Trade The Narrative; Own The Truth
With the government shutdown in full swing, it was light on the data front last week, but the data we did get was far from inspiring. The private sector ADP report showed employment contracting by 32k in September, with August being revised down to -3k. This marked the first successive decline since the Summer of 2020, with small businesses continuing to feel the brunt of the pain in this K-shaped economy (-40k in September and -44k in August). The other private sector read on the labor market we got last week was from the Challenger, Gray, & Christmas jobs report, which affirmed the widely held view that we’re in a ‘low hire, low fire’ labor market. Hiring intentions declined 71% (+117k) from where they were a year ago, and this represented the weakest September reading since 2011. Year-to-date, the Challenger report shows hiring intentions coming in at +205k, the lowest for any year since 2009. However, businesses are reluctant to let go of their current workforce, with layoff announcements falling 25.8% (54k) last month from the August tally of 86k.
In addition to the stagnant labor market data we got last week, we received the ISM manufacturing PMI index, which contracted for the seventh consecutive month, and the ISM Services PMI slipped to 50 in September from 52 in August. Below is an excerpt of the comments section from the ISM Services PMI, where most industries are highlighting difficulties of some sort with the exception of AI adjacent businesses:
You might think the start of a government shutdown (with looming mass layoffs of federal government workers) and weak economic data would elicit a modicum of sobriety in risk asset prices, but that wasn’t the case. By week's end, the S&P 500, Nasdaq 100, and Dow all notched new record highs, with the narratives of Fed rate cuts, consumption fueled by the wealth effect, and AI capex investment steamrolling any notion that this relentless rally is long in the tooth. Regarding the impact of the AI theme on the equity market, Jim Bianco quantified it in the chart below, where 41 AI-related stocks have accounted for 70% of the increase in the S&P 500’s value since the launch of ChatGPT in November 2022.
Not to mention the broadly accepted view that the fiscal impulse is set to pick up and an economic reacceleration in growth is underway – I share this view by the way. This all makes for a toxic cocktail for those professionals and investors who are lagging the market as the year-end calendar draws closer with each passing day. Career risk and bonus payouts make for a strong incentive to chase performance into year-end, irrespective of the fundamentals.
Look, I’m of the view that the equity market is morphing into a classic price bubble, just as it did in the late 1990s. Every valuation indicator I look at—CAPE, price-to-EBITDA, the Buffett Indicator, price-to-sales, and price-to-book—is 2 standard deviations or higher relative to their historical average. Then you have strategists tripping over each other to raise their year-end target while arguing you have to embrace asset price bubbles because the best gains come at the very end of bubbles. History doesn’t disagree with such comments, but come on – is this what passes as prudent investment advice today? I’m not suggesting that anyone should fight this everything rally, I’m surely not, but I’d be lying if I didn’t say that every day I’m spending more and more of my time looking for off-ramps rather than where I can take more risk with client capital. For all any of us know, this could go on for another year, or it could start to unravel next week – “history doesn’t repeat itself. Man does.” Voltaire.
The upside volatility is even ensnaring boring diversifying assets like gold, which is nearing the $4,000/oz price level and up 50% on the year. Gold just posted its 8th consecutive quarterly gain, its third-longest streak on record.
Even with how well gold has done, it is lagging its precious metal cousins, as silver is up +65% ytd, and platinum has skyrocketed +79%. I’ve spilled plenty of ink over the last 6-24 months about my constructive view on other areas of commodities markets: uranium, copper, and gold miners, to name a few, but even these areas (as much as I still like them) are starting to give me anxiety with their upside gains. Keep in mind, even pretty girls and boys get dinged up in a bus crash. This same logic applies to the Teflon AI narrative permeating the investing environment at the moment. ZeroHedge posted an excerpt from One River Asset Management’s CIO, Eric Peters, recent commentary, which I thought was a very balanced and objective view of asset markets at the moment and worthy of sharing:
“Investors and traders seem to be projecting patterns from 1999 onto today’s markets. Jeff Bezos joined the chorus this week, and he’s rich, so he should know, right? They see parallels and think history repeats. In some ways it often does. But in the boom that started with the Netscape IPO in Aug 1995 and ended in the summer of 2000, the price of gold went down. Over that 5yr period, the S&P nearly tripled, while gold prices fell 25%. It’s one of those inconvenient facts that are easy to set aside, ignore as an aberration, and carry on in ignorance.
I was born 59 years ago today, and the annual inflation rate was 2.9% that year. The Consumer Price Index back then was 33. When I started trading, 22 years later, inflation was 4.8% and the CPI Index was 125. When Chairman Bernanke invented a clever term for money printing in Nov 2008, consumer prices had just fallen 1.7% in a month, gasoline had collapsed 30%, and the CPI Index was 212. Today the CPI Index is 317. Inflation cut 90% of the dollar’s purchasing power over my lifetime. 61% over my career. And 33% since Bernanke went Brrrr.
Why would gold suffer from outflows in the late-1990s tech boom, but attract record inflows in the AI tech boom? What might this aberration foreshadow? All the booms in my career have ended in deflationary busts. Policy stimulus has been increasingly swift and powerful, eroding the purchasing power of a dollar by 61% in that time. So perhaps markets are signaling that despite growing bubble fears, we are entering an inflationary boom. Or, possibly, that in the next bust, debt dynamics will force policy makers into a wild inflation. Maybe both?
OpenAI released ChatGPT on Nov 30, 2022, kicking off the AI trade. Gold surged +120% since then, and the S&P 500 is +70%. Trillions will flow into Nvidia chips and data centers, mirroring dot-com exuberance. But key differences undermine the analogy: the dot-com frenzy relied on intangible software and unproven business models. Pets.com. In contrast, this cycle emphasizes infrastructure - hardware, networks, energy systems - creating durable assets with measurable productivity gains. Capex as a foundational force, not simply speculative.
AI infrastructure demands extend to essential resources, also differentiating today from prior tech cycles. LLMs consume electricity equivalent to small countries and vast water volumes for cooling, straining national supplies. Unlike the Pets.com website, AI requires investments in power grids, solar, wind, nuclear (someday fusion). These project commitments transform capital spending into a multi-decade buildout, not a short-lived hype cycle. Such large investments uncover our real-world supply constraints, evident in the surge of copper prices.
More buyers than sellers, simultaneously, in the AI theme and gold appear to be signaling it’s time to recalibrate to an inflationary innovation paradigm. And it’s happening as the Fed cuts rates when they should probably be hiking, not unlike the 1990s. Having watched the Fed reaction function become more aggressive in each cycle, markets may be signaling an inflationary resolution for the globe’s $340 trillion debt overhang.
What’s fascinating is that I don’t disagree with much of what Mr. Peters penciled out above, in particular that more investors are becoming wise to the ‘debasement trade’ – own real/tangible assets that will retain their value as currencies get debased at an accelerated pace. Additionally, we get confirming signposts each week that the path of least resistance from a policy standpoint is to inflate/grow our way out of this global over-indebtedness problem. President Trump last week said as much in an interview, “You can grow yourself out of that debt, it’s not a question of paying it.” One thing I’ve picked up from observing President Trump is that he will tell you the major points of his latest briefing. This administration understands that they don’t have any other alternatives than to run the economy hot, thanks to the decisions of U.S. leaders (including Trump 1.0) going back to the turn of the century.
So, while I think investors need to allocate their capital in a manner that allows them to maintain their purchasing power over time and protect themselves from inevitable currency debasement, I don’t think a ‘set it and forget it’ approach is the best way to execute such a thesis. Sure, it will likely work over the long term, but I think there are going to be periods of gut-wrenching upside and downside volatility in the years ahead. Which is what has me a little bit nervous at the moment, where everything is rallying together: U.S. equities, foreign equities, gold, commodities, and Bitcoin. The only thing not going up much in value is bonds and cash. Yes, those are assets worth holding in a well-diversified portfolio, but they are unlikely to work well over the long term if global policy is geared towards ‘running the economy hot’ and central banks are willing to turn a blind eye to inflation running well above their 2% inflation target for nearly six years now.
The current setup has become a situation where you’re forced to embrace the bubble and hang on for the ride. Step aside, accept mid-single-digit yields in cash and the fixed income market that will preserve your capital, but is unlikely to maintain your purchasing power over time. Or build out your version of the debasement portfolio: Merrill Lynch is advocating 25/25/25/25 (equal allocations to stocks, bonds, commodities, and cash/gold), Morgan Stanley came out last week recommending investors shift their asset mix from 60/40 stock/bonds to 60/20/20 where 20 points comes out of bonds and into gold, and JP Morgan has been advocating a similar approach to its clients.
There have always been many ways to succeed or fail in this craft we call investing. My advice at this moment is not to abandon diversification, discipline, and prudence. You only have to get ‘rich’ once, and I use the term ‘rich’ in a relative sense. For some, multi-millions isn’t enough, and for others, a few hundred thousand is all they’ll ever need. Once you're there, treat it as such; the downside to losing that financial freedom drastically outweighs the upside of adding an extra 10% to what is already ‘enough’. This isn’t a top call, as I’ll continue to allocate client capital accordingly to participate, but I’m content with not keeping up step for step at this point in the rally, especially if it means keeping risk management tight and tucking some money away for better opportunities sometime in the future.
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