The Dividend Cafe - Bookies vs. Pollsters and Your Portfolio - June 17, 2016

Episode Date: June 15, 2016

Bookies vs. Pollsters and Your Portfolio - June 17, 2016 by The Bahnsen Group

Welcome to this week's Dividend Cafe market podcast. Market volatility is back to some degree, though we're a ways away from feeling like it did in January. If anything, the volatility we've seen this last week has been remarkably subdued when you consider the effort the media is going to to scare people about Brexit, when you consider the state of the election, the despicable terrorist attack in Orlando, and even the overall economic picture. We have several weeks to wait for earnings season to begin, so headlines will continue to rule the day for a while more. But this week's podcast will tell you what is actually driving the decisions we're making in your portfolio. There's a lot to say, so let's get into it, starting with an

executive summary of five quick points. Number one, markets experienced reasonable volatility this week around the Brexit vote, which is scheduled for next Thursday, around a weak economic backdrop. Oil prices have dropped a bit. And of course, there's ongoing election anxiety. Our view is that this somewhat subdued volatility, which has begun to intensify, may actually intensify more in the coming weeks. Number two, the way the stock market does in the three months before the election has predicted the outcome in 86% of the presidential election since the 1920s. Take that as you wish, but do check out a chart we have in this week's Dividend Cafe blog entry that may be interesting to you.

century, that may be interesting to you. Number three, the Fed did not raise rates this week, and it looks less likely that they will in July as well. We believe this is making the eventual reckoning around eventual interest rate increases worse. Number four, no, we do not believe Brexit is something to be afraid of, even if the voters do vote in favor of it next week. Number five, there's a lot of sentiment and short position built up against emerging markets. Too much, if you ask us. And index investing sure looks like a lot of volatility for an adequate reward right now in this kind of market environment. for an adequate reward right now in this kind of market environment. In the news this week, a ISIS-driven jihadist terrorist killed 50 people and wounded 50 people in Orlando in what was actually the worst act of terrorism on American soil since 9-11.

Toyota sold $186 million of bonds at a rate of 0.001% to investors. That was the interest rate those bonds were bought at. Yes, investors are basically giving their money to a privately owned car company at no return to them whatsoever just for the privilege of avoiding a negative interest rate in the bank deposit world or government bond world. More and more Brexit polls are showing the race as closer than once thought with several polls actually having those wanting to leave the eurozone as being in the lead now betting market odds say brexit has a 45 chance of passing so still less than half but those odds were just at 22 a week or so ago the vix the measurement of fear around the s&p 500 hit three-month highs on Tuesday. Came off a tad on Wednesday, but then even then kind of moved higher near the end of the day.

This heavy protection buying, which is what the VIX technically is, is heavily focused for the next 30 days, meaning they're buying protection covering a 30-day period of time. So that indicates traders are really perhaps buying relief from the volatility around Brexit. The Fed did not raise rates on Wednesday at their June meeting and in fact increased the likelihood that we will only see one rate hike in 2016. We would add to that if we even see that one. Moving on to CORE, our homemade acronym for what we see happening in capital markets that is relevant to all investors right now around China,

oil, recession fears, and the election. With China, it's certainly interesting to see how China's recent growth stabilization measures have borne fruit only in real estate, but not at all in actual private sector investment. One would hope that using a nation's real estate sector as a means of artificially propping up growth would be a lesson learned from the United States to the negative. But be that as it may, construction increases will likely help the growth number. The overall capital spending continues to decline as the first chart below shows. And the corporate sector, what we consider the real economy, is at the heart of this. So go online and look at these two charts that we referenced.

You'll learn more about the Chinese slowdown. It's not a debatable point that China's growth is slowing. The manner of their landing is the trillion dollar question. One other point real quickly. The yuan is back to January levels against the dollar. Very interesting. By way of oil, it dropped actually five consecutive days beginning late last week. It's dipped from the $51 range to the mid-47s as of this recording.

It is hard to say how much of this is supply-demand fundamentals when in reality the dollar has been strengthening a bit in response to euro and sterling pound weakness, meaning the oil drop is just as likely to be a currency response as anything else. By way of recession fears, there wasn't any particularly heavy U.S. data to point to this week. Painting a picture one way or the other about U.S. economic health, industrial production and manufacturing data came on Wednesday and they were down as expected. But if the Fed was hyper confident about the economy going forward, they would be raising rates. We're just not at this point looking at recessionary conditions. Maybe we should emphasize, though, we're not at this point looking at that. event in Orlando of last weekend. It is interesting to note that those expecting a bump for the Trump campaign in the polls or the betting markets have not seen what they expected. If one wants to have some sort of potential predictor of election results on their side, we might suggest the

stock market itself. 86% is pretty good odds, and 19 of the last 22 presidential elections Have indeed been predicted by what the S&P 500 did in the three months prior to the election We have a chart in our dividend cafe entry this week That that kind of walks through some of that very interesting stuff The questions from readers this week number one was how do you interpret the Fed's actions and statements from their Wednesday meeting where they declined to raise rates. And they made several comments pointing to continued accommodation and monetary policy. We wouldn't say a July rate hike is off the table, but we would say it's pretty darn close. say a July rate hike is off the table, but we would say it's pretty darn close. And our outlook has been all along that they would be telegraphing their next move before making it, and they have

not begun to do so. The Fed is also beginning to talk down how aggressive they see themselves raising rates in 2017 and 2018. They're still predicting a rate that is 1.5% higher than today's 0.25%. But that forecast was for 2% higher than it is now. So in other words, they're kind of telling you that they think they're going to do six interest rate increases over the next two years. That's what they are now forecasting. And prior to that, it had been eight. Remains to be seen what they really do. Our belief in what the Fed should do is the most documented part of our own monetary policy beliefs.

We think this zero-bound short-term interest rate is distorting markets, and simply put, leading to a worse consequence later. But as far as what the Fed will do, we see lower for longer as the continued mantra. Question number two was, is this equity market we're in still considered a bull market? Sure, it is. A bull market does not end until there's been a 20% drop, at which point we've reached what's called a bear market. This historical run that began off of market lows in March of 2009 is technically still in effect. It's lasted 88 months so far. There was a 19.8% drop in the summer of 2011. It didn't last very long, technically didn't quite get to 20%.

And of course, we've had a couple 10% plus drops just in the last year, but there have been 108 closing highs over the last 88 months, 108 days at which the market closed at what was at that point an all-time high. However, the last one of those was all the way back to May 21st, 2015. 21st, 2015. Another reader asked in a single sentence, summarize for me why you're so bothered by negative interest rates around the globe. And I will say just as a preface to this, it's not just negative interest rates, it's all sorts of artificially low interest rates. The answer is that they distort risk relative to the potential return, which inevitably causes a poor allocation of capital. That's the best I can do in one sentence. The fourth question was, do you really believe we have nothing to fear from a potential Brexit, the British exit from the Eurozone? Yes, I really believe that.

It's not because we don't believe a Brexit's possible. As I said, the polls have recently moved. It's certainly not because we don't see the possibility of volatility around such a thing. In other words, the fact that we believe Brexit could happen, and it will likely mean some short-term sell-offs and ripples and media uproar, it doesn't mean we think investors should fear it. We make a pivotal distinction between silly, unfounded short-term volatility, generally coming from poor investor behavior and broad-based confusion over fundamental reality, between that and a real-life basis for fear. The anti-Brexit crowd is doing their best and

will continue to do their best to scare people into voting against it. But the reality is that those are poor and invalid arguments. To quote the great Charles Cobb, I cannot remember a single incident of increased freedom being followed by a sustained decline in living standards. Not one. Final question, how can investors continue to like the United States with our slow growth and political headwinds? Well, listen, risk on, risk off environments can turn in the blink of an eye. And if there's one thing I'm confident in as the chief investment officer at the Bonson Group, our client asset allocations are designed effectively to withstand various reversals around global

appetite for risk. But with that said, those continually confused by the appeal of U.S. investment assets need to remember the reality of what we frequently call TINA, the there is no alternative idea embedded in capital markets. U.S. government bond yields are brutally low, 1.6% on the 10-year treasury yield right now, but they're not negative, which is more than we can say in Germany, Japan, Switzerland. We're in the camp that believes the U.S. will face recessionary pressures down the road, but right now it attracts foreign capital due to the reality of TINA. In the deep end of the pool this week, where we like to explore a little bit more complicated concepts, I like the idea of using this as a resource for MLP updates rather frequently.

We are heavy MLP investors and we've been doing that in the deep end of the pool lately. But as a refresher, the technical definition of MLP is a master limited partnership. It's just simply a tax and legal structure. But when we use the term, we're more practically referencing the oil and gas pipeline sector. One thing that really grabbed my attention this week is the record number of DUCs, drilled but uncompleted wells out there, totaling over 1,000. They're essentially not yet rigged for fracking, but they could be at any time, which would serve as a potentially big catalyst to increased volume. And volume of oil and gas is the mother's milk of the pipeline sector's revenue. We're also watching with great attention the short interest in the MLP sector. It continues to dwindle. The short interest is a reference to the percentage of shares that are owned by

short sellers, those that are betting for the stock prices to decline. In addition to the explanation, this decrease of short interest gives to the continued price strength of the last few weeks. It also shows us what's happened to those betting on the collapse of the whole MLP business model. I mean, all things being equal, we'd still note that MLPs are trading more in concert with energy than interest rates, but for the time being, MLPs are acting healthy and we see a couple positive catalysts still out there. This week's weekly reinforcement of a permanent principle, the real definition of money is purchasing power. One million dollars, if insufficient to buy a burrito, is not more desirable than $100 that could buy 50 burritos.

Everyone intuitively should know this. Currency is not the same as money. It's a product used to exchange money. Money equals purchasing power. The objective of investing is not to create or preserve a fixed dollar amount. It's to facilitate the adequate ability to purchase what one wants with their funds. Therefore, to ignore inflation in defining risk is financial malpractice. From the bowl in us this week, what we like, we've written in recent weeklies about our concerns for high beta emerging markets investments, especially if the dollar were to rally unexpectedly with high magnitude. We stand by that concern, but we want to point out the following as contrarians. The short levels against emerging markets, those betting on emerging

markets going down in price, are very high and very crowded. The sentiment against emerging markets and the crowd that is built up there does not mean that there could not be a meaningful reversal if fundamentals go the other way, but ultimately our real emerging markets desire is to own high quality companies in emerging environments that are trading at attractive valuations, defensible business models, but low leverage to global economic forces. Investing in emerging markets involves some correlation to the whole space, but the whole space may benefit from how many have piled on to the other side.

Now, from the bear in us this week, how bad has it been for generic stock index investors in recent times? The Russell 3000, which is an index of 98% of the US equity market, much bigger than the S&P 500, is unchanged for 18 months, but along the way has had a 14% drop in value, a couple 10% drops, but again, no bigger than 3%. I mean, that's a lot of volatility for essentially a flat return. We believe active management, asset allocation, a tactical determination of your portfolio weightings, sector rotation, and especially the pursuit of above average dividends and growing dividends, they're the way to be invested in equities in times like this.

Generic index holds have a lot of embedded challenges right now. Switching gears outside the world of investments, cybersecurity is no laughing matter. Billions and billions of dollars are being spent fighting against it. Our own Robert Graham, a private wealth advisor on our team at the Bonson Group, has some very useful information on this subject, some best practices that may be of interest to you. Please email us if you would like to get your hands on some of that. We'll also be posting a talk on our YouTube channel about this soon. blog has a chart showing the cost of debt that S&P 500 companies have seen and how that low cost right now is really helping to preserve profit margins. It's an interesting chart to illustrate how Federal Reserve monetary policy and profit margins are working together to have kept stock

prices healthy. We'll close this week with a quote from Frederick Koch, the most glorious and satisfying of all feelings is the feeling of accomplishment. We certainly agree with that at Bonson Group. We live in extraordinary times right now, my friends. As best I can tell, the two most unpopular people in the United States are the two candidates running for president. Countries all over the world are charging people money for the privilege of those people loaning the country's money. What's even crazier, some people actually think that's a good thing for investors. Acts of despicable violence routinely take place from Orlando to Brussels to San Bernardino

to Paris. As part of this war that we've all known has been going for 15 years now. Yet with all that bad news, with all the evil in the world, with all the fear, with all the concern, there exists glimmers of hope, not only in capital markets, but in this overall world, hope for a better tomorrow. The reality is that history has always been the story of a better tomorrow. Progress has been the rule, not the exception. And while we cannot find a resolution to the evils in this world on this side of heaven, we can serve as a constant reminder for our clients that the monetization of free markets is a great opportunity for investors. The management of risk is the burden

we invite on ourselves on your behalf. Thank you for listening to another podcast edition of Dividend Cafe.