The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
Kevin: David, before we go to our guest today, Alan Newman, who I know you have been waiting to talk to for a long time on this program, we have to talk about the interest rate cuts, both in Europe and in China, recently. What are they saying? Are they saying that stimulus is necessary?
David: Kevin, I think that is really the bottom line. Things are weaker than anyone is expecting them to be at this point in the “recovery” and, in fact, further measures are needed. It was very curious, because we had a variety of central banks announcing things here recently, and it really surprised the market, but what did not happen was any sort of recovery in the equities market, whether it be in Europe, or in the United States.
The Bank of England announced their 50 billion pound monetization scheme. It really is quantitative easing for them. ECB cut rates by 25 basis points, the overnight lending rate to zero, and then the Peoples’ Bank of China cut its key rate. That is twice in one month. They hadn’t done any rate cuts since 2008, and now we get twice in one month. Are things really slowing in China? Yes, indeed. Are things still bad in Europe? Yes, indeed. Could we expect the same from the Fed later in the year? Again, our view is that it would be under duress, and we may get that in the equity markets between now and the end of the year.
Kevin: David, we have talked about trying to stimulate equities markets or trying to bail out the banks, but what it really does is penalize the savers. What we are talking about is repression of the interest rate cycle – look at Denmark. We’re talking about insanity. We have had zero interest rate policies here in America, but what about NIRP – negative interest rate policies?
David: That’s right. Talk about penalizing the savers when it could actually cost you to keep deposits at the local institution. We are doing that in the United States, we are just doing it surreptitiously.
Kevin: With inflation, and not making real rates of return.
David: Exactly. You are at a negative real rate of return when you factor in inflation, but this isn’t actually stated negative interest rate policy. That says something, as well. I think you have two areas that we should focus on that were, again, recently the keys in my view. Retail sales fell in June.
Kevin: Right, again.
David: Yes. On top of that we have an employment number which again disappointed. We reiterated 8.2. The non-farm payroll report was a disappointment. Does it come as a surprise to us? No, it doesn’t. I wouldn’t put too much into the number, at least on the non-farm payroll side, because again, we have very positive factors on a seasonal basis which get put in, in January, February, March.
Kevin: Short-term employment. These are temporary jobs we are talking about.
David: Right. And then we have extra-negative seasonals this time of the year. So, while it is bad, and I think it is bad, I wouldn’t read too much into the number in terms of it being an Armageddon-type number.
But yes, we look at 2012 as very similar to 2011, and we will spend some time looking at the stock market today with Alan Newman, 2012, and the stock market in 2011, we are looking at a behavior pattern which is very, very similar, and so we would be cautious here in the summer months and coming into the fall, and maybe it is on a delayed basis.
There are certainly political issues in the works, and do we have, really, anything to look at between now and November? I don’t know. No one does. Or is it really the issues that come unglued in 2013? Again, I don’t know. No one does. We certainly didn’t see, in spite of coming into an election year last year, things hold together that well coming into the summer months, and we could certainly see the same sort of summer swoon, if you will, here in 2012.
Kevin: David, there has been a decade change, as well. We are talking about the summer swoon. We are talking perhaps about what has occurred over the 2012 period of time. But one of the things that I have really liked about Alan Newman’s newsletter, and actually, going back to the man who recommended him originally to you, was a guest of ours from Barron’s magazine, Alan Abelson. Alan Abelson can look at the last almost seven decades and say, “Well, I’ve written about it, I’ve analyzed it.”
Alan Newman, in his Crosscurrents newsletter, has said, “There has been a fundamental change.” He has actually testified to the government on the fundamental change in the market, as far as the amount of time that people are holding shares. It used to be that people would buy a stock and they would say, “Okay, we are going to hold this, and we are even going to pass it down.” Now, people are changing stock holdings, completely, in their portfolios, in less than a month.
David: And that is what we suggested several weeks ago, Kevin, this change from an investor mentality to a speculator mentality. The Wall Street firms who are leading that charge think in terms of nanoseconds, not even weeks, months or years, as investors would traditionally do.
Summer months offer us the chance to reflect and appraise the markets from a bird’s-eye view, and quite often seasonal factors have markets languishing in the summer heat, so to say, with activity picking up in the autumn months as those cycle back around. We want to take an appraisal of the market today and we have invited newsletter writer and market technical analyst Alan Newman to do just that with us.
Alan, we are going to look at your perspective on a broad range of markets today. Let me just say to everyone at the outset that I highly recommend Mr. Newman’s publication, Crosscurrents. I think I first came across Alan’s work through Alan Abelson, and have been a regular subscriber since then. I just have to say, folks, honestly, he could charge five times the price, and I would still pay it. He is worth the reading, and I hope you will consider doing so. Maybe toward the end of the comments today he can tell us just about how the newsletter subscription would look for a new subscriber.
Alan, let’s dive in to the equities markets, because I think that is something where there is a bit of a disconnect. We are sitting, now, close to 13,000 on the Dow. I was on CNBC yesterday and the question was asked, “Have we turned a corner?” My suggestion was that we might have turned a corner to the downside, but I am not sure what kind of a corner we could turn to the upside. Maybe you can give us some general comments, and we will get specifically into things like insider selling and some of the average holding periods, things that are substructural to the market, but very important.
Alan Newman: First let me say, thank you for inviting me on. I’m very happy to be here. I think the jobs report today tells us a lot about turning the corner. We are not. It is kind of obvious. We are not creating enough jobs to make up for even a population increase in this country, and I am doing a report now for our next issue that is going to focus on the ideal market.
I am a strong believer the capital formation system in that the equity market is where we get a lot of our job creation from. It is not happening, and it is not happening because it is no longer an investment market. It is a short-term trading market. As I have shown already in Crosscurrents, the average holding period for stocks is down very, very sharply over the last 10-20 years. We are down to an average holding period for stocks that is about three months. For Apple it is far less. For the S&P spiders (SPDRs) it is five days. Who wants to invest in such an environment? It doesn’t pay to invest.
If you have a market where it is just trading, and not investment, it is very hard for companies to come to market, to bring their shares to the market in an initial public offering, and I am going to be showing, in short, in very, very, very vivid pictures how this has affected our economy and our job market. If you take a look at some of the big, popular names, like Google, they now have 33,000 employees and they have it because they have a huge idea and they were able to come to market. Apple has over 60,000 employees. Microsoft has over 90,000 employees.
In the overall picture that doesn’t really sound like a lot. If you consider a company like Home Depot, they have 330,000 employees. How about Wal-Mart? They came public, too, with 2.2 million employees. This is a big segment of our economy, and if you are not going to have IPOs, you can’t possibly have the type of job creation that we used to have, and guess what? Over the last 10-15 years, IPOs have slowed sharply. We are talking about 80%, down. It is no wonder that the jobs market is the way it is.
David: We have actually seen a trend in the direction of privatization rather than going public. Many managers, very skilled executives, have basically said, “We know how to manage this business for a successful outcome over the next 3, to 5, to 10 years, and we are tired of being micro-measured on a quarter-by-quarter basis. Maybe it just makes sense to go private.” Is that a part of that trend, do you think?
Alan: I don’t think you can raise as much money privately. The venture capitalists will generally be the first ones in, in an IPO, or in an eventual IPO. I think there is more money to be made in that respect, but I don’t think you can raise as much without the public. That’s where all the money comes in. Look at Facebook. That’s a big deal.
David: Looking at some of the things you just mentioned, the jobs report, and we also just had retail sales figures come out, retail sales fell short in June. Here is what I am asking. In your recent report you talked about retail companies and insider selling being on an increase. Do you see the connection there between the insiders at retail corporations liquidating their positions in companies that they manage, and in which they have large share positions, in this slowdown in retail sales?
Alan: Yes, absolutely. I noticed, actually, when this really hit home was at the bottom in 2009 because I took a look at the insider reports, and in the retail sector insiders had cut down their selling so dramatically, my first thought was, “Wow, this is probably a bottom.” It was the lowest I had ever seen. But that has since expanded, and in 2011 I had two reports that were off the charts. In January of 2012 I had another one that was even worse.
It is a little better now. They are still selling a lot, it’s not quite as bad as the two reports I did in 2011, or in January 2012, but I read that as seller exhaustion. They just sold so many shares that they cut back a little on sales. But if insiders at retail companies lack the confidence to hold onto their shares, or to buy shares, it tells us a lot about retail sales countrywide. They are just not going to be as good.
David: As you pointed out in the January report, insider selling was reaching peaks of 127-to-1, and very fairly, you netted out Microsoft’s regular liquidations, because several families there are mass liquidators, but still, even netting out Microsoft you were at 100-to-1, in terms of liquidations compared to purchases. Again, this is a substructural current, and I don’t know if you have intentionally named your report Crosscurrents because of this, but I think of the undercurrents here in the marketplace which sometimes show up in the technicals in the charts, that you might not see in just fundamental analysis.
You could speak to high-frequency trading. Wall Street argues that it helps provide liquidity. We sometimes wonder, and I say this somewhat tongue-in-cheek, can we assume that this is another one of Wall Street’s benevolent functions?
Alan: It does not provide liquidity. First of all, that’s a lie. Secondly, if you see any days in which it does, it’s really an illusion. If you want the perfect proof, you have to go back to the Flash Crash, which was not all that long ago, and it is going to happen again. There is no doubt it is going to happen again. Nanex has done a number of reports…
Alan: …yes, that were very interesting, and they showed not long ago how there was actually one instance in which trading on Yahoo had advanced beyond the speed of light. I mean, this is ridiculous. This is the antithesis of an investment market. How can you have people invest when it is more important to trade at a millionth of a second?
David: Doesn’t that bring up the question of price discovery and the changes in market dynamics, as trades are essentially moving off the exchanges, and into black pools? Maybe you can expand a little bit on the function of a black pool, and again, the impairment to the capital markets. We talked about the IPO markets shrinking earlier. It seems that black pools have a similar effect, in terms of a negative impact.
Alan: Yes, because you don’t see all the bids and offers out there. Mutual funds are not going to see all the bids and offers out there. Maybe it doesn’t matter for you and I, and maybe it doesn’t matter for the average Joe from Idaho who wants to buy a couple of hundred shares of something, but it is certainly going to matter for mutual funds, and it is going to matter to the system.
Insofar as investment is concerned, if oHowmost trades are taking place on these extremely short time horizons, the valuation of the stocks that you are buying or selling are of no consequence. All you are trying to do is rip a penny out of the system. The penny has absolutely nothing to do with value. The algorithms that they come up with have absolutely nothing to do with value. If you are taking all the considerations of value out of the system, or you are cutting them to the quick, there can’t be any real price discovery. There can’t be any real consideration that I am doing this for a good reason other than to grab a penny, and as those trades pile up, pricing is inefficient, and it is just growing more and more inefficient over time.
You can cite for me that the S&P price earnings ratio is moderate right now. I think it is meaningless because so much is traded without any consideration of value. I have seen the S&P price earnings ratio, in the past, fall to 8-to-1, or even down as low as 6-to-1. So if it is 14-to-1, that doesn’t tell me that it is fairly priced. What tells me whether it is fairly priced or not currently is that very, very few shares that are traded are considering whether it is fairly priced or not. The only consideration is, of the moment, can I get a penny out of it?
David: What about rebates?
Alan: That’s another thing. There are a lot of firms out there that can essentially buy and sell at the same price and make money from the exchanges. If that is not the height of silliness, I don’t know what is, and it can’t possibly help the system. If you and I are out there trying to make a buck by investing, and some high-frequency trading firm can buy and sell the shares that we are interested in at the exact same price and make money, it is like insider trading. Why don’t I have that advantage?
David: You, in the past, looked at the public leaving the markets on the basis of some of the things that you are talking about, probably just general discouragement over the last ten years, starting with the Dow at roughly these levels, and the Dow being at these levels ten years on, very similar to the 1966 to 1982 period, of just grinding sideways under 1000.
What do you see in terms of something restoring confidence and health to the capital markets? Are we talking about new regulatory regimes? I don’t know that Dodd-Frank got very much done, in terms of new regulation, and in cleaning up the mess that is, today, Wall Street. What would you suggest is a healthy course toward restoring health to the capital markets?
Alan: A regulatory regime would help. Right now, the markets are pretty much controlled by the self-regulatory mechanisms and it is like having the foxes in the henhouse. You can’t have the exchanges and the brokerage firms monitoring their own businesses, because there are so many examples where they are not doing the job. The SEC, as far as I am concerned, has been asleep at the switch for many years, and they have totally abandoned their mission statement, which is to protect us.
Yes, I think there is a lot that has to be done to bring back confidence for investors, and without a lot being done to bring back that confidence, the market is never going to get back to where it was. It is just going to remain fallow for us for years to come. It is going to be like that period from 1966 to 1982, and the way it has been for several years now, and it is just going to continue in that mode.
David: We have talked about Dodd-Frank, just briefly, in just a reference to it. There was supposed to be some legislation within that, that dealt with derivatives and controlling the derivatives market. Are derivatives a big issue, or is it the big issue?
Alan: You can make a very good case that it is the big issue. We are talking about an arena, just for the U.S, I’m not even talking worldwide, that is over 230 trillion dollars in notional values. That’s a lot of zeros. If we talk about worldwide, that’s 650 trillion dollars. For years, I have been very, very agitated about the fact that this arena was growing so rapidly. We are talking about 19% a year. Well, now it is not growing. Now, it is contracting very slowly, and I think that tells us, more so, that we have reached a point where we cannot cope with the sheer amount of contracts that are around today. There are too many contracts. There are too many counter-parties. We have no idea how they interact.
The perfect proof that there is a big problem is what we have seen in recent years. We saw it first, actually, in 1987, with the stock market crash with stock futures and portfolio insurance. We saw it, to an even larger aspect, in 1998, 11 years later. Long Term Capital Management nearly took down the world financial system. We were probably hours away from total financial collapse. We saw it again in 2008 and 2009, so that’s another ten years.
I think these episodes are going to come more quickly, and now that growth has slowed, it is actually starting to contract, and it is telling us that the system cannot accommodate this daisy chain of contracts. It could get a lot more rapid.
David: We talked about high-frequency trading, and the argument that Wall Street makes that it provides liquidity. The argument for derivatives is that it provides safety. You mentioned the 1987 period, the fact that derivatives were called portfolio insurance at that point. Now, derivatives, whether it is credit default swaps or what have you, are there to “protect” and eliminate, or broadly diversify risk throughout the system. Hasn’t it really been just the issue of increasing leverage within the financial community?
Alan: Yes, absolutely. It is another way for bean-counters to show profits that really aren’t legitimately there, and there are all these huge banker bonuses, and that is one of the things that they are predicated on. We are dealing with very dangerous things here. If we cannot account for every single way that these contracts interact, something is going to hit the fan sooner or later, and it is going to take us down. It has already done so a number of times.
I think what we saw with MS Global was part of the problem. I think what we saw recently with J.P. Morgan was part of the problem. Insofar as derivatives being beneficial, Alan Greenspan, who was one of the greatest proponents, and in my mind will go down as the worst Fed governor of all time, and the worst Fed chairman of all time, has already admitted he was wrong. I don’t think we need to know much more.
David: If there is this sort of looming issue with derivatives and counter-party risk, what, in your opinion, is a reasonable approach to insuring, not portfolio insurance, as in via the derivatives market, but insuring against the kind of issues which can arise directly from the derivative markets? Is there a way that an investor should be insulating themselves from market vulnerability?
Alan: A way for investors to insulate themselves from market volatility?
David: Not so much volatility, but just systemic risk.
Alan: I have always told the big investors that I have had, to really do their own homework, and I think that advice has been paramount throughout the years. If you don’t do your own homework, you are going to suffer, in the final analysis. You have to sit down and read the newspaper every day, you have to be aware of the financial markets. You have to do some of your own research. You have to be very, very aware. That is the best way to insulate yourself from a potential downfall.
Insofar as our authorities, I think they have to admit that we have serious problems going forward, and that they are affecting the small investor, they are affecting larger investors, and we have to worry less about banks making money, and more about banks making sure that business and the economy survive and prosper.
David: Alan, whether it is the retail jobs reports, or the newest unemployment numbers that are out, we have some headwinds, and we are seeing those show up in the insider selling, the high-frequency trading, the substitution, if you will, for the man-on-the-street. Now it is just Wall Street who is playing the game of investor. I hope that next week we can take a look at the metals markets, because I know that you have been keenly interested in precious metals, going back to about 9/11.
For the better part of 11 or 12 years now, you have been looking at the metals markets with a positive prognosis and you still have a very bullish outlook on gold, which you consider to be a super bull market. So let’s pick up where we are leaving off today, with your comments on precious metals, this next week. We look forward to carrying on that conversation.
Alan: Thank you.
Kevin: David, it has been fascinating listening to Alan on this program. I do want to hear what he has to say next week on the precious metals.
But let’s look back at Europe just for a moment. Last week, they supposedly solved the problem. The Spanish interest rates dropped back down below 7, they kicked the can down the road, but it seems like every time they kick the can, they keep catching up with the can quicker.
David: In fact, this time around, they caught the can before it even hit the ground. Yes, they intervened in the markets, they are going to spend another 100 billion, and Spain should be fine. The ten-year treasury in Spain dropped below 7, dropped precipitously below 7, and it is back above 7 already. They used to spend 100 billion and it would buy them six months, and then it bought them four months, and then it bought them two months. Now it is not even buying them 6-10 days, so we are seeing an acceleration factor in Europe.
We are seeing an acceleration factor in China, two rate cuts in less than a month, and that is after not having cut rates since 2008. There is an acceleration factor on the world scene, and from a macro perspective, we see more risk in the market than at any time that we have seen going back to 2008.
I think the conversation about metals, particularly, as an insurance component in one’s portfolio, will be particularly apropos. I would like to do that this week, in fact, but we are out of time, so we are going to postpone, and we will pick up the conversation with Alan next week, specifically on precious metals, next Wednesday.