The Dividend Cafe - Behaving Thyself

Episode Date: February 22, 2019

Topics discussed: The Fed Minutes More Clarity on Tax Refunds Calm Before The Storm? 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 video and podcast. I am recording both at once today in the interest of time. It is Thursday, kind of mid-morning, and I'm in New York City at our office here and market is open. We're down a bit today. We've been up a bit the rest of the week. We were closed on Monday for the President's Day holiday so it's a short week and I guess if we were ending right now we'd be about even on the week. Maybe up a few points and we'll see what happens by the end of trading on Thursday and of course throughout our Friday market day but the market has been up in the Dow nine weeks in a row if you

go back to Christmas week that week where it started and then of course it went much lower in the beginning of the week but then the way it ended that week where it kind of began this bounce it ended that week higher than where it started and it has done so every week since some weeks dramatically so and many of those weeks barely just by you know 50 points on the whole week but technically nine weeks in a row of positive movement. So obviously this V-shape recovery has been really quite sudden, quite dramatic, meaning we had a very sharp line down that created one side of the V in the fourth quarter. And now we've had one side up, equally sharp, equally sudden.

And a lot of that just simply has to do with one of the things I'm going to talk about a lot today, which is the Federal Reserve. And so let me get into kind of the main gist of it. The dividend cafe written I have printed out here does a lot this week to talk about the Fed. But the very first point I'm going to go through here for you listening and viewing is the same thing I lead with in the written commentary. And that has to do with kind of the behavioral sciences of investing. And I really wish I wrote something about behavioral modification every single week because I do believe it is the most important thing I could write about. On an ad hoc kind of current events basis, there are various things that come up in the news cycle, in geopolitics, obviously around monetary policy.

There's macroeconomic you know events that become newsworthy so I think a lot of people view listen and read the dividend cafe and its various properties for that kind of stuff and I love doing it it's I love researching I love researching. I love analyzing. I love sharing such research and analysis. But at the end of the day, I really do believe that in one investor's interpretation of data and events and information, the most important thing to their investment outcome will be behavioral response to such things that more information is proven time and time again to not necessarily lead to better results but it is sure to lead to more confidence and And so when I talk about behavioral modification, meaning the avoidance of behavioral mistakes, one can be tempted from a significant amount

of incoming information to develop a confidence level that can be very tricky and perhaps problematic around a thesis. If one does not do what I think we at the Bonson Group do rigorously, and that is constantly challenge their own presuppositions, constantly look to counterpoints, alternative data, various differing points of view, various differing points of view. Because what happens with a great degree of confidence is the possibility of stubbornness, the possibility of a confirmation bias where you only look for information. That's one of the things about having a lot of information out there. You can always find information that will help support what you've already concluded to be true. And so it takes a lot of intellectual honesty and it takes a lot of behavioral modesty.

One can become so convicted of esenthesis that they can take on more risk than is appropriate for their financial position. We see it all the time. There's an ignorance. There's a wanting something to be true, therefore believing it's true. There's all kinds of things that can take place based on what the human psyche is. And we can't work at the Bonson Group to change the human psyche. We don't have such outlandish aspirations. So we think that what we have to do is manage human nature in our clients and manage our own human nature, hold ourselves accountable to our process so that we behave with modesty and with appropriate levels of intellectual humility, but also within foundational principles. And those foundational principles serve as governors of avoiding excess and of making prudent investment decisions that are not emotional, not greedy, not fearful, but are sound. So let me move on to just a couple more intriguing things

in terms of the markets. And for those who found that behavioral sermon to be useful, I appreciate it. And those who found it to be boring or not relevant, you should probably rewind it and listen to it again. Okay. I'm just kidding. Sort of. Let's talk just in terms of the rally that's taken place since Christmas. We were talking about nine weeks in a row. You know, I really do want to be cautious in this sense. I don't think that the trade deal with China is a foregone conclusion. I certainly don't think all the specifics thereof are a foregone conclusion. I think the market is largely pricing in the deal as if it is. I would point out that the most defensive parts of capital markets,

let's say in the stock market, the utility sector, in the bond market, the treasury sector, they're not exactly getting beat up. They haven't been abandoned. Now, they're not leading market performance, but they're holding up just fine. And a lot of times, those defensive areas of the sector might really struggle in a period of total full-blown, okay, all bets are off, let's put risk back on. So there is this sort of prudence that I think you can see embedded in that. Global bond yields are very low. That best case means the U.S. would just simply be an outlier against a backdrop of what is clearly a globally slowing economy. But worst case, it could mean the U.S. joins the rest of the world in some form of global malaise.

That's not our view, by the way, but I think one has to look at the worst and best outcomes, neither of which are necessarily fantastic. Interest rate-sensitive parts of the economy are struggling. Now, monetary tightening had worked its way through the economy, which created some of that struggle. And yet now, I think a transition to a Cap the early levels of Trumpian policy, fiscal policy, deregulation and tax reform out be the resurgence of business investment and capital expenditures necessary to enhance productivity? We don't know the answer to that. So I guess here's my conclusion. Are there reasons to be bullish? Of course. And I would argue probably the preponderance of data goes that direction. But is there a justification for defensive caution?

goes that direction. But is there a justification for defensive caution? Certainly there is. For balance, for asset allocation, for prudence, for discipline. These are permanent conditions in investing. And right now you're just sort of seeing the argument for both sides of that balance. Okay, let's talk real quickly just about the Fed minutes this week, and then I'll let you go. Okay, let's talk real quickly just about the Fed minutes this week, and then I'll let you go. The minutes that they released in their January Federal Reserve meeting were actually more telling, I think, than I expected them to be. I mean, there was no doubt that the Fed governors were saying, we need to stop shrinking our balance sheet later in the year, which is a really stark reversal of their prior autopilot language. When Chairman Powell famously said in December, we want to keep the Fed balance sheet reduction on autopilot. And what that means is that they would automate the process of $50 billion a month

that was, as these bonds were maturing, they were letting them roll off, reducing the overall size of balance sheet instead of allowing, instead of reinvesting the proceeds, which was keeping the level of assets that they held in reserves as a level dollar amount. They're allowing that amount to shrink. And they got up to the point of about $50 billion a month, having started at $10 billion a month a couple of years ago. All in, they were able to reduce about $400 billion. And that extraction of liquidity, I think, is such a big deal. And I'm going to say a couple of comments on that here. Look, this matters. And I know it sounds wonky and boring, but the liquidity available in the credit markets is the key aspect right now, I think, in terms of confidence in continued economic expansion. And their explicit statements about their plans for balance sheet in 2019, what Chairman Powell very clearly said October, December has been explicitly reversed.

And I think that investors ought to have an expectation that that Fed view of very long-term sidelined, which means supporting credit markets with greater liquidity and potentially even downward pressure on interest rates because the Fed will be back in the market as a buyer of U.S. Treasury bonds. That's one thing you've got to understand that they talked about. of U.S. Treasury bonds. That's one thing you got to understand that they talked about when they stop the reduction of balance sheet, they'll begin reinvesting proceeds from matured mortgage bonds they bought from quantitative easing with Treasury bonds. So they would be maybe changing the composition of their balance sheet, but not the dollar level.

acquisition of their balance sheet, but not the dollar level. And that would have an effect, I think, of holding interest rates level as well. So how serious am I about this issue mattering to markets in terms of the liquidity that is extended in the economy, the U.S. monetary base fell year-over-year in January by 12.6%, which is the largest year-over-year drop since the 1930s. Now, a lot of that was on purpose. This is what the Fed policy was, was to extract some of that liquidity out. It's a direct result of their intentional efforts to reduce excess U.S. dollars from the system. But if you believe now, as we are telling you, the Fed is telling us that the reserves at the Federal Reserve will be higher than they had previously expected,

then the logical conclusion is that those dollars that maintain in circulation will migrate into risk assets and serve as a backstop to where risk assets go. So I think that it would be very unwise to underestimate the significance. That tax refund story I talked about last week is becoming a real non-story. One report this week estimates that the refunds will end up being 26% higher than they had been last year. I think a lot of it was timing and processing. There was a lot of politicking going on around the story. Ultimately, people paying lower taxes would mean less refunds because the withdrawal tables calculated that in.

But we'll see how that plays out. We do have a section about the marijuana stock industry in this week's Dividend Cafe. I'm not going to get into it now out of time, but I recommend you check that out. What else do I want to conclude with? The written Dividend Cafe just has so much stuff. I think it's worthwhile looking at the chart of the week to understand the commodity price movement that we've seen so far this year and how that is so compatible with the reflationary thesis in stocks. You see oil and gold, but also wheat and sugar, and then the industrial commodities, copper and iron ore, all moving higher this year.

And so sometimes you can have various forces in the market that allow stock prices to move, but don't move commodity prices or, in fact, commodity prices go lower. a real reflationary thesis, that maybe the Fed felt that they had gotten too disinflationary with their tightening of 2017 and 18, and that now there's a kind of reflationary theme, certainly in U.S. markets and potentially in other markets as well. We're sort of waiting to see what Japan, Europe, and China do in terms of monetary policy. The commodity price movement is a sort of validation of that thesis in the stock market of reflation pushing asset prices higher. So I really don't know how much longer this particular equity extension goes. I mean, you have to think you get a weak negative at some point. But I do think that people waiting to enter the market to try to catch that negative week deserve for this nine-week

winning streak to keep going higher because the sin of market timing is one of the behavioral sins that is just punishing people if they're guilty of doing it. And certainly you look at a period right now where you've had, you know, 4,000 points come back into the market from one holiday to the next holiday. I mean, it's insane how quickly this has gone. And so just let your risk appetite and your financial profile of goals and objectives determine an asset allocation, not an outlook on what the market will do tomorrow or next week. I mean, that's pretty elementary advice for me to conclude with. So the Fed's the story of the week. The balance sheet right now could be the story of the year. Very little on the geopolitical front to talk

about today. And I'm going to leave it there. Thanks for listening to the Dividend Cafe podcast. Thanks for viewing the Dividend Cafe video. Please check out DividendCafe.com. Please subscribe to any of these mediums that you like. Write reviews, make comments, whatever you want to do. We're here for you. We love this interaction and we wish you a very good weekend. Go Tritons! Thank you. The 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. It does not constitute investment advice. The team and Hightower should not be in any way liable for claims and make no express or implied representations or warranties as to the accuracy or completeness of the data and other information or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced.

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