Why It's Time to Hope

The stench of the Nifty Fifty... The destructive power of human nature... 'A big economic boom'... Milei's chain saw comes to D.C... I recommend hope...

Let's pick up from last Friday's Digest by recognizing that some smart folks have also noticed what I've said many times in the past year...

The "no brainer" stocks everybody is in love with today aren't great investments right now... And they have the potential to be the utter disasters of tomorrow.

Last week, we pointed out that the Magnificent Seven stocks (Apple, Amazon, Alphabet, Microsoft, Meta Platforms, Nvidia, and Tesla) had underperformed the S&P 500 Index since they peaked on July 10, implying that the Mag Seven's epic run of market leadership might be ending.

This week, courtesy of Apollo Chief Economist Torsten Slok, we can show you an important reason why that's true...

I (Dan Ferris) have often said valuation is a lousy timing mechanism but that it's also the force of gravity for long-term investment returns. Investment returns are like objects attempting to leave the Earth's gravitational field, which never quite make it. They can get into the upper reaches of the atmosphere, but they can never achieve escape velocity – making their return to solid ground inevitable.

Slok recently posted a chart of the top 10 S&P 500 stocks (which includes the Mag Seven) showing the group trading at an average valuation near 50 times earnings. The average is skewed higher by Tesla, which trades at 118 times earnings. Without it, the remaining nine stocks trade at a still-stratospheric average of 41.7 times earnings.

The S&P 500 trades at about 26 times earnings today, meaning the top 10 stocks trade at close to double the average of the entire index. While there are certainly opportunities among the remaining 490 stocks, as a group they're not cheap, either... trading at roughly 36 times earnings, according to recent data compiled by Bloomberg.

So it's very hard to find compelling value unless you – like us here at Stansberry Research – are in the full-time business of poring through lists of equities trying to find underappreciated value. Even then, it's harder now than ever.

The exorbitant valuations carry the heavy and unfortunately familiar stench of the Nifty Fifty stocks...

These stocks were the large, growing, popular stocks of the late 1960s and early 1970s. We've mentioned them before, but given the current environment, they definitely deserve a revisit...

The Nifty Fifty were viewed as wonderful businesses that would never stop growing. Investors viewed them as "one decision" stocks, which you could buy and hold without a care in the world.

In 1972, the group traded at an average of about 42 times earnings. (Sound familiar?) Some traded above 60 times earnings. Like every extremely popular investment idea, the Nifty Fifty trade went south in short order. By the bottom of the 1973-1974 bear market, several of these stocks had fallen between 60% and 90%.

I'm not predicting that the Mag Seven will fall 60% or more. Regular Digest readers know predictions are not our thing. I'd rather prepare my portfolio for what's likely and own what's prudent and attractively priced by some reasonable measure. Owning a bunch of "Nifty" or "Magnificent" stocks trading near 50 times earnings seems to me like a huge mistake under any circumstances.

And no, the fact that about half the Nifty Fifty earned respectable returns from their pre-crash highs over the next 25 years doesn't matter to me. Because you and I both know how investors behave. They don't hold for 25 years when they're down 60% to 90%. At that point, they can't stand the pain anymore, so they sell out and abandon equities for a decade.

I don't want you to do that, because I believe equities of great businesses are some of the very best investments you'll ever own. And that'll remain true indefinitely. There is simply no substitute anywhere in the world for the long-term value created by the world's greatest businesses. It's one of the great miracles of capitalism.

But if you buy stocks willy-nilly at or even anywhere near mega-bubble peaks, you'll likely lose money on many of them, and you'll also likely have to endure massive amounts of pain before you start enjoying any gains.

Human nature being what it is, you'd likely throw in the towel before that point. But even in the best case, you'd have to hold on for at least two or three decades for that investment to work out.

You could do that. But why?

And yes, plenty of smart, wealthy, experienced investors aren't at all bearish...

Hedge-fund manager Bill Ackman did an interview with Megan Kelly on Wednesday. He thinks Donald Trump's election victory will usher in a "big economic boom" as the Trump administration frees up "a meaningful number of government employees to make them available for the private sector," which he expects to help keep inflation down.

I can't tell you how much I hope he's right. I hope the Trump administration is the best thing that has happened to America during my lifetime. I hope it dramatically shrinks the burden of government on the American people. I hope it frees up massive amounts of underutilized human, financial, and intellectual capital.

Folks like me could easily make the mistake of being too skeptical about the positive effects Trump might have on the U.S. economy. I understand that. I'm a government skeptic through and through. German philosopher Friedrich Nietzsche captured a fair portion of my attitude toward government well when he wrote...

Everything the state says is a lie and everything it has is stolen.

I was skeptical when libertarian economist Javier Milei was elected president of Argentina and promised to take a chain saw to government. But so far, he has lived up to his promises. He's exactly what every large government needs. I hope the momentum continues and that he takes Argentina to previously unimagined heights of liberty and prosperity.

Milei was elected almost a year ago. Trump was only elected last week...

I'm acutely aware that Trump is no Milei. I haven't forgotten that he promised to "drain the swamp" in his first term and never got around to it.

But this time, he hired two successful entrepreneurs – Elon Musk and Vivek Ramaswamy – to head up a new "Department of Government Efficiency."

Musk famously acquired Twitter and quickly reduced its staff by 80% while making improvements to the platform (now called X). And while campaigning for president in 2023, Ramaswamy proposed firing 75% of government employees and eliminating five large federal agencies: the Department of Education, the FBI, the Bureau of Alcohol, Tobacco, Firearms and Explosives ("ATF"), the IRS, and the Nuclear Regulatory Commission.

It sounds like a libertarian fantasy, but it could become a reality. Since their appointment, Musk and Ramaswamy have discussed entirely eliminating the Department of Education, the FBI, and the IRS.

It's a great idea. The federal government has 15 executive departments and nearly 3 million civilian employees. There is no way we need all that. If a government department does research that's truly valuable, then it can be done by a private research company, either for-profit or nonprofit, whatever the market wants.

Any and every piece of the federal government that isn't directly in the business of protecting Americans against infringements of their persons and property should be on the chopping block.

I'm not naive enough to think the welfare state will be reduced at all...

But a fella can dream. The welfare state has decimated American families, in large part by supplanting heads of household with the state. That robs humans of their dignity. The family is a much more important institution than the government. Too much of what government does seems to be aimed at destroying the American family unit.

By the way, this is no mere confessional. I'm actively recommending that you give Trump credit for getting anywhere near folks like Musk and Ramaswamy, let alone hiring them to take a chain saw to the federal government.

I didn't vote for Trump and likely never will vote for anybody in the red/blue axis. But I'm a U.S. citizen and I'm stuck with this government, same as everybody else. So if there's any tiny way I can help nudge these folks further in the direction of Javier Milei, it's worth it. The worst that can happen is that the status quo is maintained. There's enormous upside potential above that.

It's worth hoping the folks Trump is appointing right now will have a huge, positive, and lasting effect on America. As the late Stephen Hawking once said:

However bad life may seem, there is always something you can do and succeed at. While there's life, there is hope.

And I think we can all agree there's plenty of life in our nearly 250-year-old republic. So hope we must.

Between my bearishness and my attitude toward government, I may have given you the wrong impression...

I'm not a permabear, no matter what you may have heard. I believe deeply in the ability of businesses to create tremendous value for their customers and investors. I think equities are great long-term investments.

And I'm highly critical of government only because I believe deeply in the sanctity of life, liberty, and property and see most government as a threat to those cherished values.

Overall, I consider myself an optimist and believe deeply in man's ability to create a better life for himself. The endless "ascent of man," as author Jacob Bronowski once put it, is the most irrepressible and undeniable trend in the history of humanity. We shouldn't take that for granted, and I don't want to see it disrupted or sidetracked, whether by an endless sideways stock market or a massive, out-of-control government.

No group of human beings has any special ability to tell the rest of us how to live. Government isn't supposed to do that. It's simply there to recognize the few important things on which all agree, and most of those fall under the category of protecting the right to life, liberty, and property. Everything in government that doesn't do that probably falls somewhere on a continuum from unnecessary and wasteful at one end to crimes against humanity at the other.

And for the first time in my life, folks openly discussing a "massive downsizing" of the federal government bureaucracy have been charged with doing exactly that. That sounds like decent potential for less waste and fewer crimes against humanity, starting in the near future. I never thought I'd live to see it. Even if they fail, it's worth the attempt.

Likewise, even if it succeeds, it'll be painful...

Musk has publicly admitted that the path of drastically reducing government will not be an easy one for anybody. He replied, "Sounds about right," to an X post that said:

If Trump succeeds in forcing through mass deportations, combined with Elon hacking away at the government, firing people and reducing the deficit – there will be an initial severe overreaction in the economy – this economy propped up with debt (generating asset bubbles) and artificially suppressed wages (as a result of illegal immigration). Markets will tumble. But when the storm passes and everyone realizes we are on sounder footing, there will be a rapid recovery to a healthier, sustainable economy. History could be made in the coming two years.

I agree and acknowledge that there's no way you can fire hundreds of thousands of government employees without quite a bit of pain for many folks, and very likely a hit to GDP growth.

Simply put, a large reduction in the entity that accounts for 25% of U.S. GDP could tip us into recession, perhaps even if it's handled adroitly (though mass firings and spending cuts don't seem inherently compatible with adroitness).

Given the exorbitant overvaluation of the stock market, the recent appearance of 40-year-high inflation, massive growth in federal debt, and the growing burden of the welfare ("entitlement") state... massive downside is looming for everybody who depends on the U.S. economy.

The unfortunate irony of Trump proposing to reduce the burden of government by creating a brand-new government department run with not one but two people in charge has not been lost on anyone. Let's hope the irony fades as the reality lives up to the promises.

I'd rather be prematurely optimistic than set myself up to say 'told you so' if things don't work out...

In the past, I'd have been openly pessimistic about the likelihood of Trump and his new appointees making any real progress in reducing the size of government. But the longer I live, the less I can afford the luxury of a negative thought. I'd rather be hopeful and wrong than pessimistic and right.

And if Trump's appointees – especially Musk and Ramaswamy – can genuinely improve the long-term outlook for the U.S. government... and if Ackman is right and we're about to see a sizeable economic boom due to Trump's policies...

Then we'll all look back on this moment as one of the great turning points in the history of our country.

And who doesn't want to do that?

I'd like my hope to influence my investment outlook, but I'm not quite there yet.

I'm still bearish on stocks because you can't make a lot of money buying them for 50 times earnings. History and the current state of the market support that view well.

I'm hopeful that the huge burden of government gets drastically reduced in the next four years. I have no precedent for that one, since government has done no such thing all my life.

Hope is not an investment strategy, but it's the only way to walk into an uncertain future. I highly recommend it.

New 52-week highs (as of 11/14/24): Alpha Architect 1-3 Month Box Fund (BOXX), CyberArk Software (CYBR), Electronic Arts (EA), Enterprise Products Partners (EPD), Flutter Entertainment (FLUT), Intuitive Surgical (ISRG), Markel (MKL), Altria (MO), Spotify Technology (SPOT), Toast (TOST), and Invesco DB U.S. Dollar Index Bullish Fund (UUP).

In today's mailbag, feedback on yesterday's guest essay from Stansberry Asset Management Chief Investment Officer Austin Root... and nuclear energy... Do you have a comment or question? As always, e-mail us at [email protected].

"Howard Marks of Oaktree fame would concur with Austin, as pointed out by his recent Memo.

"Also, the sooner the world embraces nuclear power the better. If you are concerned by Co2 emissions, a very good solution. Why are large AI investors like Amazon and Google researching building small modular reactors to run their platforms?" – Stansberry Alliance member Mike O.

Good investing,

Dan Ferris
Eagle Point, Oregon
November 15, 2024

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