«An orgy of money printing»: Since the financial crisis the Federal Reserve has ballooned its balance sheet from 900 to nearly 4500 billion Dollars.
It’s unchartered territory: For the first time since more than half a decade the global financial markets are supposed to live without the constant liquidity infusions of the Federal Reserve. Fred Hickey, the outspoken editor of the widely-read investing newsletter «The High-Tech Strategist», says this won’t work well for long.
«By the end of this year or by the start of next year, without QE, the market is going down», says the sharply thinking contrarian. In his view, especially the outlook for semiconductor makers like Intel is gloomy. As protection against the upcoming crash he recommends investments in gold and in gold mining stocks.
Mr. Hickey, after the short setback in October the hunt for new records at the stock market is on once again. What’s your take on the current situation?
We are living in an aberrational world. It’s all driven by an orgy of money printing. All the major central banks are engaged in this. From the Federal Reserve in the United States to the ECB, to the Bank of England and the National Bank of Switzerland to the Bank of Japan and the People’s Bank of China. It’s been tried ever since there was money, but in thousands of years of history it has never worked. When the Roman empire was unraveling the Caesars would shave the silver from the coins in order to be able to make a lot more of them. And in Weimar Germany, Reichsbank president Rudolf Havenstein ran the printing presses day and night, seven days a week. And here we are now, repeating the same mistake.
Yet, the markets love cheap money. The S&P 500 just climbed to another record high this Monday.
I lean towards the school of Austrian economists and they tell you that you can’t get out of those things. As a reminder, I keep the following quote from the great Austrian economist Ludwig von Mises pinned to the bulletin board in my office: «The final outcome of credit expansion is general impoverishment». Von Mises also warned that the boom can only last as long as the credit expansion progresses at an ever-accelerating pace. That’s why the Federal Reserve is unable to get out of this. Shortly after QE1 the stock market sold off 13% and the economy tanked. Then they did QE2 and when that ended the market sunk 16% in just a few weeks. That led to Operation Twist and that led to QE3, the biggest money printing operation of them all. Even before QE3 ended the markets started to take a dive and the Fed had to come to the rescue again. James Bullard of the St. Louis Fed came out and said that maybe they shouldn’t stop QE. That led to what they call the «Bullard Bounce» or «Bullard’s Charge». So they gave the green light to speculate once again. But fact of the matter is that money printing does not work.
Nevertheless, Fed chief Janet Yellen stopped QE3 at the end of October.
That’s why I expect things to fall apart in the market. I don’t know what’s going to happen between now and the year end because this is a seasonally strong period for stocks. Money managers who have been underperforming all year are under pressure to get into the stock market. And we might see what I call a «Run for the Roses» and the market gets to even more extreme levels. I don’t know how much longer this global money printing experiment can continue. But it sure feels to me that we’re nearing the day that it spins out of control. By the end of this year or by the start of next year without QE the market is going down and we will end up in chaos.
But without those constant shots of liquidity the situation might be even worse today.
Money printing has unintended consequences. Some of them cause asset prices to rise, that causes real estate prices to rise and that makes houses unavailable for many people. Mortgage applications to purchase a home are at the same level as at the bottom in 2009. And the reason is that prices are too expensive, wages are stagnant and the cost of living is up. First time home buyers are suffering. They have 1.2 trillion Dollars of debt hanging over their heads and living in their mom’s basement. These are the kind of things that create imbalances, including wealth inequality. So the situation worsens for the general population.
Where do you spot the biggest risks in the stock market if the Fed doesn’t come up with a new round of quantitative easing?
I was there in 2000. I was one of the few tech guys who didn’t understand «it» because we were supposedly in an a new area. And that was the greatest bubble that I ever saw in technology. The spread of that boom was narrow. Other parts of the stock market weren’t anywhere near as overpriced and there were things you could actually buy. Sure, today’s stocks prices are very high and they’re 25% overvalued based on the P/E ratio. But they aren’t as high as they were in 2000 when the P/E ratio was much higher. The big problem is that this one is broader than 2000. Also, the earnings per share are inflated by a number of financial tricks. Corporations have been piling up record amounts of debt and a lot of that has been done to fund buybacks. These buybacks lower the share count and increase the E of the P/E ratio. As a consequence, you end up with higher earnings per share without commensurate increases in revenue. So when you look at the price-to-sales ratio, that’s as high as it has never been before.
What should investors do in such a kind of market?
There is a huge lake of liquidity out there. And most market participants – the herd, the crowd, Wall Street or any name you wanna put on it – have been swimming in this lake of liquidity for a long time. They think it’s the greatest invention ever and it’s beautiful: They shout: «The water is warm, come on in!» But I don’t see it as a safe place. I look at it and I see it as a cesspool. And if you stay in there long enough you’re going to get buried and die.
Such criticism isn’t always appreciated. For example «Barron’s» did disinvite you recently to its famous investors roundtable. How do you personally get along as a contrarian when stocks prices rise further and further?
It’s very difficult to do. You have to be an independent person. I always thought being in New Hampshire was the best place because I was out of Wall Street and away from all the pressures that other people feel. But that was still too close to Wall Street and now Costa Rica seems to be doing the trick. I’m able to separate myself from the insanity of the world out here and it helps. To maintain your sanity, you need to turn off the hype machines of some of the financial media like CNBC. Take long walks and clear your head. Don’t let the pressures of the crowd get to you to make an emotional decision because the crowd is always long. The same people who were encouraging you to go into the market in 2000 and 2007 are encouraging you now again. Learn from that. And the most important thing is to be patient. It’s very hard to stay out when it goes on year after year after year and all the others swim in that cesspool of liquidity and are having a great time.
Especially Silicon Valley seems to have a great time again. What are your thoughts on the IT industry as a veteran high-tech strategist?
The IT market has not been particularly good. That’s because the economy is not good. IT is too much a part of the broader economy now to be not a subject of the cyclical forces of economic winds. Worldwide, capital spending has been disappointing. In the U.S., every year Goldman Sachs and the Fed forecast a pick up in capital spending and it hasn’t happened. The major companies, the Hewlett-Packards, the IBMs, the Oracles and the Ciscos, they all report disappointing number after disappointing number. So it has not been good. But the market holds them up, except in some cases like IBM because it has gotten so bad there.
In which parts of the tech world do you see the biggest troubles on the horizon?
PC sales have been negative year after year. Recently, they have been slightly less negative. But that’s only because Microsoft had pulled the support of its old operating system Windows XP in April 2014. And when they did that they did all sorts of things to pressure companies to upgrade. So PC sales were still not good but they were less bad in Q4 2013 and if you want into this year. Now going forward, that upgrade cycle has ended. The resellers of the world, the CDWs, the Insights, the PC Connections, they have all said that the impact of that is over. As we go forward into Q4 of 2014 and the first half of next year, PC sales are likely to go deeper negative again. And those numbers are going to be compared against strong quarters. In addition, the economy is worse around the world and last quarter they had only one month when the Dollar was really soaring. But this quarter it’s going to be awful with the Dollar so strong all three months. Those pressures from the skyrocketing Dollar are going to be worse.
And what about Apple? The company is now so big that it’s almost an economy of its own.
Apple is going to have a big quarter and it will be safe. We will have a big number from Apple, and we had big numbers from Apple suppliers. Everybody will be buying iPhones because Apple didn’t have a large screen phone for a very long time and their customer base is jumping on the new phones. This is probably the biggest upgrade cycle we have seen in Apple. In the past, other upgrade cycles have led to cannibalization of the available money on tech spending. People will buy less of other things. So it will be bad for PCs and other types of electronics. And there’s another thing which is very interesting: A lot of the very large internet companies – Amazon, Google, Ebay, Yelp, Priceline – missed their earnings estimates or guided lower. That tells me more than anything that we have an economic problem because these guys were not losing market shares like Hewlett-Packard or IBM. These guys are the winners and they’re all struggling.
What does this mean with respect to your investment strategy?
We’ve seen all this weakness that occurred and the buildup in inventories. And we’ve seen key semiconductor companies like Microchip Technology which famously caused quite a stir about a month ago when they said: «We’re a canary in the coal mine and we’re seeing a downturn in our numbers.» In addition to that, a whole assortment of other semiconductor companies from Freescale Semiconductor to Fairchild Semiconductor to Intersil and Altera echoed the comments of Microchip. So there is clearly a downturn that is in process right now. Intel for example, is going to be in a lot of trouble in 2015 since they even have been building up inventory. I follow Intel close to thirty years now and I’ve seen this many times before. They’re constantly over optimistic. At the same time, the SOX semiconductor index is near its highs. That’s very, very dangerous and that’s why you probably should short semiconductor stocks.
Here’s my caveat: We’re in this environment where money is not only easy but they’re printing money. Therefore, even if the economy is weak nominal prices can go to any level and when you’re short it means potentially infinite losses. So all these years I have basically not been shorting technology even as much as I wanted to. I have been very careful and I do only what I call «guerilla warfare»: going in the market and being short for just a couple of hours right before an earnings report that might miss. But now, we’re in seasonal strength in November and December so I will only act again when comes January and we’re going to have those earnings disappointments. Then, I will definitely go after some of these companies again.
And how does your strategy look like with regard to longer term investments?
I was never a gold bug and I’ve never even owned an ounce of gold until the late nineties. But in 2002 when Greenspan was dropping rates rapidly and all the money printing started, I said to myself: I need to protect myself. The technology stocks that come and go wouldn’t be the right place since they’re not a long term store of value. But I knew that the best way to protect yourself in an easy money environment historically has been precious metals. Yet at that time, I would have never imagined that we would end up with central bankers printing trillions of Dollars. But all that happened and for ten years gold was the place to be and outperformed stocks dramatically. So despite the 2000 decade was considered to be a lost decade for stocks, I had double digit year after double digit year.
In the last few years, though, the gold price has been falling quite rapidly.
In 2011 gold got overbought. We had a lot of hot money that came into the market and we had a sell off and that sell off has continued. I would argue this sell off has gone on longer than normally, partly because there are so many gold haters out there. That same herd that’s willing to pay any price for bubble stocks like Tesla, GoPro or NetSuite also dislikes gold intensely and the owners of gold. Anything they believe in, is based upon the theory that the central bankers will be able to stop QE successfully, that they will be able to raise interest rates to normal levels, that the economy will normalize and that we will live happily ever after. That’s their belief. Gold owners don’t hold that belief. They say: «You’re going to die in that cesspool of liquidity.» But the herd doesn’t want to hear that. So I believe that they use a lot of their leveraged money to punish the gold owners. And they’re having a good time doing it.
Are you suggesting that the gold price is being manipulated?
We have basically all prices manipulated right now: Interest rates are manipulated down, stock prices are manipulated up and gold prices are manipulated down. That’s the way they want it. I think they can do that in the short run. And I do think they target major technical break levels with their enormous leverage. They can throw billions of dollars at something in the dark of night or the wee hours in the morning when trading is illiquid. But we’ve also seen a number of things happen: We’ve seen that investment demand for precious metals skyrocket around the world, even in Germany according to reports. We’ve seen it even in the U.S. where the mint ran out of silver coins. In addition to that, the leasing rate for gold has gone negative. That’s a very rare occurrence and a good sign that there are shortages of gold. I’m not going to say that the gold price won’t come back more but I’m hopeful that these pressures will go away and that the amount of buying that we have will be enough to hold off those attacks that occur in the futures markets.
So what’s your advice when it comes to investing in gold?
It’s easier to hold the metal. You can own it through an ETF but it’s important that you hold at least some physically and some amount outside of your country, particularly for U.S. investors. The gold stocks, on the other hand, are extremely volatile. They will go widely to the upside and widely to the downside. At this moment, they’re historically depressed, back to the levels we only saw before the bull market began. So this is an opportunity and I try to own only the highest quality names. I start with where they are located. If it’s Russia, I’m worried about expropriation. The same goes for Venezuela. In a lot of other countries like Bolivia, I’m worried about big tax hikes. So a good example is Agnico Eagle Mines. Their mines are located in Canada, Mexico and Finland. You can’t get a better basket than that. And then, I look for the quality of the mines, the track record of the management and that they have sustaining costs. That’s why I like names like GoldCorp, New Gold, AuRico Gold and Detour Gold, which is a little bit more risky. But I’m not levered and I never go in debt. Therefore, I’ll never get a margin call and I can wait until the rally comes.