The Dividend Cafe - A Trip through the Fed, the White House, China, and Your Portfolio

Episode Date: October 19, 2017

A Trip through the Fed, the White House, China, and Your Portfolio by The Bahnsen Group

Welcome to the Dividend Cafe, financial food for thought. we have quite a few things to cover here today. I always talk about how much I want people to also read our weekly commentary at DividendCafe.com. And a lot of the reason is that the podcast can never capture some of the charts and things that we post. And frankly, this week has as many charts as I think we've ever done, about five different things that provide kind of a graphic and visual illustration that can be very useful. We're working on a lot of ideas to kind of beef up the podcast, particularly going into 2018, to kind of give the podcast its own fresh content, make it something that will be even a bit different from what we're communicating via our Dividend Cafe commentary, what we do on our YouTube video, weekly contribution, and provide something that podcast listeners will really get a lot out of.

So please email us any ideas or preferences or thoughts you have. We'd love to get your feedback. But let me kind of get into a few of the things that are top of mind this week. I'm extremely interested in who will be appointed to head the Fed. And we understand that Chairwoman Janet Yellen was to be meeting with President Trump this week. He has already interviewed both current Fed Governor Jay Powell, as well as economist John Taylor and Kevin Warsh, who would be my personal preference for the pick. I would certainly say Taylor and, to a slightly lesser degree, Warsh would be the most hawkish of the bunch. I mean, John Taylor is literally the author of the Taylor Rule, which is kind of the grandfather of rules-based systems in monetary policy. Warsh is much younger than Taylor.

He could maybe even be asked to serve as a vice chairman for a while. I would not rule out that he may want to try to reappoint Janet Yellen. I have no indication as to whether or not she's even interested in that. So there's a lot of ways this could go, but I think that there's some profound implications to the policy that will come out of the personnel. And the fact that this is not just a Fed governor we're talking about, but a vice chairman, not just the chairman, but the vice chairman has to be selected because Stanley Fisher is retired. And there are several vacancies on the Board of Governors.

Do I think there will be a complete paradigm shift in our central bank in terms of the governing ideology? I think it's possible. I think we have not had that for a long, long time. And it would be very interesting to markets. A little summary, kind of pedestrian, not very nuanced way I would view it is that if you were to go the sort of Kevin Warsh direction, I think there could be some short-term market disruption or volatility around that direction versus the present status quo. But I think it would be much healthier long term. And then inversely, I think if he goes with a J-PAL or certainly a reappointment of Janet Yellen, I think the markets will breathe easy into the short term, but I think that longer term, the path we're on does invite further stability issues over time. You know, when you look at the concept of normalizing monetary policy,

the Fed is basing a lot of their desire on, we've talked about this, I think, flawed Phillips curve idea that, well, you have real low unemployment, therefore inflation is going to be coming and I don't agree with that that logic or that economic sequential forecast nor does history but I I guess I beg the question but the feds models clearly say that inflation should be picking up and they're very adherent to their own models and and and I am in a school of thought that wants them to normalize monetary policy, but for an entirely different reason. But one of the things I would say about the Fed's idea that we have this very low unemployment is that we have a very low unemployment rate as a result

of a very low labor participation force. And I don't invalidate that labor participation force. I don't assume that every bit of the data contributing to a low labor participation force is somewhat negative. I think that there are some legitimate demographic realities and cultural shifts, but there's no question, and we ran a chart at Dividend Cafe this week, that we would have an unemployment rate of over 8% right now if the labor participation force had just stayed the same, if the denominator of people in the workforce looking for a job or having a job had been the same. But because that number has declined so much, it's allowed for a much lower unemployment rate. unemployment rate. But it's very possible that the Fed can look at the labor data and see that it is not quite as rose-colored as some of the headline numbers may appear. You know, we talk a lot about a lot of the dysfunction of the White House, and I'm pretty

vocal about some of the things that I believe in, in terms of the agenda from this present administration, but also some of the frustrations I have around the temperament and style and whatnot of the president things I think undermine his own agenda but from a stimulus standpoint they talked about how Obamacare repeal was not able to get through and we're presently in the fight on what's going to happen on tax reform but let me tell you something the. The data I read this week about oil and gas capex being up 17% in the second quarter, even with oil still in the 40s and 50s, maybe mid to high $40 range or a low $50 range. Look, that deregulation and that favorable personnel, those positive expectations around energy policy, look, they are driving a lot of that. I don't think that that's debatable.

elements of stimulus work their way through the real economy that could not necessarily or will not necessarily be a result of legislative successes. There's more than just congressional scorecards on the line here. I do really want to keep our eyes open, really want to keep our eyes open, particularly the eyes behind our heads. You know, the very big things in markets are always and forever going to be earnings. And in the economy, we want to follow fiscal monetary policy. But there are less obvious indicators or catalysts around the globe. And I think that China is something we do not want to stop talking about. It's certainly not something I'm willing to stop reading and absorbing data from. Because frankly, the last two major market gyrations we got in January 2016, August 2015, were both completely China driven. And I think it's important that we be on our game

there and understanding those things. But I have a chart at drivencafe.com you can see when the kind of turnaround in global markets began certainly in China's little 18 month period now they've gone through a very impressive economic data very well managed for now uh process of this sort of slowdown in their economic growth. And copper prices tell you a lot there. As the industrial metals and industrial production go, we know how China goes. And that contagion effect, in this case positive contagion, to world economies has been fantastic. Well, fundamentally, we do really believe that the S&P looks a little expensive right now. I do think a data point is worth noting. We're trading about 19 times earnings on the S&P, and if you just take out four companies, just those infamous FANG stocks, the multiple of the S&P. And if you just take out four companies, just those infamous FANG stocks,

the multiple of the S&P drops all the way to 17. And you could argue about whether or not those multiples for those companies are warranted or not. But I guess the point I'm making is that there is a nuance into the overvaluation story. We do think buying the index carries some valuation risk. We don't think valuation is very useful as a timing tool, but our focus is going to be what it always is, is on selectivity, particularly around growth of dividend stocks. So I guess as we look to Congress now, we believe by the time you're listening to this podcast, the Senate will have approved their budget proposal, that it will be necessary to attach budget reconciliation to with tax reform. And then we'll end up with a period of time in which they start debating and horse trading around those issues. So it could be very interesting.

But overall, we remain cautiously optimistic that tax reform will get done. 30 years ago this week, one of the most famous days in stock market history came and went, and that's Black Monday, October 19th, 1987. The biggest one-day percentage drop in market history, over 22% selling begat selling and unsophisticated computer systems piled onto the problem, resulting in a negative feedback loop that could only be called a crash. The story of Black Monday will never be what happened that actual day, a 500-point drop in what was at the time, you know, a 2,500-point market. Rather, it will be forever. The 18 months that followed that fateful day wherein stocks recovered every penny of loss

and then some. Some bear markets in stock market history have taken years to recover from, but one of the most famous bloodbaths in stock market history of Black Monday only took a year or so, permanently searing into public consciousness the behavioral advantages of not panicking when times are bad. We have always had good times and bad times and we always will. Behavioral management is a core value proposition of what we do. As long as that reality is true, that investors are prone to euphoria during good times and panic during bad times, then we will continue working towards managing our clients' responses to those negative things. Can we have another day in which the markets drop over 20%? Oh, dear Lord, we hope not.

Even through some of the just ghastly days of 2008, we didn't have a day like that. But who knows? What we do know is that the Long March of History supports overwhelmingly private enterprise, the miracle of innovation, the miracle of profit growth, of profit creation, the miracle of human flourishing. And we seek to monetize that for our clients. Black Monday notwithstanding, that's the long, great march of history. Have a great weekend. Go USC. Beat Notre Dame. We'll see you next week. Thanks for listening to Dividend Cafe. Thank you for listening to the Dividend

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