The Dividend Cafe - Are Markets Aware Of This Positive Earnings Season?

Episode Date: May 4, 2018

This week, David covers ..... Topics discussed: Positive earnings reports Reasons behind the market reaction to this postive earnings season. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Hello and welcome to this week's Dividend Cafe podcast. This is David Bonson. I'm the managing partner and chief investment officer at the Bonson Group and we are into another exciting week in the market. Lots of volatility. We're not closed in the market as I'm recording here on Thursday afternoon, and so as of the time I'm recording, the market's now up a little bit on the day.

It had been down almost 400 points earlier, so if that rings a bell in terms of the kind of intraday volatility and so forth from a month ago and what we've really kind of seen off and on much of the last three months now. That's what we've been dealing with this week. And so what we're going to kind of go into this week is sort of with this earnings season, phenomenal results, talk about these market hesitations and concerns. And from there, it kind of leads to a broader conversation that will cover asset allocation, it will cover fixed income, the bond market, and what we're viewing in inflation data, and just overall

investor behavior. So a lot of topics we're going to get into. Let me start with this, what I'm calling three-act play. I see the volatility since late January as very much non-monolithic, meaning definitely not just simply one cause, one sort of creative force behind it. In fact, I'm dividing it into three acts. The first act was the post-wage growth scare that led to that big VIX spike and technical market breakdown back in early February. That didn't last long. But then the second act was this sort of on-again, off-again Trump trade tariff debacle of late February and much of March. of debacle of late February and much of March. And then I think that story is persisting now in the background, elevating skittishness in the market, but it's subsided around the market hopes post-Kudlow that the president will not follow through on some of the more outlandish trade war

comments. But then you get to this third act, I think we've been in the last couple of weeks, and it centers around bond yield movements, bond yields going up, the repricing of equities due to bond and interest rate conditions. As I've said and elaborated on many times, and we'll do more so here today, It's very much tied to inflationary expectations. So ironically, for such fear of inflationary expectations moving higher, gold has sold off, the dollar has rallied the last two weeks as markets allegedly are fearing this greater inflation threat. Markets do not need reasons to do what markets do sometimes in a week or a day or even a month hiccup and things like that. But in this case, the reasons are multiple.

And as I say in my sort of three-act play scenario, they've been sequential. What will the fourth act be? Well, for me and my clients, it will be discipline maintenance of a plan rooted in fundamental dividend growth. And it will be devoid of noise. But I guess you probably knew I was going to say that. Let's talk thoughtful asset allocation. The whole point of asset allocation is what exactly? It's to create a more optimal overall experience for an investor in terms of both the return and the risk taken to generate that return. You do that by mixing different asset classes together that in their relation to one another

help create a better risk-adjusted outcome. At the heart of this belief and the most common implementation is the idea that bonds often buffer the volatility of stocks, a belief that's well verified by history. But from a thoughtfulness standpoint, asset allocators may very well find bonds an imperfect hedge against stock volatility in 2018. When deflationary pressures hurt stocks, bonds generally move higher, creating the offsetting zig for the stock market zag that asset allocators love. But if inflationary pressures hurt stocks, those same interest rate pressures are likely to hurt bonds too, at least in the short term. Does this diminish our commitment to asset allocation in the pursuit of optimal asset alignment towards the objective of a better risk-adjusted return?

Not in the least. But it does cause us to believe that the role of alternatives may be more important in a thoughtful asset allocation right now. Perhaps alternatives will prove to be a better and more optimal volatility suppressor in terms of the equity market volatility than bonds will. We're quite open to that increase of alternatives in our asset allocation. From a GDP growth standpoint, last week the numbers came up. The GDP number for Q1 showed real GDP growth of 2.3%. The consensus expectation had only been 1.8%. It's a big deal. But I do want to point out that perhaps the bigger deal is that

even adjusted seasonally, the Q1 in 2017, the Q1 in 2016, Q1 in 2014. So three of the last four years, you had a very tiny move up in Q1 and a very substantial move up in Q2, 3, 4. If that track were to keep true again this year, and we have no reason to believe it would not, then we think an annualized rate for GDP growth, again, a real rate we're talking about, net of inflation, not the nominal rate, something north of 3%, we think is very, very likely. Under the hood of this number, the 2.3%, that is, the, I guess, pessimist or bearers would be saying, well, you know what, the consumer, you know, kind of had a little less than impressive type numbers. And that's probably true. But the thing we would point to, which is far more impactful, is that the capital goods orders that drove business investment were absolutely on fire. Commercial construction,

technology and software purchases up 6.1% year over year. Structural spending was up over 12%. This is the story. And we believe the one thing, by the way, I'm anecdotally going to tell you, the one thing that was sort of down in the capital goods area was dishwashers and cars, down 3.3% year over year. The worst drop since 2009. What do they have in common? The washing machine space and so forth.

It was obviously the advent of these tariffs, so I'll let you do the math there. But my point is that tax reform stimulus, derogatory efforts, renewed business confidence, I think will get us above 3% real GDP growth. Only unforced errors could undermine that from our perspective. Yes, earnings growth has been remarkable this quarter, both year-over-year growth and even relative to the expectations of what growth would look like. And a lot of that is just simply because, of course, of the tax reform.

You know, as things have been priced in, it's created better after-tax earnings results, year-over-year in particular. But I hope it goes without saying, taxes are only paid on profits. So while tax reform may have added to the earnings growth, it certainly can't be the determinant factor in revenue growth. It is the top-line revenue increase that's most encouraging this quarter and that we believe has been completely organic.

What do we do about this rising dollar in the last couple weeks? It's surreal to me that the argument that dollar strength is a secular negative for stocks still has media credibility. As I've been writing and talking about for years, there's no way around the historical reality. The relationship between the dollar and stocks in a whole host of short-term horizons is hyper non-correlated. Zigs and zags and no clarity on what one does to the other. And in the long term, in fact, secular currency strength out of a strong economy is bullish for stocks, not bearish. I think the entire 1980s and 1990s would

agree with that. With that said, short term, we expect the current market dynamics in trading windows to inversely trade to a country's currency for a variety of reasons. And we're, again, talking short-term trading windows. It's primarily because the dollar is moving around longer-term interest rates, and longer-term interest rates are in a phase of repricing equities, as we discussed last week. The problem with formulating an investment policy around this is, well, it's transitory, meaning it's true until it isn't. There's not a secular theme out of such a move, and it's the textbook definition of noise. By the way, I do want to comment quickly about inflation expectations.

You know, we know they're causing interest rates to move up, and the 10-year bond yield is up 90 basis points over the last eight months. TIP yields, the inflation-protected treasury yields, are up 50 basis points. But I do want to point out in 2013, we saw the 10-year rise 130 basis points. TIPS were up a whopping 170 basis points. And stocks ended up with a massively high year, the highest post-recovery, post-financial crisis year that we've had in the stock market. Now, 2014 and 15 were modestly positive, and we saw a massive, robust move in 2016 and

2017. The key issue would be whether or not we actually face inflationary pressures and how deep and wide they prove to be. It will not just simply be continued mutterings about or chatter about the potential of inflation. The chatter now does increase volatility, just as it did in summer 2013, but it doesn't help us forecast the years ahead. We think that the reality is that you will see a modest uptick in inflation that does not prove to be disruptive inflation levels to the overall global economy. There's some charts you just have to look at about inflation, by the way, at DividendCafe.com.

Some of the truly fascinating things that we've put out regarding the subject this week, where you've seen a lot of inflation over the last 20 years, where you've seen kind of modest inflation and where you've seen a lot of inflation over the last 20 years, where you've seen kind of modest inflation and where you've seen actually no inflation. It's really interesting how this stuff gets broken up by different categories in the economy. I'm going to close with a pretty important point. I'm going to call it the fatal error. I heard a speech the other day from the founder of a very large, low-cost provider of index funds. And his underlying point was that cost and fees are the major factors in long-term funds. And his underlying point was that cost and fees are the major factors in long-term performance. And there's certainly something appealing to the idea

that all we have to do is find the lowest cost something and all will be well in the world. But the thesis is, of course, preposterous. Investor behavior has derailed more successful financial outcomes than every other problem put together since the beginning of capital. Investors fare well to be cost conscious and to make sure they receive value for whatever they are paying for in their investment experience. I might add, as a long-time drum banger for the fiduciary movement, investors have a much better chance of making sure they receive value for what they're paying when they actually know the truth as to what they are paying. But destructive decisions with low-cost investments will save no one. All access to grind that the index industry has notwithstanding, fees that pay for themselves many times over through value added are never a problem, and investors' propensity to temperamental errors

can be fatal. So to that end, we work. I'll ask you again to go to the dividend cafe, look at what the S&P dividend yield has been doing relative to other bond and cash instruments, and get a very visual indication of why we are so gung-ho on the idea of investors why we are so gung-ho on the idea of investors looking to the necessity of active dividend growth, more fundamentally managed bottom-up selective dividend growth investing in this era as much as any. And so check out the chart of the week. Please reach out with any questions or comments. I wish I could tell you that I thought markets were all about to settle down. I don't have any idea.

The volatility is, to me, a gift for us accumulators, for those looking at it and sweating it out day by day. It is headache-inducing, and there's only one behavioral thing to do to solve that. And those that are clipping income are seeing more dividend growth this year thus far than we've had in almost a decade. So plenty of good, plenty of bad out there, but it is all about your perspective. And from our perspective, we feel very competent, confident, qualified, excited about the entire environment we're dealing with. We're going to keep working.

We're going to answer your questions. And thank you for listening to this week's Dividend Cafe, financial food for thought. The Bonson 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. This is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors. All data and information referenced herein are

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