Motley Fool Hidden Gems Investing - A Shift to Hard Assets

Episode Date: April 21, 2024

Investors have big dreams about the future of artificial intelligence, and it’s going to take a lot of energy to get there. Lawrence McDonald is a risk consultant, the founder of The Bear Traps Report, and the co-author of “How to Listen When Markets Speak: Risks, Myths, and Investment Opportunities in a Radically Reshaped Economy.” Deidre Woollard caught up with McDonald for a conversation about: - What an aging American population means for stocks. - How natural gas companies benefit from a growing global middle class. - The case for adding commodities to a retirement portfolio.  Companies discussed: NVDA, INTC, TSMC, BTC, AA, RIO, CHK Host: Deidre Woollard Guest: Lawrence McDonald Producers: Ricky Mulvey, Mary Long Engineers: Tim Sparks, Desiree Jones Learn more about your ad choices. Visit megaphone.fm/adchoices

You've got to try breakfast at A&W. You've got to try breakfast at A&W. And what better way than with the delicious Pret Organic Coffee? Starting with just one dollar, all day, every day, now until December 31st. You've got to try breakfast at A&W. At participating A&W locations in Ontario. When people look at stock prices, you don't want to look at the stock price. You want to look at the market cap.

It's very difficult for a $2.3 trillion company, double. But the companies that support this historic industrial revolution of artificial intelligence, that's where the upside is and kind of the second and third tier names that don't get a lot of attention. I'm Mary Long, and that's Larry McDonald, a risk consultant and founder of the Bear Traps Report. He's also a co-author of the new book, How to Listen When Markets Speak. Deidre Willard caught up with McDonald to chat about why this market cycle feels different from others, the possibility of a dividend renaissance, and why there may be a bull market coming for commodities.

Well, I've been thinking a lot about that. We seem to be at an inflection point. I've been listening to a lot of different podcasts and talking to authors. And some of them, one of them that I talked to recently said, you know, we might experience a different type of market. We might experience a renaissance in dividend payments and, you know, less buybacks. What do you think about the potential for that kind of shift? Yeah, renaissance in dividend payments makes a lot of sense in the sense that certain companies are producing lots of cash. And there's been in a lot of different sectors has been a capital retention management style where companies are holding capital and a lot of they're building up cash and they want to return that cash to shareholders.

And we've been too much so. And I think, you know, the last 10 years, too much so on the buyback programs. And I think that there's going to be some big political pushback on the buybacks. So, yeah, I think that that's a pretty, pretty important point around dividends. And I just think that, you know, also the biggest point that we make in the book from this perspective is the passive revolution. David Einhorn's in our book, famous hedge fund manager, founder of Greenlight Capital. And his point is that once passive gets too big, and that's your index funds owning lots and lots of equities and lots and lots of value, trillions.

is about over $35 trillion tied to passive investing through the S&P and say that the NASDAQ. And there's not a lot of eyeballs on those ideas because when passive investing gets too big, those investors are just passive. So in other words, there's not a lot of homework and there's not a lot of due diligence. There's not a lot of questions being asked of senior management. And that's one of the points in the book I think is really important for our watchers and readers and listeners right now. Yeah, I think that's really true. And And Jamie Dimon's letter this week from JPMorgan Chase also addressed that idea of how big those passive investors are and what that means for the market, what it means for things

like proxy statements, that all of these decisions are being made mostly automatically now versus active investors trading in and out of the market. Yes. And so for the viewer, they need to understand that essentially your 401k has been hijacked by 10 to 15 companies, maybe eight companies. In other words, the market is so big and so concentrated. And the higher it goes, the more money comes in and you get a lot of chasing into bull markets. And in bear markets, you get a lot of what we call capitulation selling. And so what happens is when you're too big on the passive side and the market's going up and up and

up, there's a lot of inexperienced money coming in, fast money. It's kind of what we call weak cans and poker where it's coming in it's chasing chasing chasing and the ownership the the actual market itself is becoming more concentrated and fewer and fewer and fewer names and uh that's very important for people watching us right now if you have a 401k yeah very true another thing you brought up in the book that i hadn't quite thought that much about was the impact of cheap credit between 2007 and 2019 the way that it helped large businesses really wipe out the competition because they had all of this cheap money does that shift a bit now if we've got capital being more expensive is is there any way that this sort of levels out the playing field a bit i mean like is is there

a bright side to this yeah that's that's a good point so in other words well what we do know and the wall street journal has said this is that the percentage of profits from the largest hundred companies. And this is just a blood-curdling stat. It's gone from like, in say the 1970s, 54, 1960s, 70s, 54 to 60% of the profits were in the top 100 companies. And through the 80s and 90s, it's become more and more concentrated. Now we think it's over 90%. 90% of the total profits are within those 100 companies. So in other words, the bigger companies are getting bigger and bigger and bigger. To your point, when interest rates were low, they could borrow money at very, very cheap

rates. And that really helped the Home Depots wipe out a lot of local hardware stores, for example. And now, I think it'll take some time. but your point that point is very correct but it's going to take some time for the for this higher interest rate regime to equal out the playing field yeah and we don't know how none of us know how long it's going to last there's another phenomenon in the book that you talk about that i've been thinking about too which is the aging of america i've been thinking about it in a different way i think than than you have because you brought up this point of the demographic

time bomb which is baby boomers they start moving you know money out of stocks they go into that maybe that traditional 60-40 portfolio, maybe not investing deeper into bonds, maybe some other areas. What does that do in terms of the passive situation that you mentioned and what happens next? Well, so this is one of the most important parts of our book, When Markets Speak. And that is if you think about the Lehman era, right, the post-Lehman world, it was about a $4 trillion dollar fiscal and monetary response four trillion and that and then there was this massive uh what we call austerity regime in 2000 say 2010 11 12 with the election and republicans versus democrats then we had austerity in europe and so there was a massive pressure on what we call deflation or

disinflation because we had a a smaller fiscal and monetary response relative to now and then a lot of austerity immediately after. Today, if you look at the response to COVID and the response to the banking crisis over the last year and a half, which we had like four banks, four or so banks go under, Silicon Valley Bank and the New York Community Bank and the like, the response today is not $4 trillion, it's $16 trillion on the fiscal and monetary. And so what that's doing is creating a more sustained inflation regime uh we're seeing that now uh we have an election you think about team biden right they know that the 2008 election when we had when we had that banking crisis that had a lot to do with the outcome and president obama was an amazing

politician up against john mccain in 2008 but the banking crisis actually had a you know pretty pretty, pretty impact on that election. And so what's happening now is the team Biden and the whole fiscal and monetary, they're, they're going all in, right? They don't, they don't, they wouldn't want to have, they want to have a low unemployment rate. They, they care a little bit less about inflation because they want, they don't, they want to prevent that banking crisis from really kind of what we call a contagion, a credit spread contagion. And they put out the fire. The problem is they've created a sustained inflation regime. And that means that you need an entirely different portfolio from 2010 to 2020. You needed a 60-40 portfolio, no big deal,

and a portfolio that was heavy in growth stocks and what we call financial assets. And those are growth stocks and bonds. Today, in this new stained inflation regime, that 2020 to 2030 portfolio needs to look a lot different. And that's one of the most important things for people watching us right now. And that's more like maybe a 40 percent stocks, 40 percent bonds, 20 percent commodities, a whole different asset allocation and risk parity. As we know it, that 60 40 portfolio is dead. And I'm happy I'm happy to talk about demographics if you care. Well, I want to I want to talk about that, that 20 percent commodities, because that isn't something a lot of people are talking about. Maybe we're a little bit more aware of it over the last

little the little cocoa crisis, I think, has all of a sudden made people pay attention to commodities. But what what do you think people are missing about commodities? People, for the most part, don't rush to invest in commodities at this point. Well, the mind blower is that that's in the book. It's say 2011, 12, 13 in that range. The Nasdaq 100 was about the same size as the energy sector. So the NASDAQ 100 was about the same size as the entire energy complex. Today, the NASDAQ 100 is about $18 trillion larger than the energy space. NVIDIA is 5% of the S&P, one stock, 5% of the S&P. The entire energy complex is about 3%, 3.5% of the S&P. So you're right. There's two parts of commodities. There's the commodity

the equities that are a very tiny part of the market now. And then there's the commodities themselves. So the commodities in terms of ownership of asset classes is in one of the lowest spots in decades. And that's, once again, that's because we've conditioned investors. This is so important for people watching this right now. We've conditioned investors through 20 years what we call deflation disinflation that pushes money into what we call financial assets growth stocks and bonds and where where commodities typically do well is when you have inflation that normalizes at a say three four five percent and stays there for a couple years that's when you start to get a flush of money into commodities and if you look behind me right now in the markets

that's what's starting to happen. Well, it seems like last year we were talking so much about the recession that never came. Like that was the story of last year. This year, as you mentioned, we're trying to get the, you know, we're trying to get to that magic 2%. So maybe Powell starts, starts cutting. It's looking less and less likely as the year goes on. So what are you seeing in that cycle? I mean, we know that, that markets have cycles. This cycle doesn't seem to be going exactly the way one's had in the past? Well, David Einhorn, who's in the book, a famous and famous hedge fund manager,

he talked to us and he's talked over the years about what he calls the jelly donut. And it's a funny expression, but what it means is that because the baby boomers are turning about the oldest boomer now is turning about 78, but the boomers have 78 trillion of wealth. The millennials only have about 9 trillion.

And so if you think about it, To keep it simple, if you have $10 million in a money market fund in Palm Beach, and that's a very wealthy individual, but just to keep it simple, your income on that money in the money market fund for two years ago was about $80,000 a year. Fast forward to now when you're getting close to 5%, that $10 million in a money market fund today is paying you close to $500,000 a year. And so Einhorn's point, which was brilliant and prescient years ago, he felt that if you cut interest rates too much, the way the Fed did in that 2008, 9, 10, that disinflation regime, it actually creates more disinflation and deflation because those boomers, you're really punishing the savers, and people have to be more careful with their money because they have less interest.

And now the team Powell and all those rate hikes have given those wealthy people in Palm Beach essentially a 300 percent pay raise. But at the same time, the sad, the sad, really sad fact is the bottom 60 percent of Americans are in recession. The New York Fed told us multiple times in the last couple of years, the bottom 30 percent of Americans only have $400 in the checking account. That's the New York Fed. That's the bottom 30 percent. But that's a lot of people. And when interest rates go up and inflation goes up, that hurts that group. So if you look at companies in the S&P 500, you can clearly see a divergence where companies that face the bottom 50% of consumers are in a lot more difficult place than the companies

that face that top 20% of consumers that just got that huge pay raise. interesting that makes me think about a little bit about what has been happening with with dollar stores uh cutting their amount of stores and things that have been happening on that right yeah that that's that's an interesting idea i want to talk to you also about what's happening with outsourcing and now the move to bring semiconductor manufacturing back to the u.s we have all this money going to intel and taiwan semi uh you know i'm i find myself maybe a little cautiously skeptical about how how much this is actually going to uh really jump start growth what are you thinking about that turn in outsourcing now back to some some form of

insourcing well they mean well but unfortunately what we talk about in the book when markets speak is republicans and democrats lectured us for 20 years that free trade was good and we basically took 5 million jobs from the United States. Some of that's in the Rust Belt manufacturing jobs. We've moved them all over the world to India, China, Bangladesh, all these countries. The good news is, if you're part of the Davos crowd, we've raised the standard of living dramatically in many parts of the world. If you're working in a call center in India, you're making 50 times more than your great grandparents. And so, but guess what? Those people in the developing world that just got this big pay raise, the first thing you do in India, there's a billion people in India

that don't have air conditioning, a billion people. So what you're doing is we're raising the standard of living globally. We're increasing carbon consumption. That's going to create this kind of like massive renaissance in terms of carbon demand over the next couple of years. So that's part of this whole new commodity boom. But then on the other side of the coin, in the United States, politicians now, because Trump pledged to bring back those jobs and Trump was like China, China, China, the Democrats and Republicans have picked up on that playbook around trying to bring jobs back home. and they've created different pieces of legislation that are designed to do that. And unfortunately, like you said, it's going to take a long time. And so it's a lot of noise. But reshoring, bringing those jobs back is a lot more inflationary

than exporting them around the world. And so that's what's this kind of crazy cocktail, because tariffs, you know, Trump and Biden, Biden's actually taken on Trump tariffs. tariffs and reshoring create a lot more secular inflation. That's why people watching us right now really need that whole new portfolio for the next decade. We're talking about a colossal historic migration of capital from one or two asset classes over to the others. Well, in thinking about the energy costs, one of the things that I've been thinking a lot about lately too, is data centers, AI, the massive amount of demand and what that's going to do all

over the world, but especially in the US with our energy grids. So much of that, as much as we want to turn toward green energy, the bottom line is we need to keep data centers running and it's not necessarily going to come from solar power. This is one of the most important parts of the book, When Markets Speak, where we're talking about investing, where people are looking at any kind of new industrial revolution. This artificial intelligence is just like the birth of the internet. So what happens is you have a lot of awareness around a few different types of companies that are leaders. Everybody rushes in. And we saw this in the 90s. I lived through the 90s. We sold our company, our dot-com company to Morgan Stanley. I was on the front lines of

that industrial revolution of the internet. And people were piling into Lucent, they were piling into Global Crossing and Cisco. But what we found is there were so many other companies that harnessed the power of the internet. Your Match.com, your Facebook, your Google, you can go on and on and on. And it was the second, third trades or investment theses that played out over time. And those crowded trades didn't work out so well. And that's where we look at energy. If you believe, say, the people at NVIDIA, in 2022, there's about 460 to 480 terawatt hours of demand coming from these data centers. and then you know if you believe the growth growth forecast and if you believe the explosion of this new artificial intelligence technology we think and if we're talking to all the different different

consultants in the world it could be a thousand to two thousand terawatt hours annually and that's equivalent to you know potentially two germany's or one france combined in terms of new energy demand. And so that means that if you look around the world at cheap natural gas, or if you look around the world at companies that produce nuclear power or natural gas, these companies are extremely cheap relative to the crowded AI trades. And it's going to be those companies that produce and fund and support the infrastructure for AI that actually end up being probably the 10 or 20 or 30 baggers, whereas you look at a company like NVIDIA that's already has a $2.3 trillion valuation. For that stock to double, it has to essentially go to $5 trillion, right? So it's a

lot easier for when people look at stock prices, you don't want to look at the stock price, you want to look at the market cap. It's very difficult for a $2.3 trillion company to double. But the companies that support this historic industrial revolution of artificial intelligence, that's where the upside is and kind of the second and third tier names that don't get a lot of attention. Speaking of big ideas, another one that you bring up in the book is the idea that the United States may have become complacent about the dollar being the reserve currency for the world. This is interesting because we're seeing dollarization in some countries, but we're also seeing a move away from the dollar as a reserve currency in other areas. So

what are some of the push and pull here? Well, you know, there's no question that the dollar is not going to lose its reserve currency status in the next decade. But what we're trying to say is that the hubris and complacency from Washington, from both Democrats and Republicans around sanctions, around property, property confiscation. Listen, Putin's a bad guy, did some bad things in the Ukraine. But when you use sanctions and property confiscation to that degree, all the other players on the field in the emerging market and developing market space are going to think twice about holding treasuries. And that's why if you look at gold and what we wrote this book over the last two years, and I'm really proud because gold's now making new highs. And we predicted

this in the book because central bank ownership of gold is exploding. And you can tell because the ratio of, say, gold to platinum or gold to silver is near 30-year highs. And so that's pretty crazy because what that's telling you is the gold market is about $16 trillion in size. The silver market's less than $2 trillion. Bitcoin's around the same as silver. So the big central banks in the world that want to protect themselves or want to protect themselves from sanctions or confiscation of property, they will start to move into other assets. They'll own less treasuries. And you're seeing that in China. You're seeing that in many countries. It's not like we're going to lose the world's reserve currency status, but there's definitely a decay going on. There's a

matriculation out of dollars into other assets. And that's going to create and that's creating this incredible move in Bitcoin and hard assets. And that should also propel the next big commodity bull market so just so to wrap up here one of the things that you say in the book is the move toward those hard assets is what's next so as an investor are you looking more toward equities that own those assets or how how does investors how should they consider it well first you need to remember a tech stock that's long duration has like a 10-year group of cash flows let's just say you get a tech technology company it's going to produce a billion dollars of cash flows over 10 years and the company's going to retain those cash flows and reinvest them.

That cash flow period, that cash flow of 10 years, that company is worth a lot less. That tech company, it's what we call financial assets. It's just paper. So you own a stock of a company in technology. You own paper in that company. It's a stock. And those cash flows that you own over 10 years, they're worth a lot less. And a lot of technology companies don't really own a lot of commodity assets or anything

like that. They just own that beautiful stream of cash flows, right? But if inflation is more certain over 10 years at a higher plane, then that stream, that billion-dollar stream of cash flows over 10 years is worth a lot less. And so what happens is those growth stocks that are really popular and really sexy, and really everybody has to own them in a deflationary regime, because in a deflationary regime that's certain over 10 years, those cash flows are worth a lot more. Now, take it on the other hand, hard asset companies like Alcoa, companies like Rio Tinto, companies like Chesapeake in natural gas space, they own tremendous reserves of natural gas, of iron ore, of nickel and copper.

They own the reserves in the ground and they own commodities that typically are tremendous inflation protection tools. And so the types of companies, the hard asset type companies is very different than growth stocks. And so the inflation regime, as you move from a disinflation certainty regime to an inflation certainty regime, it's starting to move money out of those kind of financial assets into companies that own and control lots of deposits of hard assets. Fascinating. The book is How to Listen When Markets Beak. Larry, thank you so much for your time. Thanks, Deidre. And well-researched.

I've done a lot of these over the last two weeks. Probably the best interview in terms of you read the books early. I'm grateful. As always, people on the program may have interest in the stocks they talk about. And The Motley Fool may have formal recommendations for or against. So don't buy or sell stocks based solely on what you hear. I'm Mary Long. Thanks for listening.

We'll see you tomorrow. I'll see you next time.