The Dividend Cafe - All the Questions You've Been Dying to Ask

Episode Date: May 20, 2022

I have done something really fun with today’s Dividend Cafe – at least fun for me. I have taken the most common questions I receive these days from clients, in emails, in meetings, in interviews, etc., and compiled a set of answers that walk through the big issues of today. I think you will find it valuable. I doubt I cover everything on your mind here, so by all means fire away with new questions ([e-mail]). You may just see it covered in The DC Today, and you will certainly hear from me personally. In the meantime, let’s jump into the Dividend Cafe. 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. Well, hello and welcome to another Dividend Cafe. This week brought to you, as promised, from the beautiful city of Minneapolis, Minnesota, and I do mean it. It really is beautiful right now. This is my first time out here since the Bonson Group opened their office here nearly a year ago, and I got to spend yesterday in that office, had some client meetings, spoke to about 30 clients last night at a dinner event, and clearly coming in the month of May is superior to coming in January where temperatures can reach 30 below zero. So I have enjoyed this trip and really enjoyed putting together Dividend Cafe for you today. It's been a wild week in the markets. I'm not going to write every single Friday in Dividend Cafe about the behavioral habits necessary of persevering through market distress. I'll continue hitting those points as often as they need to be.

And obviously, there's been a lot of focus day by day in the DC today, this week on key days in the market. The market did see its worst day of the year earlier this week, and downside pressures continue. And yet, I don't want the Dividend Cafe to become a broken record about these things. Yet, you know, there's a lot of more fundamental issues on people's mind. And that's kind of what I did with Dividend Cafe today is take some of the most common questions that I'm being asked, that I'm hearing in emails and DMs and in clientend Cafe, it'll be even more elaborate. But I just want to cover some of the basics that are out there right now. So we'll dive into that. You know, you can imagine that one of the most common questions people want to know is whether or not equities are now cheap. Is this attractive? And that's a little bit different, I guess, than saying, has a bottom being hit? Because as I kind of talked about in the DC Today And it requires, the only answer requires one to just

simply state the humility of no, we do not know. And making the more important point, I think, that one doesn't need to know that it is a futile effort that has no real benefit to the long-term investor, that if one buys something at X and it goes lower than X before it goes greater than X, it is somewhat immaterial when one's timeline is further out. And that doesn't strike me as particularly insightful, just obvious. However, our equities generally cheap is not so much trying to time a bottom as it is just wondering from an asset allocation standpoint. And particularly with things like, let's say, the NASDAQ or the S&P 500 is a broader index, has large cap growth, which has gotten taken to the woodshed, has that become a cheaper asset class?

And that's the interesting thing is obviously anything that's gone down in value is cheaper than it was before it went down in value. And that's the interesting thing is obviously anything that's gone down in value is cheaper than it was before it went down in value. And that's the case here. Whatever criticism I would have of the valuations of certain asset classes, there's less criticism now because the expensiveness has become less so. However, I think that some metrics are important here. We like to use price to earnings ratios to measure the expensiveness of equities for good reason. That's what equities are, is essentially a price signal of a future stream of earnings. And that multiple a year ago for equities was at 32 times earnings backward looking and over 20 times forward looking, about 24, 25 times.

We primarily look at these things, though, more forward looking than backward looking. So I don't want the 32 times to jump out too much. But even forward looking, they were about 20, 21 times. And they're right now about 19 times. So the multiple has come down, backward and forward looking. But cheap, no. Overpriced compared to historical metrics, yes, but less overpriced than it was. And so does this mean we're suggesting that equities continue to be too expensive, that we would have made and did make for quite some time, which is that indexing continues to be, I think, a way to play for P.E. ratio expansion, to play for valuations getting more expensive. And I can make a very good argument that valuations are likely to get less expensive. And even if that doesn't play out, because sometimes multiples can really confound someone, I think that it's certainly likely that they're not going higher. The

valuations are not going higher anytime soon. And so the question then in the push-pull of where index prices go becomes how much can earnings growth overcompensate for whatever multiple compression may happen. And that's where you end up getting kind of a single digit return environment instead of a double digit return environment. And that is very likely best case. The worst case being that earnings growth does not overcompensate multiple compression and you get a negative return environment, which is where we've been this year. My view is that one needs to, in their equity exposure, be transcended from those things via an investment strategy that is not requiring multiple expansion, that is looking to free cash flow growth, to earnings growth, to most importantly, dividend growth that comes from the

increased capital return to comes from the increased capital return to shareholders from the free cash flow the companies are generating. And that earnings, excuse me, multiple expansion just becomes kind of a side story, so to speak. Maybe it happens, maybe you get some of that, but your return is more reliant on cash generation. And it allows for a lot of agnosticism about the thing that we should be agnostic about, which is the unpredictability of multiples. So that's my view on where equity cheapness is. Now, one of the things that has pushed multiples down in equity markets is higher bond yields. And then that begs the question of, do I still feel the same way about boring bonds that I did two years ago? And here it's a very interesting answer. I would say I do

not. I made the point throughout 2020 that there has, for what's called 100 years, been three main reasons to own boring bonds. One is the decent interest income or coupon that they would pay. The second is the capital preservation that they would offer. And the third was the hedge that they offered against real severe tail risk events, real bad moments like the financial crisis and COVID and 9-11. Those are in our lifetime. But of course, there's plenty of bad things on history. Generally, you'd see a spike up in the value of these defensive principal preservation assets, even as risk assets would get pummeled. And that my view was at a zero rate environment, you basically lost two of the three advantages

of boring bonds. You weren't going to get a decent coupon or interest income, and you weren't really going to get much of a hedge against tail risk because they didn't have much room to go higher when bond yields were already down near the zero bound. You still had the principal preservation benefit. Well, really, those two of the three that went away have now come back to some degree. I think interest income is still lower than its historical average, even with the 10-year back near 2.8%, 2.9%. The two-year is right near there, above 2.5%. And so if there were to be an awful event, tail risk hedge would be back at play.

You know, bond yields would collapse and that would push bond prices up a great deal and offset some risk asset volatility. So boring bonds do look more attractive than they did. But there is still the risk of other factors that push downward pressure on bond prices. I don't personally expect it, but it is possible. So again, one has to just be valuing the principal preservation of maturity aspect, valuing the superlative coupon income that they could have gotten relative to two years ago, and be somewhat agnostic about the pricing environment. But my own view is that borrowing bonds are more useful as sort of a dry

powder asset class. There are others who their psychology, their risk profile, their liquidity need would dictate a different use and asset allocation, but it has to be very tailored to each individual investor. But regardless of why one is utilizing the asset class, boring bonds do have right now more utility than they did two years ago. The other question I'm going to address here on the video and podcast is still around the causes of the inflation that we're seeing and whether or not I still believe that the huge amount of fiscal spending that was done throughout the end of President Trump's administration, the beginning of President Biden's administration, is not the primary cause. And obviously, I don't feel that it's a particularly controversial assertion to just empirically note that fiscal spending had exploded all over the globe for 30 years with an incredible moderation of inflation. And that all of a sudden for a year or two, fiscal spending had exploded and you did see price escalation. But it does strike me as much more logical to seek a different explanation of the inflation when the same cause didn't create

it for 30 years and then now we're asserting it may have caused it for one or two years. And what could that substitute cause be? I think the far more substantive explanation is on the supply side, not that extra fiscal spending put more money out there that drove an aggregate higher demand. The fact of the matter is I made this point in D.C. today, this week in our energy section, that demand right now, daily barrels of oil is basically back to where it was in 2019. It's actually a tiny bit lower. And yet prices are almost double. They were at 60 and now they're at 110. So what explains prices going higher if, in fact, demand has not moved higher? Well, it's clearly the supply side.

We do not have the production and the generation of more supply of oil and gas. And yet we have now back to an equal level of demand with expectations in the future that factors into pushing it higher. And so that tends to be my view across the board. Now, this is not to alleviate the responsibility of politicians and all this, because I do think plenty has been done that complicated the supply side. I think, you know, when you look at inflation, it's not just high in our country, it's high in most countries. And yet not every country had the same explosion of fiscal spending that we did. What you've primarily seen in, look, all countries that have done debt financed fiscal spending have had, you know, basically a similar

response over the last 30 years, which is non-inflationary. However, the explosion in prices right now in food and energy are more global phenomena, regardless of fiscal spending occurrences. And so I think that right now it's unlikely that people are hungrier than they were two years ago. I've already talked about the energy side. So food and oil and energy driving some higher inflation is, again, much more related to the supply side of the economy. And I will tell you that I believe the labor shortages caused by the Biden spending bill are a part of that. I think the excessive spending of both the last two administrations will ultimately suppress economic growth. And that is a thing I would be critical of from a policy standpoint. So this isn't about policy alleviation.

It's just about identifying causes of inflation. And I think that that's a more likely scenario. So what you're going to get if you go to Dividend Cafe is these same types of questions, where we are in our thought of stocks, where we are in our thought of bonds, where we are with inflation, and a number of other questions that I don't have time for here as I get ready to run out the door to catch a flight back to California. There'll be a more elaborated Q&A format at Dividend Cafe, and I hope you'll find it helpful. But the thing I would say to California, there'll be a more elaborated Q&A format at Dividend Cafe. And I hope you'll find it helpful. But the thing I would say to you, whether you're listening to the podcast,

watching the video now, and hopefully you do end up reading the Dividend Cafe, is that I probably am not covering all the questions on your mind, and I'd like to cover all of them. So questions at thebonsongroup.com, you send us that question. And if you get more granular or you have a just different macro question altogether or something else you want us to address, I'm happy to do it. That's one thing I feel very strongly about this environment is that people have tensions. Those tensions come from uncertainty. One of the things that can alleviate uncertainty is having questions answered. And I don't think people always like my answers, but I'm happy to try. And even if the answer is not likable,

I do want to give honest answers that I think will be helpful and informative. So let's keep this dialogue going. Send us questions, questions at themonstergroup.com. I hope this video podcast have been helpful in covering some of these basics that are out there. And I hope you'll read divinacafé.com where we do the deeper dive. I'm going to leave Minneapolis now, go back to the treacherous waters of Newport Beach, and look forward to coming back to you

again next week as we go into Memorial Day weekend. Thank you, as always, for listening to and watching the Dividend Cafe. 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. Past performance is not indicative of current or future performance and is not a guarantee.

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