The Dividend Cafe - A Resilient Investor vs. A Resilient Market

Episode Date: February 7, 2020

Sometimes it is important to remember that “volatile” is not a synonym for “negative.” Volatility refers to “up and down” movement – directionless – choppy – uncertain. In this week���s Dividend Cafe we do all we need to do to understand the current market volatility, to consider the right portfolio approach to all present state of affairs, and of course to break down one of the most significant political weeks in recent times. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. sound a little different than normal, it's because I do sound different. My voice is not itself. I guess I'm fighting a little cold. I have to say I've gone a pretty long time without coming down with anything. I think I had like a two-year streak going cold free, but something's kind of bit me this week. But the notion of staying home from work when the markets are open because of some sniffles is not going to happen. And so, of course, that keeps you from getting better quicker. But it makes you sound like this when you record your podcast, and yet we continue to fight the good fight every day. And it's been an interesting week.

I'm recording in the middle of the market day on Thursday, and we are up over 1,000 points on the week with a 300 or 400-point move Monday, 150 or so Tuesday, almost 500-point Wednesday. And then now this morning Thursday, we've tethered between down a few points and up 100. And as I'm sitting here recording now, we're up 60 or 70. And so it's one of those weeks where it's just a V-shaped bounce back from the 1,000-point drop we had had last week, including 600 points alone on Friday. And all of that, of course, has been made up and then some here this week. And markets are back in positive territory on the year and so forth. So it's an important reminder as you listen that volatility is not a one-directional term.

reminder as you listen that volatility is not a one directional term. It's a noun that implies bi-directional forces, both up and down. And we experienced downside volatility last week and we experienced upside volatility this week. What they both have in common is above average movements. You're getting abnormality. It's just that abnormality is not intrinsically good or bad. It is neutral. It is abnormal. It is a higher degree of fluctuation. And there can be a bias to the downside. There can be a bias to the upside. But volatility itself is not the enemy. And in fact, the ability or the need to have to persevere through volatility is, in fact, a source of risk premium for equity investors. It's one of the things you kind of have to get. And so we've argued time and time again, philosophically, mathematically, economically,

if you have less volatility, you have a less expected rate of return over time because the market doesn't need to reward you as much because you're taking on less of what is the price you pay for being an equity investor. So this is all very normal, but let's get into the causation and discuss some fundamental things about the American economy right now that I think are really important. The coronavirus was most certainly the big talk of the town last week. And markets are down 1000 points. And there's a lot of uncertainty around what was going on with the virus. And you could argue it was mostly fear driven kind of fear of unknown. You know, you get reports of maybe the health epidemic side is going to be tough to contain more economically centered to get reports of travel constriction into China, the possibility of supply chain breakdowns and trade delays. So there's some sense to some of it, but always, always sense is coupled with excess.

So it may make sense to some degree, ends up becoming excessive. Well, here's the thing. We went 1,000 points down, allegedly, largely around coronavirus, now we're 1,000 points up. Did anything change with coronavirus? No, nothing. The health epidemic's not contained. There's continued concerns around the trade and the travel, short-term economic impact, same as last week. So what happened is a lot of the people got panicked out, and then this week those people got punished for panicking out. That's it.

It was God. It was market justice. It happens all the time. The fact of the matter is, is that you probably had some sell-off last week on less than sensible reasoning. And then this week, some more sensible buyers and opportunistic buyers look and say, okay, earnings season is in fact picking up. The ADP employment number, I'm recording before the real jobs number comes on Friday morning, but the ADP number was lights out big, 257,000 private sector jobs created in January per the ADP figure,

close to 100,000 more than expected. For the first time in six months, you'd had five negative months of contracting manufacturing. You got positive growth in the US.S. manufacturing sector, the ISM data came out this week. So overall, I think that there is some positive economic news, some positive earnings news, and an overreaction to the coronavirus short-termism that resulted in markets being able to expand. Now, does it get a little ahead of itself here with the expansion? Well, who knows? Because there isn't a right price for markets to be at on a given day or given week. Only over long periods of time do markets find an equilibrium in concert with their cash flow, with their earnings, with their profits. So at any particular point in time, prices are reflecting some measurement of fundamentals combined with a lot of measurement of sentiment.

And over a longer period of time, that weighting of sentiment goes to zero and that weighting of fundamental value goes to 100. That's basically the idea. I'm being a little simplistic here, but not by much. And so I think that you got a little bit more of a vote behind fundamentals and value this week and less of a vote in sentiment. Now, that could change quickly, both because sentiment could change and even some of the fundamentals remain up in the air. Are we, in fact, going to get continued manufacturing expansion? I think it's important. Where do we stand with business investment? Are capital expenditures in the first quarter of this year, post phase one China trade deal, going to go higher. Well, as I was going to bed last night and taking my meds, I'm getting reports about China cutting in half tariffs on $75 billion of US imports. There was some degree of tariff imports that

were a part of the phase one China trade deal, but we didn't have a lot of those specifics. But this is, again, money that will now come into the global economy because it's not being taken out via tariff confiscation. It also builds goodwill for the U.S., further indicates positive direction in the trade deal with China. So you have a good backdrop there. You have an accommodative Fed. You have low inflation, low energy prices helping to feed low inflation. But I write about in Dividend Cafe this week that continued discussion about low oil prices because oil going from 70 to 55 on the Brent crude this year, about a 20% drop in a few weeks.

Well, that's not a good sign. And again, I recognize that there is this sort of push-pull. Too high of oil, it is inflationary, it takes liquidity out of the system, and it cuts into margins. Too low of oil, and it indicates softening global demand, and it potentially becomes a credit issue around a lot of the industrial sides of the economy. So at $50-ish, we've seen that the producers in the U.S. on the margin, those marginal producers are able to make money at $50-plus. $70 seems to be a threshold by which it does not become inflationary, does not pull liquidity out of the global economy. $100 oil becomes too

high. $30 oil becomes too low. These aren't exact sciences, but you follow what I'm saying. I think we're going to stay in that range. I think it's going to be not too high, not too low for quite some time. But that's a question mark when oil moves that quickly. And it begs the question as to whether or not global demand is, in fact, softening. But our indication is that oil simply went too low and you saw this week a big rebound in some of the energy stocks. So where do things stand overall? Well, given you our summary on coronavirus, we do hope and expect that the world's best

and brightest scientists are going to do what they normally do and get things resolved. We pray for that on a human level and we expect it on a market level. Earnings season is over halfway done. It's been robust, still really heavy in that theme of high dispersion. Some companies outperforming results, some companies not. But stock prices will be reflecting it and pretty good guidance going forward. We need to give you a better summary of where earnings revisions stand going into later 2020 because where their full year earnings projections stand is going to have a lot to do with where markets are currently valued.

Speaking of where markets are currently valued, put a chart at dividendcafe.com this week. Look, price to earnings, I want to summarize our view on earnings multiples and valuation of the stock market. Number one is the indisputable fact that nobody should deny, which is that markets are fully valued as an index and a little above fully valued. That's not up for debate. You average 16.5 times earnings for 30 years and you're trading over 18 times earnings. It's a little on the high side. But then the second point is that that's somewhat irrelevant because markets never drop from their median level. They drop from usually far above their median level. And so markets spend most of the time either well above their median or well

below it. And so it is not a timing mechanism. But then the third point, which also speaks to the irrelevance of this statistic, is that within the index, there is a significant amount of companies and sectors that are overvalued and a significant amount that are undervalued. So it speaks to a blended result with an index, but it doesn't speak to what the actual valuation may be on a given security, a given company, a given sector or space. That, of course, is our focus. But then I want to add another little factoid to the mix, which is that right now the market is trading at 25 times price to cash flow.

And for 30 plus years, it has averaged just a little over 25 times price to cash flow. And in fact, it has been below that median mark for quite some time. Now, is price to cash flow the best valuation metric? No, but we do care a lot about cash flow of the bonds group. And there are other factors that could distort companies generating cash flow. If the market becomes more heavily dependent on non-cash flow generating companies, that is going to affect the price to cash flow ratio. But my point being that you have a really fundamentally solid valuation metric that speaks to the market being evenly valued, opportunistically valued, not overvalued. And so the nuance on that subject is important. It's

something we talk about a lot. Okay, I'm going to quickly wrap up with politics uh and money and then and then uh allow you to reach out to us with any questions you may have it was not a good week for for the democrats and i don't know anyone that could deny that the bulk of the people saying that that are in my eardrums are in fact democrats uh the iowa debacle as of right now um we still don't know officially who won iowa but we're now at least at about 97% of the precincts finally reported. And it's Thursday. Of course, their caucus was Monday night. So it is just a gigantic embarrassment that they've had these kind of logistical faux pas and that the results are so unbelievably tainted.

It looks as if you're either going to get Bernie Sanders getting the most votes and Pete Buttigieg getting the most delegates or perhaps Bernie Sanders getting most of both. But because they started releasing results late and when they released late, they only released partial results. And at that time, Pete Buttigieg had the lead. Buttigieg got some degree of a momentum boost out of it. And it may potentially have dampened Bernie Sanders boost, especially if Sanders ends up winning both the delegates and the votes. So it's a really silly escapade. But of course, it doesn't matter who the real winner is. It's hard to declare a winner when there's different metrics and this much tardiness in releasing it and this much closeness

between Buttigieg and Sanders. What we do know very clearly is who the loser was, and that was Joe Biden. And him coming in somewhere between 13% and 15% and in fourth place, as opposed to coming in first or second with 25%, it's devastating. And if he ends up going third or fourth place in New Hampshire next week,

which right now he's polling that he will do, it does beg the question as to whether or now he's polling that he will do. It does beg the question as to whether or not he'll make it to South Carolina. And then it begs the question as to whether or not he would hold South Carolina if he makes it there. And then it begs the question as to whether or not, in fact, Bloomberg is getting that path he needs, because Bloomberg would need Biden out on Super Tuesday for him to pull off this sort of bizarre up the middle kind of covert means of getting the nomination. So very interesting week in the Democratic primary, pretty solid week, I would say politically for President Trump. Some would say that's part of the reason the market was up

this week. I don't think so, because I don't think markets respond nine months in advance to news that they know very well are going to be up and down over the next nine months. But the fact of the matter is that regardless of what anyone thinks about any of the facts behind any of it, it was a well-received State of the Union address. It was not a well-received response to State of the Union in terms of some of the antics. I'll leave that there. And it was that he was acquitted in the Senate on the impeachment thing. That issue is behind him. And then most profoundly, the highest approval rating of his presidency came out in a Gallup poll this week, and an even higher indication of economic approval.

So we see the market's response being somewhat moot here, but the betting odds are now the highest they've been about a President Trump re-election. So you got to continue watching the Democratic results to the extent that the political implications matter to the way you think about the economy in your portfolio. We're watching all of it because that's what we do. So I got to leave it there for the week. First of all, my voice is hurting. And second of all, you probably don't like listening to it. And most importantly, I'm getting back to work, doing what we do, which is looking for sustainable dividend growth everywhere and anywhere. We thank you for listening to the Dividend Cafe. We really, really appreciate the reviews you've been giving. We'd love to get a whole bunch more. Please go give us five stars

at iTunes, Spotify, Stitcher, wherever you listen to your podcasts. Thank you for listening to The Dividend Cafe, financial food for thought. Bonsai Group is registered with Hightower Securities LLC, a member of FINRA and SIPC, and 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, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance.

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