The Dividend Cafe - A Market Breakdown Like No Other

Episode Date: August 30, 2024

Today's Post - https://bahnsen.co/3Mopc0V Market Reflections and Fall Excitement: Insights from The Bahnsen Group In this week's episode of Dividend Cafe, David Bahnsen, Managing Partner at The Bahnsen Group, reflects on 16 years of delivering market insights and the significance of the upcoming September. Bahnsen discusses the end of summer, the start of USC football, and significant market movements throughout August, including the surprising resilience of defensive sectors. He explores the broader economic context, the impact of potential Fed rate cuts, and the looming concerns of national debt. Bahnsen also previews his upcoming election white paper, emphasizing the lack of focus on federal debt in the current political landscape. The episode is rich with financial analysis and historical context, offering viewers a comprehensive understanding of current market conditions and future outlooks. 00:00 Welcome to Dividend Cafe 01:30 Market Overview and Recent Trends 02:49 Sector Performance and Market Breadth 05:45 Economic Conditions and Fed Policies 12:21 Election Insights and Economic Implications 15:58 Debt Concerns and Treasury Insights 18:46 Conclusion and Upcoming Events Links mentioned in this episode: 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. Hello and welcome to this week's Dividend Cafe. I am David Bonson, Managing Partner at the Bonson Group, getting ready to go into our 16th year of bringing you the Dividend Cafe. We began in September of 2008. And now here we are getting ready to go into September of 2024. And with September means the end of summer and the beginning of fall.

And with the beginning of fall means the beginning of USC football. And many of you will recall that I devoted an entire Dividend Cafe to an analogy of decades of my love affair with USC football and tracking that with markets along the way. And I thought it was an utterly brilliant Dividend Cafe. And about four of you felt the same, and many, many thousands of you may not have. But I just want to let you know I'm not doing that again. All I'm doing is mentioning that USC is playing LSU in Las Vegas this Sunday as they launch their football season, and I am excited. I also am excited for the fall season. It's my favorite time of year. It has been since my childhood. And this has been a very, very busy summer and I don't expect fall to let up.

And I don't want it any other way. We work full time and year round at our company. Markets don't sleep. But here's the thing. There's a lot to say about this market. And I'm going to say a lot of it today. The market, the economy, certain macro issues. But it was one of these Dim and Cafes where I jumped around a lot of different topics. And I just kind of want to do the same thing for you. Go through piece by piece, kind of almost potpourri, if you will. One of the things that I think is most

interesting in terms of what has happened here in the last month in the market is that the markets rebounded. There'd been a really big volatility spike in late July, early August. And I've talked about it kind of almost to some degree or another every week this month, where markets dropped a bunch and then rallied right back and the Dow hit an all-time high a few days ago and so forth. But I do think it's worth noting that if somebody had said a month ago that we're going to go to earnings season and on the other side of it, Microsoft, Nvidia, Amazon, Google, and Tesla, five of those so-called magnificent seven are all going to be lower than they were when they started and that the market would be higher and pushing all-time highs. I wouldn't have believed it. I don't know very many people

would have, but it is a testimony to what has happened this month with the defensive sectors in the market, to some degree, utilities, to a large degree, consumer staples and healthcare. Financials had dropped a lot, but they then also had a very significant rally back. Wreaths being another space, some would consider that more in a defensive sector, but it certainly was one that had a tremendous move in August. And so you had a broadening of market participation and that significant breadth offset the fact that some of those key players were not participating. And it will be very interesting to see where we go from here. Those names not getting a spike from their quarterly results and not getting a spike from the Fed announcements and Fed expectations and things like that. I don't know what the catalyst would be at this point.

And I think that this indicates some degree of ongoing metership transition. ongoing leadership transition. Now, I want to repeat that this is not like me to try to forecast exactly what it means because that's not what I'm doing now. I've really never done it. And I don't believe it can be done. Whether we're talking about the month of September or the remainder of the year, it's totally unclear what the overall market's going to do. And I say that every week, but I'm right now saying something more particular. It's totally unclear what the overall market's going to do. And I say that every week, but I'm right now saying something more particular. It's totally unclear what the leadership space in the market may be. My belief that overpriced things eventually revert to the mean has never, ever been connected to timing. I have no reason to ever doubt that something that is overpriced can become more overpriced before it becomes

fairly priced. I've seen it happen so many times in my career, I've lost count. And so I don't have any motivation, let alone any intellectual attachment to the idea that overpriced things are at a ceiling. They can always make new ceilings. I'm not interested in investing in that potential expansion of a ceiling, which is another way of saying a bubble becoming bigger before it burst. However, there is a good reason to believe that some of this rotation where ratios revert to the mean relationships between different sectors and their valuations, the overall growth value dichotomy, that kind of transition in leadership is happening. And one day here, one week here, I think are very, very anecdotal at best. But this right

now more fundamentally feels to be playing out, but again, that could change. And there's reason to believe it will be happening whether it's happening right now or not. Now, the other question that I think is fair to ask has to do with the future of the economic conditions that the markets respond to in the course of a Fed loosening cycle. So I've talked a lot about how it's not a super high percentage, but it's over 50% of the time that six to 12 months after the Fed begins cutting rates, the markets are generally lower. And the reason, and that may be counter to people because we can think of certain times when the Fed cut rates and markets went up a lot. But when you give an unexpected stimulus to something in conditions

that are more benign, you just take things that are maybe attractive with their fundamental profit environment, and then you just give it a higher valuation because of a lower discount rate by lowering the Fed funds, you expect prices to go higher. But the majority of the time, the central bank is cutting rates is in response to weakening economic conditions. And I've talked about this more often recently. Another way to put it, you could argue, is, well, if you get a recession, you don't usually get markets going higher. And the Fed is often cutting because they held policy rates too high, too long, and the economy moved into recession. A lot of these things feel different right now. And there's five pieces I want to remind everyone about

in this rate cutting cycle we're about to begin that just provide a little context. Every situation is different historically. There are different particulars and specific circumstances that will drive that response. And that's why throughout history, there are times when markets went up and other times markets went down and the things that were happening in the economy were different. In this case, there's a number of things that are different and therefore I think it's a little bit harder to predict. Certainly, if we get into a recession, I expect corporate profits by definition to drop and expect stock prices to drop. But can corporate profits drop even if we don't go into recession? They can. And therefore, can stock prices potentially respond negatively?

I think that's on the table. But here's a lot of the bigger picture, the full milieu that I think is worth noting in the historical context. Number one is that markets didn't exactly decline a lot during the rate hiking cycle. They're up, as you well know, even despite the big drop in 2022. There may be less room to rebound when the cutting begins because there wasn't a whole lot of drop when the hiking took place. Number two, the markets have had more time to price in these pending rate cuts than almost any period I've studied. The Fed began this so-called pause 15 months ago, and that's a very long time for markets to essentially front run or discount what they're expecting to take place. And that's not very historically

common. Number three, economic conditions have slowed, but they haven't weakened. They've softened. They haven't fallen. They're less robust. They're not terrible. In other words, I don't believe we know exactly where the economy itself is going. And a 4.3% unemployment rate that ends up hugging around 4%, that's going to speak to an okay economic landing as opposed to if it gets above 5% and maybe even further than that. So there's some question about what the economic conditions will prove to be from here. Number four, S&P earnings growth is already expected to be well into double digits next year, 11, 12, 13%. S&P valuations are already north of 20 times earnings. So multiple expansion is not likely regardless of the economic fundamentals.

So there may be a bit of a ceiling in place relative to some of the historical periods when the Fed began theoretically boosting valuations by dropping the discount rate. theoretically boosting valuations by dropping the discount rate. And then number five, there's another monetary tool on the table that no one really talks about besides just interest rates, and that's quantitative easing. The use of that tool by the Fed to either continue tightening, to stop tightening, or to actually move into more accommodation, a proactive loosening and easing of monetary conditions. All three of those options are on the table. And I think it'll be, in this case, inadequate to talk about just the impact of rates to

financial conditions and therefore market expectations without understanding what the Fed may do with this other kind of twin sibling of policy, which is in the quantitative tightening, quantitative easing. All right, moving on to a couple other miscellaneous items. I just want to point out about the VIX, which sometimes is called the fear index. It's a volatility index. And it really speaks to what price people are willing to pay for protection around the up and down movements and so forth. And the VIX had been just at historically low levels for a long period of time, coming into late July, sitting somewhere between $12 and $13 for a long time.

And it exploded higher for that late July, early August market hubbub, and then it dropped. But it did not drop back to 13 or 12. It dropped back to 15, 16, 17, right now sitting around 16 as I'm recording. So it's still moderate, it's still low, still healthy, but it isn't back to where there was almost no fear priced in at all. But it also is well off of where there was just a kind of pandemonium fear outbreak with people buying VIX in the 50, 60 range back in early August. So I see this as a healthy thing. I don't like it when I think protection is underpriced. It speaks to a complacency that the contrarian in me doesn't like. But the VIX, even as markets came back to a high, the VIX did not come back to a low.

Worth noting. All right. So I don't want to get too deep into the election talk yet because I am now working on this white paper that I plan to publish next month, analyzing the election, what to expect for investors as we go into the November election, and trying to do a real thorough, objective, and reasonably nonpartisan assessment of what my expectations are out of the presidential race, as well as the congressional, both Senate and House races. And I got to go through various topics and policy

specifics. And there's a lot of history assessed in it. And I do this every four years and I love doing it. And this year I hope to make it the best ever. But in some of the preparation and research and so forth I was doing this week, I want to share one thought, kind of a sneak preview. There is a stark difference between both candidates on some issues in the economic sphere. There's obviously even more stark difference in other categories. There's a lot of issues where there's not a stark differenceconomic issue that is to me the macroeconomic issue that I've devoted the vast majority of well over 10 years now to my economic study, talking about, analyzing, trying to better understand, and that is the excessive indebtedness of the federal government. And the debt to GDP ratios, annual budget deficits, and then the impact of all the above to economic growth and economic growth expectations. So this is a hobby horse of mine

for very good reason with a lot of impact and relevance to investors. That's the one issue that I don't think is on the table in this election whatsoever. I don't think that there's anyone, if one is one of the biggest fans of President Trump, one of the biggest fans of Vice President Harris, and they really like this policy portfolio over this one and all that, no problem. But I don't think anyone on either side would say, I expect after four years of either one of these that the U.S. national debt's going to be fixed. If you do think that, please don't email me. I'm begging you not to. But yeah, I mean, I think I speak for most grownups here that this is the major issue that I believe warrants attention.

And this is the major issue that I feel very comfortable saying is not going to get attention. It overlaps with entitlement spending and it overlaps with annual budget deficits. We're running trillion dollar deficits right now as our best case. I mean, they end up being one, three, one, four, like we're not even getting it down to one. And that is, of course, without a recession. If you go to a recession at some point, the deficit probably blows out a lot more as the revenue, the tax base will drop substantially. Look, we're going to see 200% debt to GDP at some point. The question is just when.

I think that any left-wing, right-wing take is going to agree with that. That's where we're headed. And so if it's unavoidable math, barring a really significant intentional effort to keep it going, then I think you're looking at this as being an issue that might be a real controversial one, relevant one in 2028. It just isn't in 2024. And so that's just an early takeaway I want to share. And then just a kind of statistical factoid, it did take us in our country 232 years to get $10

trillion in debt. It took nine years to get the next 10 trillion. And it took four years to get the next 10 trillion. And now we're adding another trillion or two every three months, seven months, eight months. So there's an exponential component to this as well. By the way, the treasury that has this debt, primarily through treasury bills and treasury bonds, there's one concern people throw out that, well, how are we going to raise the money for the debt if foreigners stop buying it? But we have a public debt, $27 trillion plus change. And China has reduced their holdings of treasury debt by maybe $400 billion soaking wet over about nine years.

And of course, banks and investors and domestic savers and insurance companies have significantly higher weighting. So I continue to not really believe that there's a story as to who will buy the debt, but I very much understand that there's a question about the rotation of who that buyer may be. There are times when sovereign wealth funds for currency reasons want to buy and they're foreign owners. There are times when sovereign wealth funds for currency reasons want to buy, and they're foreign owners. There are times when central bank wants to buy. There are times when private economic actors want to buy, but I don't worry about the appetite for the debt. The other issue that sometimes will come up is the cost of the debt, because interest rates are so much higher that it's represented a much bigger impact to annual outlays of the treasury.

And that's very true. We were spending about a billion dollars a day in interest five years ago, and we're spending $2 billion a day now. And so that's a big increase in the amount of interest expense. But 22% of the treasury debt that is outstanding is in T-bills, very short-term maturities. Right now, those have been costing about 5%. If the futures market is correct, that the Fed funds rate will be at 3% a year from now. 22% of our total treasury debt is about $6 trillion, a 2% difference, $120 billion a year. So my friends, that is why I have been such a believer that the Fed has to accommodate the treasury. I may not want to, and it may very well be in certain signs that they shouldn't, but I'm not referring to what they want, and I'm not referring to what they should.

I'm referring to what they will do. And this, to me, is the answer. Okay, the chart of the week shows you this week the valuations of just the tech, media, telecom-type sectors in the market, and then the overall market without tech media telecom. And you can see the overall valuation I bemoan in the S&P 500 is not all parts of the S&P 500. There are some that are very fairly valued or historically valued and other pieces that

are bringing that total valuation to the top. It's a great chart for you to look at. I'm going to let it go there. I hope you have a wonderful Labor Day weekend. I'm going to do my Monday edition in Dividend Cafe on Tuesday. I'll be back in New York next week. So I'll look forward to being with you Tuesday

back in the Dividend Cafe after the Labor Day weekend. Go USC, fight on, and have a wonderful Labor Day weekend. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, member FINRA and SIPC, with Hightower Advisors LLC, a registered investment advisor with the SEC. 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. Thank you. 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.

Such data and information are subject to change without notice. This document was created for informational purposes only. The opinions expressed are solely those of the Bonson Group and do not represent those of Hightower Advisors LLC or any of its affiliates. Hightower Advisors do not provide tax or legal advice. This material was not intended or written to be used or presented to any entity as tax advice or tax information. Tax laws vary based on the client's individual circumstances

and can change at any time without notice. Clients are urged to consult their tax or legal advisor for any related questions.