#432 Larry McDonald: A Lehman-Style Warning, a Fed That Can’t Hike & Gold and Silver Set to Run

NVIDIA

Across the shows: 116 speakers in other episodes, 98 bullish and 69 bearish calls, past 30 days

• Larry McDonald · The Bear Traps ReportBearish

  Nvidia's off-balance-sheet AI financing creates systemic risk; he is short and fears CEO-related governance failure.

  Nvidia does much of its supply through outside foundries like TSMC and uses off-balance-sheet financing with many counterparties, which McDonald compares to the leverage of banks in 2008. He calls Nvidia the 'central bank' of AI deals and says dozens of AI financing deals could be scrutinized or frozen if the CEO were forced out, since there is no strong number two. He criticises the CEO's judgment and compares it to Lehman's hubris. He says Nvidia lost 30% in under 22 trading days and fell from roughly 8% of the S&P 500. He says data center financing, power and political conditions need a couple of quarters to a year to fix. McDonald's fund is short Nvidia through Nvidia ETFs and he would not buy until the CEO is replaced.

  “What NVIDIA has been doing is just doing a lot of off balance sheet financing with a whole bunch of different counterparties.”at 9:54

SoftBank Group

Across the shows: 4 speakers in other episodes, 0 bullish and 5 bearish calls, past 30 days

• Larry McDonald · The Bear Traps ReportBearish

  SoftBank's credit default swap costs are soaring due to its highly levered OpenAI and off-balance-sheet bets.

  McDonald says Masayoshi Son has gone all in on OpenAI and is highly leveraged. He recalls the WeWork failure and says SoftBank's credit default swap cost is soaring because of off-balance-sheet financing deals tied to Nvidia and OpenAI. He sees SoftBank as one of several overleveraged links in AI financing that could unwind.

  “the credit defaults with the cost of protection on SoftBank is going through the roof because of all of these shady, kinda ugly off balance sheet financing deals”at 10:36

Apple

Across the shows: 52 speakers in other episodes, 66 bullish and 39 bearish calls, past 30 days

• Larry McDonald · The Bear Traps ReportBearish

  Apple at 11 times sales is 'lunacy on roids'; it has traded at 2-5 sales for decades and is saturated.

  Apple traded at 2 to 5 times sales for about eighteen years. It now trades near 11 times sales, though McDonald says its internal numbers are rolling over and the iPhone market is saturated with no obvious new product. He argues the money moving out of Nvidia is parking in Apple as a perceived safe haven, and that a company at that multiple struggles to make money for shareholders going forward. He also wonders whether Buffett is selling.

  “Apple for twenty years traded at two to five times sales for eighteen years. And now their numbers internally are rolling over. They've saturated the market with iPhones.”at 16:04

Bank of America

Across the shows: 8 speakers in other episodes, 3 bullish and 6 bearish calls, past 30 days

• Larry McDonald · The Bear Traps ReportBearish

  Bank of America's 23-24% drawdown from highs is ominous and it can't rally.

  Bank of America is about 23 to 24% off its highs while Berkshire is at all-time highs, and Goldman Sachs is also down about 22 to 23%. McDonald says this drawdown in banks is unprecedented since 2008. He argues it is an ominous sign because Bank of America and Goldman have the most exposure to data center finance, a theme the AI financing boom depends on. He says the sector needs to act better for the market to stabilise.

  “Look at Bank America. 23, 24... 23, 24% off the highs in recent days. It can't rally.”at 21:08

Century Aluminum Company

• Larry McDonald · The Bear Traps ReportBullish

  Century Aluminum, at a $3B market cap, can generate about $1B of free cash flow and buy back stock.

  McDonald likes aluminum names because the next ten years of data center build-outs will need large amounts of aluminum, although there is a current hiccup. Century Aluminum has a market cap around $3 billion, and he thinks it will generate about $1 billion of free cash flow over the next twelve months, enough to buy back stock. He compares it with Alcoa and says these stocks are down 50-60% and are candidates for tax-loss selling. He notes aluminum buyers exist regardless of data centers, but the data center demand is a new bid. If that slows, upside might shrink but not disappear.

  “They're generating, we think, in the next twelve months, a billion dollars of free cash flow.”at 26:21

Alphabet

Across the shows: 71 speakers in other episodes, 64 bullish and 49 bearish calls, past 30 days

• Larry McDonald · The Bear Traps ReportBullish

  Would buy Alphabet with both hands at a 35% drawdown; Buffett, Loeb and Klarman have bought it.

  Alphabet has just had a roughly 32% drawdown. McDonald says that if it reaches about 35% he would buy it aggressively. He points to Buffett, Dan Loeb and Seth Klarman buying Alphabet at higher prices. He identifies it as a name to focus on, in contrast to Nvidia, which he sees as still unsafe.

  “Google literally was just thirty thirty two percent drawdown. If you can get Google at, like, a 35% drawdown, you buy it with both hands.”at 30:05

Intel

Across the shows: 16 speakers in other episodes, 3 bullish and 15 bearish calls, past 30 days

• Larry McDonald · The Bear Traps ReportBullish

  Prefers Intel over Nvidia; Washington will favour Intel over the next couple of years given its investment.

  Bear Traps issued trade alerts on Intel last week and McDonald says he would rather play the chip sector through Intel. He expects the White House and Washington to favour Intel over the next couple of years because the government has an investment in the company. He is unwilling to bet on Nvidia's CEO until he is replaced.

  “we'd rather play through Intel because, well, I think the White House and Washington over the next couple of years is gonna really start favoring Intel. They have an investment there.”at 31:08

OpenAI

Across the shows: 41 speakers in other episodes, 22 bullish and 32 bearish calls, past 30 days

• Larry McDonald · The Bear Traps ReportBearish

  OpenAI desperately needs financing and its IPO has been pushed back, as with Anthropic.

  McDonald says there is endless demand for AI compute but not endless financing. OpenAI desperately needs to finance itself and its IPO has been pushed back, as has Anthropic's, which he sees as a sign of stress. He describes SoftBank's situation with OpenAI as desperate and says the entangled financing between AI companies raises systemic stress.

  “OpenAI desperately needs to finance themselves. The IPO has been pushed back just like Anthropic.”at 32:05

Netflix

Across the shows: 28 speakers in other episodes, 21 bullish and 24 bearish calls, past 30 days

• Larry McDonald · The Bear Traps ReportBullish

  Netflix is near a screaming buy level, about $20 below where Bill Ackman was buying.

  McDonald says Netflix is getting close to a screaming buy level. He says it can be bought about $15 to $20 cheaper than where Bill Ackman bought it. He lists it among beaten-down parts of the market down about 50% from highs that offer value amid the tech downturn.

  “Look at Netflix right here is, I think, getting close to a screaming buy level. You can buy Netflix, I think, $15 cheaper than when... Maybe $20.25 dollars cheaper than where Bill Ackman was buying.”at 34:29

Market sentiment, positioning & volatility

• Larry McDonald · The Bear Traps Report

  Wealthy families are buying tail-risk protection, betting on a credit blowup, and volatility may stay high into Thanksgiving.

  McDonald says tail-risk funds run by people he knows lose a small amount each month but produce large gains in crises, one having gained about 800% in 2008. Those funds are shorting Nvidia credit and shorting or betting against Meta and MetLife, which he reads as bets on a credit blowup. He says more families with $50-100 million net worth are moving about $1 million into such protection, a trend he has seen over the last month. He also says many investors with large gains are hedging by buying volatility before Thanksgiving.

  “they're taking a million bucks, and they're buying tail risk protection through funds like Lee's. I'm seeing a lot of that in the last month.”at 4:49

• Larry McDonald · The Bear Traps Report

  Passive fund flows are the biggest market risk; outflows from retiring boomers could reverse a decade of inflows.

  McDonald says about $80 trillion of boomer wealth is in the market, and much of it sits in passive funds run by State Street, Vanguard and BlackRock. That makes the market less liquid: when a few holders want out of a mega-cap like Nvidia, prices move sharply. He says tech is about 45% of the S&P 500 and 60% of the Nasdaq, and money has been rotating from growth into Apple and value. If older investors who hold concentrated mega-cap positions get shaken, passive inflows that ran for ten years could become outflows, which he calls the biggest risk and the trigger a possible AI collapse could produce.

  “if they get shaken all of a sudden, the passive flows, the inflows that we've seen for ten years is like a raging white water river of inflows becomes a raging white water river of outflows.”at 15:12

• Larry McDonald · The Bear Traps Report

  If the VIX fails to fall through Thanksgiving, a large hidden market risk is about to surface.

  Holiday-shortened weeks such as July 4th, Christmas and Thanksgiving have typically seen volatility suppressed, especially over the last ten years. He cites 2021, when an aggressive Fed talking tough was followed by a sharp drawdown right around Thanksgiving, as a precedent. He sees the November seasonality as supportive for equities. He therefore treats the VIX failing to fall over the next week and a half and stay down through Thanksgiving as a 'screaming statement' of what is under the surface, and says something very large is then likely to emerge.

  “So if you don't see that VIX come real down the next week and a half and stay down through Thanksgiving, then something very large, a massive serpent is under the surface and is about to come up.”at 36:55

Credit markets

• Larry McDonald · The Bear Traps Report

  High yield, CCC bonds and leveraged loans are breaking down, signalling bigger problems ahead.

  McDonald says the whole market is showing unhealthy price action. Defensive rotation into staples and utilities has been followed by the high yield bond market, including triple-C credits, and the leveraged loan market breaking down. He reads this as a sign of stress beneath the surface that points to larger problems ahead.

  “the move in the high yield bond market, triple c's, and just high yield is itself breaking down, the move in the loan market. There's a lot of unhealthy price action”at 12:01

Software & SaaS

• Larry McDonald · The Bear Traps Report

  AI labs' new products are targeting software companies whose stocks trade at 40-60 times sales.

  McDonald says the top holdings of the software ETF trade at 40 to 60 times sales, including ServiceNow, Palantir and CrowdStrike. He argues that Anthropic's new products are aimed at software, and that OpenAI's announced products this week will compete with Microsoft Office and other software companies. Analysts claim every company can win in AI, but he sees companies 'eating each other alive,' so investors should look for parts of the market not exposed to this cannibalisation.

  “[Anthropic]. All their new products to grow are coming at software.”at 17:14

US rates & the Fed

• Larry McDonald · The Bear Traps Report

  The Fed can't hike aggressively without a credit crisis; expects it to reverse course by January.

  McDonald argues inflation has been above the 2% target for about five years, and the Fed has stopped hiking and is expanding its balance sheet, which tacitly accepts higher inflation. Still, he says the Fed cannot do an aggressive hiking cycle. Financial conditions are already tight for the bottom 60% of consumers, and about $4 trillion of off-balance-sheet leverage has built up since three or four years ago. In 2022 a 50 to 75 basis-point path crushed the Nasdaq by about 35% in two months. He expects the Fed to talk tough and then reverse by January.

  “Can the Fed really do a hiking cycle with this much leverage in the system? I don't think so.”at 22:16

Gold & precious metals

• Larry McDonald · The Bear Traps Report

  Silver could rally 40-50% once the Fed backs away; silver names are screaming buys.

  McDonald expects the Fed to back away from hiking because of financial stress, which would push the dollar lower and support precious metals. Silver, aluminum names and platinum-plating names are screaming buys now, and once the Fed retreats he expects a 40 to 50% move up in silver. Silver has lagged gold recently, which he reads as a hint of an industrial slowdown, but he sees the Fed pivot as the catalyst for silver.

  “once the Fed backs away because of this financial stress in the system, that's when you're gonna see a real 40, 50% move up in silver.”at 22:33

US consumer

• Larry McDonald · The Bear Traps Report

  Financial conditions are already very tight for the bottom 60% of US consumers.

  McDonald says financial conditions are already tight for the bottom 60% of consumers, which is why companies like McDonald's, Home Depot and Lululemon and many restaurants and retailers are suffering. He argues this pressure, not just the Fed, is why the Fed cannot hike aggressively.

  “financial conditions are already tight on the bottom 60% of consumers. They're really nasty tight. That's why we've seen all this pain in McDonald's and Home Depot and Lululemon”at 23:17

US deficit & government debt

• Larry McDonald · The Bear Traps Report

  US will hit the debt ceiling in January; Washington wants higher inflation to erode the debt.

  McDonald says the debt is about $41 trillion against roughly $5 trillion in tax receipts, so the government must inflate its way out of the debt by repaying with cheaper dollars. He says that top macro traders close to Washington expect a Fed-Treasury regime, similar to 1946-1951, that keeps interest rates below inflation. He expects a big showdown between Republicans and Democrats over the debt ceiling in January.

  “we're gonna hit the debt ceiling in January, by the way... It's a big showdown coming.”at 24:12

Commodities (broad)

• Larry McDonald · The Bear Traps Report

  Hard-asset producers should benefit from slow growth with sticky inflation in a stagflationary world.

  McDonald argues the economy is starting to roll over after about $2 trillion annual deficits. If gridlock between a Democrat-controlled House and Senate produces slower growth with sticky inflation, which the Fed has not yet tried to kill, this is stagflation. He says companies that control hard assets such as silver, gold, natural gas and aluminum benefit from that environment, and he is positioning around it.

  “companies that control lots of hard assets, companies that control silver, some of these companies that control natural gas, companies control gold. Those are the type of companies that benefit from that stagflationary world.”at 26:39

Copper & industrial metals

• Larry McDonald · The Bear Traps Report

  Silver underperforming gold signals markets are pricing in an industrial slowdown.

  McDonald says silver is an industrial metal and gold is a precious metal, so when silver dramatically underperforms gold, as the silver-gold index shows, the market is pricing in an industrial slowdown. He cites Caterpillar's roughly 40% drop as another indicator. He says parts of the market that offer value have already priced in a major data center slowdown, while the Nasdaq and semiconductors have not.

  “The silver gold index is pricing in a big industrial slowdown because silver is the industrial metal.”at 29:18

US stock market outlook

• Larry McDonald · The Bear Traps Report

  Nasdaq's recent swings resemble pre-COVID, Lehman and 2022 patterns; S&P 500 could fall about 30%.

  The Nasdaq has had several 2%+ down days, a 3.5% and a 6.5% drop, then a 3% gain within about forty days. McDonald says this choppy price action has historically appeared only before COVID, Lehman and 2022, when buy-the-dip investors took heavy losses. He says the downside is 'more confident than ever' because the data center financing is unwinding and SoftBank and OpenAI are under financing stress. If the S&P 500 fails at its 50-day moving average, he expects new lows and a drop of maybe 30% from the highs. He has been making this call for some time and reinforces it here.

  “I think we're going a lot lower than the Nasdaq. ... If we fail there, we're gonna go to new lows, and we go a lot lower, maybe 30% down off the highs.”at 33:28