September 6, 2024
By Steve Blumenthal
“It’s not whether you get knocked down, it’s whether you get up.”
— Vince Lombardi
Bonds now, stocks later.
When I started in the business in 1984, few investors thought long-term. Most believed the way to succeed was to trade the market. “No one buys and holds stocks,” they all said. That was the prevailing mindset.
The 1970s had just seen three painful waves of inflation, and in the early 1980s, long bonds were yielding more than 15%—a lay-up trade few wanted to make. Real Estate and gold were the asset classes of choice.
For equity investors, today’s starting conditions are not good:
- High valuation (as illustrated below)
- Investors overweight in stocks, underweight in cash
- Elevated geopolitical risks
- Overindebted governments
- High internal conflicts (polarized extremes)
- Globally restrictive monetary policy (except in the U.S., which continues to print money to fund excess government spending)
Look at the yellow line in the chart below for a historical perspective. Look at where it was in 1970 and the early 1980s. Then, look at 2000 and 2008. Do the majority of investors really buy and hold stocks? The answer is NO.
Investment starting conditions matter.
If I’m right that we are in a period of a series of inflation waves similar to the 1970s, why invest in fixed-rate bonds? The 10-year Treasury note yield is 3.67% this morning—which is lower after today’s weaker-than-expected jobs report. If inflation and rates move towards 8% or higher (which I believe is probable), bond investors will lose to inflation, and the principal value of the bonds will go down. After all, who wants to buy a 3.67%-yielding bond when they can buy a bond yielding 8% or higher? Given government behavior, I think that 8% yield is coming within the next five years. Debt continues to accelerate unchecked, and I believe we could jump from $35 trillion in debt to $50 trillion in the blink of an eye. I hope I’m wrong.
If governments choose to inflate their way out of the debt crisis, we may see inflation back above 10% (or higher) and a 10-year Treasury yield closer to 8%, vs. the current 3.67%. It could go even higher. So we must watch the Fed and the Treasury, we can’t yet know. If I’m correct, bonds will lose to inflation, and bond prices will crash.
Bonds now (slowdown/recession), not later. Stocks later (after correction), not now.
I expect the 10-year yield to fall to 3% in the short term, with a probable recession approaching. That would make for a profitable bond trade, as bond prices rise when interest rates fall. However, the government’s massive debt issue could (likely) lead to more money printing. Inflation is the feature, not the bug.
Instead of traditional bond investing, seek alternative differentiated return streams with floating interest rates—funds yielding in the high single-digits to mid-teens. They exist. If rates rise, so does your yield; if rates fall, your yield follows. The point is, I think rates will be much higher five years from now.
To that end, I wrote a paper titled Understanding Private Credit. You can sign up to read the paper here.
Grab a coffee and find your favorite chair. Today, let’s examine Dalio’s “Five Major Forces” and regain our footing around current market valuations.
On My Radar:
- Where Will the Money and Productivity Come From?
- Month-end Valuation Update (Buffett’s GDP, Price-to-sales, and more)
- Random Tweets
- Personal Note: Your AI Personal Assistant
- Trade Signals: September 4, 2024
See Important Disclosures at the bottom of this page. Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.
Excerpt: “Where Will the Money and Productivity Come From?”
By Ray Dalio, Founder, CIO Mentor, and Member of the Bridgewater Board. Published August 26, 2024
I write a lot about the coming restructuring of the debt and entitlement systems. We don’t know how they will be restructured or if there exists the will to do it. Regardless, the time to do so is racing towards us whether we like it or not. Ray Dalio wrote up his thoughts on the issue last week. “What is happening now has happened many times before in only slightly different ways,” he says.
Below is a later section from his post, “Where Will the Money and Productivity Come From?” though I encourage you to read the full piece here on LinkedIn.
From Ray:
The Five Major Forces
“It is readily apparent that the world order is changing 1) within countries via the moves toward increasingly extreme and polarized sides on the hard right (almost neo-fascism) and hard-left (almost neo-socialism/communism) that are squaring off as they move increasingly toward neo-civil war, 2) between countries via the increasing conflicts that are leading the major powers (and their smaller power allies) to align into neo-allied and neo-axis sides in neo-cold wars with neo-hot wars on the horizon, 3) with the classic big debt bubble/bust cycle approaching its late and more turbulent stage, 4) in the increasing disruptive acts of nature, and 5) impactful new technologies emerging. All these things have happened together many times before for basically the same reasons, though of course no two are exactly the same and what is happening now reflects the contemporary versions of these influences.
I believe that it is really important to know how this Big Cycle works in order to understand both what is now happening and what might happen. (bold emphasis mine)
For reasons explained in much greater depth in my book and YouTube video, both titled “Principles for Dealing with the Changing World Order,” the world operates like a highly cyclical perpetual motion machine to produce the events that happen. In the book and video animation, I provided a template that I use to compare actual developments to help me see and anticipate what will happen. By and large, actual events are transpiring in a way that is consistent with the template for logical reasons.
Note: The views I express in this post are my own and aren’t a reflection of the views of Bridgewater.”
Source: Ray Dalio, LinkedIn
Please see the essential disclosures in the disclosures section below.
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
Month-end Valuation Update (Buffett’s GDP, Price-to-sales, and more)
Courtesy of AdvisorPerspectives, “The Buffett Indicator, also known as Market Capitalization to GDP Ratio is a long-term valuation indicator for stocks that has become popular in recent years, thanks to Warren Buffett. Back in 2001, he remarked in a Fortune Magazine interview that “it is probably the best single measure of where valuations stand at any given moment.” It is a measure of the total market value of all publicly-traded stocks in a country divided by the country’s GDP and can be used as a way to assess whether the country’s stock market is undervalued, fair valued, or overvalued.”
The most recent number as of August 2024 is 194.9%. By this measure, the stock market is extremely overvalued. A better entry point would be at the red long-term regression line.
Courtesy of John Hussman, “The chart below shows our most reliable valuation measure, based on its correlation with actual subsequent S&P 500 total returns in market cycles across history, in data since 1928. The blue line shows the market capitalization of U.S. nonfinancial equities as a ratio to their gross value-added, including our estimate of foreign revenues. MarketCap/GVA now stands above both the 1929 and 2022 extremes, and is also easily above the 2000 and 2007 peaks.”
Price-to-Sales Ratio
Source: Bloomberg, CMG Investment Research
Shiller PE
I share the following chart in Trade Signals each week.
Source: Shiller PE
Return Probabilities based on PE 10 (which is similar to Shiller PE)
A ranking of all the 10-year periods from 1909 to 2022. The current high Shiller PE puts us in the top decile of all readings. Note the “We are here” and “We’d be better off here” arrows.
From Crestmont Research: Keep in mind that P/E drives returns. This happens in two ways. First, the level of P/E drives dividend yield (high P/E causes low dividend yield). Second, the starting level of P/E largely affects whether P/E rises or falls over ten-year periods (Components chart), which adds or detracts from the total return. The propensity to rise is greater when P/E is lower. Conversely, P/E is more likely to decline from higher levels.
Please see the important disclosures in the disclosures section below.
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
Random Tweets
The match that lights the fuse:
Source: Bloomberg’s @LisaAbramowicz1
Forward PE (an indicator I disfavor due to Wall Street estimates that are typically revised lower; however, useful non-the-less)
Source: @JesseFelder, and The Daily Shot
Personal Savings as a % of Disposable Personal Income
I “like” and “retweet” posts I find interesting. I enjoy X because I can easily follow people I like to keep On My Radar.
You can follow me on X (formerly Twitter) @SBlumenthalCMG.
You can also listen to my podcasts on Spotify, and find me on LinkedIn.
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
Personal Note: Your AI Personal Assistant
I’ve been diving deeper into ChatGPT and how large language models (LLMs) work. One of the great joys of being in the venture capital (VC) and private equity world is the people you meet and the groundbreaking ideas they help bring to life. We’re invested in an AI-focused VC fund, and I recently walked away from an investor call feeling genuinely excited. AI is still in its early innings—think back to when we were all just figuring out what an “app” was in the early days of the iPhone. The future promises a wave of AI-assisted technology across nearly every domain.
This week, I stumbled upon a series of posts from Dan Goldfield. You can find him on X (formerly Twitter) at @itsdangoldfield if you’re interested. He said, “ChatGPT just got a MAJOR upgrade: it can now remember things (making it way more like a real personal assistant).”
Dan outlined four prompts to maximize this new memory feature:
- Ask me a series of questions about myself, my life, my purpose, my goals, my work, and my challenges. Dan spent 30 minutes giving ChatGPT detailed responses on his purpose and vision, current business focus, long-term goals, audience engagement, offer creation, marketing, and tools.
- Confirm the details you’ve locked into your memory. Dan suggested always having GPT confirm what it’s remembered. It’s improving, but errors still happen. He opened a new chat and had GPT recall what it had stored—it remembered everything correctly.
- Given my responses to your earlier questions, do you have any comments on my current situation? Dan asked for ChatGPT’s thoughts, and it provided insights based on what it knew.
- Is there anything else you feel it would be useful to know about me—specifically for the purpose of adding to your memory to make your future responses more helpful? ChatGPT threw back some thoughtful follow-up questions. Dan answered the relevant ones, further refining its memory.
There’s a lot of potential here, but I’m also mindful of privacy concerns. How is my information being used, and could it end up as some kind of “Steve bot” roaming around out there? Definitely something to look into further.
On that note, I’m rushing to hit send before the 4 pm ET Malvern Prep soccer game kicks off. Here’s to a big win and a cold post-game IPA with Coach Sue (my wonderful wife).
Oh, and let’s not forget—the Eagles face the Packers tonight. Game one… Go Birds!
Best of luck to you and your favorite teams.
I’m looking forward to putting this challenging week behind me. Two to the gut and one to the chin. Thus, the intro quote. “It’s not whether you get knocked down, it’s whether you get up.”
— Vince Lombard i
Here’s to tough weeks and getting back up. Ever forward!
Kind regards,
Steve
“Extreme patience combined with extreme decisiveness. You may call that our investment process. Yes, it’s that simple.”
– Charlie Munger
Notable this week:
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Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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“The blue line in the lower section shows how much the orange line is above or below the long-term trend line. It is currently in the “Overvalued” zone. Lastly, the data boxes at the bottom of the chart display the annualized gains based on each zone (Overvalued, Fairly Valued – blue line in the middle zone, or Undervalued).”Please take note of the following text:
“The blue line in the lower section shows how much the orange line is above or below the long-term trend line. It is currently in the “Overvalued” zone. Lastly, the data boxes at the bottom of the chart display the annualized gains based on each zone (Overvalued, Fairly Valued – blue line in the middle zone, or Undervalued).”