Friday Haymaker

"What Would Rhett Butler Do?" Redux

“The U.S. is 4% of the world’s population, but makes 40% of the world’s budget deficit, (and) 60% of the world’s (trade) deficit.”  -Louis-Vincent Gave

“I believe in Rhett Butler, he's the only cause I know.” -Rhett Butler

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Bubble 3.0, Revisited

We all have our disappointments. Those are just part of the human experience (or is it comedy?). Ironically, one of mine pertains to my second book, Bubble 3.0, subtitle, Who Blew It and How To Protect Yourself When It Blows Apart. The irony stems, in part, from what I felt were some very timely warnings that have largely stood the test of time.

Because I was of the belief that what I have often characterized as the Biggest Bubble Ever was beginning to burst in late 2021, as I was finishing this project, we rushed it to publication. It was fortunate because of the asset price collapse that was right around the corner. 

As some of you are aware, my team and I released Bubble 3.0 in installments on Substack because of the need for speed. We even published some of it out of order based on what I felt were particularly urgent chapters. One example of that was the chapter on energy that we released in October 2021. It will come as no surprise to regular Haymaker readers that it was bullish on traditional fossil fuel producers. This was a MOST unpopular view at the time. Fortunately, it was vindicated when the energy sector rose 64% in a brutal 2022. (Stay tuned for some not-so-hot calls.)

The publication process was admittedly a bit messy but it did accomplish my goal of being ahead of the worst damage from that latest bubble bursting event. Where the disappointment kicked in was with both the failure to attract a mainstream publisher and the deafening silence about its main themes. 

My thought was that given the importance of the subject matter, some financially oriented publishing house would want to at least run an updated version (still hoping!). Perhaps the lack of interest is due to my peculiar unconventional writing style. Or maybe it’s because of the inflation of the echo bubble in so many reaches of the U.S. stock market. 

Both are plausible but I wanted to herein address the second aspect. While it’s undeniable that the S&P and the NASDAQ have made decisive new all-time highs — and I’m an avowed respecter of those — a number of important asset classes are in a much different state. Moreover, even the S&P and the NASDAQ were slammed after we hit send back in early 2022. At one point, the S&P had melted by 25% and the NASDAQ tanked by ~36%. 

The part of the U.S. equity market upon which I was ferociously bearish in those days was what I often called the COPS: Crazy Over-Priced Stocks. This primarily applied to profitless tech companies and myriad other “sure-fire” growth stocks. Most “sure” were torched, while the only growth was on part of the flames engulfing their valuations… like, by 70-80%. Hot stocks are one thing, but burnt to a crisp…?  

The asset class that I was just as negative on was, oddly, generally considered to be one of the most conservative: long-term U.S. Treasurys. The point I made at the time was that while one could argue about stocks being in a bubble — admittedly, not all were — it was almost impossible to deny the valuation lunacy in the world of long-dated government bonds in all developed countries. 

The fact that the yield on the 10-year U.S. T-note vaporized to near ½% in the summer of 2020 was irrefutable evidence that the “B” word applied. Even more persuasive was that there were some $17 trillion of negative yielding bonds in the rich world at the time. That led me to conclude debt markets in the developed countries were the most expensive in human history. In actuality, I was merely stating a fact. Because interest rates have such a profound impact on asset prices, it was logical to assume that there was massive and widespread overvaluation. And if rates did rise dramatically there was bound to be serious trouble in financial markets… enter, 2022.

By the time I was writing Bubble 3.0 in the summer of 2021, I was also making the repeated case that the inflation eruption back then was anything but transitory. By the end of that year, the 10-year T-note had moved up considerably in yield but it was still a paltry 1½%. 

Meanwhile, inflation was exploding. At year-end 2021 it was already at 6% but it was soon headed to over 8%. This led to one of the most aggressive Fed tightening campaigns ever and also the worst bear market for long-term U.S. Treasurys (UST) in history. As of May 2024, the 30-year UST has produced a mind-blowing negative return of 47% from its 2020 apex in price (and trough in yield). From 12/31/21, on the eve of Bubble 3.0’s publication, it has generated a negative return of 36%. Adjusted for inflation since then, the real losses are more like 60% and 50%, respectively.

The bond market thrashing that hit its crescendo in 2022, combined with the above mentioned bear market in stocks, created an extremely rare occurrence: an abysmal performance by the usually loss-resistant, and highly popular, balanced portfolio strategy. In fact, it turned out to be the worst year for blended stock/bond investors since before George Custer and the 7th Cavalry had their unfortunate encounter with Sitting Bull and Crazy Horse. This double-trouble was exactly what I warned about in Bubble 3.0. Candidly, though, even I was surprised by the intensity of the sell-off in both stocks and bonds.

There were other alleged investments that were also caught up in the greed-drenched days of 2020 and 2021. Those included cryptocurrencies, SPACs (Special Purpose Acquisition Companies) and NFTs (Non-Fungible Tokens). My derision toward these three “asset classes” was particularly strident. In the crypto realm, I was especially  critical of Dogecoin (and its plethora of offshoots) which even its founder admitted was a worthless joke. Incredibly, after losing two-thirds of its market value, from $23 billion around the start of 2022 down to a low of $7.6 billion by that summer, it is now right back up to $23 billion. Like I said, welcome to the echo bubble!

But a much more important element of this revisit, is to consider the ports in the storm I recommended at the time, how they’ve done since publication and, particularly, if they still hold investment appeal. Naturally, not all have knocked the cover off the ball. But my overall emphasis was on hard assets like gold, copper, uranium. Somewhat along those lines, I did timidly endorse buying Bitcoin once the bubble popped. Even the King of Cryptos did a bungee jump from $45,000 in early 2022 to under $20,000 by year’s end, before springing back with its usual verve, slightly exceeding its fall 2021 apex earlier this year. For anyone who dollar-cost-averaged into its meltdown, you should be more than a bit happy with BTC, one of the precious few truly valuable cryptos. (Full disclosure: I did not; my preference continues to be with scarce natural resources.)

But here’s a list of my main recommendations: 

(Because of my role as co-Chief Investment Officer of Evergreen Gavekal, I am under extreme restrictions about showing performance data. However, I have included symbols for each of my previously highlighted areas. You can use Google Finance to quite easily see where they were trading at the start of 2022 by hitting the 5-year price range)

Gold (GLD)

Gold Miners (GDX)

Continuous Copper Contract (no symbol needed)

Physical Uranium (SRUUF)

Cameco, the largest uranium miner (CCJ)

Oil (USO)

Energy stocks (XLE)

Mid-stream energy, aka, pipelines (AMJ)

Global Value Stocks  

S&P 500  +14.85%

NASDAQ  +9.06%

With bonds, I suggested floating rate securities, to protect from rising interest rates. Emerging market debt was particularly a preferred area in fixed-income land. While it didn’t totally avoid the carnage from the big, bad bond bear market, it did hold up considerably better than longer term U.S. Treasurys. 

Regarding one of my repeated self-criticisms since Bubble 3.0’s publication was my negativity toward the U.S. dollar back then. The dollar did go on to outperform most currencies, though the Swiss franc, which I recommended, held its own. Further, when valued in the ultimate non-fiat currency, gold, the dollar is actually down by the amount gold is up from 12/31/21, or 26%. Because I was such a staunch advocate of bullion 29 months ago, I think that’s a fair point. 

Overall, I feel like the investment guidance provided in Bubble 3.0 turned out to be exceedingly valuable. But, then again, I’m not exactly unbiased. (One whiff I will concede is that Jay Powell became much more hawkish than I expected… at least until he flinched during last year’s banking crisis. That liquidity blast likely helped inflate Bubble 3.5). 

For those who care to read most of this chapter (I cut out some less relevant material), you’ll find that below. For paying subscribers, I’ll provide an updated list of several asset classes that I think remain attractive in next week’s Making Hay (Almost) Monday. Realistically, however, I think we need to prepare for the demise of Bubble 3.5. Accordingly, playing good defense is imperative now, just as it was for 3.0 in early 2022.

As you’ll soon see, I used the mythic character from Gone with the Wind, Rhett Butler, as my narrative avatar to drive home and, hopefully, enliven my positioning suggestions. Part of my logic in doing so was the increasing parallels I see with the Civil War era and that of America today. 

At the time, Neil Howe had not yet published his epic The Fourth Turning Is Here which discusses many of the same points. Essentially, he believes America is in its third mega-crisis of the last 250 years. As I’ve noted in these pages, I’ve been amazed by how many top strategists and super-investors I follow also believe we are in another Fourth Turning. To that point, you may have seen that the billionaire founder of Bridgewater Associates, Ray Dalio, said earlier this week that he believes there is a 35% to 40% chance America is heading into some type of civil war. Hopefully, all of these brilliant people are wrong. However, in case they’re not you might want to read the following very carefully. Frankly, the words I wrote back then strike me as even more relevant in 2024.

What Would Rhett Butler Do? Chapter Redux

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In the classic Civil War film, Gone with the Wind, Clark Gable’s character made a cynical, yet profound observation:  

I told you once before that there were two times for making big money, one in the up-building of a country and the other in its destruction. Slow money on the up-building, fast money in the crack-up. Remember my words. Perhaps they may be of use to you some day.

While I admit it’s heartbreaking to think the U.S. could be going through an episode similar to the South, as the War Between the States was ending very much to its disfavor, it’s not outlandish to consider. The fact that the U.S. government today is resorting to massive money fabrication to pay its bills is one haunting parallel. The reality that there is such intense national division, that at times seems to be bordering on a stealth civil war, is at least another faint echo.

Yet, it is also critical to realize that the South not only survived its humiliating defeat but that within a matter of decades, or even less, it was booming. You may recall how rich Scarlett O’Hara became during Reconstruction (it helped that she was beautiful and married a wealthy man who would prematurely pass away… and, of course, it was the movies). Moreover, almost 160 years later, the South may be the most economically vibrant, and fiscally sound, region in America. 

Whether it was the post-Civil War South or Germany in the early 1920s, people of wealth faced an existential decision. If, during those episodes, they loyally kept their assets denominated in their country’s currency, like in bonds or bank accounts, they were wiped out. If they recognized the gravity — and even depravity — of the situation, they were able to come out the other end of the crisis with their wealth largely intact. Further, they had the buying power to capitalize on the immense opportunities created by the chaos.

So, what would Rhett Butler likely be doing with his money if he was operating in the U.S. in 2022? Here’s my best guesstimate on what his portfolio might look like:

Energy: Being the cagey character he was, Captain Butler would no doubt play both sides of this bet. He’d have plenty of exposure to renewable energy plays, especially those where there was a near certainty of extreme shortages. Of course, he’d also avoid overpaying, choosing to accumulate them after corrections and when bullish sentiment had cooled. The 2021 pull-back in copper prices was such an example. 

He’d also likely come to the conclusion that traditional fossil fuels were a long way from being obsolete. He would almost assuredly realize that with countless entities — like college endowment funds, government retirement plans, and high-profile investment management companies — either totally eschewing fossil fuel investing, or seeking to minimize it for ESG reasons, shortages would be inevitable. Shortages naturally mean high prices and he would not hesitate to tread where so many other investors would not — at least until they realized that the world in 2022 was still exceedingly reliant on fossil fuels. The fact that he could receive dividends on his investments that were as high as 20% would only strengthen his resolve. 

… traditional fossil fuels [are] a long way from being obsolete.

It’s also highly probable that he’d realize that decarbonizing the planet’s energy supply would require reviving nuclear power. Thus, he’d be on the lookout for opportunities in the largest uranium producers, as well as any company that had viable small modular nuclear reactor technologies.

Precious metals. Having witnessed the Confederate currency debased to nothingness, he’d have a natural affinity for precious metals. And since he’d always had a soft spot for cash generating investments, he’d be attracted to the miners thereof and their rising dividend yields. He’d almost certainly pick up on the fact that it was possible at year-end 2021 to buy an ETF of the best gold miners in America for half of what it sold for… in 2011! 

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International equities. Given his fondness for foreign trade, he would be willing to look overseas for far better bargains than in the hyperventilating U.S. market. He’d quickly pick up on the fact that while most American stocks were trading at record-breaking prices, including many producing huge operating losses, he’d prefer highly profitable companies in other markets selling for valuation discounts of 50% or more. He’d also realize that international value stocks were, in many cases, even more alluring than those in the U.S.

Rosenberg

Overseas bonds. It would be highly likely that he would put his bond investments in countries that were not practicing MMT which he would undoubtedly realize was eerily similar to what the South had done as it was losing the Civil War. He’d be attracted to the debt of nations running trade surpluses and modest budget shortfalls as opposed to the out-of-control status of America’s twin deficits. He’d also be inclined to store copious quantities of his cash in the currency of a country that has been a safe harbor for centuries. (More on that to follow.)

In addition to what he would do there are also critical things he wouldn’t do. To wit, he would refuse to:

Run with the blundering herd. Captain Butler always had a knack for spotting suckers, usually at a poker table, and he would for sure recognize the lunacy of millions of clueless amateurs recklessly throwing hundreds of billions around in 2021. In fact, the odds are high he’d have been shorting, or at least buying puts on, many of the stocks for which the Robinhood and r/wallstreetbets crowd was vastly overpaying.

Rely on a traditional balanced portfolio. Unlike most investors, the independent-minded Butler would quickly pick up on the dangers of relying on a mix of 50% stocks and 50% bonds in a time of rising inflation. With real yields deeply negative even on 30-year T-bonds, he’d avoid them like the blockade ships he’d so frequently dodged. He’d perceive that long-term fixed-income investments were now positioned to increase risk, rather than lower it, particularly if the U.S. dollar got slammed, as he anticipated. He would seek his portfolio counterbalances through the aforementioned international bonds or gold. 

Join the speculative orgy in cryptocurrencies. The combination of immense leverage and the mass dilution potential of the cryptos would almost certainly convince him that this was clearly a case of mass delusion. He might dabble in the scarce cryptos, like Bitcoin and Ethereum, when they plunged as the weak-handed suckers got flushed out, but he’d steer clear of the 6000 or so others that could be created as fast and furiously as Confederate dollars were in 1865.

Chase other absurd fads. He’d undoubtedly avoid like the plague that hit Atlanta as it was falling to the Yankees, all the acronyms and initialisms that were attracting hundreds of billions, if not trillions, in 2021: IPOs, SPACs, and NFTs. Being the hard-boiled cynic that saw him emerge from the Civil War as a very wealthy man, he’d never want to own supposed assets that were utterly lacking in scarcity value. 

Fall for the Fed’s faux-tightening rhetoric. Being congenitally suspicious of big government agencies and a believer in “watch what they do, not what they say”, he’d be a cynic when it comes to the Fed’s Put being totally kaput. More likely, he’d suspect the Put would kick in at somewhere around down 30% on the S&P vs the minus 20% that precipitated the “Powell Pivot” – the Fed Put in drag – back in early 2019. It’s further probable he would extrapolate the Fed’s increasingly aggressive market interventions, such as buying corporate bonds in March of 2020, and come to the conclusion it will buy stocks in the next panic. Thus, he’d likely suspect the Fed Put isn’t totally kaput, just modified to inflict more damage on speculators, thereby producing some political cover, before Jay Powell flinches once again. 

In that regard, and returning to my comment above on where Rhett Butler would likely keep a slug of his cash, my recommendation to wealthy Americans (and even those of modest means) is that they move a considerable quantity of their cash into Swiss francs. This is not to suggest using secret Swiss bank accounts. The objective is to avoid the probability of a crash in the U.S. dollar that could start as soon as 2022. 

… move a considerable quantity of [your] cash into Swiss francs.

Fortunately, not all bonds have degenerated into certificate-of-confiscation status. This is particularly true overseas and, ironically, in many emerging markets. These former financial basket cases, at least in many cases, are now conducting monetary policies reminiscent of developed countries, before they/we discovered QE and MMT. Thus, the tables have been turned with the developing world, in many, certainly not all, instances protecting bondholders’ capital while most of the “rich” world is busily impoverishing them (all the while insisting this is just a temporary condition). 

In my opinion, diversifying internationally is one of the most important moves an American bond investor can make these days. 

Returning to equities and how to avoid the coming reckoning for most U.S. stocks, because almost all investors are so drastically underweight energy and precious metals securities, there is, by definition, minimal downside risk. These two sectors/sub-sectors are my personal favorites and I freely admit I am in the opposition position of the investment community: I am massively overweight both of them.

It really is true that a major oil and gas producer — with, arguably, the most prolific new reserves — is projected to pay a dividend yield of 20% or more. And that’s assuming much lower oil prices than today’s $100 plus level.*

*As a literal footnote on this, Brazil’s largest oil and gas producer has returned nearly 200% since then; please realize this is just an example, though a relevant one. 

Pushing one’s equity investment dollars overseas is critical for the reasons and factoids stated earlier in this chapter. The Japanese and South Korean stock markets look particularly attractive. Both sell at far cheaper valuations than the U.S. and each also benefits from money fleeing the Chinese stock market where that country’s policies have turned viciously against investors, both domestic and international. Each of these markets have also had major upside breakouts, a critical aspect I’d also like to bring up at this point.

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That’s a Wrap!

Okay, I hope you enjoyed that Bubble 3.0 recap/redux. A lot has changed since I first came up with the Rhett Butler framing concept, but like Butler himself, I’ve held fast to my belief in economic fundamentals (an artful way of saying I still like commodities).

Finding that middle ground between adhering to proven wisdom and adjusting to daily market events is the real challenge for those in my business. Tune in next week for our follow-up piece where I’ll try to pull that off by homing in on some investment moves that might even appeal to the male lead of what is still the highest-grossing movie off all time, at least in dollars adjusted for all the Fed-enabled debasement that has occurred since 1939.

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IMPORTANT DISCLOSURES

This material has been distributed solely for informational and educational purposes only and is not a solicitation or an offer to buy any security or to participate in any trading strategy. All material presented is compiled from sources believed to be reliable, but accuracy, adequacy, or completeness cannot be guaranteed, and David Hay makes no representation as to its accuracy, adequacy, or completeness.

The information herein is based on David Hay’s beliefs, as well as certain assumptions regarding future events based on information available to David Hay on a formal and informal basis as of the date of this publication. The material may include projections or other forward-looking statements regarding future events, targets or expectations. Past performance is no guarantee of future results. There is no guarantee that any opinions, forecasts, projections, risk assumptions, or commentary discussed herein will be realized or that an investment strategy will be successful. Actual experience may not reflect all of these opinions, forecasts, projections, risk assumptions, or commentary.

David Hay shall have no responsibility for: (i) determining that any opinion, forecast, projection, risk assumption, or commentary discussed herein is suitable for any particular reader; (ii) monitoring whether any opinion, forecast, projection, risk assumption, or commentary discussed herein continues to be suitable for any reader; or (iii) tailoring any opinion, forecast, projection, risk assumption, or commentary discussed herein to any particular reader’s investment objectives, guidelines, or restrictions. Receipt of this material does not, by itself, imply that David Hay has an advisory agreement, oral or otherwise, with any reader.

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Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this material, will be profitable, equal any corresponding indicated performance level(s), or be suitable for your portfolio. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. All expressions of opinions are subject to change without notice. Investors should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed in this presentation.