It's Time to Buy 'Anti-Bubbles'
Understanding market bubbles and anti-bubbles... Buy anti-bubbles... Biotech stocks are 'net-nets'... Natural gas is another anti-bubble... Gold stocks are on the verge of an anti-bubble... Putting it all together...
It's not enough to understand and avoid market bubbles...
I've been warning about today's mega bubble in these pages for a while...
I'm convinced we're in the biggest financial mega-bubble of all time... and mega bubbles always end one way: by crashing.
But knowing about bubbles isn't enough... To protect yourself from this market, you need to know about anti-bubbles, too...
In his 2017 book, The Anti-Bubbles: Opportunities Heading Into Lehman Squared and Gold's Perfect Storm, investor and author Diego Parrilla describes bubbles and anti-bubbles.
Diego describes bubbles as the process by which asset valuations become artificially inflated and anti-bubbles as the process by which assets become artificially deflated.
Simply put, assets are super expensive in a bubble and super cheap in an anti-bubble. And Parilla says anti-bubbles are a tool investors can use to defend themselves against bubbles.
I've written to you often about bubbles. But I've only mentioned anti-bubbles once before, in my July 30, 2021 Digest, when I said buying oil and oil stocks was an excellent anti-bubble trade at the time.
Since then, the Energy Select Sector SPDR Fund (XLE) of oil and gas stocks is up about 86%. Meanwhile, the S&P 500 Index is up around 18% and the Nasdaq Composite Index is up around 10%. The anti-bubble defense worked.
So for investors, the prescription is simple: Sell and avoid bubbles. Buy anti-bubbles.
How to tell we're in a bubble right now...
You'd think it would be common knowledge that we're in a bubble right now since bubbles are fairly easy to spot. But the fact that we're in one suggests most investors are oblivious to it. So let's look at some easy ways to see we're in one now...
Veteran bubble watcher Jeremy Grantham of asset manager GMO recently pointed out that the current valuation of the S&P 500 is in the top 1% of its history, as measured by the Shiller price-to-earnings (P/E) ratio (which I often refer to as the cyclically adjusted P/E ratio, or "CAPE" ratio).
The CAPE ratio is above 34 today. If this is the top of the market, it's the third-most expensive peak in U.S. stock market history. The CAPE ratio hit higher peaks only in December 1999 and November 2021.
The prospects for good returns from these peaks have been poor in the past. Grantham also noted:
[T]here has never been a sustained rally starting from a 34 Shiller P/E. The only bull markets that continued up from levels like this were the last 18 months in Japan until 1989, and the U.S. tech bubble of 1998 and 1999, and we know how those ended. Separately, there has also never been a sustained rally starting from full employment.
Another well-known bubble watcher, economist and portfolio manager John Hussman, acknowledges that while nobody knows the future, we can't ignore the lessons of the past:
We can't know the future, but it's straightforward to examine history and do math. Presently, market conditions have a stronger positive correlation with historical market peaks, and a stronger negative correlation with historical market lows, than 99.9% of instances across history.
By Hussman's reckoning, the market is 10 times more expensive compared with history, with today's market in the top 0.1% of historical market peaks. Just as Grantham points out that sustained rallies have never happened from moments like this in the past, Hussman says the market now negatively correlates with 99.9% of all historical market lows. (I wish he'd mentioned the 0.1% of market lows when stocks were this crazy expensive).
Grantham cites CAPE, which data traces back to 1871. Hussman cites data beginning in 1928. So they're both saying that history shows that expecting to earn much – if any – return from the S&P 500 at moments like this has been a consistently losing proposition over the past century or more.
If that doesn't prompt you to question today's market, I can't help you. As I said, I think we're in the biggest financial mega-bubble of all time... and mega-bubbles never end by going sideways. They end by crashing.
So what should you do?
Buy anti-bubbles...
I believe there are at least three anti-bubbles investors should seriously consider buying today.
The first is biotech.
We spoke with Porter & Co. analyst Erez Kalir about investing in biotech stocks on the latest Stansberry Investor Hour.
Biotech is a highly speculative sector, and higher interest rates are notoriously unkind to highly speculative technology stocks.
For example, the biotech sector peaked in early 2021, along with other speculative tech stocks, but was bludgeoned in 2022 when the Federal Reserve hiked interest rates at the fastest rate since at least 1980.
You can see this in the five-year chart of the SPDR S&P Biotech Fund (XBI) below, which shows the sector soaring and crashing:
Today, many biotech stocks are trading at dirt-cheap valuations. Erez told us that several good stocks are trading at extreme discounts to the net cash the companies hold on their balance sheets. This is often referred to by value aficionados as a "net-net."
Two of the first winners we ever booked in my Extreme Value newsletter in the early 2000s were net-nets: computer maker Gateway and electronics retailer Circuit City. We closed both trades in less than a year for 128% gains and 95% gains, respectively.
There are always net-nets in the market, but the vast majority of them are dirt cheap because they're awful, dying companies that you should never own.
Bull markets tend to bid up the higher quality net-nets relatively early. And since we're currently in the longest bull market in history, my colleague Mike Barrett and I stopped looking for net-nets years ago. Instead, we turned our attention to the highest-quality businesses trading at discounts to our own growth forecasts.
So it's exciting to find out about the existence of a whole new cohort of relatively good-quality net-nets.
We also recently discussed a great new biotech play with Stansberry Venture Technology editor Dave Lashmet for an upcoming episode of the Stansberry Investor Hour.
Dave made a great point that underscores the value of the bottom-up, company-by-company research that he and Erez both do (though in very different ways). Dave told us that 94% of drugs don't make it through clinical trials.
I was floored by that statistic. It reminded me of the exploration mining sector, in which very few mineral prospects ever go through the decade-plus process of becoming a producing mine.
Until I heard that, I thought I might try to add a biotech fund to The Ferris Report model portfolio... but I think I'd rather learn to analyze the companies one at a time... or leave it to the experts like Dave and Erez.
You can learn more about biotech today from our interview with Erez here. And keep an eye out for our upcoming interview with Dave.
Natural gas is another anti-bubble...
We also recently spoke with our friend, natural resources investor Rick Rule of Rule Investment Media on the Stansberry Investor Hour.
Rick says natural gas and natural gas stocks are "stupidly cheap" today.
As you can see in the chart below, natural gas prices soared from their extreme lows during the early pandemic. And they got a huge boost from the war in Ukraine.
But anyone familiar with natural gas's hyper-volatility won't be surprised by what happened next... the bull run deflated into an anti-bubble. Natural gas prices have fallen 82% from their August 2022 peak:
Natural gas is one of the most volatile commodities. Just look at the ratio of oil to natural gas, which is currently at its second-highest level over the past 20 years. It was below 10 in 2007, went negative when oil prices were negative during the COVID pandemic, and hit its highest point in the past couple decades in April 2012, when oil was 53 times the cost of natural gas.
From there, the price of natural gas rose from about $1.91 per thousand cubic feet ("mcf") to a high of $6.15 mcf just two years later. So the ratio seems like a reasonable way to establish how utterly dirt-cheap natural gas is today.
Today, oil trades at nearly 50 times the price of natural gas.
And as Rick pointed out, you don't need to buy anything except the highest-quality stocks... and you could still expect to make three to five times your money over the next several years.
Rick named a handful of excellent natural gas stocks you should consider owning, including a couple that could be "in a yield portfolio," because they're currently yielding around 7% to 9%. You can find our interview with Rick right here.
I also discuss the benefits of being a contrarian natural resources investor in the latest issue of The Ferris Report (published today). I tell the story of how natural gas came to generate 43% of America's electricity and make up half of household energy consumption.
Then I recommend what I believe is the absolute best, slam-dunk stock in the sector right now. No matter what other natural gas stocks you might like, you should start with this one. Stansberry Alliance members and The Ferris Report subscribers can find my latest issue here.
Another opportunity on the verge of an anti-bubble...
Gold stocks have dramatically underperformed gold over the past couple of years.
For example, Newmont (NEM) – a popular big-cap gold miner – has fallen 56% since March 2022, when the Fed started raising rates to combat inflation... but gold itself has done its job and risen about 11.5% during the same period... and recently hit a new all-time high of nearly $2,200 per ounce.
Sprott Asset Management portfolio manager Shree Kargutkar says, "The sentiment in this space has never been lower."
So the anti-bubble is in gold stocks, not gold itself.
The underperformance was even evident last July, when gold stock veteran John Hathaway penned his opinions for the "unresolved incongruity" between gold and gold stocks.
Hathaway gave five reasons for the disconnect:
- Dilution
- Subpar Return on Equity ("ROE") or Misallocation of Capital
- Jurisdictional Risk
- A Decade of Margin Erosion
- Capital Expenditures ("CapEx") Bloat/Timeline Stretch
I expect you'll find most of these reasons to be self-explanatory, except the last one: CapEx Bloat/Timeline Stretch. As Hathaway explained it:
The timeline for constructing new mining and processing capacity has lengthened over the last decade. One major reason for this is the increasingly stringent permitting requirements related to environmental and social factors. The time gap between the discovery of a significant new ore body and cash generation now easily exceeds 10 years compared to 6 years only a decade ago. This increased timeline translates into capital being tied up without returns for prolonged periods, leading to higher interest burdens and heightened susceptibility to various risks.
There's also the simple fact that gold and gold stocks are two very different types of assets.
Gold is a store of value and a kind of insurance against monetary and even societal mayhem. Meanwhile, gold stocks are investments in the highly cyclical, highly capital intensive, and very risky business of extracting gold from the ground at a profit.
Simply put, gold is for holding. Gold stocks are for trading, and they look like a pretty good, medium to long-term trade right now.
Putting it all together...
I started today's Digest with Parilla's explanation of bubbles (the process of asset valuations becoming artificially inflated) and anti-bubbles (the process of assets valuations becoming artificially deflated). You may have noticed Parilla's use of the term "artificial."
So let's take a closer look at what he means...
When Parilla published Anti-Bubbles in 2017, he viewed gold as an anti-bubble for investors.
He made the case that investors often view gold as inflation protection and a safe haven against market turmoil.
But at the time, it was widely believed that the Federal Reserve had the power to keep inflation low and intervene in markets to mitigate (or at least fix) market turmoil.
If you believe the Fed really does have that power, it makes sense that you wouldn't bother with gold. So that's one of the "artificial" reasons why gold's price was down.
But, of course, the Fed has no such power. It failed to avoid the dotcom and housing bubbles, and its interventions in both of those episodes probably guaranteed future bubbles would occur. The Fed is always either fighting or blowing bubbles.
It probably seemed like the Fed had finally gotten it right for several years after the financial crisis of 2008. Official inflation data was low, the stock market was rising, and housing prices had come down in the wake of the crisis.
Of course, the Fed failed to prevent the reversal of those seemingly benign conditions... and we wound up with inflation at more than 40-year highs, a falling stock market in 2022, and high housing prices.
So there's no case to be made that the Fed is likely to ever "get it right." The Fed eventually always gets it wrong, creating or at least contributing substantially to market chaos, so you really do need gold.
That's why Parrilla said gold was an anti-bubble in 2017, because its price wasn't deflated for good reason. It was artificially deflated.
We're seeing something similar in biotech today... It's unlikely that all the companies Erez has found are worth much less than their net cash holdings. That's a sign suggesting their prices have been artificially deflated by rate hikes.
And in natural gas, it's unlikely that fossil fuels will be replaced by so-called renewable energy sources any time soon. So that's an artificial reason for gas and gas stocks to be cheap.
Now, with gold stocks, Hathaway's reasons for their depressed valuations don't seem artificial. What's artificial is the idea that mining gold is a less attractive business with gold at higher prices... which makes no sense.
Summing up... Smart, risk-aware, long-term investors will need to think about how to fight the potentially devastating effects of the biggest mega bubble ever finally bursting.
Parilla's advice to avoid bubbles and buy anti-bubbles is as good a prescription as I've ever heard on this subject.
And you'd better do it while you still have time to prepare for the inevitable changing of the guard in financial markets.
New 52-week highs (as of 3/21/24): American Financial (AFG), A.O. Smith (AOS), Atkore (ATKR), American Express (AXP), AutoZone (AZO), Builders FirstSource (BLDR), Alpha Architect 1-3 Month Box Fund (BOXX), CBRE Group (CBRE), Canadian National Railway (CNI), Pacer U.S. Cash Cows 100 Fund (COWZ), Copart (CPRT), Cintas (CTAS), Commvault Systems (CVLT), Donaldson (DCI), D.R. Horton (DHI), Disney (DIS), Dimensional International Small Cap Value Fund (DISV), Enerplus (ERF), Edwards Lifesciences (EW), Diamondback Energy (FANG), Freeport-McMoRan (FCX), Comfort Systems USA (FIX), Franklin FTSE Japan Fund (FLJP), GEO Group (GEO), W.W. Grainger (GWW), Home Depot (HD), iShares Convertible Bond Fund (ICVT), JPMorgan Chase (JPM), VanEck Morningstar Wide Moat Fund (MOAT), MSA Safety (MSA), Microsoft (MSFT), Motorola Solutions (MSI), Micron Technology (MU), Nucor (NUE), NVR (NVR), O'Reilly Automotive (ORLY), Parker-Hannifin (PH), PulteGroup (PHM), Phillips 66 (PSX), Pioneer Natural Resources (PXD), Rithm Capital (RITM), Construction Partners (ROAD), Sherwin-Williams (SHW), SPDR Portfolio S&P 500 Value Fund (SPYV), ProShares Ultra S&P 500 (SSO), TFI International (TFII), Travelers (TRV), Tenaris (TS), Trane Technologies (TT), Textron (TXT), ProShares Ultra Financials (UYG), Visa (V), Veralto (VLTO), Vanguard S&P 500 Fund (VOO), Waste Management (WM), and Walmart (WMT).
In today's mailbag, some feedback on Digest editor Corey McLaughlin's Fed analysis this week... and a general appreciation of how we go about our work... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.
"Hi Corey, Nice call on the Fed meeting and [Chair Jerome Powell] keeping the 'Status Quo'. I was hoping for that outcome as I have invested in bonds since Dan, Doc, and you educated us last year. Thanks! Some of them are maturing in the next month and I would like to roll them over in that 5% range again..." – Subscriber Steve R.
"I really appreciate how detailed and yet interesting you make the numbers appear when dissecting a company. Lessons I never learned before. Just enough but not too much. Thank you for demonstrating your expertise." – Subscriber Joel C.
Good investing,
Dan Ferris
Eagle Point, Oregon
March 22, 2024