The Dividend Cafe - An Economic Lesson For The Short Term with Long Term Implications

Episode Date: October 18, 2019

Topics discussed: Greetings from the financial capital of the world that is New York City where I have officially begun my annual "due diligence" week, and where another week in the markets deserves comprehensive analysis. We focus our efforts this week on what was done and not done in the "pre-written, phase one" trade deal, but we also delve into Brexit, the yield curve, Elizabeth Warren proposals, and even the lottery this week. But one thing I ask this week - persevere through all the weekly commentary to get to the "economic lesson" of the week. It is the subject most near and dear to my heart this week, and hopefully will be well worth the listen. So jump on into the Dividend Cafe! Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. don't have all of our fancy recording equipment set up, but I think this will do the trick. And I'm fresh off of a flight from Southern California into New York, landed in the middle of the night, and I'm literally walking out the door of my apartment momentarily, where I'll be spending the day at the Blackstone Alternative Assets Symposium here in the city for seven sessions centered around various aspects of alternative investing. It'll be a wonderful and intellectually stimulating day, but I want to obviously give you all our normal Dividend Cafe commentary. What a week it's been. As I sit here Thursday morning, and because of course it's New York City we're several hours still from the market opening here in eastern time zone the market is set to open up approximately 100 points the market's been up on the week not huge kind of a muted response but nevertheless a net net

positive the biggest positive day being on Tuesday in response to kind of a strong start to earnings season. And so in terms of where we stand with the market, you have the trade deal, phase one trade deal that was verbally reached last weekend, pretty much into the Friday afternoon time period. And we did a special Dividend Cafe podcast discussion with my whole investment committee about that Monday, and I commend it to you, but I want to recap just at least a few of the highlights and our takeaways as to where we think things stand right now.

We do believe that this is a net positive, that it was much better than it could have been. We don't think it is earth-shattering. The deal is not yet written. It is not yet signed. Nevertheless, they seem to be on a trajectory where some of the obvious things are incorporated. China is increasing their commitments of agricultural purchases. The U.S. is not going to escalate the planned tariff increases for October. not going to escalate the planned tariff increases for October. We believe by the time they sign the deal in November, they will also pull back the planned tariff escalations for December. So the two of those things coming off the table put together represents what could have been in between $25 and $30 billion of additional taxes on the american economy in the

form of tariffs on chinese imports already what was not escalated was over 12 billion so these are sizable situations in terms of what could have been now the market responded favorably but again i think you have a really classic case of how markets work as discounting mechanisms here in that most of the idea that this trade war would not be getting worse in the short term had been priced into markets on the edges some things about the deal may have struck the market as better than expected. The market moved a little higher, but the market didn't explode higher. This isn't a final deal. Intellectual property theft is not addressed.

National security interests are not addressed. The kind of long-term substance that will really represent a comprehensive deal is not there yet and i think that the market's disdain for uncertainty means that as long as there's some uncertainty out there you have to count on some continued volatility for one thing we could very well have this phase one mini deal fall apart you just don't know the way this stuff has gone and the kind of impulsiveness and unpredictability of the whole situation. I mean that both politically and economically, the various actors involved, where it could go. Now, in terms of the impact to the U.S. economy, I think you have to remember, they go, well, they're committing to billions of dollars of additional purchases

of product from farmers. Why wouldn't that be a huge boon to our agricultural industry? A lot of that is just the restoration of purchases that were already taking place. And to the degree that there is some marginal additiveness to it, it is not something that is earth shattering. And so that's the reason. But no, I am in the camp that views this positively. But no, I am in the camp that views this positively. And yet, I think you have to be wary until we get to the finish line of a comprehensive deal.

And that prudence has been rather reinforced throughout the last year and a half as this has been all playing out. Now, earnings season is the other big story that will kind of impact markets here in the short term. And what I'm going to ask you to do, for those of you listening to the podcast right now, is bear with me a few minutes. I want to give you a kind of update on Brexit and on earnings season. I think we've covered where we are with this phase one China trade deal. But I really want to close out the podcast with something that is a bit longer term in focus, that is not about what's going to move the markets this week. The yield curve has un-inverted for now. The three-month yield has come about six, seven basis points lower than the 10-year yield,

and that had been mostly inverted over the last two months, let's call it. I think that that is short-term relevant it speaks to where we are there there the expectation is still that the Fed will cut although that expectations come down a little bit here in their late October meeting I think that the yield curve, the trade war, and earnings season and Brexit are significant. They're not hype. So much of what gets covered, unfortunately, in financial media is often not a real story. I'm not suggesting these things are not real stories.

They are. But I want you to bear with me because I want to conclude our Dividend Cafe today with something I think is the real story and various ramifications of it represent the kind of significant economic story of the decade ahead, and I would suggest probably two or three decades ahead. I mean that very literally. So to wrap things up more around where we're kind of looking right now, this market that is in kind of a bit of a trading range, Dow's back above 27,000. It has a higher baseline right now.

Around a year ago, we were moving up and down around 25,000. Markets have improved substantively. It's been a very strong year in capital markets, but that came off of a challenging fourth quarter of last year. And, of course, the Fed has had to become accommodative in order for a lot of this re-rating of risk assets to take place. That uncertainty of the trade war has impacted markets. The Brexit issues are getting interesting.

trade war has impacted markets the brexit issues are getting interesting as um as i was going to bed very late last night off of a late flight into jfk and then even very early this morning the um reports are that there is apparently a deal ready to be struck with the european union in the uk prime minister johnson and eu have come to some understanding the hang up in the deal had to do in Northern Ireland. Northern Ireland is not necessarily on board. And so you don't really know how this is going to play out in the summit over the weekend. But their deadline for a Brexit deadline for a finality around Brexit is two weeks from today as I'm recording. And it appears they've made more progress to that end than we have up until now had. But that's by no means a fait accompli.

And in fact, there is a decision tree chart, like if they do this, then this, and this could happen, and so forth, at DividendCafe.com that was prepared by one of our research partners that I have to tell you is absolutely fantastic. Please check it out. I have to tell you, it was absolutely fantastic. Please check it out. There's the possibility of an overhang of instability or uncertainty around Brexit outcome coming off. That's more than likely positive for markets. Phase one China deal, what's called $30 billion of planned tariff escalation is not happening.

Positive for markets. But you have earnings season. And now we're far too early to be able to get a read on how things are going and a handful of companies including very large ones have already reported net net it's been a positive start turning season especially some of the financial names however we'll know more in a week and we'll know even more than two weeks because you need more time and more diversification of sectors and companies to report to get a feel for the guidance going forward into what earnings what revenues and what you know companies are projecting on the political front the Democrats had a

pretty significant debate this week I provided the chart of the week in Dividend Cafe the political odds in the prediction markets right now for Elizabeth Warren securing the Democratic nomination. It looks more and more expected. There's so much that could still happen that could throw that off. And I think that in the politics and money section of DividendCafe.com, I lay out what exactly are the various unknowns that would have to kind of play out. We don't know that Senator Warren will, in fact, receive the Democrat nomination, although she is now clearly in the lead. And it appears that former Vice President Joe Biden is declining a bit.

But she was hit a little bit in the debates this week. There are some vulnerabilities in her campaign and her thesis. little bit in the debates this week. There are some vulnerabilities in her campaign and her thesis. I would suggest that the odds are that, correct, that Liz Warren wound up being the Democrat nominee. In order for markets to be able to assess some of these things, and I've said this time and time again, I really believe that the Senate becomes the bigger market story. Even with a Democrat Senate, I'm not at all convinced that some of the far extreme notions would actually be codified into law. And there would be so much devil in details, things to go on. But why do the markets in October of 2019 not fear the idea of the imposition of a wealth tax,

the imposition of Medicare for all and the costs that be associated with that, some of the very severe restrictions she's proposing in financial transactions and financial regulation on private equity, things that would be very constrictive to capital markets. Why are risk assets not pricing that stuff in 13 14 15 months in advance because they're way too smart too way too smart they know there's so much between now and then certainly there are some outcomes that could play out based on a chain of events leading to them that would be extremely negative for markets. And we're just not at that time right now. So that's the nature of politics. And we will continue discussing all aspects of politics and your money

all the way through the 2020 election. Let me close Divinity Cafe with an economic lesson. This is something that I'm obsessed with. I've been studying it for most of my adult life. I've transitioned. Transition may that I'm obsessed with. I've been studying it for most of my adult life. I've transitioned, not, not, transition may not be the right word. I've evolved in some understandings of certain aspects of this, but I felt like I had an opportunity this week to simplify the way I would summarize something for those of you who care. I think we talk about the impact of negative interest rates quite a bit at Dividend Cafe. I think we talk about the impact of negative interest rates quite a bit at

Dividend Cafe. I think we talk about the deflationary spiral that excessive debt, both in America, but particularly around the world, Japan and Europe, come to mind. The deflationary spiral they've created macroeconomically. We talk about what this low interest rate environment means for risk assets, what it means for debt management, what it means for economic health, what it means for productivity, all these different things. What I think I'm in for is a almost permanent, from the vantage point of my lifetime, from a vantage point in my lifetime, a very constant and secular cycle of low interest rates. And right now, there is an absolute majority of people who believe that's a good thing. And they are wrong. And they are fatally wrong. Now, fortunately, there are enough folks out there that understand what I'm about to say, that this is not just going to pass without any controversy or go through without any kind of, you know, I guess, impact.

But let me put it this way. Low interest rates are said to be a net positive because they stimulate spending or they stimulate economic activity. But in fact, what very low interest rates do is disincentivize saving. And over the long term, there's absolutely no question that your savings has to equal investment. And to the degree that you constrict savings, you constrict investment, which is the sine qua non of productivity. You cut off the tree that produces the fruit of economic growth.

So in order to have a long-term cycle of productivity, you need investment. And in order to have investment, you have to have savings. That is an economic law of identity. Savings long-term equals investment. an economic law of identity savings long term equals investment to the extent that we are using a short-term manipulation policy tool to manage the impact of excessive debt not even counting the crowding out effect and the misallocation of capital that excessive debt represents just in the basis of the low interest rates and what they represent i believe we've created a situation in where we favor already existing risk assets that they boost up the value of some real estate some stock some company private you know risk asset

that's already in play and we fail to understand how we disincentivize the creation of new assets how can that be a good thing for investors so i want to be able to allocate client capital over the next decade and two decades and three decades with an understanding of the debt cycle, with an understanding of capital flows, with an understanding of how this sort of Japanification has created a negative feedback loop of low interest rates that then foster low growth rates. And what that looks like to risk assets could be very positive in periods of time, but it repaints the canvas for an economy. And I am adamant that most financial advisors are not thinking about it, understanding it, or prepared to apply it. Therefore, their allocation decisions, not to mention security

selection decisions, are very vulnerable either because of apathy, thoughtlessness, or it's entirely possible to get things right just by accident. And that is never sustainable. You want to get things right for the right reasons in order to have the expectation of sustainability. So this is a broader economic lesson. I've only teased around the edges with it, but I've been delving into this at Dividend Cafe for months and I want to keep doing it because it is so much more important for those of you who have a timeline that is longer than one year than even the Brexit meetings this weekend

or the trade meetings of China last weekend, which are important events in the news cycle and are important events to investors. However, I simply am trying to draw a distinction between those things impacting markets in a one-year period and those things impacting markets in a multi-decade period. So I hope that's been helpful. I hope it's useful, but I really invite any questions you may have about it. And I need to run out the door now and get to my first set of meetings. And we'll be out here in

New York for over a week. It's our annual New York due diligence meeting. We're meeting with all of our major asset partners over the next week. I promise you it's going to be an unbelievably stimulating week intellectually for me, for my investment committee partners who are joining me. And we will be coming back to you with a lot more to chew on around it. But we will be coming back to you with a lot more to chew on around it. But I thank you for listening to the Dividend Cafe podcast. I hope you got some out of it. I really appreciate you listening and rating us and subscribing and reviewing us, if you will, and sharing with those who you want to hear it

so we can grow this podcast. Thanks again. who you want to hear it so we can grow this podcast. Thanks again. investment advisor to 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's 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. This is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors. All data and information referenced herein are from sources believed to be reliable. Any opinion, news, research, analyses, prices, or other information contained in this research is provided as general market commentary and does not constitute investment advice. The team and Hightower should not be in any way liable

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