How to Profit as the Dollar Fades w/ Larry McDonald

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1:24And now to the top analysis of today's markets. If the cracks in the financial system are widening, how can you position your portfolio? Larry McDonald has three ideas.

1:42Welcome back to another edition of three ideas this time with bestselling author of a colossal failure of common sense and founder of the bear traps report a real vision fan favorite Larry McDonald. Larry thanks so much for coming on. We still have so much feedback for that last mega series that you did. I know you're still exhausted from it, but not too exhausted to give us three ideas. Let's jump right in and hear what your global macro thesis is, because I know that'll be the underpinning of your three ideas. Well, behind us, we run the largest institutional platform in the world facing professional investors.

2:19So hedge funds, mutual funds, and pension funds. And we run that live conversation every day. It's kind of like a live ideas dinner with the professionals around the world in about 20 countries. And one of the trends that we're hearing over the last couple of months is the possibility of a major M &A cycle, mergers and acquisitions, coming in to the energy space. You have, think of Chevron and Exxon. Four years ago, they had about$8 billion in cash. By the end of this year, they'll have$55, maybe$60 billion in cash. These are cash flow generating giants. And that cash is burning the hole in their pocket.

2:59And meanwhile, you've got companies like Southwestern Energy that are trading at two times EBITDA, forward EBITDA. You're talking about companies that are sitting on massive reserves of natural gas relative to their market cap. So what institutional investors that we talk to are looking at for the first time in years as you come into a new M &A cycle, as that approaches, the way you evaluate companies and create valuations changes. And so if your reserves of natural gas relative to your market cap get dramatically out of whack, and that's the case with Southwestern Energy, AR, Entero, Chesapeake, there's a number of companies.

3:43But Southwestern in particular offers tremendous value because after the dot-com bust, we had that classic M &A cycle in energy. And we know right now ExxonMobil has been looking at Pioneer. That's been publicly discussed. And so when a company like ExxonMobil comes in and very publicly is taking a look at Pioneer and companies in the oil and gas space, smaller companies, this sets up, I think, for a window of potentially spectacular M &A over the next two, three years. Okay, so let's jump right in then with Southwestern Energy, SWN. If we take a look at the chart, I want to go back to about January of 2022, not all that long ago.

4:24This stock peaked at about$9.32 in May of 2022, and currently it sits around$5.10. So why this company right now? Well, think of the geopolitical backdrop. You have, you know, the last 20 years, we were kind of a unipolar world. All that means is if you think of the United States, Russia and China, you know, the U.S. had some friends around the world. Now, in recent years, especially with Saudis, so the United States and throwing the Saudis. Now, if you think of if you say you're the CFO of Exxon or you're the CFO of Chevron and you see this multipolar world where there's more stress in the global financial system geopolitically, you're going to want to have some reserves in kind of this hemisphere or in a safer spot where you can actually access them.

5:23And if you just look at the coal space, if you look at the natural gas space, if you look at the oil space, there's massive reserves around the world of, say, copper and all kinds of commodities that are under political stress. And getting access to them for the Green Revolution or any kind of transition that we're coming at us here in terms of energy consumption is very, very suspect. So we think that these companies, these major oil majors are going to start to look at U.S. assets and make acquisitions in that realm. And just to play off what you were talking about, I just spent a couple of weeks in the Middle East.

6:03And to your point about Saudi, I mean, people all over the Middle East completely baffled still weeks after Saudi making that rapprochement with Iran via China. I mean, it just has people who are geopolitical experts who know this space so well still scratching their heads. So that unpredictability sitting right there. I'm just curious, what's your time horizon then for a company like Southwestern Energy? Clearly, you're talking about going long here. Just how long? Well, seasonally, if you look back the last 30, 40 years for companies like Southwestern, even if you just look at Southwest in the last 20 years, Southwestern SWN, what happens is a lot of times you go into the winter and there's an overstocking, where especially this past winter, there was this winter Armageddon forecast for Germany, for the rest of the world.

7:00And the weather actually turned out to be pretty mild globally. And so this created this major, the sector, including SWN, went up on euphoria and has come down on impatience. But as you come into the summer months, you know, we get a hot summer, you're going to have air conditioning demand. So seasonally, if you look at SWN between the months of, say, March and May, your returns are quite impressive. It's almost 80 % of positive returns for SWN occur in that second quarter, second, third quarter over the last 20 years. So seasonally, it's a great backdrop. But then if you look at, most importantly, the LNG demand globally in terms of millions of tons.

7:43We see this data up 300 % between now and 2027. This is a very well-known narrative. I mean, the German economy, the European economies need to replace Russian gas. And so this whole dynamic around LNG exports and the new facilities in the US and the facilities in Europe that are coming online also create a phenomenal backdrop for SWM. And any type of target that you have for them? I mean, I think we're, like we said, trading around$5.10 at the moment. Well, we did a trade alert last year in the five and a quarter range. It went up to about eight. We lightened in client trade alerts, and we've been buying it down here now.

8:25We think you're getting another shot at eight. You know, if we just think of simple risk and reward, maybe your downside's four, four, four dollars for, you know, in a normal world,$4,$3.75. But your upside, potentially in a new bull market, secular driven, you could have an upside of potentially$18. The previous cycle, you saw the stock trade well into the 20s. And Larry, we're open for questions. So if anybody wants to pop in and ask you anything, I know you'll answer. But the favorite question I always have on this show is, what would make you upend your view? I guess the better question here, what do you think is likely that could happen that would make you upbend your view and say, you know what, time to cut my losses?

9:08Well, if we had a situation where, you know, the war, the geopolitical tensions in, say, with the Ukraine war, if there's a peace detente, and then the world quickly embraced Russian natural gas, you know, in a short period, like in a two, three year period, that would be a major reason to really think, reconsider this investment. Got it. All right. Well, I want to jump into your next trade, and that really centers around the US dollar. So first, before we talk about the specifics, what is your view on where the Fed is heading now? Well, the beast in the market is hitting the Fed over the head with a two-by-four.

9:53And the serpent inside the market, we had the LDI crisis in the UK in the third quarter of last year. It was a vicious crisis. Financial conditions tightened dramatically. And the Fed was forced on October 21st, it was a leak to the Wall Street Journal, of a much softer path relative to the rate hikes they were promising. And from October to November, the Dow Jones Industrial Average in that period had one of its best 60-day periods in 40 years. So it's very clear the Fed clearly pivoted already once. And remember, a pivot isn't going from rate hikes to cuts. But when you're promising a gajillion more hikes and you tone that down by 80 percent, that's a pivot.

10:37OK, so that's the first bit. And then then then the second two by four that hit the Fed over the head was Credit Suisse and a number of U.S. banks that have gone gone gone into emergency status and into FDIC in the arms of the FDIC. And as we saw last night with First Republic, the Fed essentially, by holding rates up here, they are draining the regional banks of their deposits. It's a fact. We've already lost a trillion of deposits in the banking system. Many of those deposits are coming from the regional banks. So when I talk to my book, A Colossal Theory of Common Sense, The Inside Story of Lehman Brothers, is that whole anecdote, that whole response to the Lehman crisis from all the federal officials, from the FDIC onto the Fed, onto the OCC.

11:39See, that response has actually created a backdrop that is in some ways helping money move into money market funds, which were backstopped by the Fed during the crisis. And it also pushes money toward big, you know, too big to fail banks. So in essence, the financial crisis of 2008 is sowing the seeds of the destruction of our regional banking system. And at the end of the day, if the longer the Fed keeps the Fed funds rate near 5%, they will drain the banking system dry. And so the beast in the market is going to force them to stop right here. And I think they probably cut rates by 100 bips by this time next year.

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13:35So that'll obviously weaken the dollar there. I mean, the conventional wisdom is the dollar is weakening. Just reading a great piece. I mean, going over all different types of reasons the dollar is weakened. But I think what's clear for here in your trade is so many people think that the Fed will cut faster and more than other central banks. That's certainly what's happened in history. And I think that's one of the reasons that would push you to maybe EWZ. That's iShares Brazilian Equities, an ETF. And is that the is that your thinking there that the Fed just goes and cuts much more than other central banks around the world, including Brazil?

14:17Yes. And remember, it's the one thing I learned growing up in the business is it's it's what the Fed's doing relative to other central banks. That's a very important point. It's also like, what is the backdrop of the planet? So there's 65, there's 70 trillion of GDP outside the United States. And there's maybe 27, 28 trillion inside. So 70 trillion versus 28. And so there's much more GDP outside the United States. 2022 is going to go down as a Hall of Fame literally in the last 700 years. You can't get a better backdrop for the dollar in 2022. China lockdowns that were endless, which suppresses global growth.

15:00The war in the Ukraine, which was just a vicious stress on the global financial system. The European economy was in a lot of stress. And the Fed, like you said, Samuel, brilliantly, is that the Fed, relative to every other central bank in the world, Bank of Japan, whatever it was, the Fed was much more aggressive. Now, the next 12 months to 18 months, China's reopening. You've got a stabilization in Europe to some extent. And the Fed is more done than other central banks in the world. And just to interrupt you for a second, I mean, there are some people who think it isn't necessary that the dollar is going to be so weak.

15:38It's just going to be the strength of the yuan and the yen as one of those central camps that we see for everything else. Just look at the Bank of Japan, right? So in the fall, the Bank of Japan was promising endless, what's called quantitative easing and yield curve control. Now, this is the Bank of Japan now. The Bank of Japan is talking about literally a change and a regime shift away from yield curve control, which, you know, that gets you from a very weak yen to a much stronger yen. So there's like all these dynamics. The United Kingdom was in flames politically, right, in the third, fourth quarter.

16:17Now things are stabilized there. So there's all of this backdrop that is, those were massive tailwinds for the dollars, for the dollar last year. And now there are a lot more headwinds. But then the question is, how do you play this? So that gets us to EWZ. If we just take a step back, I wanted to pull up the five year on EWZ. We see it peaking at about$50 in January of 2022 and then hitting its bottom around$22.25 in May of 2020. I think I got my years off there because that wouldn't make quite sense. But you can see right there on the chart, you see where it's peaking. Then, wow, it goes way down.

17:00Currently, we're trading at about$30. So why this mechanism to play this move in the dollar, Larry? Well, you know, emerging market equities, gold miners, there's a lot of things that when the Fed stops hiking that they outperform. um but so so in general you want to be more long emerging markets now than you were last year uh let me go back you back 30 40 years when the bed is toward the end of the hiking cycle you want to be long emerging markets but you know countries like brazil have tremendous amount of gdp exposure to commodities and because the fed is softening the path with inflation very high like the atlanta FED, the Atlanta FED's wage tracker is actually back on the highs and moving even higher.

17:54So there's still tremendous inflation pressure. But because the beast in the market, because of financial conditions are forcing the Fed to soften the path, that sets up a much like a whole new regime for commodities for the next 10 years. So your previous decade, Darlings, your tech stocks were disinflation, deflation bets from 2010 to 2020. That was a major disinflation, deflation regime. But now you have a Fed softening the path. You have a Fed that's expanded the balance sheet by close to$400 billion with inflation above 6%. That is pure madness. If they wanted to kill inflation, if the Fed was serious about killing inflation, they would have let the financial crisis in the banking system in the United States burn for a couple of months.

18:44Instead, after one week, they expanded the balance sheet. They panicked. They hit the panic button. They expanded the balance sheet by close to$400 billion. That will fuel hard assets over financial assets. So commodities, value stocks, emerging markets over financial assets, bonds and growth stocks for the next five years. So that's a pretty clear time frame. Then what would your target be for EWZ trading around$30 right now heading toward? Well, I mean, it's pretty much near the COVID lows, which is a great entry point. And that's because of the stress and the political risk because of the Lula election.

19:25But I think you can get, you know,$38 to$42 inside of three years and potentially much more. And what would cause you to upend your view on this one? I think a whole lot would have to happen for you to change course here, no? Well, the wacky thing about Latin America now is Chile, Peru, to some extent Colombia. You have very leftist regimes that have come in. Lula is a known commodity. He was a former president, no pun intended. So I think overall there's always that political risk with Brazil, but that's why you're trading on the COVID lows. So the money has actually panicked out of a lot of emerging market political risk hotspots already.

20:17And just to bring this back full circle, the people who are still strong on the greenback say that the Fed rate path is actually underpriced. Well, if they do that, OK, this is the way. This is how you have economists in the United States. that are just literally smoking something. Because if you do that, if the Fed hikes another 50 bips, they will drain the banking system dry and they will create, like they're on the nerve. Like you can't drain the U.S. banking system dry without creating a financial crisis right now. And not to mention the Financial Times and Moody's, who are not exactly first movers, are talking about commercial real estate has yet to be priced into the banks and their balance sheets and the earnings.

21:06So the banks have just begun, after losing all of these assets, they've just begun acknowledging this colossal stress that's coming from the U.S. commercial real estate market in our major cities. So the Fed is done. But let's just not kid ourselves. Yeah, or you're smoking something, as Larry McDonald just put it. And then that takes us to your last trade. And perhaps this is the most interesting for me because I've covered the tech markets for years, and that's shorting the NASDAQ. Now, the vehicle you could use to do that would be ProShares Short, QQQ, PSQ. I just want to bring up a one-year chart, though, of course, when you're shorting, people can often get confused because it's really the inverse of what you're talking about here.

21:52So I'm not going to dwell on any of the points, but we'll keep that up for a second. But walk us through the why. Why shorting the Nasdaq and why now, Larry? Well, in the first quarter, Samuel, as recession risk rose and as this stress in the banking system came on board, all this money had to leave the financials and move into tech. And what's interesting about the last 40, 50 years of markets is when you have a real crisis that comes on fast, there's typically a drawdown in the market that pulls correlation goes to one like during Lehman and you have money comes out of the market. But here, when it's a slow moving recession with major band-aids from the Fed and things like that and the FDIC backstop, it's a slow moving crisis.

22:43So the money doesn't, it does go to cash. We have a lot of money in cash, but the money reallocates into what are called perceived safe havens. So all across markets today, a lot of our viewers, they're going back to the previous decades darlings. That's all they know. And they're assuming that the current crisis and the recession risk brings inflation back to one to two percent, because that's the only way that sector really works again. Big tech stocks just don't perform well in elevated inflation regimes. They never have as a whole. And so you have the mad mob is rushing back into tech and they're assuming that we're going back to like a one, two percent inflation world.

23:33And they're assuming that the Fed's going to cut a lot, cut rates dramatically. The problem is when you cut rates from up here, then you're weakening the dollar and you accelerate inflation. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

23:55Why do you think that those tech darlings can only work in low inflation environments? Well, you think about your net, that's a great question, your net present value of all future cash flows. And I talked about this with Raoul Paul literally around when I did this segment late 2021 into 22 about my prediction on the NASDAQ's demise. And this is all you can look at on YouTube. The net present value of all future cash flows in a deflation regime is worth a ton more. So think about Netflix is doing, say, a billion or two a quarter. They bring in the money. They reinvest it in the house. But if you have deflation and you're redistributing capital within your capital structure, within the company, you're investing it, in a deflationary regime, that net present value of those cash flows is worth more.

24:50But in an inflationary regime where you have certain inflation that's, say, 3 % to 5 % that hangs around for multiple years, if you look back 1968 to 1981, the type of stocks that outperform are materials, industrials, value stocks, commodity-based equities. And because the net present value of all future cash flows in an inflation regime, that hurts growth stocks and it helps value stocks. So your time horizon for shorting the NASDAQ, going in on something like ProShare short QQQPSQ as your vehicle? Well, let's remind everybody. These levered ETFs are for professionals, okay? They're extremely dangerous.

25:35Your timing has to be near perfect. You know, I just think if someone's watching this right now and you're overweight NASDAQ, you know, just take down exposure. You don't necessarily have to get – this is for a professional. These things are massively levered. There's a decay factor where the team that runs the SQQQ has to rebalance every day and basically short every day. So there's a massive decay. And so if the market goes sideways for two months and you're in the SQQQ, you could be down 10, 15, 20 percent. But I just think, you know, selling main go away. The average FANG stock, they say your top 10 stocks in the NASDAQ, which are about 50 % of the NASDAQ, right?

26:17So 50 % of the NASDAQ are 10 stocks. And if you look at those 10 stocks, they're up on average, not even like 120 days into the year. They're up on average 30 to close to 40 % because they had, there was such, like everybody that was puking these stocks, in december puking them into the bucket is now chasing the route and to me that sets up for a very negative you know next quarter or two for the major tech stocks which you know the fan stocks which represent most of the s like i said the qqqs and i mean if we were to tease that out then if you were would you only go into something like the nasdaq i mean really increase your exposure than once inflation got down pretty low, Larry?

27:07Well, remember, these trends go for decades. I mean, the deflation regime that we were just in lasted a long, long time. Think about this, Samuel. This is a great point you just brought up. After Lehman, we did two to two and a half trillion of fiscal and monetary response, okay? And the thing about that Lehman crisis, if you take a trillion dollars and you put it into a box. You won't really create inflation that much. And that's what happened. They took a trillion dollars. They bailed out the banks. The money was in the banking system. And it didn't really create inflation. After the COVID crisis and this latest energy crisis, the last two that hit us, where we're paying people's energy bills in Europe and we're supporting the price of energy through massive energy bailouts, we've done about 12, remember Lehman was two to two and a half.

28:00We've done about$12 trillion of fiscal and monetary responses globally, maybe even a little higher than that. So governments have massively bailed out lockdowns. They've bailed out energy prices. So they're paying people's energy bills in Europe, and they're paying people's energy bills in California. That's supporting the price of energy. And they're paying people to stay home. That's why the power of labor, it's very difficult to get people back to the labor force. People can get paid very well by working the system the last couple of years. So all of these things, the unintended consequences, are just that COBRA effect, which we blogged about two years ago.

28:42That COBRA effect creates a much higher sustained regime because of all these unintended consequences of inflation. And that basically means, to answer your question, that this value versus growth regime, where value is actually beating growth and commodity stocks and EM, this probably lasts at least five years. And what would be, I mean, if all of a sudden, I mean, you've kind of answered the question where I'm going, but what would be your first sign then if all of a sudden you thought, all right, the Nasdaq's looking sexy again, what would be the number one sign? If we woke up tomorrow and there was another COVID virus that attacked the major cities of the world extremely fast, then that would create such deflationary pressure that tech stocks would once again.