The Dividend Cafe - Calling All Investors Who Want Income

Episode Date: February 12, 2021

I do some fun things today in the Dividend Cafe. We dive deep into the dilemma facing income investors, those who want and need cash flow from their portfolio. It is a conversation that can (and does) go in a number of different directions. I hope you find it riveting. And we talk a bit about bubbles, about history, about market fads and market risk … And of course, we look at the present economy and make some bets on where things are going. I hope it will prove informative for you. A lot of topics that somehow are all loosely connected to one another, in this week’s Dividend Cafe. Links mentioned in this episode: 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. Hello and welcome to another Dividend Cafe podcast and video. It's kind of fun to see more people watching the videos. I don't know what is causing that. I just know what is not causing it, which is anything to do with my face. I have a few things we're going to talk about today, as opposed to kind of sticking on to kind of one topic. I think that what I'm going to delve into

this week in a lot of ways does flow out of what we talked about last week regarding that discussion of where we are right now in equity markets with growth, with value, how we came about becoming dividend growth investors, why we think dividend growth investing is a remedy to the dilemmas that are embedded in both what people call the growth side and the value side. And so, you know, I've really enjoyed that discussion. I got a lot of great feedback from the little two-parter we did on that. And this week, I kind of want to elaborate on that in a different, in a more specific venue, which is the venue or the objective of income-oriented investors, those who are needing to generate cash flow

from their portfolio and what the current world looks like to those people. And then there's some things that kind of flow out of it right now in the present environment I'm going to talk about. So I'm going to do my best to let this podcast kind of track where I went with this week's Dividend Cafe, which I have printed here. And I, as always, encourage you to read it. And I always say the same reasons, which is because there's charts at DividendCafe.com that I believe are really useful. And a couple of the charts that I'm going to go into this week are particularly, I think, significant. That's why I would love for you to go look at that. think significant that's why i would love for you to to go look at that but the the first chart by the way um i could walk through right now what what it means it what what it captures that i

think is relevant to the stuff i want to talk about uh you recall last year when the pandemic struck that obviously we went through this huge risk offoff moment. And so naturally, you know, bonds go way up as people flee into safety, meaning treasury bonds, and that pushes the yields way down. And I don't know if you remember or not, but the 30-year, okay, not the 10-year, the 30-year treasury almost got down to 1%. The 10-year did get down to 0.5%.

It spent much of the last year at that 0.7, 0.8 range. It's right now, a full year later, with the economy, you know, 70% to 80% reopened with many of the economic metrics back to pre-pandemic levels. Not all, but many. In fact, most, to be honest. The 10-year is all the way back to just over 1%. And the 30-year is not quite at 2%. It's about 1.9. And that's with just really significant recovery and movement higher in these bond yields.

recovery and movement higher in these bond yields. Inversely, the equity market, the S&P 500 last year, when it dropped 36% in 31 days, the yield had gone up to like 2.4, 2.5%. And now with all the recovery, not to mention a really poor environment for a lot of those S&P companies with dividend growth, either because of dividend cuts, dividend suspensions, or just a lack of dividend increases. But primarily because of the price movement higher of equity market recovery, the S&P is yielding less than 1.5%. So you have a tale of two stories. A year ago, bond yields were going lower, equity yields were going higher. Now, a year later, with a much more normalized world,

everyone could be celebrating equity markets recovery and prices. But again, you have an equity yield that is at below one and a half percent, and you have a treasury yield that is below 2%. And that's for a 30-year treasury. And so what I am trying to suggest here is that this is all at once, first of all, reflecting a lot of what I think are the tensions in the investing world. of what I think are the tensions in the investing world. And that is that equity prices are high, multiples are high, valuations are high, there's risk, people are concerned,

and that treasury bonds aren't paying much. And at the same time, people need income. So you already have the dilemmas I talked about a week ago and two weeks ago. And yet, if we just simply eliminate the conversation about what valuations look like, where growth and momentum are risky or maybe aren't risky, what the relative advantages are with this kind of school of thought called growth and school of thought called value, my remedy to that is to really do our very best to have our cake and eat it too. Avoid popularity contests, avoid momentum-oriented

fads, avoid the presumption that what just got done happening will continue to happen, avoid value traps where you believe things have gotten too good to be true when in reality there could be a systemic or embedded problem and focus on really good companies that are in fact at valuation do you think are reasonable as evidenced by the yields that they're offering you in the form of cash flow that they return to their shareholders and by the way they return that cash flow to shareholders because they actually value their shareholders. All those things are repeats not only of what I've talked about the last couple weeks, but what we've built our entire business

at the Bonson Group around, what we do on behalf of our clients, and what is my governing, well, it is an investment ideology, but it's also something I've dedicated my life to, something I believe in tooth and nail. Okay, well, you have a specific microcosm of investors, and our microcosm, by our estimation, somewhere around half of investors. You know, these are

kind of anecdotal observations. But I think there's roughly about half investors that are investing for some future need of cash flow, and half that are investing for a current need of cash flow. And I just got done telling you what the lay of the land is, not because we're about to go into a pandemic environment, but having come kind of out of much of the pandemic environment, coming out of an equity market recovery. Now, it isn't like you go, OK, well, once the S&P heals, then we'll look at like, OK, the S&P is healed and then some by 500 points better than what I would have considered healing. I've told this story before that I recall at some point

a month or so after all the COVID stuff that reading a JP Morgan analyst saying, we think the S&P could get back to 3,400 by Q1 of 2021. And me just saying, nah, I mean, that would be unbelievable. It was almost like, God, let's hope so. And then the fact that we got to 3,900 in the beginning of Q1, you know, it's incredible. But listen, I do believe there's a solution for yield-starved investors. It doesn't require doing something stupid.

The number one solution that people will pursue, besides those of you that are listening to this podcast and watching this video, is people will lie to themselves and either say, I can just get the cash flow I need off of selling off securities piece by piece because they're going to be doing nothing but going higher and I don't need a cash flow. I don't need a yield. I'll get the yield by just monetizing month by month these permanently increasing prices. Okay, well, that's a disaster waiting to happen. And even if the prices do end up going higher, it's a disaster waiting to happen because they don't go higher in concert with your cash flow need. And you put yourself at risk of negative compounding and all the stuff I've written about extensively.

But what a lot of people do is go find a big juicy yield because they need it and just tell themselves that there isn't risk in it. Like, well, I know that the Fed has Fed funds rate at 0%, and I know treasuries are paying 0.1% short-term and 1% long-term. I know muni bonds are paying 0.25% short-term, but I found this thing that's 8% and it's good. There's no reason it's 8%. I'm just kind of smart and I found it, or I'm lucky and I found it, or whatever. It's not good. Now, by the way, an 8% investment might be a great investment, but it's an 8% investment because it has some risk involved with it,

a great investment, but it's an 8% investment because it has some risk involved with it, some volatility, some factor that is driving the yield higher. My suggestion is that there are three areas in which those who want real sustainable cash flows that matter from a portfolio, and I'm defining that for our purposes today as something between four and six percent, I believe that there is the spectrum of credit, which is fixed income, but not in what we call boring bonds, the treasuries and high-grade municipals, but things that have a little more risk associated with them because the underlying instrument requires a sort of fundamental business condition to perform. And so when I talk about credit, I'm talking about high yield bonds, which is debt issued from corporations that are below investment grade in the credit quality.

I'm looking at the levered loan market, which is bank loans that are securitized and sold off as bonds. And I'm looking at structured credit, which is pools of bonds tied to an underlying asset, whether it be mortgages on residences, whether it be mortgages on commercial property, whether it be asseted securities, meaning bonds that are connected to a pool of student loans or a pool of car loans or a pool of credit card loans, all the securitized assets. So these things are juicier. They can be really money-good assets, but they have some volatility. They pay a fixed coupon. It's not unlimited upside. And then they mature at a par value. So it's not unlimited upside in the price and it's not unlimited upside in the income.

It's fixed income and it's a fixed return at principal. But that yield is juicier, not lighter, because of the underlying risks that are associated with the asset class. And I think that complementing a core portfolio with credit is a way to juice up some income. And we believe in the way that we're getting exposed into those asset classes. I also believe in the alternative sphere, that there's a lot going on that's income generative. And we are really trying to capture that through a whole number of things we're doing. And we like private markets right now. Private credit can be very cash flow generative.

Middle markets lending. First lien loans into the middle markets is a really, really juicy asset class. I think we did very well in last year. We're very aggressive with it this year. Real estate, of course, is often very income generative, and there's various managed real estate strategies that are focused on high cash flow. So the alternative space is a way that we can get income. It's going to have less liquidity,

and it is going to have different risks than traditional stock or bond markets. You're going to be more relying on the return of the manager than the asset class. It's very low beta, very low correlation of stock and bonds, but then you do have the risk of the underlying manager and execution success and things like that. But my belief then, if you want the best of all worlds, that I will talk about what the downside is because there is no free lunch. What I would be recommending for people who need income generation in this environment

as a core strategy is the thing that does have daily liquidity like credit does but alternatives don't, does have tax efficiency like really neither credit nor alternatives do, that does have unlimited upside in price like credit doesn't and alternatives somewhat do, that does have unlimited movement higher in the yield like credit does not and alternatives do not so you get growth of income growth of asset price liquidity tax efficiency and here's the real kicker all tied to very well-run companies that are generating their cash flow from operating earnings. That is, of course, dividend growth. What all sounds too good to be true,

you check all the boxes that neither credit nor alternatives check, all the boxes, they check some, they check different ones, they don't check all of them, and you're saying dividend growth does. But see, dividend growth is equities. They go up and down, they go down a lot. In certain periods of time, you still have to suffer through equity market volatility. And you say, well, I would like four to five, 6% income, and I would like no volatility at all. And anyone listening to this knows what I'm going to say, so I apologize. I don't want to beat the dead horse. But the answer is it doesn't

exist. And all the analogies I've used, I think they're all clever, but I imagine you're sick of them, you know, about really, really delicious ice cream that you can eat all you want. It doesn't have calories or whatever. You get the idea. So I can't do anything about it for people to say my remedy is to lie to myself. I'd rather pretend that there is this risk-free 7% yield out there. It is what it is. I will always tell the truth to my clients to the extent that some people that listen to Diven Cafe are not clients. I'm going to say the truth as well. I don't have the same fiduciary

obligation to you that I do to clients. But I want you to understand that this is an intensely important issue right now. And that it not only enables people to not have to guess on the right side of are we in a bubble or not? Or is it too frothy with some of the tech stuff or not? Or does this IPO stuff or SPAC stuff or Bitcoin stuff or whatever mean anything. Here's the bottom line. I want to paint both sides of it, okay? And this is why I had to bring my reading glasses because some of these things I want to share with you. There's a chart at Dermot Cafe about the volume higher of call options. Call options are people using the derivative market

to buy something they think is going to go higher. When you buy a call, you're bullish on what you're buying. You think it's going to go a lot higher. You can get a lot of leverage in the trade. People buy call options on indexes, like a whole stock market index. They can buy call options on individual securities. And all of a sudden, call option volume is kind of going like this, and then it's going like this.

Like it's just parabolically moved higher all of a sudden. That's a concern. But then I believe it's worth pointing out that the forward yield of the top 50 companies in the S&P 500 right now is about 24 times earnings, which is expensive, but it was about 30 times earnings in 1999 as we went into what became the tech crash. So I can't say that we haven't peaked, that we've peaked or whatnot. You know, you could really still have another blow off top in some of those things. The problem was, and this is one of my favorite charts that we've included here in Doing Cafe, I'm going to talk talk about a second the problem is

that when something is in a bubble you you you have a very hard time knowing it until the bubble burst you can look backwards and say oh yeah that was a bubble now no one will feel that way once it burst they'll always look back and go, oh, it was so obvious the Florida condo thing in 2006 and the Orange County housing thing was a joke. And it was. And the dot-com stuff in 1999 was a joke. But people did not feel that way at the time. There is always a need in the moment to rationalize it why it's okay why it actually makes sense why it's different this time and the reason that i chose a chart of japanese real estate

to make a point is because back in 1989 there wasn't a man woman or child on the planet who was saying, ah, this seems a little crazy. Everyone was just talking like this was the new normal. People were petrified of it. Japanese investors were using some of this huge influx of capital formation going on because of what was a bubble forming in their economy and real estate. They were buying Rockefeller Center in New York City.

They were buying Pebble Beach in New York City. They were buying Pebble Beach in Northern California. All of this stuff was happening. The housing market in Japan crashed and went down 50% and it's now been 30 years. And guess what? It's still down 50%. This is the stuff that I do have to think about. I have to take the possibility of manias and bubbles seriously because of that dynamic. And you can say, oh, come on, the Japanese role is so different. But is it? I mean, what makes it different? The intensity of conviction that people had into it was no different um the the fact that there it wasn't um unpopular it was wildly popular and and it wasn't also not like a thing without foreign investors and we're us and we're smarter or something stupid like that we have our dot-com

bubble that is every bit as horrific in fact the economic carnage down was far worse our own housing bubble i mean it brought the world economy to its knees there's a lot that goes into that besides housing the credit behind it all was the real issue there but my point is disconnection from price and reality is a very common thing and it's not just the three or four examples I've used here today it's 500 years old because it's embedded in human nature it's not going to go away I believe that investing for a solution that tries to reasonably insulate one from the violence of bubbles bursting and certain manias is a prudent thing to do is not something to be embarrassed about i'm not embarrassed about it

i also believe that when the fear of a bubble doesn't materialize and a bubble get blows up a bit bigger and i'm not referring to like fANG right now. I mean, those things are expensive stocks, but those are real companies. Okay. I think they're way too expensive and I think they will correct and reprice at some point, but that's not the same thing as a bubble where there's something without underlying value or it's just wildly disconnected from reality. There's a bunch of other examples there. And all these things are maybe symptomatic of the same underlying issue, which is excessive overconfidence, excessive exuberance, excessive euphoria around something that is totally, completely unsustainable. And I guess you could stir all that pot together.

But my point is I think that dividend growth can enable people and combine it with credit, combine it with alternatives on the safety side of one's portfolio, combine it with boring bonds. And on the greed side of one's portfolio, implement growth enhancement to take advantage of the themes that you believe are long-term, really high growth oriented, where it is appropriate to your own risk tolerance. All of those things, I think, make perfect sense. But when you look at the cash flow need, the current cash flow need a lot of people have, you just have to understand this is not going away. The market is recovered 40% and the yield is at 1.4, 1.5%. The treasury

bonds have doubled from where their low yields were. And on the 10 year, it's paying 1%. In the 30 year, it's not quite even paying 2%. They're not going to be an easy way to get income. And I have to manage the risk level for each individual client, turning knobs up and down, you know, to make things very suitable. That's all the advisors of the Bonson Group do is to go seek out the appropriate scenario for each individual client. But when I look to the questions about, you know, is this a bubble? Is this not a bubble? Is this expensive? Is not expensive? How do we, by the way, I still need cashflow. I still am going to need cashflow in a few years down the line. I'm trying to suggest

a way of looking at things that I think is far more sensible. I've kind of run out of time. So I'll skip over this last piece real quickly, but just to tell you that I do think the chart of the week is important about the notion of things are all-time highs. People can even look at dividend growth stocks and say, well, this is at all-time highs. I feel a little concerned. that for all of you who resisted the temptation to buy that very weak and weird argument, I congratulate you for all 289 times that we've hit an all-time high since 2013 and that you did not allow that to disrupt a successful investment philosophy. We have a lot of cash floating around right now. We have $1.5 trillion more in personal savings.

There's charts about that and Dividend Cafe as well and commentary about that. And we have goods, the amount of goods being bought in the economy that's back up to pre-pandemic levels. But services are nowhere near back. And a lot of money that people have saved and vaccines that are getting out there. And I am really respectful of those who disagree with my pent-up demand theory because they could be right. There's smart people that don't agree with me on this.

But I'm really, I have a high conviction about this thesis. I believe anecdotally, my study of history, my understanding of the American psychology, and then the economics of all the cash that's built up and all the services that demand for has not come back online yet. I think you're going to see a lot of pent-up demand and that cash floating around is going to get deployed in there. So there is still a lot of good things ahead for this economy, in my opinion. And I'd like to be invested in the things that are going to do well with that, that it's not already priced in for. And I'd like to measure that around dividend growth. And mechanically, I'd like to be able to pay people the yields that they need to meet their

financial cash flow needs. And I think that the sort of stew that has all the ingredients in it that we need to account for is the stew I've talked about here today with dividend growth supplemented with credit and income alternatives and things of that nature. So a lot to chew on here. A lot of underneath the hood understanding of our investment philosophy applied into real life money management that's what we do uh i hope i haven't gone too into the weeds and this stuff but i'll let you guys give me feedback if you're so inclined thank you as always i have a big announcement coming out next week on wednesday i will leave you in suspense on that for a reason there is a a holiday on Monday the 15th.

So there will be no DC today on Monday, but there will be Tuesday, Wednesday, Thursday. And then we'll have another Dividend Cafe on Friday. And actually next Saturday, I fly back to New York City for a couple weeks. So I've been out here in California. By next week, it'll have been three weeks, and I'll go do a couple weeks out in our New York office. But yeah, next week will be a reasonably normal week. Special announcement Wednesday. D.C. today, middle of the week,

and enjoy this three-day weekend ahead. Thank you so much, as always, for listening to and viewing the Dividend Cafe. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, Dividend Cafe. This is not an offer to buy or sell securities. No investment process is free of risk. There is no guarantee that the investment process or investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors. 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 informational purposes only. The opinions expressed are solely those of the Bonson Group and do not represent those of Hightower Advisors LLC or any of its affiliates. Hightower Advisors do not provide tax or legal advice.

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