The Dividend Cafe - Are We Going Into a Recession?

Episode Date: August 19, 2019

Topics discussed: We know the following things about the last 2-3 weeks in the market: (A) The China/trade war has blown up (B) The Yield curve has inverted (C) Negative yields persist all over the globe (D) Recession talk is everywhere So markets are obviously volatile, but it isn’t clear how these above things relate to one another, and people want to know what is going on. What I seek to do in this short, succinct podcast is get right to the point about what is going on – short term, and long term. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Hello and welcome to a special edition of the Dividend Cafe podcast. This is David Bonson. I'm the Chief Investment Officer of the Bonson Group and I'm recording this on a Sunday over a weekend following what has been one of the most volatile weeks in the market since last year and following another week that was itself indeed volatile with a lot of fundamental backdrop, meaning this is not just computers going crazy, not just algorithms, but actually you have a significant amount of economic story here to talk about. Some of it wildly misunderstood, and that's what our podcast is going to be about today. And some of it perhaps based on the fact that people aren't sure what to expect, aren't sure how to understand what's going on. And so when you've come off a week like the one we've just had, markets feeling

vulnerable, actually what's interesting, we were down 400 points Monday, we were up 400 Tuesday, but then we were down 800 on Wednesday, but then we were up 100 Thursday and up 300 ish on Friday so you're talking about significant triple digit move in every day but net net net across five days the Dow was down roughly three or four hundred points not a great week but obviously not quite the violence of what was looking like it could be a thousand or even more point drop on the week. Now we had been down the couple weeks before that as well. Similar stories though, with enough up days offsetting some of the big down days, the markets are not sitting at a percentage drop that is as meaningful as it feels given the volatility that we're living in. But the reason I want to do this podcast,

and there is a great risk doing it on a Sunday, and we're going to try to get it out to everybody on Monday. But by the time you're listening to it, it's entirely possible that the markets are up 1000 points down 1000 points, that there's been a new announcement on the China trade war, that there's a break in from the Fed with it. You know, all of these things are moving so quickly. And yet I don't want to let the potential for market news and event driven news to keep me from doing what I think is most important thing I can be doing for our clients at the Bonson Group, which is keeping you informed about what's going on. And here is essentially why I chose to do this podcast today.

The China trade war has obviously blown up. There has been another breakdown in the discussions with China. And what seemingly feels like an end to those negotiations. Then this week, the yield curve, defining it as the two-year treasury maturity and the 10-year treasury maturity, inverted for a brief time. The two-year was yielding more than the 10-year. We have negative yields on sovereign debt all over the world, about $15 trillion worth of government bonds from such countries as Germany, Switzerland, and Japan are offering investors a negative yield. So investors are paying money for the right to loan money to a government in theory. All of this from the trade war to the inverted yield curve to the negative yields around the globe

has dramatically heightened recession talk. So markets are volatile. It is not clear how these things relate to one another. and people want to know what in the world is going on. So let me unpack this and keep it short and simple and invite you to reach out to the Bonson Group with further questions. First of all, negative interest rates. What do they mean? Central banks right now feel that they are the only game in town, that there is no growth, there's no organic growth, there is not adequate fiscal stimulus, there is not adequate spending discipline. And I'm referring to various central banks all over the world, developed and emerging markets, U.S., non-U.S. markets, U.S., non-U.S. And so the central banks feel that they are responsible for economic protection, economic stimulus. I think that the negative interest rates represents perhaps the best example of central banks run amok of an overreach and overconfidence in their creative interventionist monetary policy

that in fact is misallocating capital and reinforcing the very deflationary forces that have got us to the position we're in. Interestingly, and you can do with this what you want. I'm just sharing it because I was unaware of it myself until research I was doing on Friday night. There is not a single English speaking country that has negative interest rates. All of the countries that are dealing with this are, as I mentioned before, Germany, Japan, and so forth. But there is a lot of questions as to whether or not the Federal Reserve, which 10 years ago, or I guess I should say 11 years ago now, we would have looked at quantitative easing as out of the realm of possibility. The notion of a central bank buying bonds with money

that didn't exist to create more reserves in the banking system, add to their balance sheet, and thereby stimulate the economy and manipulate the long-term interest rate down, we would have considered that hyper-creative, hyper-aggressive, hyper-interventionist monetary policy. And it not only was done, it was done for years and years and years, and is widely considered by them a success, and widely considered a sort of potential launching pad for perhaps even more interventionist monetary policy. But we don't have central bankers in our country at this time who are saying, you know what, yeah, negative interest rates will probably happen at some point. They sort of, without explicitly saying it, talk as if it will never happen, should never happen,

likely is not going to happen. We don't think it'll happen. if it will never happen, should never happen, likely is not going to happen. We don't think it'll happen. Maybe it won't happen. That's sort of the posture. But I do believe that it would be very calming to markets for the Fed to earnestly and zealously and clearly proclaim a refusal to use negative interest rates as a policy tool. It would provide a great deal of confidence and clarity to markets. But in the meantime, the negative interest rates we see around the world are a byproduct of central banks that are aggressively intervening so as to help manage the excessive debt load and lack of needed stimulus as in their view in their economies.

So then we look back to the U.S., where, as I said, there are not current negative interest rates. But indeed, on Wednesday, the 210 yield curve did invert. And I would like to point out that the talk is true. Seven of our last seven recessions, excuse me, seven of the last seven recessions were preceded by a yield curve inversion. Four out of the last five times the yield curve inverted, we went to recession. Nine out of the last 12 recessions had a yield curve inversion before. So it is not a 100% perfect signal. But I do think that this

part is noteworthy that in 19, let me see here, the five last times that the yield curve inverted from the point of inversion to the point of max inversion, like the largest the inverted delta got, it was 36 days, 71 days, 22 days, 46 days, and 224 days, respectively. And by the way, the inversion in each of those cases lasted even longer. Those are just the days from the initial day at which it inverted to the max level of inversion. In this case, we went from inverted to un-inverted in less than a day. Now, does that mean it doesn't count? No. Nobody knows what to do with it. We were inverted for about five minutes. And so not only did you not have the weeks and weeks that you normally have just to get to a max inversion, we were out of inversion so quickly. Now in 1998, the yield curve inverted for 22 days and we did not have a recession. In this case the theory is

global weakness which is real is adding up to a level that will tip the U.S. into recession and I can't argue that it's wrong because I find a lot of vulnerability that I'm going to talk about in a second in parts of our economy due to the trade war. But U.S. weakness generally leads to a global recession. Global weakness doesn't usually lead to a U.S. recession. I look back to 2008, 1991, 1982, 1975. Those are periods that U.S. recessions caused the rest of the world to go into recession. We've had many precedents of global weakness not leading to the opposite, not causing U.S. recession. So I don't know that that cause and effect fear is legitimate in this case. So is all okay? Well, we have to look in the U.S.

so is all okay well we have to look in the u.s and i'm i think it's very clear that industrial production ism ism services and manufacturing durable goods new orders they're all going the wrong direction recently after going profoundly in the right direction the trade war has a double whammy of a creating volatility uncertainty, uncertainty, headline risk, but then B, having the potential for creating truly systemic underlying problems if not resolved. So it's both the kind of noise and the actual legitimacy substance that we're having to deal with. We just don't know yet. Will a trade deal get done to hold things over through the election or will it get worse? Will the Fed go heavy with monetary stimulus or will whatever it does underwhelm markets? Is the U.S. economy more resilient than some are giving it credit for or are the softening business investment conditions a sign of things to come?

it for? Or are the softening business investment conditions a sign of things to come? In the short term, I don't think a recession is on the horizon for a minimum of 12 months and probably longer, like 24. And even that's avoidable, by the way, if this plays like 1998. And I've been talking for over a year now of how many things going on have felt like 1998. But in the long term, when we talk about the negative interest rate dynamic and the overall state of global indebtedness and the heavier hand of central banks in ordering the affairs of a world economy, I think central banks running amok will not slow down because government spending will not slow down. And the way that our Fed is asked to deal with national debt will be the story of the

next 10 to 15 years. So with that short-term perspective, a recession that is possible but not assured in, let's call it, 18 plus months, and then long-term challenges around higher, heavier central bank intervention, I think that the diagnosis is actually very similar for both short and long-term issues people are thinking about. You want to be invested in quality and defensiveness in your equity and risk allocations. You want to focus on the fundamentals of asset allocation. And if you want potent, which what I mean by that is tried and true practice of dividing up various asset classes in your portfolio to manage towards a risk reward trade

off. If you want some potential offense from your defense, meaning the asset classes you have that are meant to be more defensive, then I think alternatives are a better place than fixed income to get offense from your bonds, but that by no means takes away the defensive nature of fixed income, even at these very low interest rates from an ongoing deflationary spiral. I would heavily recommend cash flow generative non-cyclical companies in one's equity portfolio. A great deal of defensiveness, but also persistence and resilience against business cycle conditions exist with some of the types of companies I'm referring to. You yourself as an investor must maintain a behavioral focus on thinking about the underlying companies and businesses you're invested in, the cash that is being paid to your portfolio, and not the macro headline story and not even the current day minute by minute price or PE ratio of positions, which are largely noise, largely guaranteed, I should say highly likely to blow all over the place. And I deeply, I'll close with this thought in the context of what

we're dealing with in the short-term market and where I think we'll be for decades to come. Respect markets. Respect the possibility of melt-ups and respect the possibility of downside volatility. Unseemly realities exist for investors investing in risk assets. By the way, unseemly realities exist for investors investing in risk-free assets these days. Who would have thought that going into short-term government treasuries in countries would guarantee a loss instead of guarantee a gain here in the world of negative interest rates. Invest for what is, not what you want it to be. There's a political statement in there. And watch how a portfolio that is managed

to these characteristics with an investor managing him or herself to these characteristics behaviorally comes out of it, I think you'll be extremely pleased. Thanks for listening to this special Dividend Cafe. In a world of negative interest rates, China trade war, highly volatile markets, recessionary fears, short-term concerns, long-term concerns. I do hope there's been something practical for you out of this. Go to thebonsongroup.com and dividendcafe.com for more information, more videos, more content geared towards giving you the information you need. And of course, anytime, reach out to your advisor at the Bonson Group so we can help you in these precarious situations. Thanks again for listening

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