downside – let’s say it’s 30%, 40%, 50%, which probably is accurate, we’ve seen that before cyclically. If that’s the case, is it really worth the 10% upside to possibly lose 40%?

David: That’s a good question, and I think every investor will have to answer that on their own. I think other good news that you can look at and say, again, like the conversation with my son, “What is growth?”

Kevin: Yes, because household net worth, at least what we’re being told, is at an all-time high.

David: Post global financial crisis we’ve had massive asset price inflation, and that has taken us to record levels. We’re looking at household net worth. I think it’s worth noting that this is a nominal, not inflation-adjusted number. Nominal improvement comes in at 8,322%. That’s the improvement that we’ve had since 1950. This goes back to that critical conversation of how much of your $100 can I have – can I steal from you? From 1950, the dollar has diminished to less than a dime. The 1950 dollar is now less than a dime. It is nine cents, to be precise. So when we look at net worth improvement you realize you cannot separate your appraisal of that from what I would call the money illusion.

Kevin: Right. It’s not 1950 dollars we’re talking about that is up 8300%. It’s 1950 dollars diminished as net worth looks like it’s improving, not like you said, nominally.

David: That’s right, and because it’s something that happens gradually, we tend to forget the money illusion. If it happened overnight, say, in Venezuelan bolivars, would we notice? Yes, we would notice. 500% inflation in one year, which is what they are on track for in Venezuela, is very painful. And you can see the difference, but when the money illusion is orchestrated on a gradual basis, it’s pretty easy to be convinced that 8,322% improvement to net worth figures is real, as opposed to some sort of fiction. So I’m all for growth, and I think this is good news that we’ve seen a recovery, but asset price inflation, and the gradual devaluation of the dollar – that deliberate devaluation is a part of the story.

Kevin: That goes back to what you were talking to your boys about.

David: I want them to live in something other than a fairy tale. We learn from fairy tales. In fact, some of the best lessons that you can learn in life come from fairy tales. But I asked my boys the other day, again, “$100. What is theft?” And if I took $100, it would irritate them. They were totally upset. If I took $30 without telling them, it’s still theft. And to them, they began to see the point of whether I take 2%, or 30%, or 100 % of it, it is still theft. It is still missing, and that’s what we’re reduced to. $9 out of $100 – that’s a $91 missing problem, if you will. And that’s where we’re at today.

Kevin: Strangely enough, Dave, it would be better if you took $30, and then didn’t take any more, than take $2 on a regular basis, because you said the dollar, now, is worth about nine cents. That’s a whole lot less than it would be if they took $30 right off the bat and it was 70 cents.

David: I love connecting the dots. It was interesting, this morning over breakfast, we had a very curious conversation, but it tied into the inflation theme. My oldest son is ten. He said, “So Dad, during the context of inflation, you’ve said that some people did quite well just having whisky and vodka, and having that as a liquid trade.

Kevin: Is that what you want to teach your ten-year-old?

David: Well, I didn’t remember teaching him that. Somebody has big ears. But it’s right, there is an inflation target which, to a ten-year-old, seems criminal, but to a Ph.D. economist, it’s the necessary short-term sacrifice to generate long-term economic growth.

Kevin: I’m inflation, I’m the government, I’m here to help.

David: Right. So net worth is at an all-time high, according to the Federal Reserve Z1 accounts in the United States, and we need to reference nominal values and exclude inflation figures, and it makes us feel good, and it helps us embrace certain fairy tales. With it, you have Michigan consumer confidence numbers which are matching levels which we saw just prior to the global financial crisis.

Kevin: It’s not just Michigan. Let’s say that you were Goldman-Sachs right now and you were worried about a Trump victory. No more. Goldman-Sachs – they’re very happy.

David: Up 50% since the election – Goldman-Sachs shares – with decent representation in the top appointments, which has to be irksome for a number of the people who put Trump in office, but GS is the ticker symbol for Goldman and some people in our circles think GS stands for not Goldman-Sachs, but Government-Sachs, the number of people who work in government after having been at Goldman-Sachs.

Kevin: Let’s go back to Michigan for a second, though, Dave. They recounted the vote, Trump still won, but boy, they found something else, too, didn’t they?

David: Pretty significant voter fraud in Detroit, where some votes were counted up to six times. I guess what we’re dealing with – when I think of the Michigan Sentiment Index, when I think of the net worth figures, when I think of the Dow at 20,000 – you know what’s trending? What’s trending right now is fairy tales. And I hope we can learn some lessons. Actually, I hope that these don’t turn out to be Grimm’s Fairly Tales. I’m afraid that they do. The bright side of that is that Grimm’s Fairy Tales have a way of speaking to the psyche, and everyone understands.

Kevin: It’s not just the guys who are doom-and-gloomers who are talking about this. Alan Newman, as a guest – this is a guy who loves the stock market. He really enjoys the upside, as well as predicting the downside. Alan Newman, let’s face it, is telling us right now that we are at the top of another market very similar to the last three crises that we’ve faced.

David: Pretty emphatic about that. And the question of being at a top – we know that we’re in a level of over-valuation. That’s the difference between a Smithers, who would say, “Look, Dow 16,000? I’m happy to sit in cash, and I don’t know where it goes from here, and frankly I don’t care.”

Kevin: “And Dow 20,000, I’m frankly happy to sit in cash,” is what he’s saying.

David: Because he would say, “We were over-valued, and we still are over-valued, we’re just more over-valued.” Is he wrong? No, he was right. Newman takes a little bit more of a risk in saying we’re at a top, only because maybe it’s not the top. Maybe 25,000 is the top. But you can clearly say that we’re in over-valued territory. And to quote him, “the current environment is on the same scale as the three worst stock manias of all time.”

And I think for anyone who is sober-minded in their investing, you have to let that sink in. On the same scale as the three worst stock manias of all time. He’s no humbug. He’s a very jovial guy. But he’s just looking and saying, “We’ve seen this before.” The student of history would tell you, “We know what this looks like, and we know what happens next, and it doesn’t end well.”

Kevin: Fear and greed are the two motivators in the market, and strangely enough, David, I think we have both going on in the stock market. We have the fear of missing out, and the greed of let’s go higher and not worry about the downside.

David: Ironically, this is a period driven by fear, and you’re right, it’s a fear of being left out. It’s a melt-up dynamic that’s taking shape, and it’s buying begetting more buying, where price action becomes the reason for purchase.

Kevin: That’s called momentum, isn’t it?

David: Yes. Again, fundamentals don’t matter, technicals don’t matter. There is a radical different between doing the math of what a company will return to you as a shareholder from future cash flows, and alternatively just throwing money at the market. As our friend Bill King has been bellowing the last week, when a mania gets into full gear, the fundamentals and the technicals absolutely take a back seat.

Kevin: Isn’t this why in Vegas the coin machines pay out, to where you here them go, tink-tink-tink-tink. Everything sounds like a win. Most of the time it’s people just cashing out after losing, but even when you’re cashing out after losing, tink-tink-tink-tink – everyone wants to be a winner. That is sort of what is going on with the stock market right now. Gosh, all my neighbors, now that Trump has been elected, are going back into the stock market and playing the momentum.

David: Yes, you don’t know when it ends, you don’t know how far it goes. You do know, and I think we do, that it doesn’t end well. And what is particularly heartening for me is that our firm… (laughs).

Kevin: You’re playing the other side of the game.

David: We’ve created an opportunistic, negatively correlated account – a short when you want to be – and it’s tailor-made for this environment. We’re in a position to not employ any money into the market, deploy any money into the market on the short side. We can do that when and how we want to.

Kevin: For the listener who doesn’t understand that, what you’re talking about is, if you think the market is over-valued, you bet the other direction. You can, you just don’t want to take too much risk doing that.

David: That’s right, and you also want the flexibility to let the bulls run and not run over you, which is typically the case when you’re in a short fund of some sort, with a very narrow mandate, and without the flexibility of being nimble or opportunistic. So, yes, I think we’ve got something that is very compelling, tailor-made for this environment. It’s a loose enough mandate to get out of the way of the charging bulls, it’s a precise enough focus on credit dynamics to go meaningfully short, speculatively short, when it is meaningful to do so. And I think, frankly, the next four years will be our finest, not only in our traditionally managed accounts – I’m very excited about what the next couple of years hold for those – but also the more exotic offerings, as well. I say exotic, not because they are truly exotic, but because bears are nearly extinct.

Kevin: Nobody thinks it’s going down. The bears are gone.

David: That’s right. So I think one of the greatest value plays is being short the market. That doesn’t mean go out and short the market today (laughs) – we certainly are not, and we run a short fund. But we’re not short today. We will be when it makes sense to be. Again, you have to watch through the cloud of dust created by the herd of bulls, and then finally discern and determine when to engage.

Kevin: Over the last couple of weeks, Dave, you brought out the danger to the emerging markets with the rising dollar. We’re looking at rising interest rates now, people are starting to price in risk, at least risk of inflation, or possibly inflation because of growth, whatever it comes by. We’ve got rising interest rates – the bond market looks like it has been falling – and we have a very, very strong dollar, which is maybe good for us to a degree, but it’s very bad for the rest of the world.

David: So what can go wrong? What can go wrong with a rapidly rising dollar and a spike in interest rates? I feel like we’ve exhausted the conversation on emerging market pain, and exhausted the conversation on suffering in the form of dollar-denominated debt. That’s absolutely crucial, and it’s going to play itself out, as it already has, and it will continue over the next few months.

But there are U.S. equities that seem to be catching stride and stand to benefit from policy shifts in Trumplandia, and that’s what has been put out there, that’s what the news media has said, and that’s what the market is proclaiming with its march to 20,000. I would just say, well, not so fast. Not so fast. Temper some enthusiasm. If you are a U.S. corporation, if you’re one of the biggest out there, which is not always the same as being the best and the brightest, on average you have collected nearly 45% of your sales from abroad.

Kevin: Right. It’s not just here in America. These are international.

David: That’s right. So, with a multinational corporation, collecting 45% of its sales from abroad, what are those sales worth post currency conversion and repatriation? You may see an increase in sales in the single digits years after year, and that’s a feat that adds up over time, but to erase value, not in the single digits, but the double digits, on nearly half your income. That also adds up, and it doesn’t take very much time at all. So, you’ve heard us counter the argument of decreased taxes for corporate America being a huge boon, with the suggestion that rising rates take away with the right hand what was given with the left.

The argument I thought I would engage, just very briefly again, sort of tit for tat, is, there is this idea that in dropping corporate tax rates from 35 to 15, we’re going to see S&P earnings absolutely roar. So, we’ve gone from less than 100 to 110, 115. Now we have aspirations of 120 in terms of S&P 500 earnings. And if you back-date this – this is what the argument is, and I want to counter it completely – estimates are now reaching into the 150-160 range for the S&P 500, looking at their earnings potential, a radical jump from current levels, 115-125.

Kevin: This is that radical bullishness that you’re talking about.

David: That’s right. And the argument is, companies are going to get to keep more of their hard-earned dough. Except that – I feel like we’ve talked about this before – any multi-national worth their salt has already lowered their effective tax rate below 15%. And so instead of a massive benefit to corporate behemoths, yes, small and medium enterprises will catch a break for once.

Kevin: Right, an organization like your own, Dave. You’re going to be happy if taxes come down. But the General Electrics out there, there are some years they don’t even pay a penny in taxes.

David: There is too much enthusiasm about the increase in S&P earnings on the basis of tax breaks. I think the slim benefit to the multi-national crowd is that they’re going to be able to cut overhead in their accounting departments. They’re not going to have to be quite as creative in order to get comparable results. So, as to seeing S&P earnings shoot to the moon as a result of tax cuts, somebody out there is a bit naïve, I think, when it comes to who pays what in taxes at present. As you mentioned, GE has some years when they get credit and don’t pay anything.

Kevin: Dave, I saw a bumper sticker the other day that just cracked me up because it reminded me of this mania that we have now. We have this new twist in the political spectrum, and yes, it could be a very good new twist, but the bumper sticker said, “We shall overcomb.” It was a play on the Trump campaign.

David: (laughs) This year is a year of miracles.

Kevin: That’s what everybody thinks.

David: I think it will be, because for the first time in the history of toupees, the wind is not going to matter, regardless of a gentle breeze or gale-force gusts. But similarly, a financial miracle in which a massive increase in debt is not going to represent a new burden, it just won’t. We’ve invented something like super glue and the aerosol hairspray combined. That’s what the Congressional Budget Office under Trump is going to do to basically not see – not see – a rise in debt.

Kevin: It’s fancy accounting. Fancy accounting can translate to any administration, but right now, there is this dynamic scoring, and I’d like you to talk about that just a little bit.

David: Yes, the Congressional Budget Office can look at debt levels as very well anchored, and consider tax cuts as neutral, not needing an offset in spending, or an increase in debt as being onerous because, again, they’ve got something that is anchoring to the budget like the president’s coiffure on a blustery day. It’s better than Grecian Formula. It’s a boost in growth, and on that basis, it automatically cancels the need for a corresponding spending cut and that’s how dynamic scoring works, it gives you a free pass. Basically, it’s a fresher look at the numbers, which allows for the desired math to work. Less tax income will not require cuts. That’s one of the things that you can conclude from it. And it’s not going to force up deficit spending. That’s another thing that the new math will teach you.

Kevin: So, it really is like hairspray. It really is.

David: Yes. It’s aerosol anchoring for the financial world. And I think we have a sanguine perspective on debt, a sanguine perspective on spending, entering the oval office, which allows us to imagine a world where guns and butter spending meets tax cuts, meets new forms of debt monetization, meets an increase in consumer price inflation, in the context of full employment, and – and here’s where it gets really interesting – we get to keep everything we want. You get to keep a strong dollar, you get to keep a strong stock market, you get to keep a strong bond market. Why? Because America is great, and don’t you ever doubt that.

Let me interrupt my own cynicism and just say, really, what you get when you jump your high-powered money by 350% in a fractional reserve system – because this is exactly what has happened since 2009, this is why we do have the inflation boogeyman, which is more than a boogeyman.

Kevin: Right. If it weren’t for velocity just being incredibly slow, we would already be in the midst of high inflation.

David: That’s right. So you jump your high-powered money by 350% in a fractional reserve banking system, and you’re right, velocity has been broken. But let’s say it’s not broken any longer. That gives you many multiples of that monetary footprint. Combine that with full employment, which supposedly has dropped to 4.6%, the most recent numbers, which is strange because if 178,000 people found employment, there were over 387,000 which from the unemployment rolls simply vanished, which goes back to that “not in the labor force” figure, which continues to be abysmally weak.

But again, here’s a context where you have wage growth increasing due to a push for higher minimum wage, and also, there just being fewer skilled workers, which is ironic because as Trump takes office he is basically saying, send everybody with skilled labor back across the border, and we’ve got plenty of white people who are going to do the job here in the United States, which isn’t necessarily the case. We actually have a dearth of skilled labor here in the United States. Current jobs report comes in at 5.5 million jobs which are unfilled, but these are jobs that require skills other than flipping hamburgers or making sandwiches, or serving mixed cocktails, right. Well, I’m sorry, mixologists have great skills, I’m not meaning to diminish their skills.

Kevin: It’s just not the skills that they’re needing right now.

David: That’s right.

Kevin: Last week you brought out the difference between Reagan, when he came in, and Trump. There are differences. There is a difference, obviously, in debt. When Reagan came in there was a one trillion dollar debt burden for the United States. Now it’s 20 trillion. But things are different, also, in the context of the stock market. Reagan was walking in when the stock market was at a low. You brought this out last week. It’s very different in the present context.

David: But it wasn’t like it was at all-time lows. It had been beat up by inflation as we got toward the tail end of the 1970s and into the early 1980s. Nominal prices were not all that bludgeoned, to be frank, but it was really the inflation bit that took rates of return on your investment in the stock market and took them so deeply negative. So, on the surface, going back to this whole, what is real question, in the nominal world, what is real? It wasn’t that bad by the time we got to 1980, 1981.

Kevin: Well, and there was a rally. When Reagan came in there was a rally very similar to what we’re seeing with Trump here, but it turned into a pretty severe downturn over the next couple of years.

David: Yes. Oh sure, after the rally he had basically two years in office when stock prices went lower, two years and a decline of 28%.

Kevin: That’s substantial, Dave. That’s almost a third of the value of the stock market.

David: I think what is noteworthy is his market context ended up being rough for the first two years in office, and in terms of valuations in the equity markets at that time compared to our levels today we are five times higher based on price-to-sales. We’re four times higher than when the Gipper came in comparing the market cap of the stock market relative to the size of the economy. So market cap to GDP – we are four times higher, or price-to-sales five times higher, and it was no picnic for the Gipper in his first two years, and I see the next two years as being fairly desperate for Trump.

Spending, we already had that proposed by Obama – the shovel-ready projects, if you remember that cute little phrase – the shovel-ready projects, he spent 900 billion dollars. And either that was not enough, or it wasn’t the right thing to do in the first place. If Reagan brought in a two-year, 28% decline in equities from levels that were not in the stratosphere, can we contemplate – can we even imagine – the same kind of a timeframe, a 24-36 month decline in the equity markets, and it being because of over-valuation, more like a 40-50% decline from current levels. I think as a thought experiment you can get there.

Maybe the difference today lies in the willingness to do anything to keep the system moving ahead. And I’m talking about the world’s central banks doing anything. If this administration is willing to do anything, guess what? If this administration is willing to do anything to keep the stock market elevated and economic growth going forward, you know where their actions are going to show up? It’s going to show up in the currency.

Kevin: Well, what you mean is, it will show up in the devaluation of the currency.

David: Absolutely.

Kevin: That’s another form of inflation. That’s what it is. Now, speaking of inflation, you can only quantitatively ease so long. We’re starting to see the Europeans look at quantitative easing not as the salvation, but now as the toxic effect in their economy.

David: That’s right. It’s negatively impacted bank earnings and that is having a ripple effect throughout the economy – the economies of Europe. And so Draghi made very clear, “I’m not tapering. I’m not tapering, I’m not tapering. I am reducing quantitative easing from 84 billion U.S. dollars to 64 billion U.S. dollars.

Kevin: But that’s not tapering. No, no, no.

David: It’s from 80 to 60 if you’re talking euros. “But I’m not tapering.”

Kevin: Right.

David: (laughs) He extended the terms of the asset purchasing to the end of the year, 2017, and he reiterated that he would do whatever, however, whenever it was necessary to keep things moving forward. So his feeling was that at present 60 billion a month was the number – not a penny more, not a penny less. I think if you look at the gamesmanship of this, Kevin – when you look at the way they handle posturing some of these things – what is 60 billion a month versus 80 billion, versus 55? It’s precision which conveys certitude and conveys confidence, doesn’t it? As if he can see the figure, as if he already knows the ramification of unprecedented intervention. And to him, clearly, his vision of the future, what is on the horizon, is all good. There is nothing malignant in the mix.

Kevin: Wouldn’t you think the same way, Dave? To a degree, nothing is really catching up. There is no consequence. We talked last week about the Italian referendum – Italyexit – and the effect it would have on the Italian banks. Uh-uh. No, instead, people are buying.

David: Well, right, they did have to, Monte dei Paschi had to shut down trading after a 10% decline. Things got out of the control after the referendum.

Kevin: But haven’t they rallied back?

David: Most of the Italian banks. And it’s funny because, again, you have Italy more on a path to a euro departure, leaving the euro. Those probabilities are rising by the day, and how are the European banks reacting? German, French – they’re all up. But Italian banks finished up nearly 13% for the week.

Kevin: By golly, after talking last week in the Commentary, we really should have just gone and bought Italian banks.

David: What you should do is, everything that you think is rational, go out and do the opposite and you will make money in this environment (laughs).

Kevin: Okay, well then, let’s look at the dollar again, because the dollar is stretching and stretching and stretching. It’s hitting highs that we haven’t seen in a long time, Dave. And I’m hearing from people, “Gosh, gold just keeps going down.” But in reality, gold is hanging in the $1150s right now — $1150s, $1160s. Gold, yes, seems weak here, but honestly, with the strength of the dollar you would think gold would be weaker.

David: Actually, last week was the first time that the S&P surpassed the performance of gold for the year, so gold slipped to being up 9.3% for the year, silver is up 23 points for the year, and you have the S&P which is now up over 10% to 10.5%. So only in the last few days has the stock market out-performed gold for the year.

Kevin: Yes, so gold is still having a positive year.

David: Silver has still out-performed a 19,000, almost 20,000 point Dow by a full 10 percentage points. So again, yes, there are reversals. Yes, there have been, off of the peaks for gold and silver, June/July, certainly, we have the metals which are now over-sold.

Kevin: That’s what I was going to ask you, because there are is a certain amount of traders in the market and they can become over-bought or over-sold. It seems like the metals have been sold well beyond what they should have been.

David: The dollar is stretched on the upside at a point or two, and I think you finish that cycle. Precious metals are way over-sold and reversals are in order. And it’s actually, when you get a non-confirmation between the precious metals that you are usually at a point of reversal. And you see that between gold and silver where gold has continued to be a little bit weak, silver has actually been pretty strong over the last few days. That kind of a non-confirmation usually marks a reversal.

Kevin: The sad thing is, David, we’re talking about markets that possibly have already been manipulated for four to five years. People are getting caught with their hands in the cookie jar at this point.

David: Yes, I’ve learned to wear egg on my face very well, it’s become a fashion statement. You can actually buy egg at your local haberdashery and they will teach you how to wear it (laughs). But I gave them the footnotes on how to do it. You’re right, we have the smoking gun this week, confirmations that UBS, Barclays and Deutsche Bank all actively participated in rigging the silver market. And so, about the time that you think, “Yes, here’s a clear reversal,” there is somebody out there who thinks, “No, this is actually an opportunity to push and break the asset apart on a technical basis, get it below this point, and we can run a buck and trigger a bunch of sell-stop orders.”

Kevin: One of the markets that you watch, though, Dave, that is harder to manipulate is the bond market. It’s larger than everything else out there and people at some point are going to have to pay. If you’re borrowing money you’re going to have to pay for the risk of possible non repayment, and that’s what interest rates are.

David: You’re right, the most interesting market to watch is the bond market, and we’ve had the discussion on the bond market’s beauty being in the eye of the beholder. Do higher rates signify sensitivity to a changing inflationary backdrop, or is there another interpretation? Do higher rates signal higher levels of growth in the economy? And of course, that latter is the explanation offered by the mainstream media. We choose the former, but the proof is going to be if the 30-year treasury moves up about another 35 basis points.

Kevin: Which is about a third of one point.

David: Yes, it’s not even half a percent. If you can break above 3.5% on your long bond, I think we’re looking at a long-term shift in bonds, and with it, really, a remaking of the capital markets. And what I mean by remaking – even in the bond move that we’ve had since the election – look. Refi’s in the U.S. are already 50% off of their peak, and that’s with the rise in rates that has just happened in the last four to five weeks.

Kevin: Okay, so what you are saying, though, is 3.5% on the 30-year bond is something to look for.

David: It is. It’s a signal that is worth paying attention to. We’ve been butting up against 2.5% on the ten-year, and again, you’ve had a trade out of gold and out of treasuries to an extent where it would be totally normal to not break 2.5% on the 10, or 3.5% on the 30, and actually see yields drop and prices recover, again, because we’re at a similar inflection point. These are risk-off assets. And the risk-on assets in the stock market and in your industrial commodities – they are raging higher. But to see something of a reversal temporarily, I think, is good. What I’m saying is, sometime in the year 2017 breaching 3.5 and moving beyond that, I think you’re looking at a generational shift.

Kevin: So write it on a post-it, put it on the refrigerator and watch.

David: The real translation for most investors, because most investors have more of an interest in stocks than they do in bonds, because having an interest in bonds you have to be a guy who is really stimulated by watching paint dry. Usually not much happens in the bond market, but I think in the next decade you could see everything happen in the bond market. So, to go from boring as heck to ringside to the greatest prize fight of all time, that’s the bond market in the next ten years.

Kevin: Well, and there is an illusion, Dave. The illusion that we’ve all been taught is that money comes out of stocks when they are going down and goes into the bond market, or from the bond market into the stock market. And yes, to a degree, that occurs. What does it mean, Dave, when you have rates rising and the stock market rising? The bond market is now starting to soften because rates are rising. The stock market is raging. Is it a paradox? Is it something that we need to look for as sort of an end game for the stock market?

David: Well, again, the freebie that is being handed out by the mainstream media, the business news, is that an increase in rates is an indication of an increase in growth, and what I would suggest is, actually, the equity markets are not paying attention to what is a fairly dangerous paradox. You have rates rising in the bond market, stocks are edging higher at the same time, and you can force an interpretation onto the bond market from the stock market, but I would rather start with the smart money in the bond market and work back from there and actually say the folks in the equity market are missing something, and they’re marching headlong into a rip-your-face-off bear market in equities.

Kevin: Then, are we really just looking right now at hopeful hype? The Trump administration – yes, there are going to be people who are happy he is in, other people who are not happy he is in. But there is an awful lot of hype that doesn’t seem to be substantiated with the shift in public sentiment.

David: I think so. And the last four years under Obama we had sort of this theme, the book title, The Audacity of Hope, and I think with Señor Toupee, we’re warming up for a very interesting presidential cycle, and you could call it the Audacity of Hype, where you say the most outlandish thing and let’s get the stock market to 25,000. You say the most outlandish thing and all of a sudden it’s reconfiguring relationships with Russia or Iran. What’s next and who’s next? I don’t know, and it doesn’t even make sense. And it doesn’t have to. And I think this is an important thing. If politics and the communication from the oval office doesn’t have to make sense, recognize the parallel universe that you are in in the equity markets where fundamentals don’t have to make sense, and technicals don’t have to make sense – we’re in the fairy tale.

Kevin: Until they do have to make sense, and usually you don’t have time to react.

David: You know, I’m very curious what Victor Xi and Minxin Pei and some of our other Commentary guests have to say about China right now because as we head toward 2017 and we look at China, we look at the Chinese currency, we look at U.S./Chinese relations, I think they are going to be central to understanding global trade, international relations, and the direction of equities, bonds and currencies. I think the relationship there is pretty key.

And you can either look at – and this is why I’d really like to talk to Minxin Pei, in particular – I want to know if the capital flight that we’re seeing from China has to do with the tightening down and re-establishment of the old hardline communist themes under the current administration, or if you’re looking at anticipation of a mass devaluation, 20, 30, 40, 50%. And I don’t know if this is a reaction to politics or finance, I really don’t.

But after the first of the year we need to re-engage some of these guys who grew up there and are very sensitive to insider politics to cover a variety of these topics, because this last week I spoke to a businessman in China who was bemoaning the fact that commodity price inflation has been huge in the last two months and as the government has been trying to keep capital from exiting the country and make sure that that capital stays visible, because again, capital flight has grown from the 500-600 billion it was last year to over 900 billion this year.

Kevin: Do you think they’re seeing what they’re seeing in other countries, like India, where they’re pulling capital from banks and getting it into commodities to get it out of the system?

David: Well, and that’s what this businessman was saying. He’s in the manufacturing business. He basically said, “Look, our input costs are almost uncontrollable, and it’s really difficult, because I’d like to buy ahead before the Chinese New Year and stuff as much away as possible because what we’re watching is speculators and investors are pulling capital from banks and financial companies, shifting to commodities, and driving up the input costs for manufacturers.”

Again, if you’re thinking about price inflation, this is just one more theme in the price inflation genre. You can get it from money, that is, the increase in the circulation of money, you can get it from an increase in wages, and guess what has kept us from having a major inflation issue over the last 20 years? The equivalent of a subsidy coming from imported goods. So we can live high on the hog lifestyle because the junk that we want to buy costs less and less each year because we buy it from overseas and it’s dirt cheap. What I’m saying is, even that sort of deflation, if you will, to our total lifestyle cost, is going away, and that will be inflated, too. The input costs are rising. The export cost, if you include tariffs, if Trump has his way, will add to the cost.

And if we are forced to buy U.S. products, just understand that the cost of everything will be higher. And you may take great pride in that, but understand that if you are in the lower echelon, financially and economically, it means going without. Solidly middle class, or upper middle class, you can wear with pride your American sweatshirt, but understand that Walmart is driven by a lower socioeconomic consumer and they rely on Chinese imports. They rely on cheap stuff. What I’m saying is, it’s going away.

Kevin: Why don’t we look at what China is doing because we can put that in context with what Venezuela is doing, and what India is doing, and what Europe is doing. Over the last year or so, Dave, we’ve seen notes pulled from the system, people no longer able to use large notes in the euro. We’ve talked about this amazing cash grab in India. People have to be in the system. They’re being turned into a captive audience, like Reinhart said. Venezuela – the same thing. This week Venezuela removed ¾ of its currency, these 100-bolivar notes. People are starting to see that they’re either going to be captured by the banking system, which means inflation, it means negative interest rates, or they’re going to be out of the system, in commodities of some form.

David: I’m having a fascinating conversation with a dead economist from Yale (laughs). He’s dead, I’m reading his book, but it’s still a great conversation. His focus was on stagflation, and he basically says, “Look, the problem with Keynes and the problem with the monetarist school is that their explanations work under certain circumstances and fail miserably under others.” And he is looking at the 1970s, and saying this is a period of time where you had slow economic growth, but rising inflation, and neither school really had an adequate explanation for it.

Kevin: They had to dust off Hayek’s works from 40 years before, didn’t they?

David: That’s right. So, Keynes and a sticky wage theme fails miserably and monetarism, you should be able to jump-start the system by increasing the money supply, and lo and behold…

Kevin: We had inflation.

David: But you don’t have economic growth.

Kevin: Exactly.

David: And so these themes – I think what you’re seeing is the powers that be – and what I mean by the powers that be is your policy-makers who are directly influenced by certain academics are looking at a system which is supposed to work just so, and it’s not working as expected. And they are doing a very good job of hiding, verbally, their desperation and the levels of desperation. You’re seeing it not just in the United States, but globally. The powers that be are getting more desperate.

Kevin: “Pay no attention that the quantitative easing used to work, but it doesn’t. Pay no attention that negative interest rates used to work, but they’re not.”

David: Yes, and so we are seeing significant shifts in policy, a move toward radical policy, and they’re just brushing it off as, “This is normal, we’re fine. Everything is going just fantastic!” And yet, the measures are getting more and more radical. We’ll see a cashless society introduced in Australia before we will here, but all of these are sort of trending. It’s trending, and it’s not something that I think we should take for granted here in the U.S. Just because we see it worse someplace else doesn’t mean it can’t happen here.

And this is why I’m particularly concerned here in the U.S. We mentioned the nine cents that are left out of the 1950 dollar. There are nine cents left out of the 1950 dollar. In the process of devaluation the curve tends to go vertical at the tail end, and we’re down to our last dime. This is when inflation becomes an issue, and this is when it begins to become a vertical problem.

Kevin: This is when nine cents turns into five, turns into three, turns into nothing.

David: In the blink of an eye. And so, we’re happy now because on a relative basis we’re stronger than everyone else in the world. Just understand, the drain that we’re circling, collectively, on a global basis, and we have major monetary issues and I don’t think that the powers that be are going to play nice. They’ve proven to not be nice in Venezuela, I guess that was predictable, but they’ve proven to not be nice in India, perhaps slightly less predictable, but a decent sign.

Kevin: But in our own country, Carmen Reinhart said, “You’ve got to create a captive audience.” She wasn’t talking about India.

David: No, no, and actually, that’s a pretty nice way of saying it, but you will be forced to do what the powers that be want you to do. You will invest, you will spend, you will save, in the vehicles they prefer, in the assets that they want you to own, and if you don’t comply, consider yourself some sort of sausage meat (laughs). You’re going through the meat-grinder. That’s the world we live in, unfortunately. I look at that and say, “Okay, well, there are very few people that are prepared for the kinds of tectonic shifts in the financial markets, as people make sense of a world that is already out of control. It’s already out of control, already completely debt-addicted, already a fairy tale, if you will.

Kevin: So Dave, what are you doing with your money right now?

David: I’ve never liked cash all that much, but I’d rather have cash than an equity exposure, a huge long-only equity exposure. I told you we started a short fund for a reason, because I want to put my money in it. Our managed accounts are perfectly situated with a combination of cash and metals and mining shares. I think mining shares are going to do very well over the next three years. Why? Because stagflation – you’re borrowing some of the best and worst from inflation, and the best and worst of the concerns that come from an economic malaise.

And consensus is we have an economic malaise. That’s your lower growth thesis, that’s the new normal thesis from the folks at PIMCO. Get used to it. We’re not going to have anything like the growth we had in the last 30-40 years, in part because we have this massive burden of debt that we’re carrying. And now a new administration that says, “The debt? Don’t worry about the debt. I’m a master at the debt. All I do when I have too much debt is default on the debt. It’s no big deal, the debt.” There are ramifications if you’re a dollar-holder, if we should see a default on the debt. And you and I need to take that more seriously than perhaps the oval office will.

So what am I doing? I like cash, and I like the hedge on cash that you get by owning gold. I like the equivalent of a non-expiring call option on the price of gold which you find in the mining shares. And at a select point in time, going short the market absolutely makes sense. Are you kidding me? Going short in 1968 would have been brilliant. Going short in 1929, 1930, 1931 – do you know there were periods of time in that 1929-1932 period where if you were short you made a fortune and you gave it all back, and that’s the object. You have to be nimble and tactical, and not short only, but take it off the table if you have some winnings. I think there are some great ways to engage this market, some great ways. What else do you want me to say?

Kevin: So Dave, I’m going to repeat back for you. You are not investing in the optimist scenario of the stock market growing at this point. What you’re actually saying is, cash, cash hedge in the form of gold. And then if you are actually trying to play for a rise, play for the fall, which would be maybe a short fund, something on that order. Am I hearing you right?

David: That’s right, and I think if you just say, “Okay, well, Dave’s a dumb guy and he’s taking the dumbbell approach. The dumbbell approach is a balance between cash and gold. Call it easy. You don’t have to make it any more complex than that. So, back of the napkin, dumbbell, what’s on one side, what’s on the other? I’ve got some cash here, I’ve got some gold here, let’s call it good. You can make it more complex, and I have fun with the complexity, but if you don’t want it more complex, cash, gold, call it good, the next three years you’re going to be happy.