Preston Pysh  01:43
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 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? 

Lyn Alden  02:08
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. 

We have these two forces colliding into each other in ways that are unexpected to a lot of market participants because it’s not something they’ve seen, generally, in our lifetimes. You have to go back and read history books to find areas where situations like this played out. 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 the 5-to-10-year cycle where companies, households, take on more debt, and they expand, then there’s a recession and they run into a problem, and then they have to deleverage. They have to reduce their debt levels as a percentage of their income, as a percentage to 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 like a middle layer, and then it builds from there.

Over the course of 5 or 10 of those cycles, you end up with so much debt in the system relative to GDP, relative to the money supply, that a normal deleveraging event doesn’t cut it. We basically hit the point where it’s mathematically impossible to even kind of deleverage in real terms. 

These events are generally associated with currency devaluations, where governments end up printing a ton of money, basically trying to bail out the system nominally by losing value in the currency. 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. The virus was a catalyst, but the virus can belong to a highly-indebted global system, not just at the company at the household level, but at the sovereign level.

Stig Brodersen  04:02
Lyn, 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? 

Lyn Alden  04:18
I would say that in some ways, it’s not because, for example, in 2008-2009, most of the leverage was in the banking system. Real estate was overvalued, and banks had over-leveraged on real estate. When that all came down, the epicenter of it was in the housing market, and everyone else suffered as a result of that. That kind of emanated from that 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. Millions of small businesses, households, are just selling without income, just completely caught off. Global trade slowed down dramatically, and so it’s more than 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.

In addition, what’s different is that last time, we had a private debt bubble. Private debt, as a percentage of GDP, was extraordinarily high. Whereas federal debt, as a percentage of GDP, was moderate. We had maybe 65% federal debt to GDP, but as part of bailing out of that previous crisis, a lot of that leverage moved up to the sovereign level. 

So, the household sector deleveraged a little bit, mostly because people lost homes. The corporate sector temporarily kind of deleveraged then re-leveraged right back up, but the sovereign level jumped dramatically. They went from about 60% of GDP up to over 100% of GDP in Treasury debt. 

We went into this crisis with about 106% federal debt to GDP and due to the skills crisis, we’re already at 120% of GDP months later. Also, 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. 

Preston Pysh  06:18
And so, you’re effectively saying this is going to be a lot worse than 2008-2009. 

Lyn Alden  06:23
At least a lot messier, yeah. 

Preston Pysh  06:25
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. Explain what you’re doing with that and what it all means. 

Lyn Alden  06:37
Sure.

Most of us are conditioned to think of our currencies as things that don’t change like that’s the denominator, and we’re measuring something else in a unit that doesn’t change much. Only people from certain markets that have experienced dramatic inflation kind of have that awareness, whereas those of us in developed markets, we take it for granted that $1 is $1. It doesn’t change much. We can have faith that it’s roughly worth the same next year as it is this year.

Over a long enough period of time, the dollar loses a ton of value over the years and decades. If you look at the chart of, say, the Dow Jones over the past century, it goes up exponentially. In fact, all of those earlier massive crashes look tiny on the chart because they’re such small numbers compared to where it is today. But back then, decades ago, the dollar used to be backed by gold. They had a smaller kind of federal government, they had less leverage in the system, and the dollar didn’t change a ton over years and decades.

So, if you reprice the whole Dow Jones over the past century in gold, which is kind of like going back to something like the original dollar, and just see how it does, then the Dow actually hasn’t really increased in price than gold. It’s had this big sine wave pattern where it’s gone up, it’s gone down, it’s gone up again, it’s gone down. At that, it only had a very mild upward trajectory. 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. 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 returns in the stock market are due to inflation. 

Stig Brodersen  08:26
So, if you denominate the stock market using ounces of gold as your measuring stick, what would it look like?

Lyn Alden  08:32
A lot of us think of the market having peaked at the beginning of this year, and then having fallen pretty far if you think of it in dollar terms. Then we kind of bounced back up that level. But if you look at it in gold terms, it actually peaked back in 2018. Around Q3 of 2018, it peaked.

It’s had a series of lower lows and lower highs ever since. That mostly corresponds to the fact that if you look at GDP growth, and you look at its rate of change terms, so you say, okay, we’re growing by a certain rate in 2016. We were growing at a faster rate in 2017. 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 the rate of change terms. Roughly, when that peaked is when the S&P 500 started to decline as priced in gold. 

Preston Pysh  09:22
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 tools that the central banks are going to use moving forward.

Lyn Alden  09:43
Part of what makes this the end of a long-term debt cycle, rather than just the short-term business cycle, is that we’re at the end of a 40-year interest rate cycle. Back about 40 years ago, around 1980, interest rates peaked. Ever since then, we’ve been on a disinflationary trend, so lower and lower inflation levels. 

The world’s globalized outsourced a lot of its manufacturing. We’ve benefited from cheaper labor, and we’ve had massive increases in technology, and other things that have really resulted in much lower inflation than we’ve had. Every time that the business cycle has troubled, one of the Federal Reserve’s tools is that they can lower interest rates and that kind of eases credit conditions. Then they try to retighten them a little bit. But, if you look at the 40-year cycle, it’s gone down.

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 turned to quantitative easing, which is the modern phrase for money printing. Essentially, they create new dollars, and then they buy whatever they want. 

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 for mortgage-backed securities. But the magic happens 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 treasure or mortgage-backed security. 

So, the Federal Reserve is basically injecting dollars in an economy, taking some of those assets out of the economy, 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. 

Stig Brodersen  11:35
Via quantitative easing. 

Lyn Alden  11:37
Yeah. 

Stig Brodersen  11:38
Interesting. Which other tools do you think that they will use, including UBI? Do you think we’ll see more of that? 

Lyn Alden  11:45
One of the shortcomings of reaching this point in the debt cycle is that there are only so many assets they can realistically buy, so they have legal limits for what they can buy. They 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. 

They’re not really supposed to buy them, but they set up a special purpose vehicle with the Treasury so that they can say, “We’re not buying them. This special purpose vehicle’s buying them, and we’re just working with the Treasury to finance and do the purchases. 

So, it’s not on the Fed’s balance sheet. It’s just financed by the Fed.” They pulled that off. But even then, they kind of ran into the point where even monetary policy, there’s not a ton left to do. That’s when it becomes more of fiscal policy, right? 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 fiscal, which is actually kind of unorthodox, 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.

Now, fiscal cash. It can be kind of right-leaning or left-leaning. It could be tax cuts, or it could be spending, or it could be both. So, what he’s saying is you need to throw money at the problem. UBI is an example of that. The $1200 checks people receiving earlier this year is 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, they’re 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 who have dollars, they buy treasuries. So, the Treasury is basically extracting dollars from the economy, and then redeploying them back somewhere else in the economy. 

But in an era 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. 

Preston Pysh  13:57
For a person that hears that, and they say, “Well, why aren’t we just doing like they used to where they would issue them, pull the cash out, and then they’d re-appropriated 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 to 60 years ago?” 

Lyn Alden  14:14
That’s because the debt level is so high. Back when debt levels were 20-40% of GDP, there’s more appetite. There’s more private balance sheet space to buy those treasuries. For decades, we’ve relied on international lenders, so the way that the global monetary system is set up, we run a persistent trade deficit. 

We send dollars to the rest of the world, and we consume more than we produce. So, we have a trade deficit. We export dollars, and then foreign countries reinvest a lot of those dollars into buying treasuries to have foreign exchange reserves and to have safe investments. 

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%. But once you’re at about 100%, there’s so much already out there that when they’re issuing trillions and trillions more, there are no buyers especially because there’s going to see that the federal debt to how much money supply there is, for example, and other ratios like that that they can look at, and there’s just there are 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 still has to buy the treasuries, and pensions aren’t growing. So, what do you do? The Federal Reserve basically just prints dollars and then buys treasuries. They shift to debt monetization for lack of available buyers, essentially.

Stig Brodersen  15:32
Keeping that in mind, say that I was a person who’s ready to retire and I can’t afford to take on too much risk. Bonds are not looking attractive, and you mentioned the issues with equities before. How should I build my portfolio? 

Lyn Alden  15:48
A lot of pension-type things are somewhat indexed to inflation, but they rely on official measures of inflation, which are not necessarily telling you the whole picture and generally understating the real kind of costing increases that are happening. 

So, if I were in that position, I want to have harder assets. I’d want to have a home that’s either paid off or financed with low fixed-rate debt. I’d want to have precious metals. It’s not something that a lot of people invest in these days, but historically, that’s been a store of wealth, and that’s generally very well in inflationary environments as well as slower inflationary environments. It just kind of grinds up over time and maintains its purchasing power. 

I want to have equities as well, but generally diversified equities, and not too much– not like an overemphasis on 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. 

Preston Pysh  16:40
To be able to swap into an opportunity or something that would present itself as an opportunity? 

Lyn Alden  16:47
Yeah, as a volatility reducer, and because people have tax payments to make. They have purchases to make, so they have to 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. 

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 with really low inflation levels, over the next, year or couple years, those rates are below the inflation level. You’re basically guaranteed to gradually lose purchasing power and possibly lose it more quickly if we enter a truly more inflationary environment. 

Stig Brodersen  17:34
I’m curious. Given everything that’s been happening with COVID-19, which questions do you hear from your clients and others who trust you as their advisor? 

Lyn Alden  17:44
People just don’t know what to do. People say, “Should I be in bonds? Should I be in equity? Should I be in precious metals?” Of course, for every person, it’s kind of their own unique situation, right? The answer for someone who’s 20 is probably different from 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 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 interest rates have been above the inflation rate. 

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 kinds of harder assets if we want to kind of maintain purchasing power.

Preston Pysh  18:32
We were talking a little bit earlier about the monetization of debt. I know yourself, Luke Gromen, 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 US is being just monetized into the debt. When we look at other countries around the world, like 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? 

Lyn Alden  19:11
I think part of it is competitive devaluation. I like to look at it in the rate of change terms again. If you look back, say, from the period of 2014 to 2019, that’s when the Federal Reserve ended QE 3, right? They stopped printing money. That was their final round of QE. Then they had several years where they weren’t printing money. The treasuries that were issued were kind of actually bought by real buyers, mostly domestic buyers. 

And then after, they started that period of quantitative tightening. The Federal Reserve was actually selling some of its assets starting in September of 2019. They basically hit that point where there were not enough buyers anymore, so the Federal Reserve had to begin buying again.

If you look at that five-year period, the Federal Reserve, the US was one of the tightest markets. Japan was still doing quantitative easing. Europe earlier in that period was doing quantitative easing, then they started to slow down. Whereas, the Fed was tightening. However, since September, Fed’s actually been the loosest. 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 boundary was before towards absolute terms. The Federal Reserve has been the most aggressive printer.

Going forward, a lot of it’s going to come down to how hard these economies were impacted by the virus and their ability to recover from it. Currently, the US actually has higher unemployment rates than some of our peers, like Germany and Japan. Our economy is structured a little bit differently. We have different types of programs in place, so we’re actually, 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. I think we’re going to have periods where different regions are the ones that are doing faster printing. My base case is that the US will probably be a more aggressive printer than a lot of our major peers. Of course, some of the emerging markets will print faster, but our major peers, as my base case, I’ve expected the US to probably outpace them. 

Stig Brodersen  20:57
Everyone listening to this would likely be thinking, “How long is the money printing going to last?” What would your response be to that? 

Lyn Alden  21:05
I think it’s going to be years. There is kind of an end game, but that end game is probably years away. I think we’re at the point 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. 

Preston Pysh  21:21
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 is 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? 

Lyn Alden  21:47
I think they’re definitely related. That’s been a big part of it. The 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 *inaudible* crisis with very little cash-on-hand. They were highly leveraged, had basically no reserves, and had something like 3% cash as a percentage of assets. 

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. They filled those banks up so that they now had 8% cash as a percentage of assets. And then, by QE 3, in 2014, those banks did another round of quantitative easing. They filled those banks up to 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 the mainstream. There were small programs like Cash for Clunkers and expanded unemployment benefits for a while, but that was measured in like the hundreds of billions. 

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, we’re at the point now where most of the population just can’t go months without a paycheck. It’s just completely insolvent if they don’t get income, and that’s why you saw one of the most bipartisan actions of Congress you’ve ever seen, which is that to instantly send everyone $1200 checks. 

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. 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 there’s high unemployment. 

We’re already starting from such a terrible low 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. 

Preston Pysh  23:51
I’m a little surprised that we haven’t seen the second, third, fourth type UBI checks coming out. We had the first round. Is that more politics that is 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? 

Lyn Alden  24:13
It’s partly politics and also probably timing. Some of the democrats have proposed already those monthly supports, whereas the republican generally opposed that, so you had a little bit of a partisan thing going on. But it’s also about timing. 

They did, in the beginning, the $1200 dollar checks. If you actually look, 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 to open another check. 

Other people lost their jobs, but then they got these $600 a week and extra unemployment benefits on top of their state unemployment benefits and actually made more money. 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. So, we kind of front-loaded that a little bit so people got a really good April and then a pretty decent May.

Now, the thing to watch is, at the end of July, the $600 a week in extra federal unemployment benefits goes away under the current act. That’s why we kind of hadn’t really seen another big fiscal injection yet, 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 don’t have jobs are getting their state unemployment. 

Plus, they’re getting $600 a week in extra federal unemployment. That’s a ton of money for a lot of people. So, even though the President’s already talking about doing another round of fiscal, the democrats are wanting another round of fiscal, the republicans for the most part want to do another round of fiscal, but they would generally have wanted 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. 

Stig Brodersen  25:41
Interesting. So, Lyn, I heard you talking about weaponizing swap lines. Could you please explain what that concept means and whether you think that the US has the incentive to do that. 

Lyn Alden  25:54
What people refer to when they talk about weaponizing swap lines is that because the dollar is the global reserve currency as we’ve had decades of most international trade happening in dollars, 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. 

As a result of that, most countries have a lot of treasuries on-hand to foreign exchange reserves. Whenever you’re loaning to an emerging market company, it’s often done in dollars rather than doing in their local currency, so it gives the lender protection against currency devaluations that are common in emerging markets. 

But as a result of all this, the world has about 12 trillion in dollar-denominated debt that is in companies in countries that are not based in the US. The Argentinian government has dollar-denominated debt, the bank in Europe has some dollar liabilities, and they total at least $12 trillion. There are actually other ways of measuring it, so you get up to higher numbers, but that’s kind of the baseline to start with. It’s at least 12 trillion.

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. 

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 foreign central banks in exchange for some of their currency as collateral. These are called swap lines.

We swap currencies with major allied 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 our assets, whether it be treasuries or US 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 to make sure you pay us back. But you go and just stop selling our stuff.” 

Now, some people are of the opinion that the US 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 swap lines not because they’re being kind, but because they pretty much have to.

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. 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 to spike. It started to go up dramatically for about two weeks, and that’s really odd behavior to happen. If it’s such a sharp sell-off, why would you sell treasuries? 

Everybody would normally be going towards treasuries. That’s because foreigners started selling hundreds of billions of dollars in treasuries because they were so short on dollars that they were turning to treasuries, which are basically boxes of dollars they can sell so that they can get dollars and service their debts. That’s when the Federal Reserve said, “Okay, now it’s serious.” 

They started doing QE, started doing swap lines, and said, “Just please stop selling our treasuries. Here are some dollars. We’ll take some euros,” and that kind of helped ease that liquidity condition.

So, the debate that’s going on is will the US continue to maintain those adequate dollar lines or will they try to be more selective with whom they use it? 

Preston Pysh  29:32
Lynn, you were one of the first people to really start talking about the FAANG stocks and the NASDAQ 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 happened? And why are we seeing the NASDAQ get bid? Why are we seeing the FAANG stocks just taking over while pretty much everything else in the index is way underperforming?

Lyn Alden  30:01
There was an early movement by investors to shift assets into stocks that they think are not very impacted by the virus or even benefit from a virus. An example would be Zoom and other online companies. At best, some of those companies are just not impacted, right? Google’s not that impacted. Apple’s not that impacted. Whereas, if you’re a clothes retailer, if you’re Kohl’s or you’re Macy’s and you’re literally forced to shut down, you’re more screwed, right? 

We had a big 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, these commodity producers, retailers, industrial companies that are more cyclical, that have more hardware investments, like capital investments that they have to do.

They’ve had 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. They were being priced for near-certain bankruptcy, whereas a lot of these NASDAQ stocks, in my opinion, are dramatically priced. Software companies and all these big mega-cap companies are priced at high levels that even if they do great over the next 10 years and 15 years and 20 years if we do a discounted cash flow analysis on them, a lot of them just don’t have very attractive returns. 

It’s kind of pricing in the assumption that inflation is going to stay very low, that the discount rates are going to be near zero, and that these companies that have kind of steady incomes, even at very high valuations, will do fine. 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 continue to do well, fundamentally, for decades, they had terrible returns the next 10 years. 

Stig Brodersen  31:43
Keeping 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? 

Lyn Alden  31:52
I try to stay 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 balance sheets in their industry.

For example, I highlighted a South American Brewer, Ambev. They produce different types of beers and other drinks throughout South America. If you look at most major beer producers, they actually have a massive amount of debt. There are a couple of exceptions, but 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. Even though they were impacted, they had shifted down from very high valuations to very low valuations. I’ve been highlighting that stock as an example. 

I also follow some others like Nucor steel, for example. They have one of the strongest balance sheets in the steel industry. 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?” 

They never had to lay people off, which is kind of a lot to save for a steel company. They’re 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 has been kind of finding these kinds of high-quality companies that have nonetheless been highly impacted by the virus with the anticipation that, as this normalizes, they’ll be able to capitalize on it compared to some of their weaker competitors. 

Preston Pysh  33:14
You mentioned gold earlier. How about some gold miners or some minor stocks? 

Lyn Alden  33:19
I started being bullish on gold miners in Q3 of 2018. So, I’d call it the first wave. That played out pretty well. We’ve had pretty big outperformance of gold miners compared to the S&P 500 since that time. Even though the S&P 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 selloff. Even though gold held up pretty well, gold miners sold off very sharply. They actually showed up even sharper than the S&P 500, which is counterintuitive. There was a weird dislocation because the market was so illiquid. The major gold miner ETF was trading at a major discount to NAV, which is something like 6% below NAV. It made absolutely no sense. 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. I’m still bullish. I still hold gold miners, but I like gold. 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. 

Stig Brodersen  34:31
As we look at the equity market measured in US dollars over the next 12 months, what is your base case? And what would really surprise you? 

Lyn Alden  34:40
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 really to expect lower lows in nominal terms. I don’t necessarily expect either somewhat higher highs but not like way higher. I think in this next year, we’ll see this sideways pattern. That’s my base case.

I do have a high conviction 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 investments, like commodity producers, higher gold miner valuations, industrials, real estate, and things like that.

Now, things that have scarcity and that are not too expensive. So for example, even some of those mega-cap companies, they have scarcity in the sense like they have a certain type of technologies, certain brands, they generate very good cash flows, returns on invested capital, but because they’re so expensive, they can easily have multiple contractions. 

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 the 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 stagflation area environment. 

Stig Brodersen  36:04
You’ve been very vocal about the huge increase in money supply and the impact it has had and we’ll have in the time to come. Could you please elaborate on that, Lyn? 

Lyn Alden  36:15
We really increased the money supply by 20% to 25% in the past 6 months, which is just an outrageous amount. 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. We have so many deflationary forces. All of this debt is deflationary. There’s all of the near insolvency that so many people have. 

Those $1200 dollar 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 finance that is all basically monetized by the Fed is going to be bigger than people expect. We’re either going to get that really low nominal price level, or we’re going to get something that the equity market kind of levitates but at the cost of all this fiscal that’s propping everything up. That’s why, in that sort of environment, I’d want to have access to scarce assets that are at reasonable valuations. 

Preston Pysh  37:09
We talked earlier about yield control and the Fed basically stepping in and buying anything and everything in order to fix all the different yields on the bond yield curve at a certain percentage to keep it positively sloped, and all those things. I’m sure when we say positively sloped, it’s not by much. 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, as a person, especially to somebody coming out of business school or who just learned how to do a discounted cash flow model, what do you say when the cost of capital is zero or it’s next to nothing and they’re doing these valuations in these prices that are sky-high? How would you tell somebody to think about valuations in a world like that? 

Lyn Alden  38:06
That’s actually one of the biggest challenges at the moment because, by most metrics, the broad stock market is incredibly overvalued. The one metric where it’s not is the equity risk premium. If you compare, for example, the price-earnings ratio of the S&P 500, 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. 

There’s a pretty big gap for equities being undervalued relative to how bonds are. It’s like saying equities are overvalued, but bonds are arguably even more overvalued. Right? We’re in this really tricky environment where there’s not a lot of return potential from those major asset classes, like major equity indices or bonds in real terms.

One way I would kind of think about it, is to do discounted cash flow analyses 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 real return. That’s going to capture an artificial return. 

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 willingness to pay. 

Stig Brodersen  39:23
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 they conventionally measure it, the CPI number is understanding the real inflation. Which discount rate would you suggest investors use? 

Lyn Alden  39:43
One way to measure it is the growth in the money supply annualized. For most of the past 10 years, the growth of the money supply was over 5%. But then, because of this massive spike towards the end of it, now it’s more like 8% in the past 10 years. We’ve really kind of back loaded it. 

Preston Pysh  40:00
Annually. That’s a kegger. 

Lyn Alden  40:02
Yeah. 

Preston Pysh  40:03
Wow, 80%. Interesting. 

Lyn Alden  40:05
Yeah. That’s kind of a baseline. Going forward, it could be probably even more than that. There are kinds of different scenarios you can run if you want to get really wonky and into the depths of it. 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? 

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?” If you assume these more tapered scenarios, you can kind of calculate different inflation rates that get you there. But overall, they’re pretty high. They’re not like the 1% or less Treasury yields we see. 

Preston Pysh  40:44
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, and I think that’s a really great comment.

Here’s one of the last ones I got for you. I saw that recently, and I don’t know when you started putting this in your portfolio, but I saw that you have a position in Bitcoin. I’m curious what your thoughts are on it. 

Lyn Alden  41:15
I added Bitcoin in April of this year. It was around just under $7000 at the time. I started covering Bitcoin on my website in 2017 because that’s when we had that giant run-up in price. Of course, I got an email after email asking me about it, so, years before that, I had been aware of Bitcoin. I actually knew someone that was mining Bitcoin on her computer. I knew the idea of it, but I considered it almost like a micro-cap, like a cool thing that’s happening.

When 2017 came around, we got this pretty sizable move up. I got tons of emails, so I did a pretty big long-form article on it. I tried to say, okay, let’s value it in different ways. At the time, we can value it as a medium of exchange or we can value it as a store of value, and we can just play with different scenarios.

I took the full-length Bitcoin market cap, and I compared it to the money supply market cap of different countries. I checked how many people that country has. What is their GDP? How does that compare to how much economic activity is happening in Bitcoin? My calculation, at the time, was that Bitcoin had a very large market cap compared to how much economic activity was probably happening in it, so it’s kind of priced like a growth stock. Prices are going to explode in that scenario.

The other way to look at it is as a store of value. If the entire world put 1% of the 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 do you want to do with 3% or 5% or 0.5%?” Using that model, that showed that Bitcoin is actually still pretty cheap, in many terms, if Bitcoin ever took off. My concern at the time was that there’s also kind of the rise of all coins. We had Bitcoin dominance fall from 100% down to under 50% for a while.

My concern was that 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. It was kind of more like a question about the network effect. 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 the protocol. 

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.”

That was also the period when we were having like Bitcoin cash forked 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.” Back then, when I did that article, Bitcoin, was about $7,000 or $6,800, and then, of course, the rest of the year, sort of $20,000. Then it came back up to like $12,000. Then, at the beginning of this year, it fell down to like $4,000 again. 

In April of this year, when we’re starting to recover from that low, it got up to about $6,800 again. It kind of did this big round trip to the same price that I analyzed two and a half years ago. It behaves a lot as gold did during the sell-off where, when there was a liquidity crunch, Bitcoin sold off, but then it started to recover. I was also aware of the halving event that was happening, and kind of the different things that are happening timing-wise there.

As well, Bitcoin dominance. We’ve had kind of a fall off and all of these other cryptocurrencies, and Bitcoin’s retained up to about two-thirds of the total market cap of the space. My view of its network effect strengthened, and I had another two and a half years of trial-and-error, basically. 

We have like a full decade of history now. We have a pretty strong network effect. It didn’t get diluted by those forks that happened. It didn’t really get diluted by those other coins. So, the combination of the protocol being very efficient and seeing more and more evidence of the Bitcoin-specific network effect made me want to have a position as a scarce asset. 

Preston Pysh  45:11
Lyn, I can’t tell you how even more impressed I am 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. 

Lyn Alden  45:28
Sure, I’m at lynalden.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, @LynAldenContact. 

Preston Pysh  45:38
We’ll have links to that in the show notes. I highly, highly encourage folks to definitely follow Lyn on Twitter. Sign up for her newsletter. Super valuable stuff. Lyn, thank you for coming to The Investor’s Podcast.

Lyn Alden  45:52
Thank you. 

Stig Brodersen  45:54
All right, guys. As we’re letting Lyn go, we move on to the next segment of the show where we will be playing a question from the audience. This question comes from Thomas. 

Thomas  46:04
Hey, Preston. 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. 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? And if so, are you investing in Chinese companies? Thank you and keep up the good work. 

Stig Brodersen  46:32
Great question, Thomas. It’s hard to disagree with Ray Dalio when you read through his write-offs and see how well-resourced it is. 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. 

I think one of the mistakes that people make is that they think in terms of headlines and what they’re reading right now about China, and then might mistakenly think that big changes are happening tomorrow.

What Dalio actually defines 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. It could easily be 150 years, shorter or longer, at least historically. 

Now, I still see the US as being the dominant country for decades to come, and perhaps longer, but I also don’t think you should underestimate the historical evidence that Ray Dalio outlines for why we see that China will eventually rise and the US will fall.

One example that Dalio brings up is the Dutch, going back 250 years. Even though there were only between 1 and 2 million people, they actually invented the very first global reserve currency, the Dutch guilder. It accounted for a third of all international transactions. 

Now, as the power declined and the British slowly took over, they became deeply indebted. The Dutch overspent. They had a lot of domestic problems including social unrest due to inequality. They had political factions not willing to compromise. They also had significant disagreements between the provinces. As a reaction to the English gaining more military and political power, they also started several trade wars. I don’t know if you think that sounds familiar to what you’re seeing today.

Transitioning from one empire to the next does not necessarily happen fast. Where it can happen fast is if you see a war. That was how the British became the unrivaled world power right after fighting first the Dutch, and then later the French in 1815. 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. We’ve historically seen that more, 75% of the time, where one empire rose and the other one fell.

Now, I Don’t want to say that unless there’s a major war that we’ve only seen significant changes. What happens when I look into the future? What kind of significant changes can we expect? 

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 have 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 the same way. It’s also politically much harder to go to war in a democracy than if you were a kingdom or dictatorship. Today, you have nuclear, you have cyber-attack, as an act of war. Warfare might look very different from what you see if you look back in history.

Now, we could almost do an entire episode about this, and we might eventually do that, but going back to your question about investing. Yes, I do invest in China. Right now, that’s around 12% of my stock portfolio. I have come through an emerging market ETF where China comes at 44%, but the majority of my exposure is through Alibaba. This is a stock that I pitched in Q1 2019, in the Mastermind meeting. I’m shamelessly going to say that it’s been up more than 35% since then. 

You can hear much more about the reasons why I invested in the company by going back and listening to the episode. However, a position like that is not so much influenced by China becoming the new empire. It’s going to be the most dominant country in the world. There were so many other factors much more important going into a decision like that.

I just wanted to mention one more thing. You talked about it being a major handicap that countries and the governments across the globe not trusting the Chinese. I agree that there’s mistrust, but from an investor’s perspective, I’m not sure it makes much of a difference. Please forgive me for going back to the history of books. Going all the way back to the Monroe Doctrine in 1823, the US had a major influence in South America. 

Despite the lack of trust in the US government through time, it hasn’t really changed the ultimate income of how those markets have been developed. Going back to the US or taking the UK’s place as the world’s dominant superpower, the lack of trust throughout the world, also really stood out. Just like we’ve seen historically, China’s also using soft powers to gain influence.

Now, while the US still dominates in South America, we’ve seen in Asia how Asian nations have formed alliances with the Chinese instead of the US. 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. 

We’ve seen from Europe how the Chinese are buying more and more influence, and insist on trading bilateral with EU countries instead of the entire block. That clearly gives a lot of power to the Chinese. Europe, as a block, actually has a bigger economy than China. But as they insist on negotiating with every single country, this 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. If you’re interested specifically in that, I can highly recommend a book called China’s 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 when 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. 

Preston Pysh  52:48
Thomas, I look at this first from: Why is Ray Dalio talking about this and what kind of self-interest does he maybe have? I think this is an important point to think about. So, Ray’s firm, Bridgewater, $160 billion in assets under management, opened up a China unit in 2016. 

I think whenever a company like Bridgewater is looking at capturing more investors and managing 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. That’s something 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, as 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. I have no idea how much their research is suggesting China is going to be a powerhouse versus how much they have a self-interest in capturing some of those dollars, but I think it’s an important point for people to think about that anytime they hear Bridgewater or Ray Dalio talk about China.

I personally look at the world as that every single country in the world offers an opportunity for your hard-earned dollars to allocate into 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’d tell you don’t invest there. 

To be honest with you, personally, I don’t really like the antics of 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 thoughts.

I think that when we look at China’s role in the next 10 to 20 years, so 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 controlled and dictating. 

Just from my personal experience, anytime I see manipulation, it always turns out and kind of a bad way, 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, 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, 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, there’s always a consequence paid for that. 

I don’t necessarily know what that consequence will be long term. I just don’t trust it. 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 Chinese Communist Party and how they’re interacting in their markets, and how they’re controlling all the data and all those kinds of things have. They have me concerned, but that doesn’t mean that that market’s not going to perform in the future. So, those are just some things to think about.

Thomas, for asking such a great question. We’re going to give you a 1-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. We’re really excited to give this to you.

If there’s anybody else out there that wants to get their question played on the show, go to asktheinvestors.com. If your question gets played on the show, you get a 1-year subscription to our TIP Finance Tool. 

If people want to check out the TIP Finance Tool, just go to our website, The Investor’s Podcast. You can even search on Google “TIP Finance.” It will be the first thing that comes up. We’d love for you guys to check it out. So, with that, Stig, close us out. 

Stig Brodersen  57:00
All right, guys. Preston and I really hope you enjoyed this episode of The Investor’s Podcast. We will see each other again next week. 

Outro 57:07
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