ValueWalk’s Raul Panganiban interviews Kevin Smith, CFA, Founder, CEO, and CIO and Tavi Costa, Partner and Portfolio Manager at Crescat Capital. In this part, Tavi and Kevin discuss how we are close to a reckoning moment for equity markets, Fed’s money printing, lessons from the tech bubble, the impact of the coronavirus on airlines, the economic recovery. Check out the full interview on ValueWalk Premium.
Raul Panganiban: Yeah. And I just want to know, why is there this disconnect with all the deteriorating conditions and but the stock market right now?
Tavi Costa: I think the stock market is always forward looking. So it's definitely pricing in some sort of V shaped recovery in which I don't think it's been confirmed by the data that we look at at least. You know, you can see this in so many ways, like I've mentioned a few of them, but their car loads of railroads are also not confirming the same situation or electricity consumption or demand for gasoline and so forth. I think there is a lot of issues in terms of that that will perhaps be realigned with, with reality soon here as we get into, especially, I think the liquidity problem. You know, a lot of The bull case rests on liquidity and that the Federal Reserve is printing unlimited amount of money. And therefore you should be buying risk on assets. And I think that that ignores another portion of the narrative that I think it's very significant, which is the issuance of treasuries by the by the government, given the levels of deficits that we have, and also the indebtedness of the government in general. So, which is also sucking out all the liquidity that the that the Fed has been providing to the equity markets. Matter of fact, last month in May, we've had somewhere close to more than 300 billion of net issuance versus monetary stimulus, which is, you know, a liquidity withdraw of the system. So I think there's a lot of issues with that. There's a lot of investors betting on on this liquidity narrative when I think you're missing a lot of other important parts. You know, markets do that for some time. I think that that's quite normal and surprises us in a way. So we obviously don't expect. So. I guess I guess I think we're getting close here to some some reckoning moment for equity markets, very similar to other periods that we had in the past with large corrections in the short term. So I think, still think that this is very likely a bear market and very difficult to come out of a recession, that in average, tends to, you know, have a duration of 12 months, that will only last about one or two or three months and not have a lot of consequences going forward, so.
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Raul Panganiban: And another development in the past couple weeks here has been retail investors, and they're buying up bankrupt companies and pushing up stock prices and you can see the wild swings. Is this similar to 1999?
Kevin Smith: You know, in a lot of ways, yes. I mean, I think there is, you know, was a period that that I certainly, you know, lived through as a as a money manager. And, um, and there's a lot of similarities. I mean, today's market is almost like the almost like the Great Depression meets the tech bubble because like I was just talking about, you know, earlier you had you have these over massively overvalued tech stocks at the same time as we're in the middle of an economic downturn. But the overall market is is still near all time highs, and the valuations are truly insane. But, but when you have these millennial day traders that are involved in the market to and and you know, masses of them sit with their extra $600 a week to put to work and zero commission and you know, zero percent margin interest or close to it. It's, you know, it's just a volatile combination. So the money printing is the monster. The Fed's money printing is the excuse for why we should be bullish, even though all the rest of the underlying fundamentals do not justify it. Today, and so, but it's like a drug, the, you know, the endorphins that they are, you know, raging in everyone's brain because of the Fed's money printing and and then people are speculating. So it's a speculative mania that is no different than the tech bubble in the tech bubble in 2000. in that, in that sense, but but ultimately, the effects of the Fed's money printing are off because, you know, the money printing is not translating into into real economic growth. It's not it's not, it's only going along with more debt that these companies are taking on, and providing for more zombification of the overall economy and you know, that this is the problem, the imbalance that got us to where we are to begin with was is now You know, over a decade of Fed's money printing and and record debt and record asset bubbles record debt globally certainly and and and record asset bubbles when it comes to to global fixed income securities as well as stocks in the US and how is pumping up the stock market even more going to go to solve the problem of the economy, especially if these asset bubbles are just even more prone to burst now, once the temporary drug this money printing wears off.
Raul Panganiban: Yeah and are there any lessons from 1999 or 2000 that tech bubble that you find important today that you use?
Kevin Smith: Lessons on you know from from those errors are exactly what we're trying to apply when we when we have developed our macro model and when we look at at the At valuations and at other underlying macro economic indicators to try to determine where we are in the business cycle when there is a business cycle. And, and normally, the stock market is an integral part of that business cycle, whether it's asset bubbles, you know, developing and bursting, whether it was the tech bubble or the housing bubble and all the ripple effects that that has on the real economy or whether it's just, you know, underlying the underlying fundamentals for corporate earnings themselves ultimately been the magnet and the drag for down for stock prices. I mean, stocks follow underlying fundamentals. And, and but it's it's all related, and today, it's related in a real domino effect, where we have record unemployment and like Tavi was saying early, earlier, you know what's going to happen? When this extra stimulus expires at the end of July, you know, are there really going to be jobs for people to go back to? And I, you know, I really don't I personally do not believe I mean, first of all, the setup for this recession in this bear market we believe was in place, you know, before COVID-19 ever hit. And COVID-19 was just an extra catalyst to to really kick everything off. But in certainly there is going to be a, you know, a jobs recovery in the second half of the year one that already started like, you know, to some degree last month and given you know, just a massive decline in unemployment from everyone been been locked down. But, but where we are at the end of the year compared to to where we were at the peak of the cycle last year. I mean, it's going to take a long time. Time to recover the real economy. That backup to the employment levels and productive capacity that the economy was add back in 2019. This is going to be a full recession to play out. And stocks are going to ultimately have to catch up with the underlying fundamentals.
Tavi Costa: Yeah, I could add to Kevin's idea in terms of the lessons of 1999 and the tech bubble, I think that markets driven by 40 and never ends. Well, and that's one big lesson that we're, you know, unfortunately seen this again, you know, unfolding today. But I think, compared to the tech bubble, also is is that we have, you know, it was much more of a sector, which was the technology sector at the time, that was the issue and today it's a much broader issue, in my view. I'm sure Kevin agrees with that and the fragility Now also, it now goes to the small cap space as well. Which is highly leveraged and in the corporate debt market, which is also a problem, also in large cap stocks too. But in our view, you know, the I think the valuations can continue to grow, you know, forever. I think gravity still works. And the problem is that organic growth is in the economy will unlikely, really revamp here anytime soon. And therefore, we're going to see continue to see monetary stimulus increase going forward, and therefore why we like the idea of buying gold and selling stocks as a simple way to say it. How we position ourselves.
Raul Panganiban: Yeah, I remember the last episode that was the trade of the century idea that you had. But yeah, before we go back to those, one industry that was bullish on is the travel industry and then we saw all the airlines almost double since mid May. And is this a good time to short airlines or in the travel industry as well?
Tavi Costa: Kev, do you want to take that one or me?
Kevin Smith: Sure well I'll just comment that you know, we had been short the airlines early on in the year and when COVID started to to emerge Boeing had been a significant shortage of ours even you know way before that for for its own unique fundamental reasons and valuation extremes that it had you know, starting last year, but regarding the arrow button but you know, getting longer short the airlines right now, we're we're out of that trade. We did get short again recently the the cruise the cruise line stocks, so we you know, that was when we put on at the same time as the airlines back earlier in the year and cashed out on during the downturn in March. And we've at least added added those back again, I mean, there's so many cyclical stocks that have have come back near there. They're all time highs, it's just been too much too fast. And so I think there is opportunity in the in the travel sector at large still to put some shorts on.
Tavi Costa: Yeah. And I think related to that the, you know, when you look at the whole space of discretionary consumers and and all that, I think I think it's, it goes back to the idea of the, you know, going back to the savings mode of behaviour of consumers today. I think it's, at least throughout history, that type of behaviour doesn't revert back quickly. I think that takes a while to play out. And I think that's the case here, especially if this unemployment support here, package expires in July. I think that that will cause a lot of other issues going forward. Now, even airlines with the middle middle seats, a lot of those businesses can't even survive if they remove that as a potential part of their business and restaurants, you know, with under capacity and so forth. I mean, there's a lot of businesses We'll be having issues here. And I think Kevin, or you mentioned some issues with the labour markets. It's incredible. I mean, the labour markets, you know, had a good month, it was a good report, the latest report was the best monthly change ever. But to put into perspective, what we need to have is another five to six weeks, similar to that to that report, in order to remain the same month. So she said yes, to regain the same level of labour market that we have prior to the market to the market peak. So, you know, what's, what's the likelihood of that happening? Personally, I think it's very low. With we saw some, some pyramid permanent job losses increasing significantly, recently, too, which has been increasing significantly. And I think I think that's also not going to change. So a lot of issues an underlying part of the economy and I'm not sure if discretionary consumer discretionary sector will will look very appealing going forward.
Raul Panganiban: Yeah, yeah, I know, definitely, and you see a lot of bullish headlines for jobs but just seems more of like a bandaid like Dunkin Donuts hiring 25,000 workers or their plan to hire. So for unemployment and the economy recovering in that sense, and for full employment, you don't see that happening in the near term. And they'll take a couple couple months or a couple years.
Kevin Smith: Well, I thought the economy is going to recover eventually, but we have to go through the recession first. And you know, there's just no escaping the downturn in the business cycle, especially after the longest business cycle expansion ever with the most overvalued stocks ever and the most debt ever. I mean, these are, you know, unfortunately, there's going to be some, some hard lessons that have to be learned and and we just have To get through the downturn in the business cycle before we can really start talking about how to invest in the recovery.
Tavi Costa: Yeah, it's a good point. And what we're seeing is a tonne of money printing since the recession started, which doesn't doesn't take the economy. You know, it will it will prop up equity prices or risk on assets until until Treasury issuance starts to dwarf the amount of monetary stimulus that we're seeing, which is what I mentioned before as liquidity we draw, which I think is a case in what's happening today already. So, you know, when you when you start seeing organic growth, truly improving in profits, is starting to improve as well for companies in corporations, which is not the case one more time, profit margins are actually not improving. No, I think that that's what you need to see first, and we're not seeing that at all in our end, so we When that changes, I think we're going to change your views. But our macro models are still pointing us to the direction that there's a lot more downturn to go.
Raul Panganiban: Yeah. Do you ever see the Fed slowing down on the money printing then?
Tavi Costa: I think from that front, the only the only situation in which force forces them to stop would be an inflationary environment starting. I'm not sure if that's going to be the case here. But I'm just saying that that would certainly limit the central banks in general from from from this easy money policies that we're seeing. I think the biggest issue is goes back to the government. And in our we're going to continue to see this increasing deficits and that leads to higher Treasury issuance and leads to further monetary stimulus. So this dynamic in my view, drives you know, long term interest rates lower because the Fed has to be buying a lot of those treasuries and expansive monetary base. So it sort of forms is kind of explosive. Mix for things like gold, precious metals, which is why we're so bullish on that in that space. So I'm not I don't think that the deficits are going to improve, you know, significantly anytime soon. I think we're going to have some improvements coming in, in the following months, just like we saw with labour markets. And we already saw that actually, in May, the deficits on a monthly basis are a little bit lower than that the one from April. But, you know, still it's going to be a very large amount that will still probably, you know, force the Federal Reserve to continue to print money to step in and and not allow this liquidity draw in the financial system.
Kevin Smith: Yeah, I think the QE is not going to stop it in any way because there's just going to be this on ongoing dynamic between the markets, you know, wanting to follow the underlying fundamentals and the Fed path. And stepping in to try to to prevent the markets from from falling apart. And this is this is just the same old cycle that we've been in now for for too long and it's why this Keynesian intervention, it can work if you use it judiciously and and it you know, in times it's unique but when you when you just, you know, consistently go back to the, to the to the monetary and fiscal stimulus and means of fixing the economy to prevent every little market downturn. You don't get creative destruction, you don't get the natural, you know, cleansing that business cycles are supposed to, to produce to really pave the way for the next growth cycle instead With zombification and when you have a combination of zombification meaning, you know, unproductive companies and unproductive investments at the same time as you have this insane overvaluation, you know, it's it's a real it's a real volatile mix, and it's why we are so incredibly bullish on precious metals, like Tommy said today because it's just really an incredible opportunity for people to realise that there is an alternative to to buying overvalued stocks and and government bonds. When when the Fed is when central banks are printing massive amounts of money and that alternative is undervalued, precious metals, but people, investors need to really start waking up to that and I think they will.