The Dividend Cafe - Bite-sized Nuggets

Episode Date: January 26, 2024

Today's Post - https://bahnsen.co/3OkKhL0 I did something fun today …  I just picked random topics from various things on my mind, in my daily reading, or across my research feed – sort of stream of consciousness – and wrote about them.  Therefore, I suspect there will be a little something for everyone today.  Hopefully, each portion is “bite-sized” enough to make it all succinct and readable, and I certainly appreciate any feedback you have to offer.  In fact, I am considering something like this in the daily DC Today (where I would write my own piece every day on whatever topic I am so inspired by that day, and let Brian run with the daily data recap).  It's all a work in progress and your comments are welcome. And in the meantime, let's jump into the Dividend Cafe - bite-sized variety and all ... Links mentioned in this episode: TheDCToday.com DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Well, hello and welcome to this week's Dividend Cafe, live from New York City. It's been one heck of a week. I was in Washington, D.C. Wednesday and Thursday. I came back in at the end of the day. So it was a pretty short trip, but a really, really productive one. And I'm actually looking forward to sharing some of the takeaways more next week because there most certainly were takeaways. But you know what? You want to use this Divinity Cafe time today to delve a little bit into various topics that are floating around the globe, economic, a little bit political, market-oriented. And so I did this week's Dividend Cafe. I did enjoy writing it. It was a bit of a stream of consciousness. I kind of just throughout the week took different little topics that came to mind from my morning research. And I don't know,

every now and then I just like explaining the process. I am using the very, very early morning hours every day of my life for my research. And I read a lot of research. And most of the writing I do ends up being between hours of 3.30 and 7.30 in the morning as well. But certainly, the vast majority of the reading does. And so what I did this week is just kind of as I was going through different white papers, bulletins, macro reports, you know, from the normal process of research digestion, I would just sort of earmark certain things or highlight things to come back to for the writing. And just wanted to plug in a couple of sentences. I used to read Kiplinger's a lot. And I always loved that their format used to be kind of like a paragraph at a time. There'd

be a topic and there would just be a little bite-sized deal. Even in my kind of political reading as a National Review subscriber for many years, the first few pages after the table of contents and letters to the editor section, since I was in kindergarten, National Reviews had this little section of just kind of bite-sized bullets that were kind of random musings. And so I did that, and then it ends up covering a number of different topics. And so that's the format here today. It's really easy to do in the written version. As I speak through it right now, you know, there's a kind of embedded discontinuity because I'm jumping from topic to topic. But that's just what it is.

And I'd be curious for your feedback. One of the first things I want to jump through is about quantitative tightening. I think some people have been curious why I'm so convinced the Fed's going to end up needing to chicken out. And it occurs to me that saying things like, well, the liquidity in financial markets that they are taking out, eventually there will be a response and they'll have to stop extracting liquidity from the banking system. That sentence probably makes sense, but it may not really explain what that has to do with quantitative tightening and why and what the different mechanical functions are. And I think that it's useful to explain that last year, as they removed over a trillion dollars, it was a little over a year, they were doing about 80 billion a month. But from the time at which they started, they've gotten 1.2 trillion

off of their balance sheet in this process called quantitative tithing, where they do not roll over bonds that mature. So they allow that level of assets to be removed from the system. And what that really effectively means is less reserves in the banking system. And in this particular case, it can lead to lower money supply. There's other factors leading to lower money supply as well. But one of the things last year I think is unique is it was very much consistent for them to be doing that with their other policy objectives, which were to raise rates. They wanted tightening. So to the extent that there was less money in the banking system, it all worked out well. But why didn't it get more out of hand? We have to remember that the federal government ran a $2 trillion budget deficit. And so the Fed didn't need to be buying any of that. And in fact, was able to be selling or rolling off even while this much new issuance was coming to market to fund the government deficits, because there were buyers for it because of rates being real high. It was an attractive purchase in the private market. And I think this year, the Fed is going to want as a policy objective, lower rates, less tightening. And the Fed, hopefully, excuse me, the federal government, hopefully will be running lower levels of deficits than last year.

So I don't know how the policy objectives will line up with also then tightening. And that's why I think the quantitative tightening ends up hitting ahead, coming to a point of tension where they end up having to kind of wave the white flag. I hope that makes sense. The economy in 23, we got the number this week, the fourth quarter report looks like it's going to come in at real GDP growth of 3.1 annualized. Let's assume they revise that down a little bit. We know it was around 5%. They did revise that down already from Q3. But basically throughout the year, you're going to come in at

this 3.1 for the whole year, real GDP growth, which is just very strong. And it'd be the exact opposite of a recession. Instead of being at what our post-financial crisis trend line has been, about 1.6, you came in almost double that. There's some of it that is still attributable to post-COVID normalization, but not really. I mean, I think at the end of the day, it is a good, strong economic number. And I am more and more convinced that the economic outperformance of 23, and as we get started here into 24, people mystified in the midst of a Fed tightening cycle, why economy's done so well. I really do believe that it speaks to probably where the economy was and was going to be, um, in a continuation of normalcy had COVID not happened. And that COVID from mid, you know, uh, spring of 2020 until whenever you think normalization

started happening, let's say some point in 2022, I think that that represents this footnote in history, this kind of like total timeout from everything normal. And yet the 23 and 24 strength speaks to some of the things that were improving in business competence to a very small degree. I wish it was much more, but in the business sentiment that leads to capital expenditures, certainly an ongoing consumer who is enjoying. And I think there was a policy portfolio around

all this from deregulation, the repatriation of foreign profits that came back and got invested on shore. Obviously, the reduced corporate income rate and incentives, whether it was from opportunity zones or instant expensing, R&D. There was this kind of healthy environment. I think that it created a pretty fertile soil. And I think that's continued and then what's interesting is the thing i'm saying right now how i believe it upsets people because am i saying the policies during 2017 and 2019 helped create a pretty reasonably decent economic environment i am and some people won't like that because who was president then and then am i saying that right now the economy 23 and 24 in this aspect of economic growth and what we call output is pretty

good i am and there's other people don't like it because of who's president now so i can't help either of those people where i'm clearly not saying anything partisan because i'm saying something about two different areas two, two different presidents. But I also don't know objectively how anyone could include anything different. I'm going to move on now because I'm getting bored with that topic. The China slowdown in 23, that was supposed to be a China warm up of 23. It's been talked about a lot in my white paper and the failed prediction about the China COVID reopening boosting economic growth in China last year. My friend Louis Gob is an economist at Golf Cal Research and brilliant guy.

Eventually, Western governments shut down and encouraged workers to stay home and not work. And then they paid them not to work or to barely work. And then we reopened and there was a good size, a minority, but a good size minority that were like, we like this not working thing. So they continue to not work. Then that created a shortage of laborers that then shot wages up. That wages going higher means more spending. And so there was this kind of instant response function, reaction function in the markets, in the economy. And it explains a quick economic response in the COVID reopening. But see, China didn't pay people not to work.

And so then all of a sudden they go back and there's all these migrants returning to cities for work and wages dropped. And so I think it was a kind of opposite response. And it happened, of course, in concert with their distress in the construction sector. You know, obviously, the oil demand did not boost way higher because there was less industrial activity in China. And that all worked together to put downward pressure. Look, there's a lot of factors you could play in. But as far as explanations go that seek to touch all comers, I think, Louis, this explanation is as good as one you'll hear. Now, there is a growth story playing out in China, by the way.

We talk so much about declining trade, declining exports. And yet there's one sector, one industry that's indisputably growing. They're boosting market share. Their domestic demand and sales are up. Their exports both to the U.S., but especially even neighboring and trading partner countries is huge. And that is the electric vehicle market, a large growth sector. And yet their electric vehicle sector got killed in terms of stock prices. Why? Why are all these fundamental things seem to be going so well?

Well, with rising sales, with rising exports, with rising market share, how do you end up with declining stock prices? Well, the batteries become obsolete, have to be replaced. It stunts people wanting to invest, knowing a new battery is coming in a few years. There's very limited parking supply in the cities of China and almost no parking supply that has adequate charging. It's just a very complicated space. And then you add to it the shipping costs that erode margins. If you're going to be an exporter of electric vehicles, in some cases, their electric vehicles are quite cheap and shipping costs are quite high. And so as a percentage of the total price, it becomes a really big obstacle and hindrance and margin.

And I just think sometimes an investable thesis requires more than just the shiny part. OK, so a little sneak preview about some of my takeaways from Washington, D.C. This week, before I went, I had breakfast on Monday with the gentleman I believe for over 35 years has been the most astute political observer, pundit, I pay a great deal for his subscription research commentary now and hold him in high regard, even though we are some different political beliefs, but he's a very astute observer. I had a lunch in D.C. Wednesday that brought a lot of this stuff up with a staffer in one of the presidential campaigns, a senior advisor. And then I attended a symposium Thursday that had Barack Obama's campaign manager,

Donald Trump's campaign manager from 2016, and the head of a third party advocacy group. So you had like a lot of really significant input this week. And it would be easy to come out of all this with all this inspiration and ideas and information and make a prediction. But I don't think I have any better prediction on what's going to happen in November right now than I did before the week began, although I might have a little more perspective on what I think some of the causative factors one way or

the other will end up being. But here's the prediction I will make in my crystal ball that has nothing to do with who ends up winning what election. After the 2024 election, my prediction is that deficits are not coming down, that spending is not coming down, that austerity is not on the horizon, that entitlement reform and reduction in national debt is not coming and that accommodative monetary policy into the future will be needed to support the fiscal policy I believe is coming regardless of who wins the election. You are welcome to write that prediction down. Back to China, we have not been big investors in China throughout my career, even our emerging markets exposure, which has always been a somewhat minimal aspect of our portfolio allocation. But nevertheless, when we've had a

high growth aspiration in, but it's been decidedly underweight in China for a long time based on our desire to feed domestic demand, where China is, of course, more of an export oriented economy. But I think that right now, US investors continue to steer clear of China, even for different reasons than what our perspective has always been. I think it centers more around fear of what the CCP may do next, the overall seeming negative attitude towards their private sector, towards public equities, the internet sector, high profile CEOs, fear of policy regulations coming out of nowhere. Obviously, economic analysis about China's own economic strength and the deflationary mess I think they find

themselves in. And then the geopolitical risks, the Taiwan stuff, their support of Russia, the US's own growing adversarialness. These are things I think have just kept the sentiment rather low, and I think it all makes sense. I want to briefly cover the definition of the risk-free rate. I talk about it a lot where it's a very important concept in investment finance that there is something called a risk-free asset that is used as a benchmark or a baseline to measure other assets against. It's the opportunity cost.

I could get X risk-free, So anything I do that is not X, I have to weigh the return outlook and the risk outlook against this risk-free rate. And if an asset was risk-free and going to generate 4% and another asset was risk-free, but going to generate five, you would say, okay, well, this is a great deal, but it wouldn't happen.

But if you say, okay, well, it's going to generate seven, but it has a little more risk. That's where this, the whole entire calculation of risk and reward that we do for a living at the Bonson Group, that's what it's all about. And I want to be clear that I just believe a 90 day T-bill, an ultra short term government bond instrument is what I mean by a risk-free rate. You could look at a money market fund. You could look at a 90-day T-bill as my preference. But when people start talking about 10-year treasury, it is risk-free in terms of par value maturity, but it's obviously not risk-free in duration risk. As interest rates go up and down, there's price fluctuation, and there's interest rate risk of it going one way or the other

that affects the value and the reinvestment value. And then there's currency risk. Even though those of us buying something short term, if we're buying in dollars, getting back dollars, you don't have that over 10 years. There's any number of things with a longer timeline that happen to the currency. But I think a better way of putting it is that it just gives 10 years for a central bank to do all kinds of things in intervening with monetary policy. And that the number one thing I fear is that distortions from a central bank into the price of money can create a certain economic benefit short term, but they cannot do so without a less visible economic problem.

They alter the risk free measurement. They alter our ability to measure the risk and reward. And I think that's an important concept to understand. You know, at the end of the day, people that love an artificially low rate, I just will always want to remind them. And this is the final tidbit I'll share here. And I'll let you go to dividendcafe.com for a couple others, because I didn't get to all of them. And I'm up against a timeline. The artificially low rates crush savings. They disincentivize savings. What over time erodes savings means it erodes investments because S

equals I. Savings equals investing. Investment because investing can never come before there are saved dollars. So less saved dollars means less invested dollars. And investment is where, of course, you get the productivity that leads to economic growth. Ergo, artificially low rates, a rate of interest below the structural growth rate of the economy erodes savings, which erodes investment, which erodes economic growth. So it feels in the short-term visible like it's boosting economic growth. In the long-term invisible, it's erodes economic growth. So it feels in the short-term visible, like it's boosting economic growth, and the long-term invisible is eroding economic growth. That's an economic lesson that nobody could ever, ever, ever understand enough. Once you think you've mastered it, reread it. Teach it to your kids and grandkids and pets, because we're living in it, and it's an incredibly important idea. Those are my musings through Wall Street this week.

I appreciate you bearing with me, and I appreciate you being a listener and a viewer of the Dividend Cafe. And we hope you'll be back with us next week. Please share this far and wide. Thanks for listening and watching and reading the Dividend Cafe. The Bonson Group is a group of investment professionals for listening and watching and reading The Dividend Cafe. Thank you. 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. Such data and information are subject to change without notice. This document was created for

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