Has the Market Become a Casino?

Jul 6, 2022

Has It All Become a Casino?

Stay focused on the depth of the roots, not the height of the tree...

There’s a famous saying that says, “if you sit down at a poker table and cannot identify the sucker, the sucker is probably you.”

From 2008 through 2022, the casino operators (the Fed) have added roughly 10X to the amount of money on the casino floor. As a result, virtually everyone in the casino has won. However, the casino operators are now taking chips off the floor and out of the game. As they have done this, the smart money has been cashing out. It seems only the retail money is left, but maybe not for long.

This past weekend I had discussions with five separate individuals at two different parties who told me they had “meetings set up with their financial advisors (FA’s).” The ironic thing was two of the people were actually at the party of the FA they had scheduled a meeting with. This FA throws a big party every year. When I asked him personally what he was telling clients, he said, “who knows, the market could drop 30% or gain 30%. It’s crazy.”

It begs the question. Do we really want to gamble with our retirement accounts?

Retail investors are finally recognizing that we have an issue. What to do about it is the question. Seems everyone is watching the Federal Reserve and nobody knows what they will do.

For the better part of the last six months, we have been making the case that the Federal Reserve is literally stuck.

So too now are most investors.

The entire market today feels like a 50/50 coin flip as opposed to something investors have any certainty about. True investing shouldn’t feel like gambling.

Warren Buffett echoed this sentiment a couple of months ago at his annual Berkshire Hathaway meeting that the “markets have become a gambling parlor.” [1] Investors are now stuck betting on what the Federal Reserve will do. Their big choice is whether the Fed will follow through with their promised rate hikes to quell inflation, or not.

As we all know, the Fed has promised ongoing hikes to slow demand and get inflation under control.

However, it looks like demand may already be rolling over. We noted last week that the Atlanta Fed GDPnow tracker had signaled a recession in Q2. As we know, in recessions, the Federal Reserve has almost always resorted to cutting interest rates, not raising them.

Do we listen to what the Fed is telling us, or do we rely on our knowledge of the historical playbook of the Federal Reserve that indicates they won’t be able to raise rates much further?

Not even the biggest investment banks in the world can find an agreement. Recent articles written in Bloomberg highlight the realities. On July 1st, Citibank warned of $65 per barrel of oil on the horizon. Just five days later, on July 5th, JP Morgan was suggesting we could see oil at $380 per barrel.

This is a whopping spread of 500% between two of the most prominent investment banks in the world.

Citi’s call comes from their focus on recessionary signals. JP Morgan’s call is based on the supply chain shortages and increasing inflationary pressures as well as demand from China’s re-opening.

These opposing views and forces indicate that financial markets are a flip of the coin challenge for both institutional and retail investors alike.

Recognize that yields on government debt have been all over the place, as low as 1.12% on the 10 YR treasury to as high as 3.49% all in the last twelve months. While on paper this is only a move of 2%, in reality it’s a 3X multiple spread.

Here in the U.S. with our $22T in GDP, the Fed is promising to get a handle on inflation by raising interest rates fourteen times to 3.5% and performing $1T in annual quantitative tightening because they tell us “our economy is strong.” At the same time we are witnessing Europe, with their $23T in GDP and in a deep recession and the ECB cannot even hike 25 basis points.

This is policy divergence, unlike anything we’ve seen.

As a result, we have seen the dollar rise dramatically versus other currencies in recent months. The Euro has not been this low against the dollar since 2002. The weakness could drive the Euro to par with the dollar (currently 1.02). Today the DXY hit 107, a height not seen since September of 2002. Gold prices are higher in every major currency in the world except the dollar.

The Fed is promising rates on their overnight lending to be closer to 3.5% by the end of the year. This while the 2 YR Treasury offered only 2.78% this morning. This is a huge disconnect. The market is actually pricing in rate cuts in 2023. It seems the current course is to raise rates, cause a recession, slow demand, and then cut rates from there.

How can this be a good policy, especially when almost every market participant can follow the same playbook?

The issue becomes even further complicated when we recognize that GDP is a nominal number measured against past nominal numbers and may make an actual recession more challenging to spot.

The famous hedge fund manager, Bill Ackman, took to Twitter on July 4th to highlight this exact scenario. “In a highly inflationary economy, it is more difficult for nominal spending and growth to exceed inflation. In order, therefore, for today’s economy to grow on a real basis, nominal GDP must be greater than 8.6%.” [2]

The difference is between nominal and real...

The idea of real growth is one most long-term investors don’t take into account. It’s one of the main arguments we presented in The Great Devaluation.

To make our point, we compared the Dow Jones from 1964 through 1982. On a nominal basis, the Dow Jones was flat during this 18-year span. In 1964 the average closing price of the Dow Jones was 834 points. In 1982, the average closing price of the Dow was 884 points. [3]

On this nominal measure, it looked like the Dow Jones increased roughly 5% in 16 years. These results, while absolutely terrible by the way, were not the real result for investors.

The real result was far worse.

Notice in Figure 05 below that on a nominal basis the Dow Jones was roughly even from 1964 through to 1982. A $100,000 investment in 1964 was worth the same $100,000 eighteen years later.

We then included Figure 06 to show the real story.

On a real basis, investors holding the Dow Jones during this 18-year span lost roughly 70% of their actual purchasing power. Keep in mind that a postage stamp which cost $.05 in 1964, cost four times more by 1982 and at a cost of $.20. So while a 1964 investor may have the same nominal amount of money 18 years later, they could only buy a quarter of the postage stamps.

On an “inflation-adjusted basis”, the Dow Jones lost 68% of its purchasing power in the 1970s. This is the kind of real performance The Great Devaluation predicts for the 2020s.

We cannot measure the real value of an index without also evaluating the actual value of the dollars it’s measured by.

This is why we urge investors to think in real terms for the long term.

It’s not the purchasing power of the dollar today that matters, it’s what the dollar will purchase ten years from now that should matter to retirement investors. Our entire goldisabetterway.com platform has been designed to reveal the answer to this one riddle.

If the market doubles while the dollar devalues by 50%, did you gain anything? Nominally, after 10 years it may look like it. On a real basis, you’d only break even. This is what stagflation does, it confuses if we are winning or losing.

Ackman's Twitter rant makes the case for significantly higher interest rates and why he believes the Federal Reserve must continue with their proposed hiking plans. “In order to stop the inflationary spiral, the Fed will need to rapidly raise rates by 4-5% by next year.” [4]

On the flip side, Ackman doesn’t discuss what the interest costs on $30 plus trillion in debt would soar to should interest rates move his 4-5% target. Ackman also doesn’t infer what will happen to equity valuations were the Fed to raise interest rates to these levels.

Many experts have suggested that if the Fed were to raise rates to 4-5% we could see an S&P 500 as much as 50% lower than its all-time highs. This is the case that famous investor Jeremy Grantham has continued to make. Grantham believes that the stock market would fall to 2400 points, 50% from all-time highs recorded just six months ago.

But where should we place our bets? We believe the question reveals the answer. The solution as we see it is to stop gambling.

Think long term, buy and hold something tangible and real like physical gold and silver.

The Fed has turned us all into gamblers. The question is how many of us will continue to play the sucker?

For long-term investors seeking to see the real math behind gold prices, we suggest watching our updated video on Debt Affordability.