The Dividend Cafe - A Buffet of Answers

Episode Date: September 1, 2023

Today's Post - https://bahnsen.co/487nJFU So you may have seen in yesterday’s DC Today that my plans for an out-of-country few days with my wife this week, unplugged from work and electronics, was foiled yet again, this time by Hurricane Franklin. We have a running list over the last nearly 25 years of that which has prevented such an “unplugging,” and truth-be-told, we just are what we are. It seems to be a bigger focus to others that we “relax” and “take it easy” than it is to us. We accept this is a full-time job. But yes, it was not the week we had thought was coming. This week’s Dividend Cafe is the Dividend Cafe I thought was coming, though. A long list of really thoughtful questions is worked through covering such topics as the Fed, private credit, growth investing, the U.S. dollar, Saudi Arabia, the 2024 election, municipal bonds, and so much more. It is a lot of fun and sure to offer something for everyone. So jump on in to the Dividend Cafe. There may be a hurricane in Bermuda, but there is clarity, perspective and answers, in this place where we belong. Links mentioned in this episode: TheDCToday.com DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Well, hello and welcome to the Dividend Cafe. I am excited to do another edition. We've been trying to do about one of these per quarter where I just go through and answer questions that have come in. Every one of them is real. Every one has come from an actual person, often a client, sometimes not a client, just a regular reader, subscriber, but always good questions. In particular this week, I think there's some really thoughtful questions we want to answer. So I'm going to just go through these one at a time. It covers multiple different subjects, and we should be able to scratch a lot

of itches here. And of course, you know, the answers to any of these questions generate follow-up questions. So be it, fire away. We're going to holiday weekend. What else do I have to do? I want to thank everyone who wished me well on the trip this week. The trip ended up not totally really happening. We never did make out of the country with flights canceled around the big hurricane down in Bermuda. Our thoughts and prayers are very sincerely with those. There's another hurricane that's hitting Florida right now. And then there's the hurricane Franklin that took out our trip.

And so I don't really care much about our vacations when you're dealing with other people that have more real life consequences. But we got a little bit of time this week, and I'm grateful to Brian. I mentioned yesterday in the DC Today that he filled in capably for a couple of days with DC Today, but here we are. And it was just one of those things, and it's happened before. I'm sure it'll happen again. But I did appreciate some of the sentiments some of you shared. Now, in terms of things people shared, a question that I get a lot of questions about the Fed. I write a lot about the Fed, so I probably provoke some of these questions. But one person asked if, in particular, the Fed were abolished, would interest rates then be managed by market forces? And, you know, there's a sense which I could just say, well, yeah, sure. But, you know, there's two things

that have to be said on both sides of this hypothetical, which is interest rates could be managed by market forces without a Fed, with a Fed rather. In other words, you don't have to have the Fed abolished to have market forces guide where interest rates would go because the Fed really in its initial mandate is created as central bank as a lender of last resort, not to set the price of capital, not to try to impose a price of capital to affect policy objectives. That's a more novel and subsequent intervention into the charter of the Fed. So I am one who does believe in rules-based monetary policy, but I also am one who does believe in a Fed. I think that there is a legitimate function for a central bank, particularly in the context of being a lender of last resort, to help keep liquidity crises from becoming solvency crises. And there's rules by which I think those things should play out. And I also freely acknowledge that that is just not even in the stratosphere of what we look at our central bank to do now. So the market force idea behind interest rates, if you had some sort

of rules-based monetary policy, then you'd have market forces that are indicating where those rules go. So if you're looking at the bond market, you're looking at commodity prices, you're looking to nominal GDP growth, you're looking to a number of the Taylor rule. There's all kinds of rules. And I think there's plausibility in a lot of different theories. Of course, there's all the old gold standard. There's different levels by which money supply and the cost of capital could be set and various criteria by which those rules could be set that would be dictated by supply and demand and buyers and sellers and borrowers and lenders. In other words, market

forces. I'd be fine with any of that, but I think that could happen with the Fed as well. And then in terms of whether or not we would get market forces if there were no Fed at all, that I can't actually answer because it would depend what the Fed is replaced with. And there are some scenarios by which it could get worse and other scenarios where it could get a lot better. I hope that's helpful. What would reverse the trend of private credit gaining market share? Or is private credit here to stay regardless of what happens in the bond market or the Fed? And so again, there's kind of a theoretical here. If a lot of commercial banks took on a risk appetite to lend into a lot of the things that right now private credits are lending into, and commercial banks had the

liquidity, had the green light from regulators, and if interest rates came substantially lower, where there was the ability to do that at that competitive level on the banks, well, then, of course, that would cut into private credit market share. But none of those things are going to happen. I mean, it's kind of like, yes, theoretically, but no, not practically. And the reason being that the advent of private credit really did not just kick off in the last couple of years when this tightening cycle, it kicked off in a period of very loose interest rates, but it was regulatory out of Dodd-Frank where commercial banks were a lot more restricted on what they could do with deposit or cash and loss absorption and risk weighted capital and other metrics out of Basel III and out of Dodd-Frank substantially changed the rules of the game.

And so I wrote at Diven Cafe about this a few months ago. I think this became a very positive capital markets innovation. The private credit's a better way for some of this to take place. Now, marginally, if there was greater lending from regional banks at a lower cost, would that hurt private credit to some degree in terms of the volume of their deal flow? Well, maybe it would. But as a general trend, percentage of the lending needs in the marketplace, investor returns because of dealing at wider spreads, often with floating rate. I think it's very safe to say private credit as an S- class is here to stay for the foreseeable future,

regardless of what happens with interest rates, the bond market, or anything the Fed may do or not do in the next few months, years, what have you. A very thoughtful question came in as to why an investor at the Bonson Group in particular, want to enhance growth outside of the growth objective we have in our dividend growth portfolio. You know, we use things like small cap or emerging markets. Why would we want to enhance growth relative to what the risk and reward profile is of the dividend growth investor. And there's absolutely no question that the answer may be that they might not want to do that, that maybe they shouldn't do that. It is for those who want to enhance a growth objective with an enhanced volatility. It's not a free return. It's not free extra money.

Take on more volatility without the income, without the same parameters dividend growth offers, and see if there's a greater octane available through higher growth rates out of the organic earnings growth that is expected with other asset classes, such as right now for us, it's all around small cap and emerging markets. We could put other things in there. We actively manage that model. It's very small. Where are we at with that? I think out of our $4.5 billion, I think it's right around $300 million of what we're managing, not well over $2 billion, $2.5 billion like what we're doing in dividend growth.

Dividend growth has got to be the bread and butter core of the portfolio for all the reasons I talk about week in, week out. But where we think there's room for companies growing pre-maturity, pre-cash flow maturity to the point where they can return capital shareholders and yet with a well-managed, attractive, bottom-up approach, I think small cap could be very attractive with emerging. You deal with geopolitical and currency risk. But again, there are most certainly higher growth rates for some of these companies domiciled in emerging markets with lower valuations. Where most people are getting large cap growth is chasing expensive growth-oriented companies that they hope get more expensive. I've said that many

times. It's a line that I don't mean it to be cutesy. It's very descriptive. It's not the way we want to try to enhance growth. So we use something more boutique and more appropriate to our philosophy. Another really interesting question here, if Saudi Arabia comes into the BRICS, will they drop the US dollar as the pet, the US dollar as the petrodollar, the currency being used on oil transaction doesn't really matter. Well, it appears that Saudi Arabia is coming to the BRICS. So again, you're Brazil, Russia, India, China, South Africa has now invited Saudi Arabia, Iran, Ethiopia, Argentina, a number of third world countries to join in their sort of block of around a currency block around trading, various agreements and packs that go there with.

And I would suggest that it's very likely with or without this that marginally the dollar will end up being transacted with less with oil. So far, it's incredibly marginal. I think Qatar and United Arab Emirates have done a couple of transactions with China, maybe one with India, where the dollar was not the transactional currency. But Saudi hasn't yet. They've talked about it with China. I think that's coming with Yuan. But I got to come back to the most important point here. That's not going to change the dollar being the reserve currency.

You can trade oil for a different country's currency and then from there exchange into dollar because these countries have to hold a currency that they believe has a stability, has a convertibility, has a transactional broad utility. This idea, what does a currency strength come down to? Does it come down to a lot of weaker countries bonding together, all saying they want to use the weaker currency? Or does it come from countries themselves being stronger? Is Ethiopia enhancing the attractiveness of a BRICS shared currency block? It's just absurd. And again, that distinction between transactional and reserve currency is very important. I'm all for the arguments as to what the dollar

is subject to based on various elements of weakness from monetary and fiscal policy. But I'm not for the argument once you get to the point of now you've got to compare it to something or suggest an alternative or suggesting that Saudi would rather have transactions for petro denominated with a third world currency from another country that's significantly smaller, weaker and whatnot. It's just not accurate. So, no, I don't think it matters. I think that reserve versus transactional currency is the more important point. But all things being equal, do I think on the margin that Saudi joining this BRICS block will likely lead to less dollar transactions with oil? I think that's very possible and probably very likely and

totally immaterial. Will markets do better under a President Trump or a President Biden after the next election? Well, let's first of all make clear, I'm not convinced that either one of those are a shoo-in to be the person that will be running for president for their respective parties. I'm certainly not sure that both of them will be. It's very possible. And there's no question right now, they're both the significant leads in their respective parties. There's just a lot of things that can happen and a lot of time that can go by. And we won't get into all that. I just hope it's kind of obvious that, you know, things do happen.

And that's particularly true in politics. So perhaps things change, pivot, you know, go a different direction in the next four, five, six, seven months. That's a lot of time. But my answer about how markets would do is, first of all, the person in the White House is always vastly overrated as a determinant of market behavior. behavior. One thing I would say is, let's say President Biden wanted $5 trillion in new spending and $2.5 trillion of new taxes on investment, on capital gain, on marginal income, on productivity that was proposed in his Build Back Better legislation in 2021. He could want that, but we have to know what the composition of the Senate is, what the composition of the House is. So knowing who is president tells you one piece, but it doesn't tell you all the pieces. Markets have sometimes done very well with divided

government. Markets have done well when all the sides, legislatively and executive branch, are doing things that might be pro-growth or market-friendly. And markets could suffer if everyone is aligned with doing something that's market-unfriendly or market-friendly. And markets could suffer if everyone is aligned with doing something that's market-unfriendly, but that's hard to get to in our country, in our form of government. It's possible, but it's hard. It's harder.

So I don't know, without knowing more variables, how market could respond to some of that policy front. And you could have, in theory, really unfavorable political color for markets, but then have certain Fed activities or economic things going on that really rally markets, new technologies, new productivity, new growth, new innovation. You could also have the opposite. Maybe the political environment is supposed to be market friendly, but you have recessionary conditions that are being sorted through. You have a Fed doing this, doing that, geopolitical issues, instabilities. The politics are just so vastly overrated. So I

don't really totally care for the question, even though I very much understand where it comes from. I've been being asked this my entire adult life. And I give the honest answer, more or less the same answer for quite a long time now. All things being equal, if there was a sufficient majority, do I think that some of the things that President Biden has said he wants to do, if he had the House and Senate lead to do so, that they'd be negative for markets? I think so. Senate lead to do so, that they'd be negative for markets? I think so. And do I think President Trump's corporate tax reform was really good for markets in 2017? Of course it was. Deregulation, good for markets, some of the energy policy. But again, we don't know what the agenda would look like. We don't know what the legislative capability would be. So it's very hard to answer.

I would rather answer in a longer term perspective. Do I think that long term, the biggest challenge we face in economic growth is excessive government indebtedness? Yes, I do. And do I believe that either President Biden and President Trump have a great track record there? I do not. And would I expect any kind of meaningful improvement in the size of government relative to GDP in current spending, the size of debt relative to GDP or ongoing budget deficits? I do not. And so on a nonpartisan basis, I don't really think either one would move the needle on the more important element there.

Somebody asked, and that was a very thoughtful question, what makes smart Wall Street people embrace flawed ideas like Keynesian economics? And what makes academically trained economists continue to embrace this Phillips curve error about a trade-off between employment and inflation. I talk about this a lot that Fed economists believe they need to see more people lose their job to see inflation come lower. And I think one of the things I want to say first on the Wall Street front is that's not been my experience, that most Wall Street minds have and act upon a decidedly inaccurate worldview that is more rooted in Keynesianism and central planning and top-down command-control economic understanding. I think they're usually very agnostic, very focused on what is, and having an investment thesis, the real talented Wall Streeters, might not be very ideological at all.

might not be very ideological at all. They might be more focused on what is, and if Keynesian policies are, then they trade and create and strategize around that reality, as opposed to what they think maybe ought to be. That's on the more talented side of Wall Street. When you're sometimes just getting kind of generic macro research from some of the big Wall Street firms, and it has kind of a Keynesian bend or flavor to it, a lot of that is not investment specific. There's no activity out of it. It's not actionable. It's just kind of drivel. It's consensus groupthink that is non-controversial. It's regulator friendly. It doesn't separate anyone from the pack because risk-taking is not really what that camp is about. So if everyone sort of sounds the same, but they're

all rhyming, then someone could be wrong, but they'll all be wrong together. Someone could be right, they'll all be right together. But when you get out of consensus, bolder calls, that could be rooted in something that has a flawed ideology, or it could not be, but you just don't see it one way or the other that much in my experience. Where I think that there are Wall Street folks, whether traders, dealmakers, advisors, portfolio managers who actually have an economic worldview, I don't, again, see it very much. But when I do see it, it's kind of counterintuitive. It's not very common that they may be full-blown Keynesian. I think that the rarity is meeting worldview-minded Wall Streeters, but when I do,

I don't generally run into it in that sense. Now, the other question was why the academic class of economists embrace something like Phillips curve, despite so much incredible empirical evidence that it's a flawed theory. I think a lot of that is that there is an agenda for central planning. If your whole economic worldview is centered around the idea that there's a particular model that real brilliant people could tap into that could do a lot of economic good, then you may as well want to advocate creating that model. If you don't believe any such thing exists, if there is no Phillips curve metric, then it sort of does eliminate the need for econometric, academic, model-driven economics. So I don't know that it's always this cynical. I'm not trying to be cynical that it's sinister

or purposeful, but subconsciously, there's no question that believing in something like Phillips curve does imply a high regard for central planners. And these are the people who would be the central planners. And so that's, I think, a fair critique of what Hayek would have called their fatal conceit. I don't mean it to be sarcastic or derogatory, but that's my answer. I do think Phillips curvers largely are operating out of a kind of embedded implicit bias. Is an investment in high yield municipal bonds about interest rates or credit quality or both? And I would say it's a little bit neither. It's more about the spread. When you're talking about credit quality, the default rate is historically so low that we're not really looking at defaults. We're more talking about during periods where there's a higher risk appetite and more comfort with risk.

Spreads tend to tighten relative to the risk-free rate, and then they tend to widen when there's more concern. What the interest rate itself is could be high or low. And that's not the call around high yield muni, whether it's a high or low, it's more a spread relative to a high or low rate. So that's why I say it's not really about the rates, it's about the spreads. And it's not really about credit, because we're assuming a very, very, very, very, very low default rate historically in the high yield muni section. Now, another question in the muni bond category was what's your view of trend in the fiscal soundness of state and local governments is a positive. And I guess I would say, no, I do not have a positive opinion of the fiscal soundness

of many state and local governments. And yet, I don't think that has anything to do. I'm sad to say it has nothing to do with the payability of the principal and interest payments on bonds. I think that these states have many avenues by which their fiscal soundness can be skirted for the sake of the bondholders. That's been going on a long time, and I have no reason to believe it will change anytime soon. I'll leave it there. Someone asked me if I'd be willing to define the word deflation. Let me do it kind of quickly because deflation, just as a vocabulary term. It does mean just dropping of the aggregate price level, lower prices across the entirety of the price level, just like inflation means an increase in

the overall aggregated price level. So you could argue that deflation, when it comes from greater productivity, greater competitiveness is a good thing. But that generally speaking, when deflation, when it comes from greater productivity, greater competitiveness is a good thing. But that generally speaking, when deflation happens, it's from a contraction of money supply, a contraction of credit, and that it is not a great thing for a number of reasons. First of all, you could say, okay, well, it's good a consumer is able to spend less, but the entrepreneur and the risk taker can't go project and do economic calculation and extend risk capital into a new project when the revenues they anticipate could be deflating by then.

But fundamentally, this should make a little sense to you. Deflation is something that anyone who is lending money would love because they're going to get paid back with things that they could buy more of in the future. But it is something that people who borrow money would hate. They have to borrow a certain amount of money and pay back money that is worth more than the amount they borrowed. And then that really also ends up being bad for the lender because the solvency of the borrower is called into question. It doesn't help the lender at all if the borrower can't pay back, whether it's a bank or a company or a household. And generally, we're talking about governments

too, but governments have the ability to print money and so forth and so on. This is very similar to Irving Fisher's idea of a debt deflation cycle, that the problem with deflation is that if the asset values are dropping at a quicker rate than the debt's being paid back, you're in a vicious cycle. That's what the Great Depression was about. That's what Japan's story is about. At a different scale, it's what our great financial crisis was about. We don't have a lot of outright deflation in American history across a price level, but what we do, it's pretty ugly. But that's just the basic definition of deflation. Borrowers hate it. Lenders love it, unless the borrower doesn't stay solvent. And in periods of mass deflation, the borrower usually doesn't.

Someone else asked about what Fed now is, what the repercussions would be. Again, I want to make clear, it's not a currency. It is not a digital currency. It is a payment mechanism. The Fed, you already had Fed wire. You've already had Fed funds wire, ACH. It's a payment mechanism with banks that is meant to be an improvement. The Fed is not making payments available to consumers or businesses. The banks may do it, but the Fed's transacting with member banks and it's just a payment mechanism. Do I think the Fed is on the verge of cutting edge technology and payments? I do not. I think they struggle to do what they do well. I don't think that they should be expanding the things they don't do well. But be that as it may, I still don't buy into this idea

that Fed now is itself an existential threat of any noticeable difference to our own privacy and monetary control. All right, Well, I'm going to leave it there. That is all the questions. So I didn't rip off anyone on the podcast or the video relative to the written Dividend Cafe that covered all the questions. The two things that you'll get at DividendCafe.com are the chart of the week and the quote of the week. But as far as all the questions, those covered it. We'll reach out with any more. I hope this was interesting. And I certainly really do encourage you to write questions at thebonstonegroup.com for any additional info.

And thank you so much for listening, reading, and watching Dividend Cafe. I look forward to coming back to you next week from New York City. And in the meantime, enjoy your Labor Day weekend. And USC, fight on and beat Nevada. Securities are offered through Hightower Securities LLC. Advisory services are offered through Hightower Advisors LLC. This is not an offer to buy or sell securities. No investment process is free of risk. There is no guarantee that the investment process or investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee.

The investment opportunities referenced herein may not be suitable for all investors. All data and information referenced herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary and does not constitute investment advice. The Bonser Group and Hightower shall not in any way be liable for claims and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced.

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