Unsustainable Disequilibrium

Excessive valuations and investor overcrowding in US megacap tech stocks in my firm's view represent the biggest risk to the overall US stock market and economy today. Competition from US VC-funded startups, creative destruction from open-source AI innovation itself, and Chinese state-sponsored cyber warfare all threaten the high-margin monopolistic business models of the US tech giants. More Imbalanced Than the 2000 Tech Bubble

As measured by combined enterprise value to GDP, the overvaluation of the Magnificent Seven US tech stocks is more than twice that of the ten largest stocks at the 2000 tech bubble peak.

Crescat may or may not hold positions at any given time in the securities referenced. This is not a recommendation or endorsement of any secure or other financial instrument.

Warning: Extensive Chart Thread

The next five charts illustrate the countercyclicality of gold mining stocks compared to major US stock market indices and include periods during and surrounding the four largest bear markets over the last 100 years: 1929-1932, 1973-1974, 2000-2002, and 2008-2009.

Given today’s high valuations for the S&P 500 Index, explained in this thread, and the divergent low valuations for mining stocks, I believe the diversification benefits of adding precious metals mining exposure to one’s asset allocation today are highly attractive.

The Great Crash

In the deflationary Great Depression, Homestake Mining (HM) was the largest gold mining company in the US and dramatically outperformed the Dow Jones Industrial Average (DJIA). From the DJIA’s high on 9/3/1929 to its low on 7/8/1932, it lost 89% of its value, yet HM’s stock price was up 49%. By 2/20/1936, HM shares had gained 580% while the DJIA was still down 59% from its top.

Understanding the potential value of a large new gold discovery at a microcap price, George Hearst (father of William Randolph Hearst) and two partners bought the 10-acre Homestake Mine in South Dakota for $70,000 and incorporated the Homestake Mining Company on 11/5/1877.

Homestake Mining Company (HM) became a public company on 1/25/1879, the first mining stock listed on the New York Stock Exchange. The Homestake Mine was the largest producing gold mine in the Western Hemisphere when it was operating. It produced over 40 million troy ounces of gold and continuously operated for 126 years.

HM was acquired by Barrick Gold in 2001. The performance information in the chart above excludes dividends for both series. Stagflationary Recession Shock of 1973 to 1974

During the stock market slide of 1973 and 1974, the S&P 500 fell 48% from its high on 1/10/73 to its low on 10/3/74, a period over which the Barron’s Gold Mining Index (BGMI) rose 193%.

The BGMI began rising almost two months before the S&P 500 Index top and continued rising during the S&P 500 bear market. From its lows on 11/17/1972 to its intermediate high on 8/16/1974, the BGMI was up 376%, a period over which the S&P 500 was down 34%.

Connecting the Critical Nodes

A thread on technological innovation, creative destruction, business cycles, commodity cycles, and inflation.

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Cisco Systems was the most valuable company in the world at the peak of the dot-com bubble in March 2000. Its stock price had reached a high of $80.06 per share giving the company an enterprise value (EV) of $548 billion or 5.5% of US GDP and 37 times sales. Investor exuberance over tech stocks was high. The future economic promise of the Internet for the world economy was strong, but the forward earnings growth rates implicit in tech stock valuations were not achievable. Stocks had overshot.

Tech earnings were getting ready to inflect sharply downward in the course of the normal business cycle. Cisco’s stock price would fall 89% over the next two-and-a-half years. The stock price has yet to return to its prior high in the 24 years since. Advancements in AI technologies today portend enormous productivity benefits for the long-term growth of the economy, just like the Internet did in 2000. But valuations among the leading technology companies are even more stretched today, implying future earnings growth rates that once again should prove impossible to achieve.

For instance, Nvidia recently earned the most valuable company in the world status with an EV of $3.3 trillion, a record 11.7% of total US GDP at its recent peak on June 18, more than twice as high as Cisco’s achievement in 2000. It also has an even richer multiple of 41 times revenues. I think it has impossible future growth expectations to live up to.

The securities discussed herein do not represent an entire portfolio and in the aggregate may only represent a small percentage of any Crescat strategy holdings. The issuers discussed may or may not be held in such portfolios at any given time. This social media post is not intended to be, nor should it be construed as, an offer to sell or a solicitation of an offer to buy any security. But it is not just Nvidia. When we look at all of the largest ten tech stocks’ combined enterprise value relative to GDP in 2000 versus today, the valuation is also about twice as big, over 60% compared to about 30%. The basic law of economics that we postulate works like this: Valuation comparisons relative to GDP matter because the economy at large can only grow so much and there is only so much total economic spending to go around to drive the earnings and stock price multiples of competing free market enterprises.

Furthermore, just like the Internet proved to be, I believe that AI is a highly disruptive technological innovation, that will allow new companies to rise by attacking the monopolistic business models of the entrenched tech giants. Joseph Schumpeter, the Austrian Economist called this process “creative destruction”. As just one example of how it is already at work today, we encourage everyone to experiment with the Perplexity LLM-based Internet search engine and see how it threatens Google’s business model.

Indeed, competition is critical to expanding the real GDP growth pool necessary to make AI a truly positive-sum game for overall economic progress. We are highly confident that advancements in AI are at a critical mass phase for long-term economic progress. But for us, this means that we must first prepare for creative destruction in the short term which means a significant bear market ahead for the leading large-cap tech stocks and the S&P 500 including potentially a substantial stock market crash.

Valuation extremes combined with macro inflection signals provide generational opportunities to position opposite the crowd for potentially large gains.

A🧵👇 👇👇 As the chart above shows, analysts’ estimates for Microsoft and Apple’s free cash flow have been trending down for two years, but their stock prices have grossly diverged to the upside.

The prevalent notion that the economy is headed for a disinflationary soft landing is likely to be proven wrong on both counts.🧵👇 Value-oriented, contrarian investors positioned for a stagflationary hard landing have had to endure some short-term pain in 2023. It has been extremely frustrating but should be well rewarded soon.

A Case Study on Charles Schwab...

🧵👇 The insolvency problems revealed by rising interest rates that translated into the failures at Silicon Valley Bank, Signature Bank, and First Republic may just be the first casualties of a systemic problem that affects the entirety of the US public and private securities markets.

Inflation is one of the most mispriced macro variables in markets today.

CPI is running 5.1% higher than two years, but five-year forward inflation expectations are essentially unchanged, which is just wrong.

🧵👇👇👇 Structural forces are likely to keep the annual growth rate in consumer prices elevated for much longer and substantially higher than currently priced in the markets.

The percentage of inversions in the US Treasury yield curve just exceeded the critical 70% level last week. Every breach of this threshold in the history of the data back to 1970 has led to a near-term recession.

h/t @TaviCosta 🧵 Furthermore, Tavi’s work has identified what was a highly profitable macro trade over the next two years following the triggering of this indicator which is simply to buy gold and sell short the S&P 500 Index.

At Crescat, we are fans of seeking value and avoiding bull traps.

In our analysis, it is still way too risky to buy the dip in mega-cap tech stocks.

Valuations are still higher than the PEAK of the dotcom bubble as we show in my two charts that follow in this thread.

👇👇👇 There is substantial downside ahead based on the comparison to the early 2000’s tech bust at its washout point.

My first chart shows the top-10 market cap tech stocks at the beginning of this year in terms of enterprise value relative to GDP.

Looks like the smart money is rotating out of overvalued financial assets and into undervalued inflation-hedge assets. We call this overriding theme “The Great Rotation”.

A thread 👇👇👇 We prefer value stocks in the energy, materials, and agricultural sectors today that have low multiples and high projected intermediate-term growth.

The length of the business cycle is substantially shorter in inflationary environments.

Expect more frequent recessions.

Let me explain...

A thread 👇👇👇 The Covid-19 recession turned out to be a mere blip in what in all practicality is still the longest bull market and largest valuation bubble in US history for both stocks and bonds.

The Psychology of Inflation

A thread👇👇👇

Net profit margins are at record highs today. S&P 500 companies have been able to pass rising costs onto their customers in the short run. These windfall profit margins are unsustainable and poised to reverse. The two biggest costs of running America’s largest corporations that affect net profit margins are on track to rise imminently: taxes and labor.

The Tech Bubble Then and Now

A thread...
👇👇👇 The US stock market today is historically overextended and poses substantial risks. To understand, we need to start by comparing it with the tech bubble in 2000.

The US Stock market is at risk of P/E deflation.

Just look at the relationship between CPI and the earnings yield (inverse of P/E) of the S&P 500 Index over the last seven decades.

A thread 👇👇👇 Note the high near-term risk to the S&P 500 posed by the sharpness of today’s upward inflationary divergence.

The Great Rotation out of large cap growth and mega cap tech has begun.

crescat.net/february-resea…

Thread 👇 It is more than a shift from growth to value style investing. The Great Rotation is a move out of overvalued long duration equities and fixed income securities and into undervalued commodities and basic resource stocks.

Get ready for the Great Rotation.

A stagflationary shift like 1973-74:

crescat.net/crescat-capita…

Thread… Investors live off fear and greed. The Great Rotation is all about the impending move out of record overvalued large cap growth and technology stocks and corporate credit and into undervalued commodities and scarce resource equities. It should look a lot like the tech bust.

Thread:

Markets are cyclical. Today, stocks trade at record high valuations while commodities are historically cheap in relation. Comparable conditions were present with the 1972 Nifty Fifty and 2000 Dotcom bubbles. As capital seeks to redeploy towards the highest growth and lowest valuation opportunities, analytically minded investors should be rotating, if not stampeding, out of expensive deflation-era growth equities and fixed income securities and into cheap hard assets.