Video Update: Staying Sane in Insane Times

I am confident that A.I. will change the world, but not before the recession is likely to hit us.

But the market seems to think so…

A bubble is forming that will leave many investors high and dry that are piling into A.I. right now.

In today’s video update, Chief Analyst Adam Galas walks through part two of what he calls “staying sane in insane times.”

At Fortress Portfolio, our focus is on generating wealth over the long term. That’s why if you find yourself being swayed by today’s short-term moves, make sure to check out today’s update.

Click below to watch the video or read the transcript.

Happy SWAN (sleep well at night) investing,

Brad Thomas Editor, Fortress Portfolio

Welcome Fortress Portfolio members to staying sane in insane times part two.

Last week we warned that the market is starting to go crazy.

Well, let's take a look at a very specific example. The poster child for A.I. and the current tech mania, Nvidia (NVDA).

This is, of course, a rock star of 2023.

They released Blockbuster earnings and their management team increased sales guidance 50% higher than Wall Street expected.

In fact, in a single day, they gained about $200 billion in market cap, and are now well above twice the value of Intel Corporation (INTC).

Now, that's because they're selling $10,000 A100 chips that are the new hotness right now.

And companies can't get enough of them. These A100 chips are high end graphical processing units (GPUs) that are optimized to handle deep learning workloads that companies need to train their A.I. large language models.

Now, the problem is that in the pandemic speculative bubble, NVDA flew off into a wild period of premium valuation to 81 times earnings.

Obviously, a bubble. And it resulted in a 67% crash that nobody was surprised at.

Well, right now it's trading at 86 times earnings. So is this time different?

Apparently, no price too high to pay for A.I.

But NVDA is one of the most volatile companies on Wall Street. Crazy enough, it’s historically twice as volatile as the S&P.

NVDA does not have corrections. It has crashes. In fact, the median bear market for NVDA is a 60% decline.

Now, don't get me wrong, Nvidia is a wonderful company.

This is the master of future chip technology. We're talking the leader in chips for cloud computing, internet of things, data centers, and, of course, A.I.

But look, the fact is, even God's own company is going to make a terrible investment if you pay an absurd premium.

Now, today, NVDA is 54% historically overvalued, and that's compared to its 20-year average Price to earnings (P/E) of 34%.

That's the P/E that billions of cumulative investors over two decades have determined is NVDA’s intrinsic value.

Now, for context, the S&P at the peak of the tech bubble in March of 2000 (the most overvalued U.S. market has ever been) was 50% overvalued.

So essentially, NVDA is trading at those kind of crazy levels.

Now, just to give you an idea how volatile this stock can be, it has fallen as much as 50% in a single month.

And in the tech crash, it fell 90% in just nine months.

Now, should you own Nvidia?

Absolutely. At the right price. Hyper volatility is the best friend of the patient and prudent growth investor, but it can be the worst enemy of the fool who believes that momentum stocks can grow to the sky because of ChatGPT and A.I.

As Mark Twain said, there are two times in a man's life when he should not speculate… When he can't afford to and when he can.

Now, we've already seen that Nvidia is not a bond alternative. And I have seen people say in various comment forums that you should buy NVDA because they think it’s going to go up in this recession.

Now, in fairness to those people, legendary hedge fund manager, Stanley Druckenmiller, was on Bloomberg a few weeks ago saying that he owns Nvidia and he thinks the earnings are going to go up 70% in this recession. And that he thinks the stock will keep going up as well.

Well, with all due respect to Druckenmiller, the laws of economics have not been repealed by ChatGPT.

Now, don't get me wrong, A.I. is likely to change the world.

As you can see, Goldman Sachs (GS) estimates that it will cause long term economic growth to be about 1.5% higher, which by itself will nearly solve the U.S. deficit problem.

And Bill Gates has said that over the next two years, the current hype we have is almost certainly overstated.

But over the next decade, it will likely be understated.

That's how revolutionary this technology could be. Now, that's certainly great news for the economy, corporate earnings, and the stock market.

But here's the problem.

A.I. is not likely to stop this recession. According to GS, the personal computer (PC) productivity boom took 20 years to get started after the introduction of personal computers.

Now, the good news is companies are already starting to integrate A.I. into their businesses and even start generating revenue. So it's probably not going to take 20 years for this productivity boost to show up.

But the problem is the recession is likely weeks away and no more than a year. It's not going to help us in this recession. And here's the problem.

In every single recession, even in periods of high inflation, corporate earnings fall.

And if inflation does stay high, which would help nominal sales and earnings growth… Well, guess what the Fed is going to keep doing?

They're going to keep hiking us straight into a recession.

Now, last week, the Fed surprised the market with what Bloomberg called a “very hawkish skip.”

They specifically said that the plan is to hike 25 basis points in July, an additional 25 in September, and then we're going to hold rates higher for longer… Possibly until April of 2024.

Now, the bond market is calling B.S. on the Fed, saying, “Oh you are going to hike once and then you're done.”

But let's be conservative and say they're not going to hike at all.

They're just going to leave rates at these levels until April of 2024, as many at the Fed want.

Well, the effects on the economy from that would be significant.

Because of how real interest rates work… Basically, how much interest rates relative to how much money is in the economy.

And right now the Fed is sucking money out of the economy. As is the U.S. Treasury and the federal government in general.

Basically, it would be like the Fed hiking rates eight times if it does deliver on those two additional rate hikes because of all the money leaving the economy. And that would be the economic equivalent of ten more rate hikes in the next nine months.

Now, to understand why, we have to understand reverse money printing.

Right now, the Fed is sucking out $90 billion from the economy via quantitative tightening.

The U.S. Treasury is selling $200 billion a month of Treasuries, which is also sucking money out of the economy.

And starting in August, $11 billion per month in student loans (that have been in limbo the last three years) are once again due per the debt ceiling deal.

So this is about $300 billion a month being sucked out of the economy while the Fed is essentially threatening two more rate hikes, followed by keeping rates higher for longer… Essentially putting the squeeze on the economy.

And it’s not an accident that I mentioned the debt ceiling just now.

Guess what? There's some more important news about that.

Now Wall Street was very relieved that we got a debt ceiling deal. We prevented a default, and we averted a depression.

But guess what? The House’s initial versions of the 12 spending bills that they have to get passed by the end of September, call for 2024 spending to be at 2022 levels (not 2023, as the deal actually says).

Now, here's why that matters. That would effectively cut spending by $120 billion or 5% compared to this year's level.

Now, this is because 11 members of the House Freedom Caucus were outraged by what they saw as a betrayal in the final deal.

So for over a week now, they have been blocking all bills coming to the floor in the House.

So Speaker McCarthy, in order to get anything done, made this deal with them.

Now, this is a deal that is shocking the GOP senators in the Senate. And, of course, not surprisingly, the Democrats in both chambers are in an uproar.

So what would this actually mean if we did cut spending by $120 billion starting in October?

Well, for the full year, that would be a 0.5% hit to the economy. On its own, a mild recession.

But wait, it gets worse.

If the House Freedom Caucus were to prevent these 12 bills from getting passed in time (even if the House ends up going back to the original deal), then the current debt ceiling deal says that even if we pass a single omnibus spending bill, (which is how we've been funding the government for roughly 20 years now), then these spending cuts will kick in at 3% instead of zero as the bill currently states.

But wait, it gets worse again. There is a good chance that we will not get spending bills passed in time, in which case we'd have a government shutdown.

800,000 federal workers would get furloughed. Now, the good news is furloughed workers do get back pay when the shutdown is over.

But the bad news is there are 4.2 million government contractors who wouldn't get paid during the shutdown. And they do not get back pay.

That would be another permanent hit to the economy if that were to happen.

So, in other words, in addition to the Fed being on the warpath against inflation and possibly hiking rates effectively between eight and ten times in the next nine months, we have $300 billion per month in reverse money printing and more D.C. drama likely to come.

So now let's talk about the coming recession.

But first, I want to explain how 2022’s bear market was obvious and so is this recession.

Now, think back to June of 2021. That's when inflation hit 5% for the first time and it kept rising steadily, hitting 6% by the end of 2021.

Interest rates from the bond market had more than tripled off their bottoms. And the Fed was saying, we're going to start to reverse money printing and we're going to start raising rates.

So how was 2022’s bear market a surprise? It was not to anyone that was paying attention.

And right now again, the stock market is partying again like it's 1999 or I should say more like December of 2021.

Now, this here's why this matters.

Stocks have never bottomed in a recessionary bear market before an actual recession began.

Now, could this be the first time? Sure. It's not against the laws of physics.

And in April of 2020, oil hit -$38. So I suppose crazier things have happened, but it would be unprecedented.

So you might be wondering, well, then what the heck is going on with this bull market in 2023?

Well, Mike Wilson, Chief U.S. Equity Strategist and Chief Investment Officer for Morgan Stanley (MS), the most accurate forecasting team of 2022, has an explanation.

He believes that this is a boom bust bear market cycle similar to 1946.

Now, in 1946, America was demobilizing from World War II and we were worried about a recession. So stocks fell by 28%, almost exactly as they did in 2022.

They then spent the next 18 months grinding higher by about 24%, almost back to record highs.

Investors were feeling fantastic. The worst is over. No recession.

A-ha. Not so fast. No, the recession came. It was just later than expected.

Margins contracted. Earnings fell. And then the stock market fell 30% to fresh new lows.

This is what Morgan Stanley thinks is likely happening now.

And guess what? The data says he's right. A recession is likely coming this year, possibly even already here.

But even in the most optimistic case, it's likely to start at the beginning of 2024.

So what does that actually mean for corporate earnings?

They're likely to fall by 10 to 20% compared to current estimates, which unfortunately for an overvalued stock market, likely means 20 to 35% declines from here.

That is the most likely outcome.

Now, here's the thing. If this were to happen, basically it would be stocks falling to around 36% off record highs, which is pretty much the average recessionary bear market.

But as I like to say so many times, just to remind people and prepare you financially, emotionally, and even spiritually.

Average bear markets never feel average.

They feel like the end of the world if you don't realize they're coming.

And it is my job with these updates, to keep you sane, safe and rational in all economic and market conditions.

Look, when the market is melting down and everyone wants to panic sell.

My job is to remind you that the worst is likely already over. And short-term stock prices are vanity, while dividends are reality.

But when the market is melting up ahead of the most anticipated recession in history, in the face of $300 billion a month in reverse money printing, and a Fed that is considering raising rates effectively 2.5% in the next nine months… Well, my friends, that is pure insanity and it's my job to point that out as well.

My loyalty is only to you and your savings. And that means it's to the truth, and the financial truth shall set you free.

And the truth is, this A.I. bubble mania is pure insanity.

Now, some people say, well, my goodness, it can't be a bubble. Everyone's still bearish.

No, not based on what's actually happening with the markets. We're looking at pure greed.

This is just the 2022 bear market. And even in this bear market, there are periods of despair and complete euphoria.

 Well, right now we're in one of those euphoria cycles. Remember, the corporate earnings fundamentals are likely to come in much, much lower than currently expected.

How much lower? Well, according to the Fed's banking data, we’ll have about an 11% decline in earnings.

Goldman thinks it's going to be 11% as well. Piper Sandler, thinks 15%. Bank of America says 16%.

And Morgan Stanley, who oddly enough doesn't even think a recession is coming. Just margin compression, says 20% decline in earnings.

Now, even if all of these analysts are wrong and earnings come in exactly as expected, guess what?

Stocks are still trading at 19 times forward earnings compared to a 25 and 45 year average of 17 times earnings, meaning a 12% premium.

That would not make sense if rates were zero. Much less 5% with the Fed potentially considering up to ten stealth interest rate hikes.

Now, in case you’re thinking, well, maybe real rates don't really matter and maybe they won't affect tech stocks, right?

I mean, tech stocks, they're the new hotness.

Well, the old hotness. But the point is, they're popular.

And tech stocks are highly correlated to real interest rates, but not in recent weeks.

Right now, there is a massive disruption between the normal relationship.

But guess what? Those relationships don't tend to break down for very long, which means that anyone chasing this mania today is betting that this time is different.

No price is too high to pay for A.I.?

Well, that's a philosophy that did not work well for the Nifty 50 of the 1970s, when the most popular tech stocks fell about 75%.

We had the tech bubble of the late 1990s, resulting in an 82% crash.

We had a pandemic speculative mania with some of the most popular tech stocks falling as much as 70%.

And this time as well is almost certainly going to end in tears for many. And spectacular declines for many of Wall Street's favorite darlings.

So what does this mean for Fortress?

Well, Fortress members should not panic.

You can safely sit back and ignore all this craziness. Because, remember, Fortress is not designed around market timing or economic timing. It is designed around the most powerful and battle tested investing strategy in history with prudent asset allocation and the world's best dividend blue chips.

As you can see, we use the most effective hedging strategy in history by combining long duration U.S. Treasury bonds and managed futures.

Historically, this is a hedging strategy that mirrors the S&P’s bear market declines, but in reverse. In other words, you're looking at 33% of your portfolio, going up 20 to 35% while the market goes down.

And when a third of your portfolio does the opposite of the market in a bear market, that's how you get 50% smaller declines... Even in the worst market crashes.

But remember, that the hedging strategy is mostly there just to keep you sane, safe, and reasonable… Which helps you stay calm and more confidently stick to the long-term plan.

Volatility is not risk. It's just stock prices moving up and down very quickly.

At Wide Moat Research, our expertise is in analyzing safety and quality. We use our 3000 points safety and quality model based on a thousand fundamental metrics, which is has been proven 95% accurate at predicting dividend cuts before they happen.

Do you know what financial freedom is?

It's being able to pay the bills with safe and growing dividends in every economy and every market condition without having to give a damn about what the stock market is doing.

Let CNBC scream about markets in turmoil. Let your neighbors lose sleep worrying about their 401(k)s.

We own the world's best battle tested high yield blue chips that include dividend kings like Leggett & Platt (LEG). And LEG just hiked its dividend for the 51st consecutive year by 5%.

Now, nothing says confidence in the business, like management (not just extending the streak for another year) but giving a nice healthy hike ahead of the most anticipated recession in history.

Or how about Toronto-Dominion Bank (TD), which hasn't missed a dividend payment in 166 years?

Or about Allianz (ALIZY), which hasn't missed a dividend payment since 1890?

We also have Altria Group (MO), which in August is going to hike its dividend for the 54th consecutive year.

And U.S. Bancorp (USB). This King of Super regionals was founded in 1929, the start of the Great Depression.

9000 banks failed and USB got to gobble up some of its fallen rivals, allowing it to rise like a phoenix from the ashes of the economic inferno to soar to new heights.

At Wide Moat Research our motto for your Fortress Portfolio is safety and quality first, prudent valuation and sound risk management always. Because that's how you get rich the right way, the smart way, and the safe way.

No matter how crazy the economy or the stock market might get, we're here to help you float to your financial dreams on a river of generous, safe, and steadily rising dividends.

As a reminder, please send us your questions and feedback so I can respond to them in these videos as well as our monthly issues.

Just remember, I can't provide personalized investment advice.

Thank you for joining us this week, and I hope you join us next week.

We will continue analyzing the most complex issues battling the economy today, what it all means for the stock market, and why you as a Fortress Portfolio member are protected.

 You can sleep well at night no matter how crazy things are about to get.

Until next week, this is Adam Galas, wishing you and your family safe investing, and a healthy, happy, and relaxing week.