The Dividend Cafe - A Quarter of Optimism

Episode Date: March 31, 2017

A Quarter of Optimism by The Bahnsen Group

Hello and welcome to this week's Dividend Cafe podcast. Just like that, the first quarter of 2017 is behind us. It may seem like a year has gone by since USC's glorious win at the Rose Bowl, or it may seem like the presidential inauguration was just yesterday. yesterday, or if you're like me, a case could be made for both. Regardless of how 2017 feels to you, we are off and running and have a lot to say this week about where things stand in the markets and what we expect as the year continues. So with all that said, let's get into it. Trumpian down days or business as usual? Markets have absolutely priced in a good portion of the anticipated Trump stimulus, primarily the expectation of corporate tax reform and foreign profits repatriation. Should these policy expectations come under jeopardy, we're quite sure that the market would react negatively. The recent downside volatility from last week reflected some reality around the failure of Obamacare repeal.

The market still believes tax reform will get done, but no longer sees it as the easy ride they thought it would be. And from a risk-reward standpoint, last week's events just boosted the risk premium. Where market valuation comes in is that markets are priced to where there's little margin for error. Now, the number of consecutive down days was pretty misleading because the aggregate drop from peak to trough is still quite insignificant. And markets remain up 4% since 2017 began. But ultimately, we're a couple weeks away from Q1 earnings season starting, the next real catalyst, and market actors are wisely afraid to bail completely, as the risk-reward skew is still towards tax reform happening. Yet a little gun-shy and

timid just from the debacle of last week. But all of that didn't stop the markets from moving a couple hundred points higher this week. So all things considered, the markets are kind of back to where they were before, believing, even if more cautiously so, that much of the Trump agenda will get done. The path to tax reform. or less, what most market actors are looking to in the aftermath of this Obamacare situation and in evaluating the political lay of the land is what the outlook is on tax reform. The market is looking for significant relief to corporate tax liability and in fact has largely priced that in. We don't use Dividend Cafe to give political advice and no one would be listening if we did, but predictively we imagine there's likely to be a political realization that a quick and easy corporate tax cut separated from more comprehensive

tax reform may be an easier way to go. Investors need to remember that passing something through budget reconciliation requires just 51 votes in the Senate, but a full legislative change requires 60 votes to overcome a filibuster. The border adjustment tax appears dead on arrival, though even that could change if President Trump were to aggressively try to sell it to the American people. I personally am skeptical that he'll go that path. You never know. Ultimately, there's skittishness around how this will all get done, and our own forecasts are fluid because circumstances are fluid. But yes, we believe there will be corporate tax reform as the market desires, even if it is done piecemeal, for more comprehensive reform. We further believe it is repatriation of profits that is not totally priced into market expectations.

Is the glass half long or half weak? There's no shortage of dialogue about how long this economic recovery has been, which is true enough, but we might gently suggest that the far more important consideration is how weak it has been, not how long it has been. The very low and slow nature of the growth distorts the length of time it has been taking place and makes historical analogies impossible. Context, please. On March 21st, the Dow Jones lost a tad over 1% of its value. On March 28th, the Dow gained very close

to 1%. And in fact, once you combine March 30th in, the market was up more than the amount it had dropped last week on March 21st. The March 21st down day marked the longest streak without a 1% down day for the S&P 500 since 1995 in 22 years. The period we've been in of nearly non-existent volatility is not the norm. One percent up and down days happen. In fact, they generally happen quite a bit. We, in fact, have averaged about 60 trading days per year for nearly 100 years with one percent plus up or down days out at one out of every four days. So sometimes they happen a lot, 2008 anyone, sometimes they happen rarely like the last six months, but volatility is always and forever mean reverting. So just like returns and to the extent that we've had below average volatility for some time, our advice is to prepare for greater volatility in the future,

even if we cannot time exactly when that may be. Beyond volatility, let's talk real pain. No one troubled by a 1% down day in stocks should be invested in stocks, for rather obvious reasons. But volatility of 1% is benign. What about real down periods? For nearly 100 years, there have been on average over three periods per year of a 5% correction or more. Again, that is the norm. Investors accumulating capital and net worth should welcome these routine corrections. Reinvested dividends at lower prices,

not to mention new contributions to a portfolio invested immensely from low prices, and investors withdrawing from their portfolio who utilize a dividend orientation immunize themselves from price fluctuation because the withdrawals come from what can never go negative, price fluctuation because the withdrawals come from what can never go negative, positive dividend cash flow. Getting energized. We look at some of the companies we own and have recently bought in the U.S. energy sector and get very excited. We see an energy sector coming off an unprecedented period of five-year underperformance to the broad S&P. We see a sector nowhere near its all-time high. We have also written time and time again about the policy paradigm, and not just in terms of deregulation, but also President

Trump's obsession when narrowing the trade deficit. Natural gas exports are a no-brainer when it comes to increasing U.S. exports, not to mention creating new jobs. We see electrical vehicles gaining more traction, driving natural gas demand higher, as natty gas, not coal, more and more powers that electricity. So we see a paradigm that meets what so many people are asking us for, investment opportunity lined up with where the Trump administration is, that is not way ahead of itself in terms of price evaluation. What if Trumpflation is dead?

The market rally since November has largely been based on expectations of nominal growth to the U.S. economy centered around favorable growth policies from the Trump administration and other cyclical realities pointing to a strong and growing economy. But what if those things flat out fail to materialize? Well, for an asset allocator, which is what we are, bond yields would drop, boosting the bond prices of people's portfolio. And emerging markets would likely rally, as growth there is far less expensive and the fear of a headwind from the dollar would decrease. The point we're making, no portfolio

should be entirely levered to just one perspective or thesis within the economy. These things are dynamic and require dynamic investment allocation. We do encourage you to look at a chart this week at DividendCafe.com regarding the performance of dividend growers versus dividend payers and why that growing income meets a growing value. It's a point we make over and over and over again, but we provide some empirical support this week with some charts on the website that are somewhat compelling. Indexing in the last 17 years. We hear all the time how so many active managers fail to outperform the S&P 500. And of course, we hear it because it's true, particularly in bull markets. When a rising tide is lifting all boats, the S&P 500 has traditionally generated a return that a lot of

managers have not beaten. Of course, that tends to miss the point dramatically. The asset allocation most appropriate for a given investor is not resolved in buying the S&P 500. The emotional temperament issues that give way to behavioral mistakes is not addressed when one talks about a straight S&P 500 investment. So putting all that aside, do you know what the return is of the S&P 500 since this new millennium and century began? After all, we're up over 250% in the last eight years alone, as you may recall. Well, for 17 whopping years, going back to the turn of this new and so far rather unsettling century, the S&P is up just 4.48% per year.

And to achieve that, it has taken on a whopping 17.76% standard deviation. Let's just simplify by saying that it is a lot of volatility and risk, a lot. So the question facing investors, to index or not index? Not if the last 17 years is to mean anything. The question is, what kind of planning, asset allocation, monitoring, mistake avoidance is needed to properly understand my capital through a very complex and challenging period of economic history. So to those ends we work. We do encourage you to go to the chart of the week online,

and you will notice that the S&P 500 peaked this year so far. It also happens to be an all-time high. The day after Trump's joint address to Congress. And we think there's sort of some telling symbolism in that, just about how much sentiment and confidence goes into when there seems to be a more empowered and popular and politically savvy President Trump. So be that as it may, we're going to leave it there for the week. Look forward to having final numbers on our whole month of March next week.

We'd be happy to share some of that with you. We certainly hope you've enjoyed this week's podcast. Have a great weekend.