The Nonsense Rate Hike

On Friday, the stock market went down a lot, and bonds went up a lot. Mostly because of Google earnings but also Amazon, Reddit, and a few others. The AI trade is imploding.

If you’ve been faithfully reading this newsletter over the last few months, this should not come as a surprise to you. I’m not going to go back and hyperlink stuff like a lawyer, but I’ve been consistently bearish (and wrong) for quite a while. But the reason this is important is that last rate hike, in September, is going to look very, very foolish.

The Fed has some very smart, successful people working there (most of them). And yet they still consistently get it wrong. They are hawkish on the highs and dovish on the lows. They are wrong at every possible turn. The most famous bad rate move in history was “The Trichet,” where the European Central Bank hiked rates into an energy crisis—right before the Global Financial Crisis. Oops.

People still joke about that, almost 20 years later. And there were two individuals who wanted to hike rates again at last week’s meeting, and on the day that the stock market was melting down, on Friday, there were three Fed officials who argued for tighter monetary policy.

Dumb!

A Profoundly Bad Idea

Kevin Warsh keeps saying that we have robust economic growth. Really? Ex-AI, the economy has negative growth. The jobs market has been holding up reasonably well, but if we have a genuine downturn, a lot of people are going to get replaced with AI. Profit margins are at all-time highs right now, so there is no compelling reason to replace people with AI, but it is coming—in the next recession.

Honestly, the best forward-looking economic indicator is… the stock market. And Google is now down 30% from the highs, and all the Magnificent Seven stocks are down on the year. People are paying 39 times earnings for Apple simply because they haven’t impaled themselves on AI capex. 

I said this was a bad idea when it was happening, and it is turning out to be a profoundly bad idea. The capex, in historical terms, is bigger than the railroads. Have you ever seen a chart of railroad stocks from the 1800s? Possibly the biggest bubble in history, and nobody talks about it, because it was so long ago. There was a lot of value destroyed in the railroad bubble—people were laying tracks and then pulling them up again because there was no demand. I think I asked this before, rhetorically: What is the chance that we build the right amount of data centers? What is the chance that we manufacture the right amount of chips? Zero, of course. It’s a mania, an extraordinary popular delusion, just like every other one in history.

But AI will change the world!

Sure, but we don’t know when or how. The internet changed the world—about 10–15 years after the dot-com bubble—when its potential was finally realized. For sure, there will be a $10 trillion AI stock—perhaps in the 2040s. At some point in the near future, you will be able to buy these companies for a fraction of their current values.

The Fundamental Case for Gold

Shifting gears for a moment, let’s talk about gold… 

Gold isn’t doing very well. I am getting anxious emails from subscribers, asking if they should sell their gold. You are thinking about this the wrong way. The time to ask that question was in January, not today. 

These are the facts: Gold was a mania, a bubble, earlier this year. It peaked, and it is now down about 30% from the highs. It is in a bear market. Has the fundamental case for gold changed, at all? No, it has not. Markets will do what markets will do; they punish speculative excess, and the bear market will continue until the last late long has capitulated. 

My wife was even asking me about gold, as she has it in The Awesome Portfolio. She said it goes down every day. Yes… but you must own it. I see first support at around 3,720 or so, and 3,500 after that. Maybe it goes even lower. Drawdowns are painful, and precious metals are known for steep drawdowns, but like I said, the fundamental case hasn’t changed, unless you think that the government is going to balance the budget sometime soon.

No? You don’t see that? You see the deficits getting even worse? Then keep holding on to gold. If Ron DeSantis has a realistic shot of becoming president, I would sell my gold. Maybe that happens! But I don’t think the markets discount that far out in advance.

Speaking of The Awesome Portfolio, I’ll remind you one last time to pick up a copy of the book.  Could change your life. Will change your life. Probably the best discussion of risk in any book you will ever read. You will think about markets in a completely new way. You gotta trust me on this. Hit the buy button.

Poll

Much better turnout than the last time I posted a poll—while I was at DirtCon, we had only 16 people participate. Sixteen! Either the question was the worst question in the history of questions, or we didn’t pay the Typeform gas bill. Or, you know, tech difficulties.

Anyway, thanks for showing up this week.

Dumbest Thing I Saw This Week

It’s the “shiny rocks” comments re: gold that I’m starting to see. Whenever those start coming out (like in 2013 and 2022), you know you're close.

Jared Dillian, MFA