We Study Billionaires - The Investor’s Podcast Network - TIP303: Investing During Chaos w/ Lyn Alden (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. On today's show, we have the thoughtful Lynn Alden. Lynn has been in the investment research space for more than 15 years, and she's a contributor on major publications like Forbes, Business Insider, CNBC, and many others. I'm a personal fan of Lynn's work because she comes with an insane amount of breadth and knowledge about global macro situations while also having a deep value investing background. On today's show, we talk about how discount rates have changed and how investors should be thinking about risk-free rates.

Starting point is 00:00:30 We also talk about investing in nominal terms versus buying power terms. We talk about central banking policy during COVID-19 and what the rest of 2020 might look like. This is an amazing discussion and I'm sure you guys will really enjoy it. So let's go ahead and get started. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Hey, everyone, welcome to the Investors podcast. I'm your host, Preston Pish. And as always, I'm accompanied by my co-host, Stig Broderson. And today, I am super pumped to have our guests because I'm kind of an admirer from Twitterverse, Lynn, for your profile. You post some amazing content and some amazing charts. And I've never had the opportunity to talk to you. I just get to see your charts and tweet 100 characters at you at a time. So it's really exciting for me to have a conversation with you one-on-one, welcome to the show. You as well. Thanks for having me.

Starting point is 00:01:43 So I wanted to start off with the hardest question I could possibly ask you. And the question goes like this. Imagine that you have a young kid or somebody from high school that comes up to you and says, hey, I know you're in finance, you're in investing. So what's going on with the market today? How would you respond to that kid knowing that they literally know nothing about the market. I would say that we basically have a huge clash right now between the largest economic shock that we've had in generations, contrasted with the largest ever government response to basically help as many people as possible, help as many companies as possible. At least that's what they're trying to do. And we have these two forces cladding into each other in ways that are unexpected to a lot of

Starting point is 00:02:30 market participants because it's not something they've seen generally in their lifetimes. And you have to go back and history books to find eras where situations like this played out. And more broadly, we're likely at the end of a long-term debt cycle, which is Ray Dalio's terminology for these multi-generational periods of debt accumulation. So most people are familiar with the business cycle, which is, you know, the five to 10-year cycle where companies, households take on more debt and they expand. Then, you know, there's a recession, they run into a problem, and then they have to de-leverage. They have to reduce their debt levels as percentage of their income as percentage of all those different metrics. But every time that cycle plays out, it never resets really back to the previous level. It always resets to kind of

Starting point is 00:03:15 like a middle layer and then it builds from there. So over the course of five or ten of those cycles, you end up with so much debt in the system relative to GDP, relative to the money supply, that a normal de-leveraging event doesn't cut it. Basically hit the point where it's mathematically impossible to even kind of de-leverage in real terms. So these events are generally, associated with currency devaluations, where governments end up printing a ton of money and basically trying to bail out the system nominally by losing value in the currency. And that's kind of the environment we've been in. We really kind of started it back in 2008, but this is kind of part two of that playing out.

Starting point is 00:03:52 And the virus was a catalyst, but the virus came along to a highly indebted global system, not just at the company and the household level, but at the sovereign level. Lynn, before COVID-19 hit, and you saw this bubble building up, you heard people saying, yes, we know it's a bubble, but it would look very different than 2008 whenever it pops. What would you say to that person now? I would say in some way it's not because, for example, in 2008-09, most of the leverage was in the banking system. So real estate was overvalued and banks had over-leveraged on real estate. So when that all came down, the epicenter of it was in the housing market and everyone else suffered as a result of that.

Starting point is 00:04:36 But that it kind of emanated from the housing and real estate banking sector. Whereas this time, because of these regulations on banks now, due to the aftermath of that, banks came into this with more conservative lending standards, higher reserves, more defenses against a calamity. However, it's the rest of the system that went down really hard. So millions of small businesses, households are just suddenly without income, just completely cut off. Global trade slowed down dramatically. And so it's more in the real economy that everything has really kind of collapsed. And of course, then the banks, because they're leveraged to the economy, they're severely impacted, but they're not the epicenter this time. And in addition, what's different is last time we had a private debt bubble. So private debt as a percentage of GDP was

Starting point is 00:05:23 extraordinarily high, whereas federal debt as a percentage of GDP was moderate. So we had maybe 65% federal debt to GDP. But as part of billing out that previous crisis, a lot of that leverage moved up to the sovereign level. So household sector deleveraged a little bit, mostly because people lost homes. The corporate sector temporarily kind of de-leverage, but then releveraged rate back up. But the sovereign level jumped dramatically. So they went from 60-something percent of GDP, up to over 100% of GDP in treasury debt. And we went into this crisis with about 106% federal debt to GDP. And due to the scale of this crisis,

Starting point is 00:06:00 we're already at 120% of GDP months later. And the previous crisis took many years of massive deficits and huge amounts of stimulus to try to get those jobs back. And we're going into this with over 100% of debt to GDP. So this is more at the sovereign level now. And so you're effectively saying this is going to be a lot worse than 2008, 2009. At least a lot messier, yeah. Okay, so you're a person that shares a lot of charts repricing the major indices in other forms of currency other than Fiat currency.

Starting point is 00:06:33 Explain what you're doing with that and what it all means. Sure. So most of us are conditioned to think of our currencies as things that don't change. Like that's the denominator and are measuring something else in a unit that doesn't. doesn't change much. And only people from certain markets that have experienced dramatic inflation kind of have that awareness. Whereas those of us in developed markets, we kind of take it for granted that dollar is a dollar. It doesn't change much. We can have faith that it's roughly worth the same next year as it is this year. Go over a long enough period of time, the dollar loses a ton of value

Starting point is 00:07:08 over years and decades. So if you look at the chart of, say, the Dow Jones over the past century, it goes up exponentially. And in fact, all of those earlier, like, massive crashes look tiny on the chart because there are such small numbers compared to where it is today. But back then, decades ago, the dollar used to be backed by gold. So, and they had kind of more smaller kind of federal government. They had less leverage in the system.

Starting point is 00:07:35 And the dollar didn't change a ton over years and decades. So if you repriced the whole Dow Jones or the past century in gold, which is kind of like going back to something like the original dollar, and just kind of seeing how it does then, the Dow actually hasn't really increased when priced in gold. It's had this big sign wave pattern where it's gone up, it's gone down, it's gone up again, it's gone down, and it's only had a very mild upward trajectory,

Starting point is 00:08:02 and it's where it was literally decades ago. And so most of the returns from the Dow when priced in gold are from dividends, so from reinvesting dividends. but the actual stock prices themselves have not really increased as a whole relative to gold. And that's because you're basically normalizing for the devaluation of currency. So a lot of the nominal return you see in the stock market are due to inflation. So if you denominated the stock market using ounces of gold as you're measuring stick, what would it look like?

Starting point is 00:08:32 A lot of us think of the market having peaked at the beginning of this year and then having falled pretty far if you think of it in dollar terms. and then we kind of bounced back up that level. But if you look at it in gold terms, it actually peaked back in 2018. So around quarter three of 2018, it peaked, and then it's had a series of lower lows and lower highs ever since. And that mostly corresponds to the fact that if you look at GDP growth, but you look at it in rate of change terms. So you say, okay, we were growing by a certain rate in 2016. We were growing at a faster rate in 2017.

Starting point is 00:09:05 We were still growing at a very fast rate in 2018, but then we started to slow down. And then by 2019, we were slowing down pretty considerably. So we were actually declining GDP growth in rate of change terms. And roughly when that peaked is when the S&P 500 started to decline as priced in gold. Talk to us a little bit about some of the policy tools moving forward. Because I think most people at this point are familiar with quantitative easing because they've heard it so much. They might not understand the mechanics of it. But talk to us about the further use of that tool combined with other.

Starting point is 00:09:39 other tools that the central banks are going to use moving forward? So part of what makes this kind of the end of a long-term debt cycle rather than just the short-term business cycle is that we're at the end of kind of a 40-year interest rate cycle, which is back about 40 years ago around 1980, interest rates peaked. And ever since then, we've been on a disinflationary trend. So lower and lower inflation levels. The world's globalized and outsourced a lot of its manufacturing, so we've benefited from kind of cheaper labor. And we've had massive increases in technology and other things that have really resulted in much lower inflation. So we've had every time that the business cycle has trouble, one of the Federal Reserve's tools is they

Starting point is 00:10:20 can lower interest rates, and that kind of eases credit conditions, and then they try to retighten them a little bit. But if you look at the 40-year cycle, it's gone down. And over the past decade, we started to run into the zero bound where they cut interest rates and they hit zero, and then there's nothing else to do. So at that point, they turn to quantitative easing, which is the modern phrase for money printing, essentially. They create new dollars, and then they buy whatever they want. So they start with treasuries, they buy treasuries, then they buy mortgage-backed securities, and that's often described as an asset swap. It's like, okay, it doesn't matter. You're just swapping dollars for treasuries or dollars from mortgage-back securities. But the magic happens

Starting point is 00:11:00 in the step before then, because they just create the dollars out of nothing. and then exchange that dollar for something that exists in the system, like a treasurer, mortgage-backed security. So the Federal Reserve is basically injecting dollars in the economy, taking some of those assets out of the economy, and so that those players, like those banks and those other institutions, have more capital on hand so that they can then reinvest it into buying more of those securities or buying other types of securities, including equities. And so as we've hit the zero bound, they've turned more and more and more towards money printing as their way to ease financial conditions in their view.

Starting point is 00:11:36 Via quantitative easing. Yeah. Interesting. Which other tools do you think that they will use, including UBI, do you think we'll see more of that? One of the also, the shortcomings of reaching this point in the debt cycle is that there's only so many assets they can realistically buy. So they have legal limits for what they can buy, so treasuries, mortgage-backed securities.

Starting point is 00:11:56 They've started to kind of bend the rules by getting around the letter of the law, but not really the spirit of the law by buying corporate bonds, right? Because they're not really supposed to buy them, but they set up a special purpose vehicle with the treasury. So the Fed can say, we're not buying them. This special purpose vehicle is buying them. And we're just working with the Treasury to finance and do the purchases. So it's not on the Fed balance sheet. It's just financed by the Fed. They pulled that off. But even then, they kind of run into the point where even monetary policy is not a ton left to do. And that's when it becomes more of a fiscal policy. So that's why even in Powell's most recent press conferences, a number of times, both in interviews and press conferences, he's called for more fiscal, which is actually kind of an orthodox because usually the Federal Reserve doesn't go into politics. They try to be independent instead of saying this is what the government should do.

Starting point is 00:12:46 Now, fiscal can actually, it can be kind of right-leaning or left-leaning. It could be tax cuts or it could be spending or could be both. So what he's saying is you need to throw money at the problem. UBI is an example of that, the $1,200 checks that people were receiving. earlier this year as an example, the 600 a week in extra federal unemployment is an example, massive corporate bailouts, PPP loans, that's all fiscal. And the Fed's still relevant there because they're the ones monetizing it. So when the Treasury issues like $3 trillion in treasuries to pay for all that, under older systems, they would extract that from the economy. So someone with dollars would buy those treasuries. It goes to the primary dealer banks, but essentially people have dollars, they buy treasuries. So the treasury is basically extracting dollars from the economy

Starting point is 00:13:32 and then redeploying them back somewhere else in the economy. But in an error of QE, the Federal Reserve just creates new dollars and then buys those treasuries through the primary dealers. So we're basically pulling dollars out of nowhere and then injecting those dollars into the economy via the fiscal route. So the Federal Reserve becomes the financing arm and the treasury becomes kind of the spending arm. And that's kind of where we are now.

Starting point is 00:13:56 And so for a person that hears that, and they say, well, why aren't we just doing it like they used to where they would issue them? They'd pull the cash out and then they'd reappropriated into some other type of use. Why are they going right into the printing of it instead of the way that they would have done it 40, 50, 60 years ago? That's because the debt level is so high. So back when debt levels were 20%, 30%, 40% of GDP, there's more appetite. There's more private balance sheet space to buy those treasuries. And, for decades, we've relied on international lenders. So the way that the global monetary system set up, we run persistent trade deficits. So we send dollars to the rest of the world. We consume more than we produce. So we have trade deficit. We export dollars. And then foreign countries, they reinvest a lot of those dollars into buying treasuries as, you know, to have foreign exchange reserves and to have safe investments. So we've had a multi-decade period where we could benefit from that. We could increase federal debt to GDP from 30% up to 100%.

Starting point is 00:14:56 But once you're at about 100%, there's so much already out there that when they're issuing trillions and trillions more, there's no buyers, especially because if you look at it as say the federal debt to how much money supply there is, for example, there's ratios like that you can look at. And there's not enough dollars in the system if banks are trying to maintain certain regulatory limits, so they don't want to go too low on cash, but someone else to buy the treasuries. Pensions aren't growing. So what do you do? The Federal Reserve basically just prints dollars and then buys treasuries. So they shift to debt monetization for lack of available

Starting point is 00:15:30 buyers, essentially. Keeping that in mind, to say that I was a person who is ready to retire and I can't afford to take on too much risk. Bonds are not looking attractive. You mentioned the issues with equities before. How should I build my portfolio? Well, a lot of pension-type things are somewhat indexed to inflation, but they rely on official measures of inflation, which are not necessarily telling them the whole picture and generally understating the real kind of cost increases that are happening. So for me, like if I was in that position, I'd want to have harder assets. So I'd want to have, say, a home that's either paid off or finance with low fixed rate debt. I'd want to have precious metals. It's not something that a lot of people invest

Starting point is 00:16:14 in these days, but historically, that's been a store of wealth, and that's generally very well on inflationary environments, as well as slower inflationary environments. It just kind of grinds up over time and maintains its purchasing power. I'd want to have equities as well, but generally diversified equities and not too much, not like an overemphasis and equity exposure. And then mainly relying on things like cash and treasuries for liquidity rather than as a store of value. It's more of a medium of exchange, but not really a store of value. To be able to swap into an opportunity or something that would present itself as an opportunity? Yeah, as a volatility. reducer and because people have tax payments to make, they have purchases to make, so they have to

Starting point is 00:16:53 maintain a certain amount of liquidity. In an environment like decades ago where banks and treasuries paid you a higher interest rate than the inflation rate, you could safely put your money in those investments and then get a return that at least equals inflation. So you're not losing purchasing power and in some cases you're growing your purchasing power. But in this current environment, interest rates on those types of investments are generally lower than the run rate of inflation. So even though we can have a quarter or two of really low inflation levels over the next, say, year, a couple of years, those rates are below the inflation level. So you're basically guaranteed to gradually lose purchasing power and possibly lose it more

Starting point is 00:17:30 quickly if we enter a truly more inflationary environment. I'm curious, giving everything that's been happening with COVID-19, which questions do you hear from your clients and others who trust you as their advisor? People just don't know what to do. Like people just say, should I be in bond? Should I be in equity? Should I be in precious metals? And of course, for every person, it's kind of their own unique situation, right? So the answer for someone who's 20 is probably different than the answer for someone who's 80. But in this environment, we've had, because of this 40-year period of disinflation, we've kind of programmed our financial

Starting point is 00:18:04 system that older investors should have more money in bonds, which for most of that period has been good advice. It's lower volatility, and they've consistently generated positive real returns because the industry rates have been above the inflation rate. But now that we're in this environment where interest rates no longer keep up with inflation, I think we have to kind of challenge that notion a little bit and move back some of that capital into something like gold and other kind of harder assets if you want to kind of maintain purchasing power. Let's take a quick break and hear from today's sponsors.

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Starting point is 00:22:33 slash WSB. That's Shopify.com slash WSB. All right. Back to the show. So we were talking a little bit earlier about the monetization of debt. I know yourself, Luke Roman and others are out there saying, hey, it's just a one for one at this point where pretty much every obligation that is put out there here in the U.S. is being just monetized into the debt. So when we look at other countries around the world, Europe, Japan, they're doing the exact same thing. So I'm of the opinion we're starting to see this competitive devaluation phase. I'm kind of curious if you see it the same way or if you would describe it differently and what are the implications if true. I think part of it is competitive devaluation. I like to look at it in rate of change terms again. So if you look back, say,

Starting point is 00:23:28 from the period of 2014 to 2019, that's when the Federal Reserve ended QE, So they stopped printing money. That was their final round of QE. And then they had several years when they weren't printing money. The treasures they were issued were kind of actually bought by real buyers, mostly domestic buyers. And then actually they started that period of quantitative tightening. So the Federal Reserve was actually selling some of their assets. Starting in September of 2019, they basically hit that point where they were not enough buyers anymore. So the Federal Reserve had to begin buying again. So if you look at that five-year period, the Federal Reserve, the U.S. was one of the tightest markets. So Japan was still doing quantized.

Starting point is 00:24:04 quantitative easing. Europe, earlier in that period, was doing quantitative easing, then they started to slow down, whereas the Fed was the tightest. However, since September, Fed's actually been the loosest. So we've actually printed money faster. However you want to measure it, you can measure it as a percentage of GDP, as a percentage of where the balance sheet was before, or just absolute terms. The Federal Reserve has been the most aggressive printer. So going forward, a lot of us can come down to how hard these economies were impacted by the virus and their ability to recover from it. So currently, the U.S. actually has higher unemployment rates than some of our peers, like Germany and Japan. Our economy structured a little bit differently. We have different types of programs in place.

Starting point is 00:24:42 So we're actually kind of at the moment running at a higher rate of change money printing. Going forward, I think we're going to kind of leapfrog each other a little bit. You know, I think we're going to have peers where different regions are the ones that are doing faster printing. Actually, my base case is that the U.S. will probably be a more aggressive printer than a lot of our major peers. I think, you know, of course, some of the emerging markets will print faster, but our major peers, like as my base case, I'd expect the U.S. to probably outpace them. So everyone listening to this would likely be thinking, how long is the money printing going to last? What would your response be to that? I think it's going to be years.

Starting point is 00:25:17 There is kind of an endgame, but that endgame is probably years away. So I think we're at the part where they're going to print for many years, and then they're going to do yield curve control to lock treasuries and other sovereign bonds below. the inflation rate. I guess I'm of the opinion that when I look at what these policies have done over the last 10 years, specifically with QE, I think that a lot of the social unrest that we're seeing around the world right now as a result of these policies. So if we do more of those and we're doing them at an even more aggressive pace, are we accelerating this social unrest that we're seeing today? Or do you see those as two different issues? I think they're definitely related. That's

Starting point is 00:26:00 been a big part of it. But one shift we have going forward is that most of the printing over the past decade was not really used for fiscal spending. It was mostly used in the financial sector. Like I mentioned before, banks came into the 2010-A crisis with very little cash on here. They were highly leveraged. They had basically no reserves. They had something like 3% cash as a percentage of assets. And during the crisis, the Federal Reserve printed money and bought some of their assets. So they bought mortgage-backed securities, and they eventually started buying treasuries. And they filled those banks up so that they now had 8% cash as a percentage of assets. And then by QE3 in 2014, those banks, they did another round of quantitative easing and they filled those banks up to

Starting point is 00:26:41 about 15% cash as a percentage of assets. And that was their high watermark. So a lot of that money printing was buying financial assets, trying to create the wealth effect of boosting up stock prices, recapitalizing banks. And none of that really got to Main Street. Like there were small programs like cash for clunkers and expanded unemployment benefits for a while. But that was measured in like the hundreds of billion. It wasn't a massive amount. Whereas going forward, because there's so much wealth concentration as a result of these decades of fiscal and monetary policy, throughout the point now where most of the population just can't go months without a paycheck, just completely insolvent if they don't get income. And that's why we saw one of the most

Starting point is 00:27:17 bipartisan actions of Congress who've ever seen, which is to instantly send everyone $1,200 checks. I mean, months ago in the presidential race, Andrew Yang was considered controversial. It's different shades of Andrew Yang now. Everybody's Andrew Yang. We're in an environment now where a lot of this QE that's going to happen is going to be to fund these programs that get to the people. And I think we're going to see an interplay where whenever they try to taper that, they're going to risk more social unrest because they're so high unemployment. And we're already starting from such a terrible low of wealth concentration that it's going to be this kind of game back and forth where whenever they're not doing enough fiscal, we're going to see more civil unrest. when they do fiscal, then we see currency devaluation and debasement.

Starting point is 00:28:02 I'm a little surprised that we haven't seen the second, third, fourth type UBI checks coming out. We had the first round. And is that more politics that's entering into why they haven't done the second and third and basically set it up as a monthly kind of thing? Or is that coming here in the short term future? So it's partly politics and also partly timing. So some of the Democrats that proposed already those monthly supports, whereas the Republican generally opposed that. So you had a little bit of a kind of a partisan thing going on.

Starting point is 00:28:34 But it's also about timing. So they did in the beginning the $1,200 checks. If they actually look at their personal income went up in April for the nation as a whole rather than down. Because a lot of people didn't lose their jobs and they still got $1,200 checks. And then other people lost their jobs, but then they got these $600 a week in extra unemployment benefits on top of their state unemployment benefits. So they actually made more money. So there are some people that lost more money than they got, but there are a lot of people that actually got more money than they otherwise would have.

Starting point is 00:29:02 So we kind of front-loaded that a little bit. So people got a really good April and then a pretty decent bay. Now, a thing to watch is at the end of July, the $600 a week and extra federal unemployment benefits goes away under the current act. So that's why we kind of haven't really seen another big fiscal injection yet is because the other one kind of brought us through the end of July. Right. So people that have jobs, they're doing okay. The people that do and have jobs are getting their state unemployment, plus they're getting 600 a week and extra federal unemployment. And that's, you know, a ton of money for a lot of people. So even though the presidents are already talking about doing another round of fiscal, the Democrats are wanting to another round of fiscal. The Republicans, for the most part, want to do another round of fiscal, but they would generally want to have a smaller version of it. That conversation really expanding starts to become important as we get into July. That's when the current money taps kind of come to an end. interesting.

Starting point is 00:29:53 So, Lynn, I heard you talking about weaponizing swap lines. Could you please explain what that concept means and whether you think that the U.S. has the incentive to do that? So what people refer to when they talk about weaponizing swap lines is that because the dollar is the global reserve currency, right? So we've had decades of most international trade happening in dollars. So even if France buys oil from another country, even though the dollar is not any of their currencies, they still pay for that transaction in dollars. So as a result of that, most countries

Starting point is 00:30:25 have a lot of treasuries on hand for foreign exchange reserves. And whenever there's, say, you're loaning to an emerging market company, it's often done in dollars, you know, rather than doing it in their local currency. So it gives the lender kind of a protection against currency devaluations that are common in emerging markets. But at a result of all this, the world has about $12 trillion in dollar-dominated debt that is in companies and countries that are not based in the U.S. So, like, the Argentinian government has dollar-dominated debt or bank in Europe that has some dollar liabilities. And they total at least $12 trillion. Now, there's actually other ways of measuring it. You can get up to kind of higher numbers, but that's kind of the baseline to start

Starting point is 00:31:05 with. It's like at least $12 trillion. And so when we have a slowdown in trade, so when we have kind of the COVID crisis or any other major recession, trade slows down, oil prices fall. So there's less dollar trade between countries. But those countries still have those dollar debts and they still have payments to make on those dollar debts. So if their currency is weakening compared to the dollar and they have to get dollars to make their payments, we have this kind of period where everybody wants dollars at the same time. So it's not necessarily that the dollar is good or that it's steady, it's that they need dollars to service their debts. And so what generally happens is that the Federal Reserve then tries to ease this by loaning dollars to some

Starting point is 00:31:45 foreign central banks in exchange for some of their currency as collateral. These are called swap lines. So we swap currencies with major ally countries. And that helps them relieve their dollar shortage. But the Federal Reserve doesn't do this out of the kindness of their heart. We're not just bailing out Europe for the fun of it because we like them. They're doing it because Europeans and other countries own so much U.S. assets, whether it be treasuries, U.S. stocks, they don't want them to have to sell those assets to get dollars, because that just drains liquidity from our market. So the Fed says, okay, stop selling everything. We'll give you some dollars. You give us some euros and some yen. We'll hold that. Make sure you pay us back. But you go and just stop selling

Starting point is 00:32:22 our stuff. Now, some people are with their opinion that the U.S. could use these swap lines more aggressively and say, we're not going to give you a swap line unless you meet these conditions. Whereas my view has generally been that they've been pretty liberal swat lines, not because they're being kind, but because they pretty much have to. So if you look back in March, for example, at first, when this whole crisis happened, people started buying treasuries, which is normal because they want to rush into a safe haven asset. So treasury yields were driven to very low levels because there's so much buying. But if you look at mid-March, during the absolute worst part of the equity sell-off, treasury yields started a spike. They started to go up dramatically for about two weeks. And that's a really odd behavior to happen in such a sharp sell-off.

Starting point is 00:33:04 Why would you sell treasuries? Everybody would normally be going towards treasuries. And that's because foreigners started selling hundreds of billions of dollars in treasuries because they were so short dollars that they were turning to treasuries basically a box of dollars. They can sell that. They can get dollars. They can service their debts. So that's when the Federal Reserve said, okay, now it's serious.

Starting point is 00:33:24 They started doing QE. They started doing swap lines. And they said, just please stop selling our treasuries. Here's dollars. We'll take some euros, and that kind of helped ease that liquidity condition. So that's kind of the debate that's going on is will the U.S. kind of continue to maintain those adequate dollar lines or will they try to be more selective with who they use them with? So, Lynn, you were one of the first people to really start talking about the Fang stocks and the NASDAQ

Starting point is 00:33:50 breaking out after the COVID crash way before anybody else was talking about it. So huge kudos to you for being so in front of that. What's happening? Why are we seeing the NASDAQ get bid? Why are we seeing the Fang stocks just taking over? And pretty much everything else in the index is way underperforming. So, yeah, there was an early move in by investors to shift assets into stocks that they think are not very impacted by the virus or even benefit from the virus. You know, example would be Zoom, other online companies.

Starting point is 00:34:23 So at best, some of those companies are just not impacted, right? So Google's not that impacted. Apple's not that impacted. Whereas if you're a closed retailer, right? So if you're Coles or you're Macy's and you're literally forced to shut down, you're more screwed. Right. So we had a big kind of divergence between the top few stocks and the index, which happened to be all these big tech stocks that are more comfortably immune from it versus all these other companies,

Starting point is 00:34:47 these commodity producers, these retailers, these industrial companies that are more cyclical, that have more hardware investments, like capital investments that they have to do. So we've had kind of a huge divide. And in my view, back in March and April, that got to a point where a lot of those beaten down stocks were actually oversold, right? They were being priced for near certain bankruptcy. Whereas a lot of these NASDAQ stocks, in my opinion, are dramatically priced. Right.

Starting point is 00:35:13 So software companies and all these big megacacac companies are priced at such high levels that even if they do great over the next 10 years. 15 years and 20 years. If you do discount cashful analysis on them, a lot of them just don't have very attractive returns. And it's kind of pricing in the assumption that inflation is going to stay very low, that the discount rate is going to be near zero, and that these companies that have kind of steady incomes, even at very high valuations, will do fine. And it looks a lot like the 1960s, nifty, 50 period, where a lot of those companies back then became so overvalued that even though they continued to do well fundamentally for decades, they had terrible

Starting point is 00:35:52 return for the next 10 years. Keep that in mind, do you own any individual stocks that you think will hold up especially well if we see a second wave of COVID-19? So I try to say diversified, but some of the companies I've been highlighting lately are some of those really beaten down ones that actually have some of the strongest bound sheets in their industry. So, for example, I highlighted a South American brewer, Ambet, right? So they produce different types of beers and other drinks throughout South America.

Starting point is 00:36:22 And they, if you look at most major beer producers, they actually have a ton of debt, just a massive amount of debt. There are a couple of exceptions. The big ones often have a ton of debt, whereas that company has no net debt. They have more cash than debt on their balance sheet. So they have a fortress financial position. So even though they were impacted, they had shifted down from very high valuations to very low valuations. So I've been highlighting that stock as an example.

Starting point is 00:36:45 I've also like some others, like New Core Steel, for example, they have one of the strongest balance sheets in the steel industry. So if you start with the assumption that the entire steel industry won't go bankrupt, you say, okay, what is the strongest one? Which ones have handled previous recessions way better? For example, they never had to lay people off in 2009, which is kind of a lot to say for a steel company. It's so highly cyclical, but they don't really have to do layoffs because of how well they manage themselves through those down periods. So my view's been kind of finding these kind of high quality companies that have nonetheless been highly impacted by the virus with anticipation that as it normalizes, they'll be able to capitalize on it compared to some of their weaker competitors. How about you mentioned gold earlier? How about some gold miners or some minor stocks? I started being bullish on gold miners in Q3 of 2018.

Starting point is 00:37:35 So I'd call it the first wave of that played out pretty well. So we've had pretty big outperformance of gold miners compared to the S&P. 500 since that time because even though the SP 500 kind of chopped along and did okay since that time gold miners really kind of took off the time that I kind of pounded the table again on gold miners was during that March sell-off even though gold held up pretty well gold miners sold off very sharply they actually showed off even sharper than the S&B 500 which is counterintuitive there was like weird dislocations because the market was so illiquid so like the major gold miner ETF was trading at a major discount to nav which is something like

Starting point is 00:38:11 like 6% below NAF. So it made absolutely no sense. So that was kind of another giant buying opportunity in those gold miners. Now I still like them, but we've already had kind of a nice stretch. And we've had a period of consolidation lately. So actually, I'm still bullish. I still hold gold miners. But I like gold.

Starting point is 00:38:27 I like silver. I like gold miners. And I'm increasingly diversifying a little bit more into base commodity producers. So copper producers and some of the energy stocks that have pretty good balance sheets. I'm kind of diversifying more into other types of commodities while also retaining my gold positions. As we look at the equity market measured in US dollars all the next 12 months, what is your base case and what would really surprise you? My base case is a choppy sideways pattern. I don't know if we're going to have lower lows or lower highs. My base case is not

Starting point is 00:38:57 really to expect lower lows in nominal terms. And I don't necessarily expect either, you know, somewhat higher highs, but not like way higher. I think in this next year, we're kind in this sideways pattern as my base case. I do have a high conviction. I don't know over the next year, but definitely over the longer term, that the S&P 500 as priced in gold will probably continue to go down. Whereas in nominal terms, as priced in dollars, I continue to expect it to be kind of choppy. One of the things I'm tracking is to see if we have rotation out of some of those highly valued mega caps, companies like Apple and Google, into some of those inflation hedge type of investments, like commodity producers, higher gold, minor valuations, industrials, real estate,

Starting point is 00:39:38 things like that. Well, things that have scarcity and that are not too expensive. So, for example, even some of those mega cap companies, they have scarcity in a sense. Like they have certain type of technology, a certain brand. They generate very good cash flows returned on invested capital. But because they're so expensive that they can easily have multiple contraction, right? So their valuations can decline and offset the fact that fundamentally they'll probably do okay. Whereas a lot of those cheaper companies that have scarcity, they have that balance sheet to get through rough times, they're the ones that really have some upside potential if we have a more reflationary environment or even a stagflationary environment.

Starting point is 00:40:15 You've been very local about the huge increase in monetary supply and the impact it has had and will have in the time to come. Could you please elaborate on that land? We've literally increased the money supply by 20 or 25% in the past six months, just an outrageous amount. And so going forward, I think people are underestimating how much fiscal. spending would have to be done in order to avoid a big deflationary shock here. So we have so many deflationary forces. All of this debt is deflationary. All of the near

Starting point is 00:40:46 insolvency so many people have, you know, those $1,200 checks were lifelines to them. So it's like they're in a situation now where we're either going to have a big deflationary crunch or the amount of fiscal that is all basically monetized by the Fed is going to be bigger than people expect. So we're either going to get that really low nominal price level or we're going to get something that equity market kind of levitates, but at the cost of all this fiscal kind of propping everything up. And that's why in that sort of environment, I'd want to have access to scarce assets that are at reasonable valuations. So when we talked earlier about yield control and the Fed basically stepping in and buying anything and everything in order to

Starting point is 00:41:28 fix all the different yields on the bond yield curve at a certain percent to keep it positively sloped and all those things. And I'm sure when we say positively sloped, it's not by much. It's like the long tail will be 50 basis points for all we know in a year from now. When we think about the implications of that moving forward and we think about how everything comes down to the cost of capital for the valuations of equities, how is a person, especially somebody coming out of business school or who just learned how to do a discount cash flow model, what do you say to a person like that when the cost of capital is at zero or it's next to nothing and they're doing these valuations and these prices that are sky high. How would you tell somebody to think about valuations

Starting point is 00:42:14 in a world like that? That's actually one of the biggest challenges at the moment because by most metrics, the broad stock market is incredibly overvalued. But the one metric where it's not is the equity risk premium. So if you compare, for example, the price or earnings ratio of the S&P 500 or even the cyclically adjusted version or even the dividend yield. If you take some of those percentages and you compare them to the 10-year interest rate, for example, on the 10-year treasury, that's actually pretty wide, right? So there's a pretty big kind of gap for equities being undervalued relative to how bonds are. It's kind of like saying equities are overvalued, but bonds are arguably even more overvalued, right? So we're in this really tricky environment where there's not a lot of return potential from

Starting point is 00:42:58 those major asset classes, like major equity indices or bonds in real terms. So one way I would kind of think about it is to do discounted cash flow analysis using my expected inflation rate as the discount rate, rather than using something that is basically price fixed, because that's not going to capture a real return. That's going to capture an artificial return. So we've kind of faced the possibility that if the market starts using higher discount rates to adjust for inflation, some of these mega cap companies could be devalued in terms of what multiples the market's willing to pay. So let's talk about how an investor can go about finding an appropriate discount rate, because what you're saying is that inflation, at least the way we conventionally measure it,

Starting point is 00:43:44 the CPI number, is understating the real inflation. Which discount rate would you suggest investors to use? One way to measure it is the growth in money supply annualized. For most past 10 years, the growth of money supply was over 5%. But then because of this massive spike towards the end of it, now it's more like 8% of the past 10 years. We've really kind of backloaded it. Annually, that's a kegger. Yeah.

Starting point is 00:44:13 Wow. 8%. Interesting. Yeah. So that's kind of a baseline. But going forward, it could be probably even more than that. So there's kind of different scenarios you can run if you want to get really wonky and into the depths of it. You can see you can do ratios like what would the money supply have to be to get to a debt to money supply ratio that was back where it was before we had these big debt bubbles.

Starting point is 00:44:35 And you say, okay, that's the money supply by the end of this period. How long do I think it's going to take to get there? What is the growth rate between now and then? So if you assume kind of these more tapered scenarios, you can kind of calculate different inflation rates that get you there. But overall, yeah, they're kind of pretty high. to not like the 1% or less treasury yields we see. Let's take a quick break and hear from today's sponsors. No, it's not your imagination.

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Starting point is 00:48:01 Carefully consider the investment material before investing, including objectives, risks, charges, and expenses. This and other information can be found in the income fund's prospectus at fundrise.com slash income. This is a paid advertisement. All right. Back to the show. And that's a really unpopular opinion. I suspect for a lot of people in academia that are just hung up on the idea that CPI is pretty much the holy grail of what an inflation rate is and not really thinking outside the box on maybe money supply. I completely agree with you, Lynn. I think that's a really great comment. One of the last ones I got for you. And I saw recently that, and I don't know when you started putting this in your portfolio,

Starting point is 00:48:43 but I saw that you have a position in Bitcoin. I'm kind of curious what your thoughts are on it. I added Bitcoin in April of this year. So it was around just under $7,000 at the time. And the reason I did that is, so I started covering Bitcoin on my website in 2017, because that's when we had that giant run up in price. And so, of course, I got email after email, asked me about it. So years before that, I had been aware.

Starting point is 00:49:07 of Bitcoin. I actually knew someone that she was like mining Bitcoin on her computer. That's how long ago, like, I was like, that's neat. So I knew the idea of it, but I just kind of considered it almost like a microcap, like cool thing that's happening. But of course, when 2017 came around, we got this pretty sizable move up. So I got tons of emails. So I did a pretty big long form article on it. And I tried to say, okay, let's value it in different ways. So I said, okay, at the time, we can value it as a medium of exchange, or we can value it as a store value. And we can kind of just play with different scenarios. I took the full like Bitcoin market cap and I compared it to say the money supply market cap of different countries. And I said, okay, how many people does that country have? What is their GDP?

Starting point is 00:49:49 How does that compare to how much economic activities happening in Bitcoin? My calculation at the time was that Bitcoin had a very large market cap compared to how much economic activity that was probably happening in it. So it's kind of price as a growth stock. You could call it. It was price as though it was going to explode in that scenario. The other way to look at it, it is a store of value. So if the entire world put 1% of portfolio in Bitcoin, what would that be? What would the size of Bitcoin have to be in order to have it so that everyone can have 1%. And then you say, okay, what if you want to do it with 3% or 5% or half percent? Using that model, that showed that Bitcoin was actually still pretty cheap in many terms,

Starting point is 00:50:23 if Bitcoin ever took off. And my concern at the time was that there was also kind of the rise of all coins at the time. So we had Bitcoin dominance fall from nearly 100% down to the to briefly went under 50% for a while. So my concern was, although Bitcoin is scarce as a protocol, anyone can technically create a cryptocurrency because it's known how to do it now ever since they figured it out. So it was kind of more like a question about the network effect. So anyone can create, for example, a social media website. The coding is not that hard, but it's almost impossible to create the next Facebook, right? Because basically your code is worthless until you have enough adoption, until you have enough security, until you have this trust in

Starting point is 00:51:02 the protocol. So back then, I concluded by saying, I don't really want to have a position. I think it's very speculative. I don't think it's a bubble. I'm not criticizing it, but I don't see a ton of value at the moment. And I'm concerned about whether or not Bitcoin's going to retain market share. And that was also the period when we were having Bitcoin cash fork out of it. So I just kind of put that on the back burner and said, okay, I think it's not something I want to touch at the moment, but I'll keep monitoring it. And over the next two and a half years, so we had Bitcoin. Back then when I did that article, Bitcoin was about $7,000. It was something like $6,800. And

Starting point is 00:51:34 And then, of course, the rest of the year, it sworeed up to 20,000. Then it felled. Then it came back up to like 12,000. Then at the beginning of this year, it fell down to like 4,000 again. But in April of this year, when it started to recover from that low and got up to about 6,800 again, it kind of did this big round trip to the same price that I analyzed it two and a half years ago. And it behaved a lot like gold did during the selloff where when there was a liquidity crunch, Bitcoin sold off, but then it started to recover. I was also aware of the happening event that was happening. And kind of the the different things that are happening timing-wise there. And then Bitcoin dominance, so we've had kind of a falloff in all of these other cryptocurrencies, and Bitcoin's retained up to about two-thirds of the total market cap of the space. So my view of its network effect strengthened, and it had another two and a half years of trial and error, basically. So we have a full decade of history now. We have a pretty strong network effect.

Starting point is 00:52:28 It didn't get diluted by those forks that happened. It didn't really get diluted by those alt coins. So the combination of the protocol being very efficient and seeing more and more evidence of Bitcoin-specific network effect made me want to have a position as a scarce asset. Lynn, I can't tell you, even more impressed after talking to you. I was already super impressed following your feed, but so impressed with your discussion points and just how thoughtful you are on all these different ideas. People want to learn more about you. Give them a handoff where they can find you. Sure.

Starting point is 00:53:02 I'm at Lynn Alden.com. I do a lot of free articles. I have a free newsletter and then I also have a research service. And I'm on Twitter at Lynn Alton Contact. And we'll have links to that in the show notes. I highly, highly encourage folks. Definitely follow Lynn on Twitter. Sign up for her newsletter.

Starting point is 00:53:21 Super valuable stuff. Lynn, thank you for coming on the Investors podcast. Thank you. All right, guys. As we're letting Lynn go, we move on to the next. next segment of the show, where we will be playing a question from the audience, and this question comes from Thomas. Hey, Preston.

Starting point is 00:53:38 Hey, Stig. My question today is about China. I've been reading a lot of Ray Dalio lately, and it seems that he believes China will be the next great empire. I do believe China has a lot of potential and see his point. On the other hand, I don't believe the rest of the developed world is very trusting of the Chinese Communist Party, and I see this as a major handicap to their ability to grow. What are your thoughts on this, and do you agree with Ray Dalio's viewpoint?

Starting point is 00:54:01 and if so, are you investing in Chinese companies? Thank you and keep up the good work. Great question, Thomas. It's hard to disagree with Redalio when you read through his write-ups and see how well-resourced it is. And I think that where he really does a good job is to zoom out and look at the rise and fall of empires throughout centuries. Because I think one of the mistakes that people make is that they think in terms of headlines

Starting point is 00:54:27 and what they read right now about China. and they might mistakenly think that big changes are happening tomorrow. What Dalton actually defined is that whenever you have an empire and an empire in this case could be the United States, it typically lasts 250 years before it's replaced, but it easily be 150 years shorter or longer, at least historically. Now, I still see the U.S. as being the dominant country for decades to come and perhaps longer, but I also don't think you should underestimate the historical

Starting point is 00:55:00 historical evidence that Radalia outlines for why we see that China will eventually rise and the U.S. fall. One example that Delhi brings up is the Dutch going back 250 years. And even though there was only between one and two million people, they actually invented the very first global resource currency, the Dutch gilder, who had accounted for a third of all international transactions. Now, as the power declined and the British slowly took over, they became deeply indebted. They became deeply indebted. The Dutch overspent. They had a lot of domestic problems, including social unrest due to inequality. They had political fractions not willing to compromise. And they also have significant disagreements between the provinces. And as a reaction to the English

Starting point is 00:55:47 gaining more military and political power, they also started several trade wars. And I don't know if you think that sounds familiar of what you're seeing today. But transitioning from one empire to the next does not necessarily happen fast, but where it can't happen fast is if you see a war. And that was how the British became the unrivaled world power right after fighting first the Dutch and then later the French in 1815. And you could also make the comparison to that was how the US swiftly took over from the British after World War I, even though they didn't even fight each other. And we've historically seen war 75% of the time when one empire rose and another one fell. Now, I don't want to say that unless there is a major war, that we won't see

Starting point is 00:56:37 insignificant changes. So what happens whenever we look into the future? What kind of significant changes can we expect? Well, first of all, I think it's important to say that some of the rules have changed. The gains and losses of going to war has changed. For instance, you're not going to war to get the enemy's gold and silver, today the riches of a country look very different and it can't be stolen or one if you like the same way. And it's also political much harder to go to war in a democracy than if you were a kingdom or a dictatorship. So today you have nuclear, you have cyber attack as an act of war. So it might look very different warfare than whenever you look back in history. Now, we could almost do an entire episode about this and we would

Starting point is 00:57:24 We might eventually do that, but going back to your question about investing. Yes, I do invest in China, and right now that's around 12% of my stock portfolio. I have some through an emerging market DCF where China accounts are 44%, but the majority of my exposure is through Alibaba. This is a stock that I pitched in Q1, 2019, at the mastermind meeting, and I'm seemingly just going to say that it's been up more than 35% since then. And you can hear much more about my reasons why I want to invest in the company. by going back and listen to the episode.

Starting point is 00:57:56 But a position like that is not so much influenced by China is going to be the new empire. It's going to be the most dominant country in the world. There are so many other factors much more important going into a decision like that. Now, I just wanted to mention one more thing. Whenever you talk about it being a major handicap that countries and the governments across the globe not trusting the Chinese, now I agree that there's a mistrust, but from an investor perspective, I'm not sure it makes much of a difference. And please forgive me for going back here in the history books, but going all the way back to the Monroe Doctrine in 1823, U.S. have had a major influence in

Starting point is 00:58:33 South America. And despite of the lack of trust in the U.S. government through time, it hasn't really changed the ultimate income of how those markets has been developed, going back to the U.S. or taking U.K.'s place as the world's dominant superpower. The lack of trust throughout the world also really stood out. And just like we've seen historically, China is also using soft powers to gain influence. Now, while the U.S. still dominates in South America, we've seen in Asia how Asian nations have formed alliances with the Chinese instead of the U.S. That's not just through one belt, one road that connects 70 countries and is controlled by the Chinese, but Chinese companies in some countries even have privileges that national companies do not.

Starting point is 00:59:15 And we've seen in Europe how the Chinese are buying more and more influence and insist on trading bilateral with EU countries instead of the entire bloc. And that clearly gives a lot of power to the Chinese. Europe, as a blog, actually has a bigger economy than China. But as they insist on negotiating with each single country, the situation obviously looks very different. The EU has not been good enough in terms of sticking together in those negotiations. Most noticeable, you have seen in Africa that was historically heavily influenced by Europeans that the Chinese are closely working with multiple governments. And if you're interested specifically in that, I can highly recommend a book called China's

Starting point is 00:59:58 Second Continent, written by Howard French. I read it three times already, and I can only recommend that you read it at least once. But before dragging on too much, I'm not saying that China's influence is not concerning and that you're not right whenever you say that there's a problem with mistrust in the Chinese government. But with power always comes mistrust and this time is just not different. So, Thomas, I look at this first from why is Ray Dalio talking about this and what kind of self-interest does he maybe have? And I think this is an important point to kind of think about. So Ray's firm, Bridgewater, 160 billion assets under management opened up a China unit

Starting point is 01:00:40 in 2016. And I think whenever a company like Bridgewater is looking at capturing more investors and to manage other people's money and they look at the Chinese market and how massive it is, I think he has an interest in order to capture some of those funds and play nice with the Chinese government, which anyone who wants to do business in China has to do, which really kind of gets at your point. Can that be trusted if people have to placate to the Chinese government, opposed to saying what they actually think? Now, how much of this conflict of interest that I'm bringing up plays into Ray Dalio personally or Bridgewater as a company? I have no idea how much their research is suggesting China is going to be a powerhouse versus how much they have a

Starting point is 01:01:33 self-interest in capturing some of those dollars. But I think it's an important point for people to think about anytime they hear Bridgewater or Ray Dalio talk about China. I personally look at the world as, you know, every single country in the world offers an opportunity for, for your hard-earned dollars to allocate into those countries in order to seek a return for owning a business that performs work in that area and providing products and services in that region of the world. So if it makes you uncomfortable, I would tell you, don't invest there. To be honest with you, personally, I don't really like the antics that the communist party that rules China the way that they play ball. So I don't invest there. That's just my personal preference. Those are some of my

Starting point is 01:02:17 thoughts. And I think that when we look at China's role in the next 10 to 20 years, do I think that they're going to be a major player in the economic space? Yeah, I kind of do. But that doesn't mean that I want to put my dollars over there and invest when there's a government that's controlling and dictating because just my personal experience, anytime I see manipulation, it always turns out in kind of a bad way. That's just my personal experience. So I avoid situations and I try to avoid markets where I think things are being manipulated. I think that's probably one of the reasons why when you look at my Twitter feed and I'm calling out the Federal Reserve for manipulating interest rates and manipulating the bond market, that's why I'm doing that because in my experience,

Starting point is 01:03:02 in this short life I've lived, it's always been evident to me that whenever there's manipulation and there's somebody stepping in and tweaking the dials on how things should naturally occur, that there's always a consequence paid for that. So I don't necessarily know what that consequence will be long term. I just don't trust it and I don't think that it's a place that I want to participate because I just don't know how it's going to resolve itself. So those are some of my thoughts on Ray Dalio specifically, Bridgewater, the China, Chinese Communist Party and how they're interacting in their markets and how they're controlling

Starting point is 01:03:37 all the data and all those kind of things have, they have me concerned, but it doesn't mean that that market's not going to perform in the future. So just some things to think about. So Thomas, for asking such a great question, we're going to give you a one year subscription to our TIP finance tool, which helps you do intrinsic value calculations. It helps you see companies that have positive and negative momentum trends, which I think are very useful right now in this particular market setting where we do have so much Fed printing and central bank printing all around the world happening. And we're really excited to give this to you. If there's anybody else out there that wants to get your question played on the show, go to Asktheinvestors.com.

Starting point is 01:04:15 If your question gets played on the show, you get a one-year subscription to our TIP finance tool. If people want to check out the TIP finance tool, just go to our website, the Investors podcast, where you can even search on Google TIP finance. It'll be the first thing that comes up. And we'd love for you guys to check it out. So with that, Stig, close us out. All right, guys, Preston, I really hope you enjoyed this episode of The Investors Podcast. We will see each other again next week. Thank you for listening to TIP.

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