The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick
“There is a growing awareness that something is not quite right. Investors are figuring it out. Analysts on Wall Street are figuring it out. They’re not quite sure what behavior modification they should adopt, but it’s not lost on them anymore. And I think this is, again, the point where an investor says, ‘I have just enough fuel to land it. I need to disengage now and get home, put this thing on the ground.’”
– David McAlvany
Kevin: Boy, Dave, it seems like forever since we have actually sat in the studio together. You’re just finishing up the Naples conference. In fact, you’re going into consultations right now. I thought you might want to mention that you are still coming into Orlando and there is still a chance for people who are in the area to come and meet you, and maybe sit down with you in the Florida area, or it’s even worth the drive if you are in the surrounding states.
David: Just a great reminder of what it takes to run an effective company, and that is having really remarkable people around you. I have been on the road for the better part of a month, we’re coming into the final stretch of client conferences. Orlando is the last one. And to be out of the office for that amount of time and know that our management teams are operating smoothly, I am remarkably blessed by amazing people around me, at both our wealth management company, and our precious metals brokerage company.
Heading back home, as we get back in December, it will be great to re-engage the day-to-day there in the office, but again, grateful that we have such great people keeping track of things in between.
Kevin: One of the things that is so humbling, Dave, is meeting, also, the people who do business with us. I agree, you have great staff and great people who work with you here in the business, but in a way, our clients are almost like family, and they are almost like part of the staff, as well. It is humbling to hear – I was just talking to our editor before you got on the line – just how humbling it is when people come up at these conferences and they say, “Thank you so much for the Commentary. I listen every week.” When you’re sitting here and it’s just three, four, five people putting something together, you don’t really realize that it can really impact thousands of lives. So I think these conferences, meeting people face to face, is a good reminder that there are real people on the other end of that speaker, giving up real time in their lives to listen to some of the things that you have to say.
David: We certainly plan on being out and about in 2018, and look forward to being in different cities next year and meeting with our clients as they are scattered hither and yon in the tens of thousands. So I look forward to that.
Kevin: I can’t speak for Orlando, but in six of the seven conferences bitcoin is one of the first questions that come up, and I can’t help but think over the last five or six weeks while these conferences have been going on, we have seen the capitalization of bitcoin go from less than 100 billion to over 162 billion at this point. Bitcoin is nearing $10,000 as far as the price level. I was just reading an article that you had brought up to me that says the capitalization right now of bitcoin is larger than Disney, larger than IBM.
David: (laughs) “To infinity and beyond,” says Buzz Lightyear.
Kevin: It reminds me of the tech stock bubble when pets.com – the little sock puppet – that company got to be larger than all of the airlines combined in America before it popped. And when it popped, it just disappeared.
David: I think we will continue to see bitcoin go higher, and that is just a reality. Bull markets, or if you want to call them manias, go until they can’t go anymore, and that is when you run out of buyers, then all of your buyers turn to net selling, and you begin to see price dynamics on the downside. Bitcoin has proven itself to be very volatile, which is helpful on the upside, but can lose 60-80% in a short period of time. We’re still very fascinated by block chain technology and its iterations, perhaps even the cannibalization that we see from that technology, in various places, whether you are talking about escrow companies, title companies, which have played a significant role in land and property industries, and may play no role in the future, given what can be embedded in block chain.
Kevin: Dave, you talk about when you run out of buyers, that can happen in any market, but there is one market in particular where that does not seem to be happening since the financial crisis, and that is the debt markets. If you have an automatic buyer, someone who is coming in from the central banking community and buying up all of the debt assets, interest rates go to zero and they don’t seem to rise. We can talk about bitcoin being larger than Disney, but that is still only 162 billion dollars. We have trillions and trillions in the debt markets that people in the past have been dependent on the interest rates, 3%, 4%, the magic 5%, to be able to retire. That has gone away. We haven’t seen anything like that for six or seven years.
David: Bloomberg wrote this last week, “I’m melting, I’m melting.” And the dying lament of a wicked witch is what they were referring to. An apt description is they write of what is happening to bond yields since the financial crisis, according to Bank of America, Merrill Lynch. In 2008 there was 28 trillion dollars of debt yielding 4% or more, and in that Bloomberg article they go on to say, “Now it’s down to 3 trillion. An era of unprecedented monetary accommodation and structurally lower growth has been accompanied by a seemingly insatiable search for yield. Investors will now accept lower relative returns on risky debt for extended duration to clip coupons on sovereign bonds that still aren’t anywhere close to pre-crisis levels.”
Kevin: So just to repeat, 28 trillion dollars were yielding better than 4% back in 2008. That’s our memory. You talk to someone who retired back in the early 2000s and they will say, “Yes, I retired because I knew I could get 4% on my money.” If you have a million dollars, that’s $40,000 a year that you are bringing in. But at this point, if you have a million dollars, you can’t even bring in $10,000 or $12,000 in the same kind of instrument. What you are saying is, 28 trillion was yielding 4% or more about ten years ago. Now it is one tenth of that that you get the 4% or better. But the instrument that you would get your 4% in would be much more dangerous at this point, would it not, higher risk?
David: That’s right. I quote the article as a reminder that people can be aware of problems without changing their behavior. There is awareness of greater risk for less reward, but without a change in behavior at all. So as long as it works, you might as well go with it. That has kind of been the trend, 25 trillion dollars in debt has been priced for perfection. You have a world of low inflation, you have virtually no volatility in interest rates. Risk is viewed as a thing of the past. There is virtually no consideration for what used to be at the top of mind for people investing in overseas or foreign sovereign bonds – political volatility. But risk is a thing of the past, right? So we have bonds, almost universally, priced at levels recorded only one other time in 5,000 years at these kinds of levels.
Kevin: It reminds me of people who do things to their body that they know are ultimately going to kill them – smokers, or what have you. And there is an awareness of risk. You can talk to most smokers and they will say, “Yes, I understand that this is probably going to give me cancer, or what have you. Yet, with many of them there is not a change of behavior. Do you think, in a way, is it a little bit like a co-dependent relationship? In other words, there are a lot of intolerable conditions that they can put up with as long as their current certain needs are met – the immediate need. In this case it would be income.
David: That’s right. As long as you provide income you have the intolerable conditions that can be put up with. It is a lot like the co-dependent relationship. It’s not healthy, but why change behaviors when the punishment is infrequent and not really present tense, not right in the present moment. So as long as we have free markets – of course this is where the problem comes in because as long as we have free markets you are assured that punishment will come.
The shift toward more normal interest rates, whenever that occurs, I think will leave scars on a generation of investors who accepted a new normal as normal and don’t realize that it is actually quite abnormal. The assumption gradually entering into the mental framework of investors all over the globe seems to be that central banks are in control of prices. On that basis it would follow that there will be no market-driven price volatility – no punishment.
So back to that idea of codependence. Nothing to worry about. You are getting your needs met. 25 trillion dollars in debt that has been shifted into lower rates. Mind you, 12 trillion of that as of October of last year – so roll the clock back 12 months – at negative yields – 2 trillion corporate paper, 10 trillion sovereign debt. This is negative yields – negative. You’re not getting anything for it.
Kevin: You are getting less than what you put in. That is the thing that is amazing. You put $100,000 in and you get $99,000 back, and you say thank you to the banker? Excuse me.
David: When I describe pain or punishment in the bond market, it is with an historical focus on the swings of rates from low levels to high levels, and back again. A world of no volatility, which is more of what we have today, is a world of grave presumptions, control being one of those presumptions.
Kevin: Dave, you have talked about this, especially after we talked to Russell Napier a couple of years ago, and you asked him, “How do we move forward?” He said, “You are going to have to learn how to survive in a command and control environment.” One of the things that he is basically saying is that your freedom is lost. There are many freedoms that are hidden, even in the prices of items. When you have an unlimited buyer of debt, which is what we have had with the central banks, you can’t get real rates of return.
And in a way, you are in a form of slavery because, Dave, at this point, you and I both know that for the person who can no longer get that 4% safely because the central bank is the competitive buyer of that same debt, they’re having to go out and speculate. A lot of these people are looking at bitcoin and saying, “Well, gosh, if this is easy money then I’m going to go ahead and go into bitcoin.” Or a stock market that has price-to-earnings – 31 years of earnings to break even on the price of the stock market. People are having to speculate. Like you said, they’re not changing their behavior, but they’re chasing whatever they can get to get what they need, which is the income.
David: It’s not just cyclically adjusted earnings, but what you see is people who, in a world of no volatility, assume that there is safety, and again, it presumes a certain control in terms of the outcome, which doesn’t exist. You see that kind of control in people’s lives all the time, not just in the markets. You probably know it to be true of yourself, as well. You live with a sense of normalcy until disturbance of one sort or another turns peace and calm into temporary chaos or uncertainty. If you lost a job, or if you got dumped by a boyfriend or a girlfriend, or if you have experienced a health scare. I don’t know if you have ever been cruising along at 30-50 miles an hour and you catch an edge while you’re skiing at high speed, and you go from having that sense of control to wondering how is it that you are in this vortex of snow and ice?
Kevin: You can call that disturbance. That’s definitely disturbance.
David: When someone presumes control there is a belief in outcomes which are more or less guaranteed. We have talked about in global debt, or U.S. debt, on the Chinese debt markets, a few weeks ago we mentioned this. Not only is the yield curve inversion uncommon in China, the first time I recall was 2013 when that happened, and then it started again in June of this year, but it often signals a recession.
Kevin: Right. And just to remind the listener, the inverted yield curve is when short-term rates actually surpass long-term rates.
David: That’s right. And we know that pattern in the developed world markets, particularly. Perhaps it is different elsewhere, but China has emerged as an economic giant. I can hardly think of it as an emerging market anymore, so I include them in that yield curve pattern where it may be a portent of recession on the horizon. Tightening in the credit markets via the PBoC, the People’s Bank of China, has been in place since late last year, kind of an on again, off again effort, as the PBOC has tried to discourage speculation in a variety of markets, whether it is the real estate market, or growth of credit in the shadows, or shadow banking.
But monetary policy tightening has come in a variety of forms. It has come in the form of higher rates, if you’re just looking at Chinese government bonds, again, back to that yield curve inversion. But we have also seen it with higher rates in the reverse recall market, and in other interbank lending rates, as well. What are they doing? They are addressing bubble excesses which have been in play for some time. For more than 12 months you have seen an active role in terms of regulatory reforms in complement to those monetary policy initiatives.
Kevin: Wouldn’t that be called removing the punch bowl, Dave? Isn’t that what a central bank is supposed to do if they are going to go provide loose monetary policy – tightening before things actually turn to collapse? Isn’t that what you would want to see?
David: That’s right. So the temperature is right from your regulators and your central bankers, along with yields, again, of course, as a part of that. And the intensity increases within the financial system in China to discourage credit growth. This is in contradiction to what we have mentioned on the IMF assuming that credit growth in China is going to be 27 trillion dollars over the next five-year period. That is a doubling from the current 27 to 54 trillion total. The IMF says credit is going to double in that five-year period. But frankly, the PBoC’s actions are moving against credit expansion and toward bringing expectations back to planet earth amongst your Chinese investors, where they’re expectations have been, really, unrealistic.
Kevin: Speaking of unrealistic, haven’t we seen the Chinese become lax in their worry about volatility, just like we have seen here with Fidelity and the Vanguards, these large, passively managed types of funds? China has smoothed out the volatility in their own asset management products, and so coming from a communist country to a sort of half communist, half capitalist country, you have an entire generation that doesn’t really understand crashes or volatility that come with the free market. And China has smoothed that out. What do you think the emotional reaction will be with the Chinese if market forces actually return?
David: It is an interesting idea that thus far they have seen the bright side of capitalism, not necessarily the dark side of capitalism. This is where Schumpeter is not the most popular economist because in the Schumpeterian world where you have creative destruction, somebody does get hurt, and that is the nature of the free markets, that is the nature of capitalism, that bad ideas ultimately go away, and it is not just about free money and a free lunch, which is on the front end of what the Chinese have experienced to this point. Last week you had the PBoC which began to take aim at asset management products. Our friend and tactical short manager in house, Doug Noland, highlighted a Bloomberg article describing how asset growth over the last 13 years in this asset management product space has gone from zero to 15 trillion dollars.
Kevin: Wow – with a T.
David: That’s right, trillion with a T, in dollars, not RMB. This is multiplied times six, or whatever the current exchange rate is. So yes, trillion with a T, dollars, not RMB. And the attraction to the Chinese, really, has been like our mortgage-backed securities market. If you go back, roll the clock back to our market prior to 2008-2009 everyone assumed that when you bought Fannie Mae/Freddie Mac paper, you were buying mortgage-backed securities paper, that there was an implicit guarantee. You got a little bit more return than treasuries, but the implicit guarantee of the government was there. That has been the guaranteed government protection of invested capital, that has been the assumption of Chinese investors with these asset management products now for some time.
Kevin: And that’s why you call it perfect world expectations, which means that things are priced at the absolute max as long as everything goes perfectly. So the pricing is correct if you have perfection for the future.
David: You have profit without the potential for loss, you have a guaranteed high rate of return with no downside, and can you imagine a more perfect world? You have 15 trillion dollars in Chinese money that cannot imagine a more perfect world either. That’s why they are parked there. You have the PBoC which would like to reset those expectations. They have to do this very carefully because they need to reset expectations without cratering the financial universe. You have moral hazard which is alive and well in the Chinese markets where there is only gain and the impossibility of pain – that’s the presumption of investors today.
First we need to see that there is a mistake by investors, believing in a something-for-nothing pipe dream. Risk and reward have always been in the same equation, and if they are separated temporarily, they typically are slammed back together. Think of two magnets and that compelling unseen force which brings them back together in spite of separation.
But second, you have the central bank that believes that they can actually tame the beast of investor appetite, and they can that without crushing the spirit of the market. This is where I don’t know what happened in China.
Kevin: Dave, in parenting, sometimes you have to let the lesson be learned the hard way so that your child can grow up into an adult and can be a responsible adult. But we have seen parents that are always praising their children, maybe praising them for things that aren’t necessarily praiseworthy, but never allowing the negative to come in. Ultimately, that destroys expectations and destroys the child, and it creates the inability to ever become a responsible adult. In a way, you had mentioned the something-for-nothing pipe dream, and that really sticks with me right now because you have people in bitcoin – I keep bringing it back – who are getting something for nothing, and they still swear up and down that it is not a bubble.
You have the same thing going on in the U.S. stock market. You have the same thing going on with the 15 trillion dollars in these asset management products that the government of China is making sure has no volatility. They are scratching their heads now saying, “Wait a second. Maybe we should have raised our children in a different way. Maybe we should have shown them that there were risks and that not everything turns out rosy.” Can they pull that off, Dave? Can that be pulled off anywhere in the world after this last eight years of artificial stimulation?
David: It’s a fascinating thing because for them to develop in the direction of free market capitalism remains to be seen. If the current administration puts them more on lockdown mode and the politburo consolidates power and moves things forward in a decidedly command and control way, or if in fact, we continue to see a blossoming, flourishing, free market system within China. But the free market – I recall a phrase from growing up – pain builds character. (laughs) I think my dad said that just before I got a spanking or something. I don’t remember. But pain builds character. There is character which needs to be built within the system of capitalism in China and it is only going to be through pain. I say that because unless a high degree of pain is felt by the Chinese market they are going to continue to inflate their asset prices, and they will reach levels that ultimately remove the People’s Bank of China, the central bank there in China, their ability to even influence, let alone control. And it’s ironic that they want to cool the markets down, but thus far they have been timid. And when they begin to see too much of a shrinking in credit growth, or what have you, then they reverse course. And I think they are creating a world in which the markets play off the central banks’ fear of the unknown. When you can’t predict an outcome, and you act with timidity, then that timidity, on one side of the equation, encourages more boldness from investors on the other side of the equation, and in fact, your best attempt to cool things off in fact just heats them up further. In all likelihood, credit growth is going to continue. It will continue in the shadow banking arena until you have a market collapse. And I don’t know what the trigger is for a market collapse in China. It’s unknowable.
Kevin: One of the unknowable items, Dave, speaking of unknowable, is the fact that we now have a new People’s Bank of China head. We have had 15 years of the same person. Now we’re seeing a transition. Is it going to be just benign, like what we are going to see with Yellen and Powell? What do we know about the Chinese central bank head?
David: The real question remains the politburo question. What do they hope to achieve over the next five, 10, 15 years in terms of regional hegemony, or in terms of international influence? And what is the optimal way to use monetary policy as a tool to complement those goals? Perhaps nothing changes. The PBOC is an extension of public policy, it can help shape financial market priorities. Nothing changes over here in the U.S., and as we shift from Yellen to Powell coming into February of next year, essentially, we have the same policies as expected.
This isn’t me, alone, thinking this. Greg Ip from the Wall Street Journal had that same thing to say last week. He said, “Choosing Jerome Powell as Fed Chairman is a safe gamble since his views match Janet Yellen’s.” And as I recall, he has never had one dissenting vote. He has always gone along with the party line. So, in both cases, “The King is dead – long live the King.”
Kevin: Right. So maybe nothing changes. Dave, as we see countries who are trying to extend their influence – we talked about China and their resources – five or six years ago George Friedman told us that Russia would need to take over the breadbasket of Eastern Europe, which was Ukraine. So that was a prediction that came true. What we are seeing right now, it seems, with China is that they are wanting to take over, or at least have expanded influence over, the breadbasket of Africa, which would be Zimbabwe.
We have a transition of power in Zimbabwe right now, from Mugabe to a man who is nicknamed “The Crocodile,” and you just sort of wonder. I remember hearing your dad when we were in these conferences saying, “China is extending their power through building friendships and applying money to those friendships.” Do you see the same thing happening right now with China and Africa?
David: I do, and I go back to that same thought, “The King is dead – long live the King.” Does that apply in Zimbabwe, as well? I haven’t yet talked to friends of ours who live in the country, but as Mugabe steps aside, the “coup” sure looked more like a wrinkle-free succession plan with the military facilitating a peaceful move to new leadership from Mugabe to, lo and behold, Mugabe’s number two man.
Kevin: The Crocodile.
David: Yes, granted, he left the country for a few months just before returning to take the helm, but that seems to me like the drama of kabuki theater. You have The Crocodile, as he is called, and he may have his own personality, but I doubt very seriously that with the number two in Mugabe’s power structure very much will change in terms of corruption and abuse of power. And frankly, corruption and abuse of power in Africa has become as stylized as thinking about zebras and elephants on the savanna. It is part of the essence of the continent.
Here is the deal. He is status quo on land seizures, so no one is going to get their land back. You remember, we had a couple of fine gentleman on the program to talk about Zimbabwe and hyperinflation. They were farmers and had their land seized by Mugabe a number of years ago. They’re not going to get their land back. No. But he is, at least, promising compensation for land that was seized.
Kevin: Well, let me ask you, though, is that compensation in pre-financial collapse, or is that in devalued Zimbabwean dollars?
David: Right. If you look at today’s fair market value on farmland, it has to be near zero. You have had productivity which has dropped to zero. You have land which has been left fallow for years and years now. I think if you had a different kind of leader elected in Zimbabwe in the coming years, that would be a fascinating country to invest in. But it hinges on the character of the individuals at the top. If you are looking at it from the macro perspective, essentially, Zimbabwe is at a secular market low. You just don’t have any catalyst for growth, and you may never get one.
Kevin: But China is leaving a pretty substantial footprint there. Could that also be a reason for optimism or hope, at least from an economic standpoint?
David: Maybe, maybe not. I see where you’re going with that. If “The Crocodile,” as the new president likes to be called, wants to revive the economy he can ink deals with the Chinese and get up-front development dollars in exchange for an option on food production in the future.
Kevin: Meeting the immediate need, like we were talking about before. It is either income or food – if you are at the lower strata of the economy, you’re either looking for income, or you are just plain looking for food. And in Zimbabwe, food would be a very powerful tool, would it not?
David: Yes, and I do not think that reviving the African breadbasket is a miracle. You have the skills there. You have organizations and people that could take the desolate landscape that exists today and return it to being a cash cow. But what that would require is allowing the free markets to operate in that space. That would be the fastest way to return the land to health and productivity. If that doesn’t occur, then back to the Chinese – the Chinese will do it. And guess what they have done in every instance where they have sent money? They have provided labor to put together various infrastructure projects.
So it hasn’t been good for the locals. It has not been good for the locals. It has brought in cash flow, and certainly that cash flow has gone to a few corrupt politicians at the top of the food chain. But that is basically the kind of footprint that China has left in Africa. They have been willing to step in, they want long-term access to resources – they have done that in central and South America, looking at minerals and those resources. But Africa is different. It has a combination of minerals and strategic assets like that, but it also has food. If you’re feeding billions of people, the difference between success and failure in the One Belt/One Road project, may be having a cheap supply of rice and maize and various other staples, which obviously Zimbabwe could provide.
So, in this African food chain, where is The Crocodile? Where is The Crocodile, in terms of the African food chain? We know that corrupt politicians are at the top, and my guess is that he is going to sit there comfortably at the top, himself.
Kevin: Dave, keeping with the China theme, what has been striking me is, I think sometimes we are happy to say, “I don’t believe anything on fake news,” yet we can still be influenced by it. One of the influences that I know I have experienced is, I have just repeated like a parrot, “Well, Trump hasn’t really been doing anything. Trump really hasn’t gotten much done. Even though Trump is standing strong on some issue, he is not really, actually, affecting a lot.” But, actually, behind the scenes in China, that’s really not the case. I wonder if the Chinese understand Trump, but he seems to be getting things done quietly, and in this particular case, it is one of those rare occasions where Trump is getting something done and not talking about it.
David: I think he is actually a master at the art of misdirection. You have his Twitter feeds and his idiotic statements that he makes practically every day, but I think he is playing a very interesting game on trade. You have the mainstream media which has written him off as a dolt, as an idiot. I would say, not so. Brash? Yes. Stupid? No. Just since November he has managed to oversee the slashing of import taxes on 187 imported goods by the Chinese, according to investors.com. That is no small task.
Then, on his recent visit to Beijing he was offered what previous U.S. administrations have begged for – that is, access for U.S. firms into China’s financial industry. And twice, both in the courtship process before he went over, and then as he is actually leaving the country, twice he feigned indifference to the offer. I don’t presume to know what is going on in his mind, but it appears that he is managing the Chinese by keeping them off balance and keeping them guessing at what his grand strategy is. He’s doing a good job of it. I don’t know if he has a grand strategy or not, but if he can imply one, then that is very effective in terms of Chinese perception.
Kevin: I wonder sometimes, Dave, if part of his grand strategy is not having one, or at least giving the perception of not having one, and not telegraphing that. It is interesting to me, it is sort of ironic, because when people have talked about dealing with Chinese businessmen, that is one of the things that they do. They don’t telegraph their intentions. And in a strange way, even though it is in a different style with Trump, he is a hard guy to read, and I think the Chinese are getting a taste of their own medicine.
David: Part of the reason he is so hard to read is because you have such a hard time taking him seriously. Just like you have the North Koreans, who you think, “These guys are crazy,” on the one hand, they are either stark raving lunatics, or they use that as a means of keeping you off guard. “They can’t possibly come up with an intelligent strategy, they’re stark raving nuts. You need to read the DSM-5 to figure out what is really going on in North Korea, because they’re psychotic.” I don’t even know if they use the word psychotic in the DSM-5 anymore (laughs). They don’t use any of the old psychological terms.
Kevin: We talk about fake news, and it is getting harder and harder to actually determine what the truth is. You have to use a lot of wisdom and discernment in anything that you hear. But fake news is one thing – fake data is another. It seems that the financial markets, as we move to the European Central Bank now, the financial markets really don’t know how to react to anything anymore, not just because of fake news, but it is the data behind that news. We have doctored GDP for so long, and unemployment for so long, and inflation for so long – how do you react to any of that data in an intelligent way?
David: The growing concern with the European Central Bank is, specifically, Reuter’s has quoted Benoît Cœuré, who is an ECB board member, an official at the ECB, an actual board member, who says, “Fake data, the relative of fake news, is a threat to economic stability.” He says, “There is this growing prevalence of poor quality data which risks fueling economic manias and panics.” (laughs) I read that here in the last few weeks and I thought, “Yeah, is that just dawning on him? Of course it stirs mania and panics.” This is the point of having data out there – to cajole and manipulate the crowed into doing something.
He goes on. Benoît points out that “actions by economic agents could become less anchored to actual activity, and more prone to manias and panics, with obvious implications for economic and financial stability.” (laughs) I quote the article to point out that those people who are deeply embedded in the system who have benefitted from fabricated statistics, at some point realize that there is risk of – what they were using to create this reality – what if people actually believe it, what if it is popularly accepted?
Real risks are obscured and ignored, and that is a problem, because then when you have people ignoring risk – it is one thing to think positive thoughts; all for it. But it is another to think only positive thoughts and never keep it in balance with the yin and yang of life. Societe Generale –Alain Bokobza is the head of global asset allocation – he says investors are way too optimistic. They are too optimistic, and they are taking on too much risk in this low volatility environment, setting the stock market up for a potential downfall. And he says, “In a Goldilocks scenario of low interest rates, abundant liquidity, stable growth, and a focus on the ‘good’ Trump, investors continue to push asset prices, volatility, and leverage to historical extremes.”
Kevin: It reminds me of our guest, Bill King. He continually tries to point out that there is a reality behind the smokescreen.
David: You’re right, King has been like a broken record on that. Over and over again he will say, “It’s the U.S. government which for decades has used economic statistics and understated inflation, and overstated employment, as well as GDP, as a means to sanction the Fed to pay for over-debt and declining living standards.” Fake data is not new to our listeners.
Kevin: Dave, one of the dangers of simulation when you are in a particular activity that could be life-threatening – you are a rock-climber, you and I have both flown private planes, when they are training men for war – a simulation, unless it gives you as accurate a simulation as possible, can actually, ultimately, teach you a life-threatening habit. I think of flying simulations. They can be very, very helpful in one respect, but the fact that you have a reset button, you can crash and crash and crash, it can cause you to start making decisions more loosely than the risk would allow. In a way, the world market system, especially since September of 2011 when Draghi said, “We will do whatever it takes,” and they have since then done whatever it takes – in a way we are training an entire world that there is no risk, there is only reward. Again, it is that free money mentality. You just wonder, when reality does return, when that mountain that you are flying into, to use the flying example – they say there is a mountain in that cloud sometimes and a lot of times pilots don’t realize it until they hit that mountain – when that happens, we have never really experienced a period of time of so much false or fake simulation as we have experienced in the last six years, have we?
David: No. And I think, again, this is where understanding your limits is very important. The idea that you raise of flying in a simulation and getting to start over, not dealing with consequences – there are real world consequences to ignoring natural limits. I spoke with a fighter pilot the other day who spent many years in the navy, and then has flown commercially, and now with NetJets for a good bit of time. He referenced bingo fuel when we were talking the other day. He said, “This is the amount of fuel that you know on your gauge – it doesn’t matter what you have going on, it doesn’t matter where you are in a conflict engagement, if you don’t turn around right then, you will crash your plane because you have exactly the amount of fuel required to get you back to the boat. And you have to drop everything and go because, again, that is the real data. You have to deal with reality in that moment. You can’t press for another two seconds, you can’t take the shot, if you just opened up, you have to deal with reality.”
I think our listeners would say, “You guys have talked about unemployment stats being fudged for some time, inflation stats being fudged for some time. What do you do as an ECB president, or as a Fed official, when you get this news flash that they’re dealing with, and they have been fabricating their own fake data?” On the one hand, it is liberating for me because I can do something about it. And you can do something about it. You can vote with your feet. But I think, for them, they’re really stuck.
Investors with a modicum of wisdom have to hedge their bets, and as a greater number of people come to the awareness that current surges in asset prices are built on a house of cards, perception of fake news and fake data becomes the reality within the marketplace. People begin to hedge their bets. You do that en masse and that is the turning of the market. That is the movement from a bull to a bear.
We have these things emerging now, Kevin. I started by referencing a Bloomberg article, moving from 28 trillion dollars in debt to 3 trillion – only 3 trillion left, that is above 4%. And it is really an interesting thing. There is a growing awareness that something is not quite right. Investors are figuring it out, analysts on Wall Street are figuring it out. They are not quite sure what behavior modification they should adopt, what they should do to change their portfolio structures, so they’re not doing anything yet. But it is not lost on them anymore that we are in la-la land. And as and when they decide to change course, this is where we begin to test the limits of liquidity in a lot of different markets, and begin to see, I think, a radical adjustment in price.
I think this is a very interesting time as we transition in 2018 where people begin to act, not just observe and listen, but begin to act on what they know to be true. I think this is, again, the point where an investor says, “I have just enough fuel to land it. I need to disengage now, and get home, put this thing on the ground.”
Kevin: Bingo fuel.