The Dividend Cafe - A Present Under Every Investor's Tree

Episode Date: December 20, 2019

Consider this week’s Dividend Cafe an early Christmas present, not just because of Brexit and the phase one China trade deal and, of course, a 2019 in risk assets that has been one for the ages … but mostly because this is essentially a double issue Dividend Cafe with ample coverage on all the things you should be caring about right now as an investor. Because there will not be a Dividend Cafe next week we doubled up for you this week, so take a break from wrapping presents, grab a coffee (or egg nog), and jump on into the Dividend Cafe … Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Christmas and in the couple of days after Christmas, I'll still be celebrating with my family and you'll still be celebrating with yours. And so no, it doesn't matter if I'm talking or not, no one will be listening. And so I think that we're going to take next week off and then going into the new year, of course, that final week will start as 2019, but it'll end as 2020 as New Year's Day will take place on that Wednesday. And so this will be the final podcast of the year, but we're going to cover a lot today. So buckle up. Hopefully you want, let alone need, a little break from your Christmas shopping and preparations and holiday festivities and planning. And I think if you're like me, you might have a whole lot of family getting ready to come or you're going somewhere, all that kind of stuff. We're up against it now. Every year, it seems like to me that the actual just normalcy and

work and busyness goes further and further up against the edge. Next week will be the holiday weekend and we'll be focused on that, including my team here at the Bonson Group. And markets are only open three and a half days. Now, normally, even that's a joke because barely anyone's working, although I'll remind you last year was not anything like that, where you had the Christmas Eve where the markets just completely, totally tanked. And then you had a day after, and that was only in a half day. And then you had a day after Christmas where the markets rallied a thousand points. And so within a day before and day after the holiday, there was a whole lot of market activity.

But right now we're in a pretty healthy market environment. I'm going to talk about that this week and where we are going into the holiday. I'm hoping for a more boring week to close out the year. of the holiday. I'm hoping for a more boring week to close out the year. And then we have a lot of special plans for you for 2020 as far as the content we want to create to recap 2019, to review it, to evaluate our own forecast from a year ago. And then of course, offering a lot of new perspective, including forecasting around 2020. And I think that this has become a fun annual tradition, but it's more than just fun. It's somewhat actionable in the way in which we're positioning client portfolios. And we want to give you as timely and as extensive of a view

into our thinking as possible. There's been incredible preparation for where we want to position things in light of 2019. And in so many ways, as you'll see when we recap the year, 2019 has been one I don't think people will soon forget. So I'll hold you in suspense on those things because we got plenty enough to talk about this week. As you can tell from the special podcast we had to do on Monday after last week's normal Dividend Cafe, that special podcast being necessitated by the incredible domino effect of news out of the phase one China trade deal being verbally announced by both sides, the British election results and what that means to Brexit. I'm going to be talking more about that here today. And the NAFTA 2.0 being agreed to by the Democrats and the White House both. And that might be the

last time you hear me utter that sentence for many years. But then over the weekend, there is still some kind of uncertainty around if the revised version is going to be agreeable to North American trading partners in Mexico and Canada. So it was quite a weekend and the market had rallied significantly coming into these events and in response to these events. And then now throughout this week, yet another kind of move higher in markets. And you have this combined effect. The environment right now is both where there's good news that then causes markets to go higher. And there is, I believe, this sort of what else are we going to do with our money phenomena? Things look good in the U.S. They're getting pricey.

They're getting more expensive than they were a few months ago. And yet most of the other available places one might put capital right now looks somewhat less attractive. And so that relative competition for investor dollars, that constant intrinsic and immutable search of the most efficient allocation of capital right now continues to lead a lot of that capital into U.S. equities. But I will say this about the China trade deal. I've studied everything I can get my hands on the last several days, and I am quite convinced that the markets responded appropriately in the sense that not having a further escalation in the trade war was the biggest need of the global economy and the American domestic economy. It was the biggest need of the American

stock market in the sense that you had some degree of, after the Fed kind of repriced risk assets or set the table for repricing with the reduction of the risk-free rate by lowering the Fed funds rate significantly over the last couple months. Yet what I think was somewhat holding back the market multiple, the valuation people would put, the discounting of future earnings from American stocks, I think what was holding it back was still that kind of uncertainty of are we going to walk into a woodshed of a trade war impact that would suppress global economic growth and U.S. economic growth and impact the earnings of a lot of American exporters of goods and services. And the fact of the matter is that we, in phase one deal, still have a legacy tariff on $250 billion of imports from China,

tariff on $250 billion of imports from China. Yet, we have reasonable confidence now that there will not be another escalation of more tariffs, which, by the way, happens to be some of the products that would have been tariffed that would have been most detrimental to the US economy, frontline consumer type products, particularly electronics and consumer goods. But you also had a reduction in the tariff that was put on in September of this year. So there are still more tariffs out there than the business economy wants. And there are more tariffs out there than David Bonson wants. And yet there are less than there could have been. And markets are responding appropriately to that. The piece – I have a chart on this that you got to look at in DividendCafe.com – is the expected exports of US goods and services to China is high in this deal.

They're kind of committing to a number that I think the question mark you have to have is, is it even doable? Can we really get that 200 billion increase in Chinese purchases of U.S. exports? They're saying 40 to 50 billion of it, and that's 100 per year, by the way, getting the 200, 100 next year and 100 the year after, higher than now. That would be the largest percentage increase year over year that we've ever had by far. And even with 40 or 50 billion in soybeans, and I don't know if they need that much soybeans and agricultural product, but that's what they're committing to. But I suppose that lingers as a potential uncertainty in the deal is whether or not they can hit the targets. Is the demand there? And then I presume the supply would be on our side. So all things considered, China trade deal,

I think, continues to be a very good positive. And yet there are a couple uncertainties that linger, as we talked about in the special podcast earlier in the week. One of the things that I'm most focused on right now and have been for quite some time, told you over and over I'm going to be for the rest of my career, but particularly as we get ready to close out the year, I'm trying to study more and more of the internal ingredients of the Federal Reserve balance sheet. And there was a big kind of change in the structure of things with the repo market hiccups from a couple of months ago. These stories come together, but let me simplify things for the listeners that right now just heard about five buzzwords that

are going to cause them to fall asleep. Risk assets in the fourth quarter of 2018 fell because they were worried about tightening of credit markets. And our U.S. economy is unbelievably dependent on the free flow of credit right now, largely as a result of the reconditioning of American economic expectations out of the financial crisis. So that expectation, in fact, that need of highly lubricated credit markets in the combined whammy in 2018, fourth quarter of the Fed raising rates two extra times, along with the tightening of their balance sheet, the reduction of the balance sheet, which meant tightening of dollar liquidity and bank reserves, it caused markets to throw up. They unwound it. Now we've had this big rally of markets. You know all that already. What you don't know is

that very recently, as a lot of people said, geez, how's the market continuing to go higher? The Fed has been buying an awful lot of T-bills. They bought $60 billion a month for the last couple months and have said they're going to do that probably five, six more months. Now their motive here is not QE. You remember quantitative easing one through three. They were buying a lot of bonds on the longer end of the curve, shorter too. There was a thing called operation twist, where they sort of twisted around the maturity profile of the bonds they were buying. But that was largely to manipulate the longer dated yields, the longer term cost of borrowing. And what you have now was that they, first of all, substantially un-inverted the

yield curve. The three-month T-bill right now is almost half a percentage point lower than the 10 year. And because rates are also low, the difference between 1.5 and 1.9% is a lot. As a percentage, a 40 basis point spread is a 33% move higher from the 90-day to the 10-year. On an absolute basis, half a percentage point isn't very much, but 33% move, 33% differential is substantial. But that's all up against where we were in just September and August, inverted. The 10-year was actually a lower yield than 90-day. So look, I said then, and I stand by it now with even greater confidence, I don't believe that that inverted yield curve was a foreshadowing of recession. I understand that oftentimes an inverted yield curve is meant to recession was coming later,

but I don't think that this was causative. And in this case, it may not even prove to be correlative because the fact of the matter is that you had the unbelievable buying volume of U.S. tre the process in the short end of the curve caused the short-term rates to go higher. Now they're back in. They're buying short-dated bonds. And guess what? All of a sudden, the yield curve is normalized. I'm not in defense of the Fed re-intervening. I'm simply pointing out that when you intervene and then stop intervening, the stopping of intervening becomes an intervention. It becomes distortive to what you were previously intervening in. It's why the Shakespearean line of don't, you know, when you first practice to deceive, you make a tangled mess when you first practice to intervene. But then that leads to domino effect. And that's what took place. And that's where we are now. The Fed is buying $60 billion a month, and that's really focused on technical factors that were more environmental a few months ago. Treasury had sucked out a lot of liquidity from the system for various technical reasons and timing issues. we do not have the amount of excess bank reserves we thought we did and ready access to dollars

because so many of these banks to fund government deficits are holding on to greater amount of treasuries. So you have this greater amount of collateral and that reduced the amount of liquidity that can come from the collateral in the form of actual dollars. I hope you understand what I'm saying. So as a general rule of thumb, whether you think it's good or bad, it happens to be maybe sometimes short-term good and usually long-term bad. But regardless of applying any kind of conclusion around it, just simply describing the environment in which we're in, it's very clear to me that markets will have a hard time going down when we are amping up liquidity, when we're amping up credit markets. And that's sort of what's going on right now. And markets will have a very hard time staying up

when and if that reverses. I don't know how it can't at some point reverse, but that could go on for a very, very, very long time. So I would pay a lot of attention to the stories of what's taking place with Fed interventions in the yield curve. My own forecast is that they're not likely to stop anytime soon, continuing to buy on the short end of the curve. And what that means is that short-term rates stay lower, and that enables a greater amount of excess reserves to build up in the banking system. A lot of people in my world call it non-QE, QE.

I think that's a reasonably fair and not altogether inaccurate description of what's going on. I don't want to call it straight QE because it is different, but it has a very similar effect to QE in that it does raise their balance sheet and it does put more liquidity in the system, which ends up being a boost for risk assets, for risk asset valuations. So more on that in Dividend Cafe this week if you're in the mood to read about it. We'll move on to some politics. I'm going to talk Brexit and go from there.

Listen, the budget that passed this week is an atrocity. I guess you could call it a political story. It's $1.4 trillion of spending. I guess you could call it a political story. It's $1.4 trillion of spending. From an economic standpoint, there's this massive amount of excess debt that has to get issued, either treasury bonds or treasury bills, depending on the maturity. And the primary dealers then acquire those.

Of course, there's a lot of foreign buyers as well. And that becomes an asset to the entity, but it becomes a liability to the government, right, to the taxpayers. The government owes that money. And so you end up basically, as I talked about earlier, the liquidity factor. We look at it as taxpayers, like the government spending a whole lot of money. There's more debt being issued. All that's true enough. But the way it actually gets financed matters. The way it gets financed is that their bonds are generated. That adds to the debt of the government. But it then creates an asset on the balance sheet. But

then that asset has to be bought with dollars so that they go out of pocket dollars unless there are additional reserves being built up in the banking system. So that's where the budget level of activity ties into the prior conversation about Fed activity, Treasury operations, and overall liquidity. They're boring topics to a lot of people, but I'm telling you it is making a tremendous difference in the way things are priced in the overall economy. And so the budget story this week has that kind of economic and financial technical ramification to it, in addition to the politics of the fact that both parties love to spend money. So let me move on to Brexit quickly. I have a very lengthy write-up in Dividend Cafe

this week. It's just bullet point by bullet point the history of how we got here. I don't think a lot of people remember. It was Prime Minister at the time, David Cameron, who was running for re-election, who promised a referendum. He was not a pro-Brexit guy, but there was a movement of independents that wanted this opportunity to exit the European Union. And he stated, okay, well, I'm not running pro-Brexit, but what I'm running in 2013 is if you elect me, I'll put a referendum up. And I think he certainly thought it was going to fail, but he thought he'd honor the will of the British people by putting a referendum on a ballot. And of course, that referendum got on the ballot in 2016, and it shocked the world by passing. And to make two

and a half years of activity go very quickly. David Cameron resigned immediately after Brexit passed as a rejection of his leadership. And Theresa May became prime minister, pretty much tasked with an orderly exit from the European Union in line with the will of the British people. Try as she may, no pun intended, she was unable to perform. And you ended up with Boris Johnson as prime minister earlier this year, who ran on a promise to do a no deal Brexit if he had to. No pre-formulated negotiations. If the Brexit is not going to happen, then we're just going to walk the heck out. And yet, of course, his intention was to, within the timelines agreed, do get a Brexit done. He got to the point

of an arrangement with the European Union. There was support in Parliament, but not enough support on the timeline that had been set. So they continued to be obstructionist. There were still enough folks opposed to Brexit that could hold the thing up. So Boris took a huge gamble and Prime Minister Johnson put this special election that would effectively realign Parliament and, of course, potentially realign the Prime Minister's office itself. And if he won and added votes, it would give him greater leverage and ability to implement the vision for Brexit, the vision of the British people as democratically passed. But if it had gone the other way, then it would potentially have

undermined Brexit. His gamble paid off. The election went not only the way he wanted last week, but then some, adding significant votes in the majority needs. And now what we will get is not a hard Brexit, a no-deal Brexit, and not a Brexit in name only either, a real watered-down one that kind of isn't really much of a Brexit. It will be the right, sober, judicious Brexit that had been anticipated that frankly was doable over two years ago had Brussels not fought it tooth and nail. And I think the idea that he could do this too quickly is absurd. is absurd. I really hope all my listeners and certainly my clients by now have learned the just incredible fear mongering that has taken place around Brexit, how utterly embarrassing it's been. If people have a political or ideological argument against Brexit, that's fine. I would

probably disagree with them, but that's neither here nor there. But the notion that all of a sudden Britain is making itself anti-competitive in the European ecosystem and the global economy is preposterous. Every prediction these people have made has not come true as it pertains to economic growth, as it pertains to sterling pound, as it pertains to the British stock market. Where there is genuine and existential and generational economic weakness and threat is in the European Union itself. The last time the British people were told, by the way, if you don't do this, or with Brexit, it's if you do do this. But what I'm referring to is back in the 90s, it was if you don't do this, you're going to pay the price, it's going to be terrible, you won't be competitive. That was them joining what? The European currency, the EU, the euro. Britain held the ground, did not join it. And of course,

that decision now has been so powerfully vindicated that it is incredible to me that we're still listening to the same fear mongers. Britain is now in a very strengthened position. Britain is now in a very strengthened position. We expect the right Brexit arrangement to go forward in the months ahead. And it reinforces to us the very difficult position that particularly the southern part of the European Union finds itself in right now, locked into this currency, leaves them basically tethered to the needs of one or two other countries. So there's my take on Brexit for now. Well, you may have heard an impeachment took place this week. You may not have known it because the market was up over 100 points the next day. It was flat the day it happened. It took place after the market closed. The market's up on the week.

So I don't want to keep breaking this record. The market doesn't care. Everyone's known that. We don't even know right now if the House is going to send it on to the Senate. I mean, the whole thing. Regardless of what anyone thinks about politically, what I really believe is interesting to watch, and I put these two charts in DividendCafe.com, and you've got to go look at them. And it is how 22% of people said that the impeachment makes them more likely to vote for Trump and 24% said it made it less likely and 39% said no effect. So you can do the math. It has no effect. 22% and 24% offset each other, maybe marginally.

It helps the president. It doesn't hurt him nationally. internationally however the the chart i put in dividend cafe is state by state and it shows that 12 percent differential oppose impeachment in wisconsin and iowa 11 percent oppose in florida 10 percent oppose in north carolina nine percent in michigan seven percent in pennsylvania six percent in arizona so the net net numbers are all against impeachment in those key battleground states. And yet where is overwhelming net support is in New York by 8% in California by 27. So I guess it sounds like Trump's going to lose New York and California. There you go. I do think that's interesting to watch. Not the national mood around this impeachment endeavor, but the particular states.

So I'd pay attention to that political atmosphere. We're going to talk a lot more about it in 2020 as the election will become a bigger story then. And then, of course, the chart of the week, non-residential fixed investment. non-residential fixed investment, will we get that sort of U-shaped recovery taking place where you start to see some pickup in business investment in light of phase one China trade deal? I don't know the answer. We're going to look for any green shoots that indicate that things are moving in the right direction. But overall, the economy right now is very strong in the United States, particularly in employment market and wages. The business economy has not been, but we have reason to hope and believe that it could have seen its worst times in the second and third quarter of this year. And you could start to get some recovery in that non-residential fixed investment silo of GDP, of economic growth.

If that takes place, then I think you get an extension in this economic expansion. As far as what markets themselves do, there's a whole lot of other circumstances that will play into that short and midterm, and we're going to be unpacking that going into 2020. So with that, let me say both Merry Christmas and Happy Holidays to everybody listening. I hope you'll found the Dividend Cafe to be useful this year, and I hope this particular week you've gotten a lot out of it. I hope you'll found the Diven Cafe to be useful this year. And I hope this particular week you've gotten a lot out of it. I covered a lot of ground. I very much solicit your feedback, your input. I ask you for reviews and stars and ratings and shares and all those kinds of things. And we will, if you do so, we will send you a copy of my new book on Elizabeth Warren. If you

will just send us a copy that you did a review, we as a little gift to you, we'll you a copy of my new book on Elizabeth Warren. If you will just send us a copy that you did a review as a little gift to you, we'll send a copy of that book as it comes out here in the next couple weeks. Thanks so much for listening to The Dividend Cafe, and we wish you and yours a wonderful holiday season and the very merriest of Christmases. Take care. Thank you for listening to The Dividend Cafe. rest of Christmases. Take care. Thank you. Any opinion, news, research, analyses, prices, or other information containing this research is provided as general market commentary. It does not constitute investment advice. The team at Hightower should not be in any way liable for claims and make no express 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 reference 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 team and do not represent those of Hightower Advisors LLC or any of its affiliates.