JACK FARLEY: Welcome to the Daily Briefing. It is Monday, January 11th. Soon, I am going to be joined by Real Vision managing editor Ed Harrison, but first with the day's stories, Haley Draznin.
HALEY DRAZNIN: Hey, Jack. Market sentiment is dim on Monday. It is a modest reversal after last week's strong start to 2021 for equities. Investors are confronting a number of both political and regulatory risks. To start, Twitter fell after the social media platform permanently banned President Trump's account after last week's insurrection of the Capitol. This shows the company is making editorial decisions and opens the door to more regulation of social media under the Biden administration. Shares of Facebook which also suspended Trump's account also declined, and House Speaker Nancy Pelosi on the political front announced that the house may move to impeach President Trump as soon as this week. That is if Vice President Pence does not choose to invoke the 25th Amendment.
Stimulus efforts might be slowed as a result of this, and last week's rise in the markets was really attributed on bets that the Biden administration would push another round of aid under the Democratic controlled Congress. We saw the dollar up Monday which has been lifted since US Treasury yields rose last week. Again, this was on bets that the Democratic controlled Congress would mean more stimulus for the US economy, feeding into inflation and an uptick in economic growth.
With the 10-year Treasury note yield logging its largest weekly rise since June, the move in yields could prompt investors to really rethink 2021 strategies. Yields which move in the opposite direction of bond prices edged a bit higher on Monday. It is interesting, with the dollar up, Bitcoin is seeing its first major correction of 2021 selling off over 25% from its high of nearly 42,000 at the end of last week. As major institutions seem to be increasing their appetite for the flagship cryptocurrency, they really need the banks open in order to allocate capital into this market. It could be important to pay closer attention to how Bitcoin trades during the week versus on the weekends when the banks are closed. Time will only tell if the crypto market finds this near term support.
In the near term, speaking of, there is a very real and present danger that the US could double dip in the first quarter. We saw the first signs of that with Friday's jobs report. There were 140,000 job cuts in December, and a shocking gender gap was revealed. Women accounted for all of those job losses, losing 156,000 jobs, while men gained 16,000. This of course, signals the US economy is backtracking.
Bottom line, it feels like 2020 has not really ended. We were in the middle of a pandemic still, and we are continuing to talk about US politics maybe now more than before. The underlying story is still pretty much the same. Back to you, Jack.
JACK FARLEY: Thanks, Haley. Welcome, Ed.
ED HARRISON: Yes, good to talk to you as usual, Jack.
JACK FARLEY: Yes. Great to have you on the Daily Briefing, and great to be here. Ed, what did you make of today's market action? We had stocks down. All three major indices down. The bond market was-- yields actually increased a little bit, which is confounding. Then we had a big, massive selloff in crypto. What do you make of that today?
ED HARRISON: Actually, I would almost say it is not confounding when yields go up finally. Equities, they are reacting to that, but the big moves are gold on Friday, and then now, we have crypto selling off. To be honest with you, I feel like markets have been overheated and really, there is no news. I saw what David Rosenberg was writing. He was like, interestingly, you get bad news from the ADP and you get bad news from the Labor Department, but markets are up and then on no news over the weekend, we get the markets down. Who knows what is driving them in the short term, but from my perspective, it is good to take a breather, because markets have been overheated to the upside and that makes the potential for an air pocket of significant measure much greater.
JACK FARLEY: You said that markets are getting a little bit overheated. We have got a chart here, which is the price to sales ratio of the three major indices going back all to 2000. Now is the case that the price to sales ratio, meaning the market capitalization relative to the amount of revenue of these companies in the indices are at all-time highs. Needless to say, Ed, to use one of your favorite words, things are getting a little bit bubblicious. What is your take on that?
ED HARRISON: I think that the all-time highs for price to sales makes a lot of sense to think about that as being bubblicious, because obviously, the only way that that works is if you are thinking profit margins are going to increase. We know that profit margins had increased, and they have remained relatively elevated at a minimum from a non-GAAP perspective. The potential that they could go even higher, especially during a pandemic is limited.
I think record price to sales is a sign that things were at a high level. You could try to say, hey, look, it is the DCF, stupid, meaning that when the rates go-- and by the way, I got this from Holger Zschaepitz, it is a great little line. " It is the DCF, stupid", we can go into that a little bit, but when bond yields are so low, then you can get away with that.
JACK FARLEY: Yes, Ed, that is a really interesting chart. For all those who are listening to this as a podcast, on the left axis, we have the Fang index shooting up from July 2020 to now and we also have the US 10-year yields shooting up as well. They mirror each other pretty closely, and, Ed, this actually surprised me, because the typical logic is that as yields decrease, that makes it more attractive to own companies whose cash flows are well into the future, such as the ones in the Fang, so therefore, I would expect it to have a little bit of a V rather than have these charts to follow each other so closely.
ED HARRISON: Yes, it is amazing. I think what it boils down to is that there is something amiss so when Holger Zschaepitz said, it is the DCF, stupid, and you see a chart where 10-year yields are rising, and stocks arising, especially stocks that have supposedly profits into the future, you do wonder what is going on there? To me, this is a sign that we do not have all the answers, because I agree with you, Jack, it should be the opposite.
JACK FARLEY: Just connecting this to what you said earlier, I said the bond market action was confounding, you said not so fast, Jack. This goes through there are two opposing forces because when the bond market sells off and yields rise, that means that there is liquidity that was in the bond market, and now it is out of the bottom market, where is it going to go? Most likely, a good portion of it is going to go into the stock market. That is typical, when bonds yields rise, you have stocks rise with them.
On a longer term chart, you would expect there to be a more structural effect of investors saying, hey, yields are so high. I am going to go buy bonds and then sell the Fang, or yields are so low, I am going to park my money out of bonds and put them into companies whose cash flows are projected well into the future. Would you agree with what I just said how there are these two different forces that oppose each other? If so, what do you make of them?
ED HARRISON: It is interesting, you are talking about an effective rotation play between assets. When you talk about the 60/40, the 60/40 moving to 65/35, or a 55/45 ratio, so that money moving out of one market is going into the other and that is what is impacting. When bonds sell off, meaning yields go up, then also equities should go up at the same time. That is what we are seeing with this Fang stocks.
Over the longer term, when bond yields rise, the discount rate rises. When Holger Zschaepitz writes, "it is the DCF, stupid", what he is saying is the discounted cash flows of companies that have a lot of their cash flows with five or 10 years out, then you are looking at the net present value of those cash flows being diminished when those bond yields rise. The DCF is getting worse when bond yields go up. I would think everything else being equal, over time, that is a headwind for stocks.
JACK FARLEY: Ed, just for the folks at home, can you quickly explain what you mean when you say companies that have cash flows well into the future? Just to pick two companies that are at the polar end of the spectrum, let us say Tesla, versus a mining company. What are their differences?
ED HARRISON: We will use Berkshire Hathaway because-- I think if you look at those two companies, Berkshire and you look at Tesla, Berkshire, basically, they are making tons of money today. In 2021, they are making a ton of money, they are going to make it in 2022, and then 2023, and relatively speaking, not that much more in 2028. From a discounted cash flow perspective, much more of the money that they are making is in the here and now, relative to the future.
Then you look at Tesla, as an example, they are not really making a whole lot of money at all, relative to their market capitalization. Both Tesla and Berkshire have about the same market capitalization, so really, in order to justify that market capitalization, all of the cash flows that needs to be discounted to the present are way into the future, that is when they are going to make much, much more money according to the discounted cash flow model that they have. That money has to be discounted back to the Future to put it in net present value terms.
Obviously, the higher the discount factor is, the worse those cash flows look. If money is low, that is, if interest rates are low, then that is good. When interest rates go up, then the discounted cash flows go down.
JACK FARLEY: That is a great explanation. Thanks, Ed. Just talking about interest rates going up, we look at a chart of the US 10-year Treasury real rate, so that is adjusting for inflation. Since the beginning of the new year, it has inched up. It is now higher than negative one. You look at the US Dollar Index, and it is closely matched onto there. What do you make of, number one, nominal real yields rising? Then number two, what happens if that real rate rises as well?
ED HARRISON: This is where the gold comes into play more than anything else, because there is a term that people used to use a lot called financial repression, and that is this term that started when QE was big. In the first Great Financial Crisis, that last recession that we had when QE was first being used, that when you are suppressing yields, you are creating so called financial repression by making it so that people cannot earn any money. That means negative real yields. That means that after inflation, I am not making any money, actually, I am losing money. That is what people think of when they think of financial repression.
When you look at owning gold, which is not earning the yield, the penalty of owning gold, which you have to store, there is a cost associated with that, and then you are not earning any, any interest on that. The penalty is not there. In fact, it is actually to your benefit relative to interest rates, where you are losing money after inflation to own gold. That makes gold and other precious metals interesting in those cases. When your real yields are starting to rise, then gold is relatively speaking less attractive, because the financial repression has decreased, and therefore, the advantage you have of holding gold goes away.
JACK FARLEY: That is very interesting. Ed, would you say that it is true about most commodities since they have a negative carry, so to speak? In other words, if I chopped down lumber, and I have lumber in my backyard, I am not getting a yield on my lumber until I sell it and it is not yielding, it is your capital appreciation, it is the price, but does cost money, I do have to say, buy a little rack to store the wood. In case of Exxon Mobil, you have to pay companies like Scorpio Tankers to store your oil. That is why we had the problem last year in April when the price of storage was greater than the price of the oil itself so the price of oil dipped. Ed, what you said about gold, would that be true about all commodities more broadly?
ED HARRISON: Yes, it is true but all the dynamics that you were talking to make a lot of sense in terms of the supply and demand. The supply and demand of gold certainly is there. People talk about that with the need for jewelry in places like India and places like that. When you talk about silver, you are talking about the industrial use of silver as well. Ultimately, gold is a store of value, people think of it as money. Therefore, these monetary aspects are much more important than they are in commodities where the commodities are being used, and there is a supply and demand element associated with them. That is the thing that is really the biggest driver.
JACK FARLEY: Ed, gold has been thought of as a hedge against inflation or a hedge against currency depreciation. Over the past year, we have seen that Bitcoin has become all too common when discussing things like hedges against inflation, and people say, oh, I want to sell my gold, I want to own Bitcoin. Obviously, Bitcoin has been on a tremendous tear over the past year. Today, we had a mighty selloff.
At one point it was down, I saw 22%. It has had a little bit of a rally. It is now only down 9% at about the $34,000 level. Ethereum has followed suit, I have not followed the other cryptos, but I assume that they generally are extremely correlated to each other in my experience. What do you make of the selloff in in Bitcoin and Ethereum today?
ED HARRISON: I thought it was pretty interesting in the sense that Bitcoin is supposed to be an uncorrelated assets. By the way, before I even start talking about this, let me say, let me just give a shout out to you and Max, because I know for a fact that you and Max are going to be doing the RVDB next week on Monday, because that's Martin Luther King, Jr., the holiday, and we are going to be closed and you are going to do an AMA, if I am right, and you are actually going to be talking about Bitcoin, because the two of you are a little different in terms of how you think about crypto.
JACK FARLEY: I would say that is right. Yes.
ED HARRISON: You are doing the AMA. You are taping it sometime later this week, and you guys have different opinion. My opinion on the whole Bitcoin phenomenon is that it is supposed to be an uncorrelated asset. It is a hedge against fiat currency more broadly, but it is not a guarantee [?]. What concerns me is that when you have Tesla going up, like eight times, and Bitcoin going up four times in the same year, you are at a point in the economic cycle in the financial markets where that uncorrelation has diminished, where actually, the reason that you own Tesla is exactly the opposite reason that you own Bitcoin.
You own Bitcoin, because bad things are going to happen and fiat currency, you need a hedge against it. You own Tesla because you think that everything is hunky dory, and Tesla's going to benefit, and you want to get in there. When those two are going up together, that tells you that you are in a place where Bitcoin is not uncorrelated, and that concerns me.
JACK FARLEY: Ed, that is such a good point. Now, I, perhaps I am like you, I am someone who believes that Bitcoin does have a place in your portfolio, a relatively small place, basically, based on its volatility, but I believe that it does have an attractive risk reward profile if you just look at its history. As Mike Green said, and Mike is the ultimate Bitcoin skeptic. He said, I have never doubted its ability to go up. Now, do I believe the lofty claims that people who think that it is going to become a global reserve asset? Probably not, the most likely outcome is that it goes down a tremendous amount, but I think that in the rare option in which it does, I think it will go on such a tear that is basically an asymmetric bet.
It will have the payout relative to it will be long volatility. However, that does not mean that it is going to be same have the same correlation that other long volatility bets will have. For example, the S&P 500, the exact opposite bet the S&P 500 is going short the S&P 500 or another version of that is buying a put option. If the S&P goes up, your put option decreases in value unless implied volatility spikes which happened in March, but if it goes down, you make money. That is essentially a lock step pretty much, it is pretty close.
I think the claim that Bitcoin is not correlated to other financial assets, I too have a little bit of doubt with that. One thing I do not have a doubt about is that all the cryptos trade remarkably similar to each other. If Bitcoin is down 10% and you look at the other ones in market caps, you are going to be seeing a lot of red. Maybe one green, maybe one green here, but you are going to be seeing a lot of red and we actually have a chart here of the one-day return of Bitcoin versus the one day return of gold.
Bitcoin is in the red. Today, it was down 20%. That was the worst selloff we have seen since March. Again, I made this chart about two to three hours earlier, it is now only down 9% although Ethereum remains down 20%. As you can see, it trades somewhat similar to gold and that it is an inflation hedge, but it is just the peaks and valleys are just magnified so much.
Ed, sorry, I know I have been I have been talking for so long, but my brother actually asked me if he should buy Bitcoin the other day. I told him no, because that would be his first investment of his life and I do not think he is ready for that level of volatility. However, I think that people who are prepared to accept the risk, I think it will have a favorable risk reward profile.
ED HARRISON: You just wanted to keep all the gains to yourself. You want to keep him