Lawrence McDonald is a risk consultant, the founder of The Bear Traps Report, and the co-author of How to Listen When Markets Speak: Risks, Myths, and Investment Opportunities in a Radically Reshaped Economy.
In this podcast, Motley Fool host Deidre Woollard caught up with McDonald for a conversation about:
- What an aging American population means for stocks.
- How natural gas companies benefit from a growing global middle class.
- The case for adding commodities to a retirement portfolio.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
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This video was recorded on April 21, 2024.
Lawrence McDonald: When people look at stock prices, you don't want to look at the stock price, you want to look at the market cap. It's very difficult for $2.3 trillion company double. But the companies that support this historic industrial revolution of artificial intelligence, that's where the upside is, and the second and third tier names that don't get a lot of attention.
Mary Long: I'm Mary Long and that's Larry McDonald of risks consultant and founder of the Bear Traps Report. He's also a co-author of the new book, how to listen when market speak. Deidre Woollard caught up with McDonald's to chat about why this market cycle feels different from others. The possibility of a dividend renaissance and why there may be a bull market coming for commodities.
Deidre Woollard: Well, I've been thinking a lot, we seem to be at an inflection point. I've been listening to a lot of different podcasts and talking to authors. One of them that I talked to recently said, we might experience a different type of market. We might experience a renaissance in dividend payments and less buybacks. What do you think about the potential for that kind of shift?
Lawrence McDonald: Yeah, renaissance in dividend payments makes a lot of sense. In the sense that certain companies are producing lots of cash. There's been a lot of different sectors, has been a capital retention management style where companies are holding capital and a lot of their building up cash and they want to return that cash to shareholders. We've been too much so and I think over the last 10 years, too much show on the buyback programs. I think that there's going to be some big political pushback on the buybacks. I think that that's a pretty important point around dividends. Also the biggest point that we make in the book from this perspective is the passive revolution. David Einhorn's in our book, famous hedge fund manager, founder of Greenlight Capital. His point is that once passive gets too big and that's your index funds owning lots and lots of equities and lots of, lots of value trillions is about over 35 trillion tied to passive investing through the S&P and say that the NASDAQ, and there's not a lot of eyeballs on those ideas because when passive investing gets too big, those investors are just passive. In other words, there's not a lot of homework and there's not a lot of due diligence, there's not a lot of questions being asked of senior management and that's one of the points in the book. I think it's really important for our watchers and readers and listeners right now.
Deidre Woollard: I think that's really true. Jamie Dimon's letter this week from JP Morgan Chase also addressed that idea of how big those passive investors are and what that means for the market, what it means for things like proxy statements that all of these decisions are being made mostly automatically now versus active investors trading in and out of the market.
Lawrence McDonald: Yes. For the viewer, they need to understand that essentially your 401K has been hijacked by 10-15 companies, maybe eight companies. In other words, the market is so big and so concentrated and the higher it goes, the more money comes in, and you get a lot of chasing into bull markets. In bear markets you get a lot of what we call capitulation selling. What happens is when you're too big on the passive side, the market's going up and up and up, there's a lot of inexperienced money coming in, fast money. It's what we call weekends and poker where it's coming in as chasing, chasing, chasing, and the actual market itself is becoming more concentrated in fewer and fewer and fewer names. That's very important for people watching us right now if you have a 401K.
Deidre Woollard: Yeah, very true. Another thing you brought up in the book that I hadn't quite thought that much about was the impact of cheap credit between 2007 and 2019. The way that it helped large businesses really wipe out the competition because they had all of this cheap money. Does that shift a bit now, if we've got capital being more expensive, is there any way that this sort of levels out the playing field a bit? Is there a bright side to this?
Lawrence McDonald: Yeah, that's a good point. In other words, what we do know, and the wall street journal said this, is that the percentage of profits from the largest 100 companies, and this is just a bloodcurdling stack, it's gone from like instead of the 1960, 70s, 54-60% of the profits were in the top 100 companies. Through the 80s and 90s it's become more and more concentrated. Now we think over 90% of the oral profits are within those hundred companies. In other words, the bigger companies are getting bigger and bigger and bigger. To your point, when interest rates were low, they can borrow money at very, very cheap rates. That really helped the Home Depot's wipe out a lot of local hardware stores, for example. Now, I think it will take some time. But that point is very correct, but it's going to take some time for this higher interest rate regime to equal out the playing field.
Deidre Woollard: None of us know how long it's going to last. There's another phenomenon in the book that you talk about that I've been thinking about too, which is the aging of America. I've been thinking about it in a different way I think than you have. Because you brought up this point of the demographic time bomb, which is baby boomers, they start moving money out of stocks that go into maybe that traditional 60, 40 portfolio, maybe not investing deeper into bonds, maybe some other areas. What does that do in terms of the passive situation that you mentioned and what happens next?
Lawrence McDonald: Well, this is one of the most important parts of our book when markets speak, and that is, if you think about the Lehman error, the post Lehman world, it was about a four trillion-dollar fiscal and monetary response. Then there was this massive, what we call a sturdy regime in 2010, 11, 12, or with the election in Republicans or Democrats then we had austerity in Europe. There was a massive restaurant, what we call deflation or disinflation, because we had a smaller fiscal and monetary response relative to now and then a lot of austerity immediately after. Today, if you look at the response to COVID and the response to the banking crisis over the last year and a-half, which we had like four or so banks go under Silicon Valley Bank, the New York Community Bank and the like. The response today is not for trade, it's 16 trillion on the fiscal and monetary. What that's doing is creating more sustained inflation regime. We're seeing that now we have an election. You think about team Biden. They know that the 2008 election, when we had that banking crisis, that had a lot to do with the outcome. President Obama was an amazing politician up against John McCain in 2008. But the banking crisis actually had a pretty impact on that election.
What's happening now is the team Biden and the whole fiscal and monetary, they're going all in. They want to have a low unemployment rate, they care a little bit less about inflation because they want to prevent that banking crisis from really what we call credit spread contagion. They've put out the fire. The problem is they've created a sustained inflation regime, and that means that you needed an entirely different portfolio from 2010-2020, you needed a 60-40 portfolio, no big deal, in a portfolio that was heavy in growth stocks in what we call financial assets. Those are growth stocks and bonds. Today, in this new stained inflation regime, that 2020-2030 portfolio needs to look a lot different. That's one of the most important things for people watching us right now. That's more like maybe 40% stocks, 40% bonds, 20% commodities, a whole different asset allocation and risk parity as we know it, that 60-40 portfolio is dead. I'm happy to talk about demographics if you care.
Deidre Woollard: Well, I want to talk about that 20% commodities because that isn't something a lot of people are talking about. Maybe we're a little bit more aware of it, the little cocoa crisis, I think has all of a sudden made people pay attention to commodities. But what do you think people are missing about commodity? People, for the most part, don't rush to invest in commodities at this point.
Lawrence McDonald: Well, the mind blower is stuff that's in the book, it's 2011, 12, 13, in that range, the NASDAQ 100 was about the same size as the energy sector. The NASDAQ 100 was about the same size as the entire energy complex. Today, the NASDAQ 100 is about 18 trillion larger than the energy space. NVIDIA's 5% of the S&P one-stock, the entire energy complex is about 3, 3.5% of the S&P. You're right, there's two parts of commodities. There's the commodity equities that are a very tiny part of the market now, then there's the commodity themselves. The commodities in terms of ownership of asset classes, is at one of the lowest spots in decades. That's once again, that's because we've conditioned investors. This is so important for people watching us right now for your 401K. We've conditioned investors through 20 years of what we call deflation disinflation that pushes money into what we call financial assets, growth stocks, and bonds. Where commodities typically do well is when you have inflation that normalizes at a 3, 4, 5% and stays there for a couple of years, that's when you start to get a flush of money into commodities. If you look behind me right now in the markets, that's what's starting to happen.
Deidre Woollard: Well, it seems like last year we were talking so much about the recession that never came. That was the story of last year. This year, as you mentioned, we're trying to get that magic 2%. Maybe Powell starts starts cutting. It's looking less and less likely as the year goes on. What are you seeing in that cycle? We know that markets have cycles. This cycle doesn't seem to be going exactly the way ones have in the past.
Lawrence McDonald: Well, David Einhorn, who is in the book, a famous and famous hedge fund manager. He talked to us, and he's talked over the years, about what he calls the jelly doughnut. It's a funny expression. But what it means is that because the baby the oldest boomer now is turning about 78, but the boomers have 78 trillion of wealth. The millennials only have about 9 trillion. If you think about it, to keep it simple, if you have $10 million in a money market fund in Palm Beach and that's a very wealthy individual, but just to keep it simple, your income on that money in the, in the money market fund two years ago, it was about $80,000 a year. Fast-forward to now when you're getting close to 5%, that $10 million in a money market fund today is paying you close to $500,000 a year. Einhorn's point, which was brilliant in prescient years ago, Keith, he felt that if you cut interest rates too much, the way the Fed did in that 2008, 9, 10, that disinflation regime, it actually creates more disinflation or deflation because those boomers, you really punishing the savers. People have to be more careful with their money because they have less interests. Now the team Powell and all those rate hikes have given those wealthy people in Palm Beach essentially a 300% pay raise, but at the same time, the really sad fact is the bottom 60% of Americans are in recession. The New York Fed told us multiple times in the last couple of years, the bottom 30% of Americans only have $400 in the checking account. That's for the New York Fed, that's the bottom 30%. But that's a lot of people. When interest rates go up and inflation goes up, that hurts that group. If you look at companies in the S&P 500, you can clearly see a divergence where companies that face the bottom 50% of consumers are in a lot more difficult place than the companies that face, those, that top 20% of consumers that just got that huge pay raise.
Deidre Woollard: Interesting, that makes me think about a little bit about what has been happening with Dollar Stores, cutting their amount of stores and things that have been happening on that end.
Lawrence McDonald: Right.
Deidre Woollard: That's that's an interesting idea. Want to talk to you also about what's happening with outsourcing. Now the move to bring semiconductor manufacturing back to the US. We have all this money going to Intel and Taiwan Semi. I find myself, baby a little cautiously skeptical about how much this is actually going to really jump-start growth. What are you thinking about that turn in outsourcing now back to some form of in-sourcing?
Lawrence McDonald: Well, they mean well, but unfortunately, what we talked about in the book when markets speak is Republicans and Democrats lectured us for 20 years that free trade was good. We basically took five million jobs from the united states, some of that's in the Rust Belt manufacturing jobs. We've moved them all over the world to India-China, Bangladesh, all these countries. The good news is, if you're in that part of the Davos crab, we've raised the standard of living dramatically in many parts of the world. If you're working in a call center in India, you're making 50 times more than your great grandparents. But guess what? Those people into developing world that just got this big pay raise. The first thing you do in India, there's 1 billion people in India that don't have air conditioning. What you're doing is we're raising the standard of living globally. We're increasing carbon consumption. That's going to create this massive renaissance in terms of carbon demand over the next couple of years. That's part of this whole new commodity boom. But then on the other side of the coin, in the United States, politicians now because Trump pledge to bring back those jobs and all. Trump was like China, China, China. The Democrats and Republicans have picked up on that playbook around trying to bring jobs back home. They've created different pieces of the legislation that are designed to do that. Unfortunately, like you said, it's going to take a long time. It's a lot of noise, but reshoring bringing those jobs back is a lot more inflationary than exporting them around the world. That's what's this credit crazy cocktail because of tariffs, Trump and Biden, Biden's actually taken on a Trump tariffs. Tariffs and reshoring create a lot more secular inflation. That's why people watching us right now really need that whole new portfolio for the next decade, we're talking about colossal historic migration of capital from one or two asset classes over to the others.
Deidre Woollard: When thinking about the energy costs and one of the things that I've been thinking a lot about lately too, is if data centers AI the massive amount of demand and what that's going to do all over the world, but especially in the US with our energy grids. As much as we want to turn toward green energy, that the bottom line is, we need to keep data centers running and it's not necessarily going to come from solar power.
Lawrence McDonald: This is one of the most important parts of the book when markets speak, where we're talking about investing, where people are looking at any new industrial revolution. This artificial intelligence is just like the birth of the Internet. What happens is, you have a lot of awareness around a few different types of companies that are leaders. Everybody rushes in and we saw this in the 90s. I lived through the 90s. We sold our Dot-Com company to Morgan Stanley on the front lines of that industrial revolution of the Internet. People are piling into loosens. They're piling into Global Crossing and Cisco. But what we found is there were so many other companies that harness the power of the Internet. You're match.com's, your [Meta's] Facebook, your [Alphabet's] Google. You can go on and on and on. It was the second, third trades or investment thesis is that played out over time and those crowded trades didn't work out so well. That's where we look at energy. If you believe, say the people at NVIDIA, that in 2020, I'm sorry, 2022, about 460-480 terawatt hours up demand coming from these data centers. Then if you believe the growth forecast, and if you believe the explosion of this new artificial intelligence technology, we think we're talking to all the different, different consultants in the world, that could be 1,000-2000 terawatt hours annually. That's equivalent to potentially two Germany's or one France combined in terms of new energy demand. That means that if you look around the world at cheap natural gas or if you look around the world that companies that produce nuclear power or natural gas. But these companies are extremely cheap relative to the crowded AI trades. It's going to be those companies that produce and fund and support the infrastructure for AI that actually end up being probably the 10 or 20 or 30 baggers. Whereas you look at a company like NVIDIA that's already has a 2.3 trillion dollar valuation for that stock to double, it has to essentially go to $5 trillion. It's a lot easier when people look at stock prices. You don't want to look at the stock price, you want to look at the market cap. It's very difficult for $2.3 trillion company double. But the companies that support this historic industrial revolution of artificial intelligence, that's where the upside is. The second and third tier names that don't get a lot of attention.
Deidre Woollard: Speaking of big ideas, other one that you bring up in the book is the idea that the United States may have become complacent about the dollar being the reserve currency for the world. This is interesting because we're seeing dollarization in some countries, but we're also seeing a move away from the dollar as a reserve currency in other areas. What are some of the push and pull here?
Lawrence McDonald: Well, there's no question that the dollar is not going to lose its reserve currency status in the next decade. But what we're trying to say is that the hubris and complacency and from Washington, from both democrats and republicans around sanctions, around property confiscation, listen, Putin's the bad guy, did some bad things in the Ukraine. But when you use sanctions and property confiscation to that degree, all the other players on the field in the emerging market developing market space are going to think twice about holding treasuries. That's why if you look at gold and we wrote this book over the last two years. I'm really proud because gold is now making new highest that we predicted this in the book because Central Bank ownership of gold is exploding. You can tell because the ratio of say, gold to platinum or gold to silver is near 30-year highs. That's pretty crazy because what that's telling you is the gold market is about 16 trillion in size. The silver markets less than 2 trillion. Bitcoin's around the same as silver. The big central banks in the world that want to protect themselves from sanctions or confiscation of property, they will start to move into other assets. They'll own less treasuries and you're seeing that in China, you're seeing that in many countries. It's not like we're going to lose the world's reserve currency status, but there's definitely a decay going on. There's a matriculation out of dollars into other assets and that's creating this incredible move in Bitcoin and hard assets. That should also propel the next big commodity bull market.
Deidre Woollard: To wrap up here, one of the things that you say in the book is the move toward those hard assets is what's next. As an investor, are you looking more toward equities that own those assets or how should they consider it?
Lawrence McDonald: Well, first, you need to remember, a tech stock that's long duration. Has a 10 year group of cash flows. Which is saying, you got a technology company, it's going to produce a billion-dollars to cash flows over 10 years and the company is going to retain those cash flows and reinvest them. That cash flow period, that cash flow of 10 years, that company is worth a lot less, that tech company. It's what we call financial assets. It's just paper. You own a stock of a company and technology, you own paper in that company, it's a stock. Those cash flows that you own. Over 10 years, they're worth a lot less. A lot of technology companies don't really own a lot of commodity assets or anything like that. They just own the beautiful stream of cash flows. But if inflation is more certain over 10 years at a higher plane then that stream, that billion-dollar stream of cash flows over 10 years is worth a lot less. What happens is those gross stocks that are really popular and really sexy and really everybody has to own them in a deflationary regime. Because in a deflationary regime that's search and over 10 years, those cash flows are worth a lot more. Now, take on the other hand, aren't asset companies like Alcoa, companies like Rio Tinto, companies like Chesapeake in natural gas space, they own tremendous reserves of natural gas, of iron ore of nickel and copper. They own the reserves in the ground and they own commodities that typically are tremendous inflation protection tools. The types of companies, the hard asset type companies, is very different than growth stocks. The inflation regime as you move from a disinflation certainty regime to an inflation certainty regime, it's starting to move money out of those financial assets into companies that own and control lots of deposits of hard assets.
Deidre Woollard: Fascinating. The book is how to Listen When Market speaks, Larry, thank you so much for your time.
Lawrence McDonald: Thanks. Deidre and it well-researched have done a lot of these over the last two weeks. One of the best interviews in terms of you read the books early on, I'm grateful.
Mary Long: As always, people on the program may have an interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Mary Long. Thanks for listening. We'll see you tomorrow.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Deidre Woollard has positions in Alphabet, JPMorgan Chase, Meta Platforms, and Nvidia. Mary Long has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Bitcoin, Cisco Systems, Home Depot, JPMorgan Chase, Meta Platforms, Nvidia, and Taiwan Semiconductor Manufacturing. The Motley Fool has a disclosure policy.
