The Dividend Cafe - Bearish Fears vs Fear of Missing Out

Episode Date: March 22, 2019

Topics discussed: “FOMO” – that fear of missing out Earnings watch Brexit Exit Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. and it's necessary this week just because of scheduling and other things like that. Look, we're recording in the middle of the week, and as we talk here right now, the market's down a bit on Wednesday. It had been up in the week prior to that, so it's too early to tell how the week is going to end up. But there's a couple of other things I kind of want to go through, and I'd like to match the stuff I'm talking about for you listening and those viewing as much as possible over what we've written about in this week's Dividend Cafe commentary. I really think there's some, it's a nice week for a refresher around some kind of basic behavioral principles and also a bit of an assessment about some of the things going on

around the world right now. I think are relevant to our overall economic position and also the portfolio positioning. I talked about this concept this week of, you know, you hear this expression FOMO, the fear of missing out. And the reality that that fear has for people in natural human psychology is profound and it is particularly profound when it comes to investing. There is a sense in which most, if not all, investors have a fear of missing on a move to the upside. There may be a sense in which a lot of logic and a lot of sensibility may indicate a kind of rebalancing or profit-taking or moderating a portfolio risk.

But that fear that if they exit something too soon, they're going to miss a big move up. If they don't go buy some hot new IPO, if they don't go participate in some kind of risk-on endeavor, that fear of missing out. and some kind of risk-on endeavor, that fear of missing out. And yet the thing that's so ironic is that I don't know that there's anyone left who doesn't know, doesn't believe that when it comes to investing, the pain of downside is significantly more real, more severe, and more felt than the thrill of upside, than the participation in a gain. And so there is a almost kind of permanently asymmetrical relationship between risk and

reward because the realities of risk hurt people more than the pleasures of reward when it comes to investing. And it's incumbent upon those of us in the private wealth management space who actually work with human beings for a living to both construct a portfolio in line with what a client's stated objectives are and in line with their often unstated psyche, their unstated emotional tolerances. And that's a tricky thing to do. The point I want to make about this point for you all is that it is unnecessary for us to choose between which one we're going to adopt. Are we going to embrace the fear of missing out or are we going to embrace decline in terms of that downside portfolio risk? The reality is that if you're doing asset allocation, meaning the

blending of various categories of investments to a very customized particular portfolio composition that meets an actual client's real-life need, their risk tolerance, their age, their timeline, their liquidity profile, all of the particulars that fit into what makes that client that client, what their own goals, objectives, and situation may call for. The asset allocation that blends different asset classes of varying risk and reward characteristics meets both the FOMO and the risk aversion. And for some people, they favor one more than the other and some people significantly so. Now, here's the other thing I guess I'll throw in there because it's another real significant

reality in investor psychology. It's somewhat unfair about the human condition, but life's not fair. Investors also have an unbelievably predictable desire to favor risk when everything is going well and to favor risk aversion when everything's going poorly. And that is not very profound. I've always stated there's nothing necessarily wrong with it. It's only wrong if you actually think it can happen. So the asset allocation has to deal with that reality. Now, I guess right off the bat, one's asset allocation being I want to be in the market whenever it's up and out of the market whenever it's down, you have to kind of eliminate that because it's not possible.

Like if you could create an asset allocation that could do it, you could effectively execute on a portfolio objective of never being exposed to the downside, always capturing the upside. Of course, everybody would do that. But we just – we start off talking to people like they're grownups, talking to people not disrespecting their intelligence. That type of thing obviously can't be done. If anyone doesn't know it can't be done, then that's a separate issue, a separate challenge altogether. So I think that when you accept the fact that there's going to be different degrees of volatility and risk in a portfolio and you're able to customize it so that you are both addressing the fear of missing out

and getting that participation and upside that you want, both that you need because you need some accumulation of capital to meet an investment objective, but also because you just have that kind of aspiration, obviously, for growth and things like that. And then also the protection and staying within a comfort zone of downside volatility. You know, there's generally speaking, this isn't always the case. I don't think anyone likes it when their portfolio goes down. There's a lot of people that wouldn't know or care, even acknowledge a 3% move down, a 5% move down, a 7% move.

And some people start getting triggered, so to speak, at about 10%. And others wouldn't even care until 20%. You know, There's different thresholds. So it behooves you to set the asset allocation at different levels based on that comfort. I got to move on to the next topic. But I guess one thing that does complicate this is not everyone's aware of it. You can say, I would never get out of bed. I've had this happen many, many times. Clients say, I wouldn't mind at all. I can deal with anything down up to about 15% and then I start getting upset. They go down 2.5% and it becomes really unnerving. So sometimes you don't know what's

going to unnerve you until it happens. That's, again, part of the particulars of private wealth management. They're dealing with people, private people, individual people, real people. So this behavioral reality and the challenges that it represents for the financial counselor and advisor like myself and my colleagues and then where the process of asset allocation fits into it, it may be the most important topic we can ever address. Now, I'm going to go on now and talk about earnings and I'm going to talk about China and Brexit and all that stuff's going on. And I think a lot of people enjoy those types of ad hoc conversations more than anything

else. But I never want to get away from remembering the entire point of asset allocation is to address both the fear and greed realities of the human personality and apply it to the investing process. That's what we do. Reach out to me with more questions on this subject. It's a very important one. All right. So we may get $172 of earnings out of the S&P 500 this year. The projection had been $176. There are some new revisions indicating it may end up being around $166. So we'll see. That's the aggregate earnings across the U.S. S&P 500. But at $172, which is the middle of the road from where projections were to where some new revisions are, that would represent about $10 a share more than we were last year at 162.

And why am I going through all these numbers with you? Because having some degree of a jump, let's call it 4% earnings growth, is significantly different from no earnings growth at all. But I want you to remember where we were and why the stock market has moved the way it has. People talk about how long this rally has been going on. The bull market started in 2009, still going now. Well, remember, the market rally was seven years old in 2016, and the market has moved 40% since then. The fact of the matter is that the earnings of the S&P 500 in 2016 were $119 a share. And we're right now debating if it's going to be $165 or $170. So there's a perfect justification in the market being at a higher level relative to

the earnings growth that has taken place. level relative to the earnings growth that has taken place. It's a three-year move from 119 to 132 to 162 in earnings, okay? Well, look, my belief, and I don't want to go in and repeat the whole same speech again about CapEx and business investment. My belief is that 172 of earnings, it's going to be difficult to see those things accelerate without new rounds of business investment that create new productivity in the economy. And so I've already talked about that issue quite a bit over the last year or so. But I think that this concept about earnings

growth and are we vulnerable to a possibility of markets teetering off if we do end up having a decline in earnings, I think it's a legitimate question. The points I've been making in past weeks are that we don't know that, in fact, well over half the time earnings decline in the market is actually at a positive year. Maybe it ended up going down the year after that or something like that. But here's the point I'm trying to make. I'm not as focused on predicting what exactly the earnings will do and what exactly the market will do in response to that. I am focused on those types of questions around our individual companies where we have earnings growth, cash flow growth, and, of course, dividend growth. But I want people to understand the reason why the question is perhaps more heightened right now, and that is because of the valuations we're starting at.

right now. And that is because of the valuations we're starting at. You're starting right now with a PE ratio of 17 times last year's earnings, 16 and a half times next year's earnings. So you're not undervalued starting off like we were a few months ago. You have a price to sales ratio of 2.1 times. So you look at total earnings, we're trading about two times total revenue, rather not earnings, revenue. And then price to book, the book value accompanies the prices about 3.3 times that. And the average has been about 2.7. We're high in some of these valuation metrics. We're even or fair valued in some others. And that doesn't mean that we're going to go down or going to go up. It doesn't tell us anything. What it doesn't mean that we're going to go down or going to go

up. It doesn't tell us anything. What it tells us is that there's a more heightened sensitivity around what earnings end up doing. It's difficult to justify a full market multiple if earnings growth is going to go backwards. My forecast right now continues to be that we end up being flat or even slightly negative in Q1 versus last year's Q1, but it stops there. And then into the later quarters of the year, you end up seeing earnings growth to squeak out something in between 4% and 8% earnings growth year over year. And that comes on top of the 25% from last year and the 17% or whatever the year before. This story continues, and we wait and

see what kind of top line we get. I have to cut it off there. By now, you probably know that Prime Minister May has asked for an extension of Brexit, that they not execute the full Brexit that was already kind of voted upon for a March 29th exit, that they want to kick that can to June 30th. I don't have any real comments for or against the idea other than to say that it's not very common that your first request for a delay will be your last. So this has the risk of kind of leading to an ongoing path of real drudgery.

Some comments I make in the Dividend Cafe this week about our China trade deal, about inflation, and the correlation between oil prices and MLPs. It's a shame I'm kind of in a hurry right now for you podcast listeners and video watchers because I really would love to cover some of these topics. There are things I had a lot of fun writing and therefore would have a lot of fun kind of walking through and talking through right now. So I guess that's my little bait to get you to go to dividendcafe.com this week. But we're going to leave it there.

And I really welcome any questions or comments you may have and encourage you to reach out to us with those. And we look forward to coming back to you next week. The month of March will be ending. And with that, the end of Q1 and 2019 is just sailing on by. So there we go. Enjoy your March Madness weekend. Thanks for listening and viewing Dividend Cafe. Thank you for listening to the Dividend Cafe, financial food for thought. advisor of 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

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