Big Tech Reckoning

Investment Director Tom Dyson warned of Inflation Volatility in July. Below, see what he means by the term and why investors can expect liquidity to flow out of tech and into energy and value stocks.

Thursday, October 27th, 2022

Laramie, Wyoming

By Dan Denning

A reminder that the amount of oil in America’s Strategic Petroleum Reserve has fallen for 59 consecutive weeks. The Reserve is down 32% this year alone–its largest one-year decline ever. The last time it was this low, in 1984, the number one hit on the charts was Stevie Wonder’s ‘I Just Called to Say I Love You’.

It snowed last night in Laramie. Bill Bonner’s ‘Winter Nightmare’ is on the way. And as a reminder to new readers, our founder is on a short sabbatical from his daily reckoning of the financial world to work on a different project, getting our message out to as many people as possible while there’s still time to prepare. He’ll be back soon.

In the meantime, we continue introducing you to the three biggest ideas published this year by our Investment Director Tom Dyson. We started Tuesday with why we’ve recommended readers stay in ‘Maximum Safety Mode’ this year. Yesterday, we republished Tom’s work from late spring on ‘The Fed’s Wrecking Ball’ and why Quantitative Tightening (QT) may be worse for stocks than higher interest rates.

Today, Tom shows you what’s behind the market’s violent mood swings and how to manage them. First a quick note of caution…

Mr. Market is a Trickster

Mr. Market–the personification of the stock market’s moods and whims–likes to humiliate and embarrass investors. In a bull market, he sows you with doubt that keeps you on the sidelines. In a bear market, he tempts you with rallies and the fear of missing out. He’s a manipulative jackass.

How else do you make sense of the big positive opening on the Dow Jones Industrials this morning? Facebook (META) reported earnings after hours yesterday and the stock fell over 20% in after hours trading. The company’s sales–most of which come from advertising–fell 4.5% from last year. That’s the largest decline in Facebook’s history. And though monthly active users were up by 2%, they seem to have peaked at 2.96 billion (TikTok is eating Mark Zuckerberg’s lunch in terms of new subscriber growth.)

The Big Tech companies are no longer growth companies. And with both advertising and cloud computing revenue growth slowing down (or in outright retreat), the market is revaluing them. You can see from the chart below (after yesterday’s close) that Facebook, Netflix, and Cathie Wood’s Ark Innovations ETF have all been whacked. Microsoft and Google are down, but not out. And of all the Big Tech Generals–only Apple has managed to stay above break even since the broader market peaked last year. Apple reports today.

Big Tech ‘Generals’ in Retreat

Source: www.stockcharts.com

But what’s this? Old Economy stalwart Caterpillar (CAT) is up almost 10% in early morning trading. It reported record profits and ‘healthy demand.’ Is this the rotation out of tech and into Old Economy value that Tom Dyson told readers about earlier this year? And if so, what should you do about it? 

I’ll let Tom explain below. It’s a note we first published in mid-July. But it’s arguably even more relevant today. Rather than focusing on week-to-week price action, it’s important you understand what’s driving the volatility in stock prices and in inflation.

As for the market itself, our view since the beginning of the year (when we unveiled our Trade of the Decade in energy) is that the leadership of the market would change this year. The Big Tech generals would be quietly ushered from the podium (like Hu Jintao in China last week), taken out back, and either put out to pasture or, in the case of the profitless companies, liquidated). 

Meanwhile, the entire energy sector and select ‘Old Economy value’ stocks–those with little debt, healthy free cash flows, and big competitive moats around their business–would benefit from all the new liquidity coming their way. In the big picture, however, the volume of liquidity flowing stocks is going (or ought to go) down. 

On days like today, when the dollar index is up and bond yields are down, it might not seem like that. Dollar denominated assets in general, and stocks in particular, are getting a bid, despite the Tech Reckoning. Tom explains below why this may not last in an edited version of his July 6th research note. He starts with how met Bonner Private Research founder Bill Bonner many years ago. Read on…

How I met Bill Bonner

By Tom Dyson, Investment Director

In case you’re not familiar with my work or my back story, I had the opportunity to get started at a very young age (my dad was in finance and my mother bet on horses.) For better or worse, I’ve spent nearly my whole life (since I was 11) trying to figure out how to beat the market… by studying… by hunting for ideas… by making mistakes… and I am still doing this. I don’t see that ever changing. Being a great trader is going to be a lifelong obsession for me.

When I first met Bill Bonner and Dan Denning in 2003, I was a banker in London working for Citigroup. And before that I qualified as an accountant. I bought my first stocks when I was eleven years old. Now I’m a full time family man, I manage my family’s savings and write these letters. 

Like you, I just want to make returns on investment. But I’m extremely risk averse, which is why I don't bother with short selling, why I'm pathologically cautious and why I'm one of the only newsletter advisors brave enough to recommend holding cash. I think people find this cautiousness paradoxical about me when I say I’ve been a gambler nearly my entire life. 

But if you think about it, it makes perfect sense. Who would have more respect for risk than someone who’s been gambling with the stock market since they were 11 years old?

I’m really glad you’re on board. Please send any questions you may have for me to at research@bonnerprivateresearch.com I can’t write back to you personally or give any personal investment advice. I’ll never reveal your identity or any personal details if I address your question publicly in my column.  

Deep unease

One thing a good newsletter writer must never do is seem indecisive or confuse his or her subscribers. I hope I’ve been clear over the last six months about how I see the big picture and what to do about it. 

But as I have watched the markets these last few days, I have begun to feel deeply uneasy. The crisis seems to be accelerating...

I’m a market strategist. My job is to read the tape as best I can and tell you what I see, even if it’s bad news. Please don’t shoot the messenger. 

Let’s recap...

The greatest speculative bubble in history has now burst and we’re in a bear market. The S&P 500 has fallen 20% from its peak on January 3. The decline has been orderly so far, but rivets are popping and ropes are fraying. A hard landing is coming. 

Our simple model says “inflate or die.” 

Right now, the economy is dying. 

That might seem a little dramatic. Even hyperbolic. But remember what we're talking about. We're talking about a 40-year period of easy money and low interest rates. They built whole industries on cheap credit. 

The system now requires a constant expansion of credit and debt to survive. The minute that debt stops expanding (or being refinanced at affordable rates) the system collapses in what economists call a “debt deflation.” Think of a hot air balloon that suddenly loses its hot air. It does not float gently to the ground. It plummets. It's as simple and unavoidable as that.

My guess is, we’ve entered the stage of the crisis where inflation and commodity prices collapse and the liquidation begins. I’m expecting the bankruptcies, defaults and layoffs to begin soon. In other words, the decline is about to turn “disorderly.”    

In this phase, the only asset that goes up is the U.S. dollar. 

The Bloomberg Commodities Index is down 19% in a month. Copper is down 21%. Cotton is down 32%. Soybeans are down 29%. Zinc is down 23%. Crude oil is down 16%. Natural gas is down 41%. Silver is down 14%. And gold is down 4%. 

The 1-month fall in all commodities prices is the 3rd largest in 90 years, behind only the Covid and GFC collapses.

Shipping stocks, natural resource stocks and other inflation trades are getting hammered. Even Berkshire Hathaway, Warren Buffett’s holding company, is down 23% in the last three months.

Inflation Volatility

For a highly leveraged economy, deflation would be catastrophic. If I’m right about this – and the economy is slipping into deflation – the Fed will soon be coming to the rescue with a bail out.

When? 

My guess is the Fed will come to the rescue sooner than people expect. 

The problem with turning the economy “on” and “off” like a light switch is, the market isn’t able to invest in new capacity so there’s no supply response. Whenever the Fed turns the inflation switch back to “on”, shortages return and the CPI begins rising again. 

This leads to a phenomenon we call “inflation volatility”, a type of manic-depressive price behavior that’s very hard on an economy and on business. One year prices run hot, then the next year they recede.

This happened in the 1970s. Inflation came in three waves. Investing for inflation volatility is different from investing for inflation. You never know what you’re going to get next, so either you have to hedge… or you have to pivot your portfolio with the ebbs and flows of inflation. In a lull after the second wave of the 1970s, for example, gold fell 50%... then soared 700% in the third wave.

The good news is, we’re watching this play out from the sidelines. Earlier this year, we battened down the hatches and we went into Maximum Safety Mode, holding mostly cash, physical gold, silver and a few value stocks with tight stop losses. 

No one’s making us “buy the dip” in profitless tech stocks or busted inflation plays. No one says we have to become short sellers. We can sit on the sidelines holding cash and physical gold as long as we want, staying out of harm’s way until the bear market has bottomed and a new secular bull market is beginning.

QUESTION:

I’m wondering if we shouldn’t change the strategy for the stop loss during the bear market. I realized that many times I had to sell the shares at a much lower price than the stop loss because we received the alert after the closing and the day after the shares kept going down (sometimes plunging) . Shouldn’t we be more prudent in this “maximum safety moment” and use regular stop losses to avoid having to sell the shares at a much lower price.

MY RESPONSE:

You’re welcome to front run our stop loss triggers if you like. We use stop loss triggers on most of our positions. We only use end-of-day closing prices to judge whether a stop has been hit. It’s usually pretty clear several hours beforehand that a stock is going to hit its trigger at the end of the day. My guess is, it’s a coin flip whether the stock will bounce back the next day or continue falling. I haven’t studied it, but I suspect this isn’t important to our returns over the long run. What’s important is that we’re using stop losses. 

QUESTION:

Can you please help all your followers understand what is going on with gold and silver? I thought that as the markets collapsed there would be a flight to quality. I recognize that gold stocks will initially go down as the market corrects, but do you expect at some point that gold and silver stocks will start to go up while the overall market keeps going down. 

MY RESPONSE:

We must distinguish between physical gold bullion and gold stocks. The first is a store of value. The second is a bet on a type of mining business. In my experience, gold bullion tends to fall in price during the initial stages of the liquidation as speculators and asset managers sell anything they can to raise cash and meet margin calls. Once things settle down, gold begins to rise from the safe haven bid. As for gold stocks, I suspect they’ll rise and fall according to the appetite for risk among speculators. I sold all the gold stocks I had previously recommended earlier this year. 

QUESTION:

Are you expecting a further drop in the price of gold? Should I continue deploying cash into gold at today’s levels or wait further? 

MY RESPONSE:

In the short term, anything’s possible. We’re entering a deflationary slide and it’ll cause the dollar to rise. Who knows how far gold can fall before they intervene? In the long term, gold will simply preserve the purchasing power of savings, as it always has.  

COMMENT:

Your research makes me think and ponder and try to make the right decision to continue to have our nest egg grow but also to avoid any major loss.  It’s kind of like playing the U.S. Open. He who makes the least mistakes and keeps it near par has a good chance of winning.

MY RESPONSE:

I like your golf metaphor. It’s a good way of explaining what we’re trying to do with our strategy.

QUESTION:

How low does oil go in a recession?

MY RESPONSE:

It depends when the Fed flips the switch back to “on” again. If the Fed began QE today, I imagine oil would immediately head for $150 a barrel and beyond. But if the Fed keeps the switch to “off”, oil could go lower than anyone expects. 

QUESTION:

I get the 5 Oz of gold = fair value of the Dow. With gold at roughly $1,800, 5 Oz is a Dow at 9,000. From 31,000 where it’s at nowadays, that’ll be a drop of 60+ %. Can you explain how you see that happen a little bit more?

MY RESPONSE

I think it’s more likely that gold gets revalued to about $7,000 an ounce and the ratio hits 5 with the Dow at 35,000. 

[Tomorrow we’ll look at what’s next for the dollar, interest rates, and gold. One ominous new threat to Middle Class savings: a Central Bank Digital Currency. More on that shortly! Meanwhile, here’s a picture I took a year ago of Tom and Bill hard at work in Baltimore when the three of us last met in person. Since then, the BPR team has only met in person intermittently. But we hope for a virtual gathering with all our paying subscribers before the end of the year. Stay tuned].