The Dividend Cafe - Confidence in the Future

Episode Date: November 19, 2021

This week I did something a little unique. I dedicate the Dividend Cafe to the topics du jour in the space of prices, labor, production, and the Fed – basically, all the stuff everyone is talking about (and should be talking about). But rather than it seeming like a single, monolithic essay on it all, I think I have it broken up into bite-sized pieces that will be easier to understand and take in. We live in interesting times, and if this week’s Dividend Cafe helps you to understand these times better than you did before reading it, I will be a happy man. Let’s dive in and see if that happens. 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 this week's Dividend Cafe. It's kind of our last normal Dividend Cafe video and podcast we'll do until the week after Thanksgiving. I do want to come to you next week with a short dividend cafe on our Thanksgiving reflections. But from a market standpoint, there's quite a bit to talk about this week. What I won't be talking about is the updates with the reconciliation bill that the House voted on this morning and passed. Obviously, it's not really much of a story because now is where the fun really starts

going to the Senate, which is where we've known most of those conflicts are. Markets itself, there's not a whole lot to say kind of about this week. I think that the big things that are on most people's minds that are actual students of the economy and are mostly curious about where things go from here are all in the same vein about inflation, about the price level, about the supply constraints in the economy, about labor, about Fed policy, and all these things sort of intersect to some degree. And that's really the subject of this week's Dividend Cafe. I think that there are short-term and longer-term issues that I would hope people who regularly listen to or watch or especially read the Dividend Cafe know how I feel about.

Diven Cafe know how I feel about that longer term there is absolutely no question that the great things that occupy my mind and how I steward capital for my clients center around the excessive indebtedness in the society and its ramifications to long-term growth and the policy prescriptions to deal with that constrained growth, both fiscal policy and monetary policy, that I think invite further complications, including sometimes exacerbating the low-growth problem that they're intended to address. So you have this negative feedback loop that has become kind of the story of global economics and how one gets return on investment and return on capital in a period of growing stagnation in the economy is a very complicated thing and one that I'm incredibly committed to as a long-term fiduciary advisor of clients.

as a long-term fiduciary advisor of clients. In the shorter term right now, I think that there are more people focused understandably on what they see right in front of them, which is tremendous disruptions in our supply chain, tremendous shortages of necessary laborers to help increase the level of supply needed to meet current levels of demand, to help increase the level of supply needed to meet current levels of demand,

and the escalating prices that come with that conundrum. And so both things are true at once. In the shorter term, there are supply-induced upward price pressures that are very real and relevant to economic actors. And longer term, there is a fear of stagnation that is very concerning to me. When we talk about the transitory nature of price increases, there's a couple things I want to say and I want to start with energy because I think that that is a different story than what is happening with some of the other aspects of growing prices, particularly in raw materials and other commodity prices. Look, allegedly people would say we had like

negative $40 oil at one point during the COVID pandemic. I've already explained over the, you know, months that followed that that was a bit of a misstatement that had to do with at the time futures contracts expiring and there not being a place to store oil and so people were actually having to pay to get rid of oil so it prints as if it's a negative price but it had to do with basically storage costs. But regardless, oil prices very sustainably collapsed behind a total erosion of demand that took place during the COVID lockdowns. And now here we are a year and a half later with WTI crude somewhere around $80

and natural gas somewhere around $5 to $6. And so both prices are substantially lower than they were in the early part of last decade. And both prices are significantly higher than they were at their low points of a year ago. And even their kind of five-year average, they've been sitting more somewhere around $50 to $60, not 75 to 85. I think that there is very little that's going to prove transitory about oil and gas prices for a number of reasons. I don't know that we're going to see over $100 oil. I think that if we did, it would be immediately remedied by the political emergency of the moment

but I don't think that we're going to go sustainably lower than 70 you know that you could get to back to the 50s for a period of time but really the only thing I see that could bring that supply and demand into a price equilibrium that resulted in a $50 oil price anytime soon is a recession, is some demand shock that was so severe that it didn't bring supply levels up to meet equilibrium. It just brought demand down so substantially. But right now with the normalized demand that we're seeing, not just in a demand recovery, a pent-up demand spike post-COVID, I think that what we're seeing is an undersupply that is a result of some political factors and a result of economic decision-making when prices were so low that

there is a lag in our ability to get production prices higher. And I just do not believe there's an easy way around that. And in the meantime, capital allocation has not exactly helped the cause because of this huge movement for decarbonization. Some people could be very for the idea environmentally. Other people could be against it. But out of the various decarbon pressures, you had a reallocation of capital that has resulted in underinvestment into increasing supply. And if demand is going to stay level or grow and prices are where they are, to get prices into a lower and more favorable

equilibrium with demand would require higher supply. And that's just simply not in the cards right now from a political standpoint, from a public sentiment standpoint, let alone from a capital allocation standpoint. So I don't think you want another COVID lockdown or global recession. That's not the way to create lower prices, but that's the only thing I think creates lower prices

on the energy front. But then you look to other parts of the economy and I think it's a different story. The labor shortages that exist I believe are very problematic and yet I'm not sure that there's an easy solution. Is it three weeks? Is it six months? I really don't know. I do know as I I've written about before, that there's a heavy concentration of decreased labor force participation for those 19 to 26 years old and those 55 years old and older. And so you have entry-level people that are less zealous to enter the workforce and you have older people, not necessarily of retirement age, maybe of retirement means, but either way, if they have brought their services off the table in terms of economic use,

it has profound ramifications. You know, I do understand. I'm not immune to it either. The different people's political leanings are likely to inform how they view this subject, that some would be prone to want to use the extended federal unemployment and their criticism of that policy, which, by the way, is a criticism I freely admit I have as an explanation for the entire issue. The ongoing amount of government payments that took place from the past administration into

the new administration throughout the COVID moment. I think right now there is an increasing amount of discussion around whether or not vaccine mandates from certain employers are contributing to the problem. And I would imagine that the way someone feels about that subject might inform the level of intensity they want to ascribe to its role in labor shortages. The fact of the matter is all these things are somewhat un those things, when I can't prove it, I avoid as much as I possibly can as an objective person. I happen to be very, very, very for the vaccine and very, very against vaccine mandates. And yet the role in which vaccine mandates may or may not be exacerbating a diminished interest in the workforce, I simply have no way to measure.

Prima facie, part of it makes sense to me to some degree, but is it 1%, is it 10%? I just don't know. So my point is, regardless of various opinions on aspects of these social components and political components that are contributing economically, what I do know is it's somewhat immeasurable. And anything that can't be proven to be true or proven to be false is kind of unhelpful. I do think that the labor shortage is an extremely complicated subject. It is very much behind a lot of the supply disruptions,

and yet a lot of the things that we say we want to do or could do or should do, we could do tomorrow, and we're not going to get 80,000 truck drivers, 80,000 new truck drivers ready to start driving supply and goods around this country. There is a lag that's going to exist before we find equilibrium. Now, one of the things I want to bring up here is that there's a leverage that laborers have because of the labor shortage that many believe, totally understandably, is going to put downward pressure on profit margins

because increased cost of wages is an input that would drive a diminished level of profitability. The only thing I can say about it is that I pretty much agree in theory, but I'm not so sure about the stickiness of that. agree in theory, but I'm not so sure about the stickiness of that. There's a wild card now that's a bit different than past situations where you have greater digital options, greater technological options, there's greater automation. And I think that the extent to which employers solve for higher labor costs and lower labor supply with non-labor solutions is something we don't know the answer to. I don't imagine any of it can happen very quickly.

But I do think that higher wages are not always necessarily profit suffocating. Higher wages can be a very good thing when they're coming with higher revenue generation, higher productivity but where higher wages are coming because of a labor shortage that is pushing that input price higher than it otherwise would be, I accept the argument it could cut into profitability. And growing productivity is the only solution. And the only way to grow productivity is on the supply side. And I don't know that people are necessarily going to like how that turns up. You have to remember that getting the supply side higher is a little Pollyannish.

No matter how many times I say it and how much I believe it, we have gone almost two years, not quite, it's over 18 months and less than 24 months, where I think there's been very, very little investment into new factories and new oil wells and new R&D and the things that would help right now if they could hit a switch and say, let's get going, we need more supply. I think that through the COVID moment, there was not exactly the right incentive or capacity for increasing production. And therefore, seeing it now ramp up is going to take some time. Those that would advocate for the Fed to come in

and solve things as a monetary solution, I think have to understand, I have been, I got to figure out 20 additions of Dividend Cafe this year that were devoted to my criticisms of certain aspects of Fed policy, including quantitative easing and certain distortions I think they create in the marketplace that make things challenging for investors. And yet, even as a critic of QE, I would objectively say that if they stopped all QE tomorrow, I would objectively say that if they stopped all QE tomorrow, no tapering, they just cut cold turkey, I don't think that it would do one iota of good for getting 80,000 new truck

drivers into the marketplace. And so, you know, the Fed's role is different than a lot of people understand right now. And that's not me saying that the Fed is doing nothing wrong. I do believe, as an advocate of the notion of tradeoffs and the reality that there is no free lunch, I think that there is a tradeoff in Fed policy that is a difficult thing to swallow. Very bad result for savers who are living off very low interest rates. Very bad result for banks

that have a really flat yield curve. However, the challenge of greater money supply has not proven to be the cause of this particular problem we face. It's invited other problems. And when those say, well, the long-term bond rates are quite low because of Fed activity, I do think we have to remember that the Fed owns less than 20% of the bond market.

And that is very different than Japan's bond market where they own over 60% and that they represent 100% of new issuance. We have gone through this before three times, QE1, QE2, QE3, where our Fed had been buying a lot of bonds and stopped. And all three times bond yields did not go higher. They actually went lower. But even if they don't go lower this time, there is right now 80% of the bond market with full price discovery that could very well go out and be pushing yields higher. The Fed's buying $80 billion a month of treasuries. It's peanuts compared to the total size of the treasury bond market, which is many tens of trillions of dollars.

And should people be demanding higher rates because of their inflation expectations, they can get those if they wanted to go into market and bid the price of those bonds down and those yields up. But from QE1 through QE3 and the way the bond market itself is behaving now, we're not seeing any of that. I think all of that reinforces that these price escalation concerns we face now are very much related to supply challenges and labor shortages that require a solution and I believe we'll get a solution, but that is in a sort of TBD timing framework.

I wrote last week about the algebraic formula, this money times velocity, the money supply times velocity being one side of the equation and then the prices equaling that money times velocity when they're multiplied by total supply of goods in the economy and so my view is that

prices have gone higher as supply has gone lower to stay in equilibrium to money in that quantity theory of money equation if I've lost you it's okay you could read last week so it's not important right now the thing I want to get to is that I would love to say that one of the upsides of this period of escalating prices we're living through out of this labor shortage and supply disruption is that it will offset some of those disinflationary pressures or economic

stagnation pressures that I refer to as Japanification but fundamentally the incredibly low velocity of money that we experience right now is not changed and so if we do end up getting the supply level back up, I think that brings prices in equilibrium, but it won't do anything for the fact that our money supply is being multiplied against a continually collapsing level of velocity. Why is that velocity of money declining? of money declining again in my mind it is the excessive indebtedness that puts uh future growth into the present and represents a significant headwind to economic opportunity and this is kind of i think the on the the underlying thing that we're dealing with right now is confidence in the future. People do not want to save money for future when they don't have confidence in the future. Savings is the predicate

to investing. You cannot invest a dollar that you didn't first save. This is such an important economic law, such a basic economic statement of fact. Investment first comes from savings. Savings into investment, investment into productivity. One who has optimism for productive growth into the future is more prone to invest, which makes them more prone to save. People are less prone to save when they have less confidence into the future. That is the issue that we deal with that creates a lower velocity, that creates less business investment, and ultimately serves as a stagnation inducing force in the economy is that lost confidence that comes from the dynamic of future growth being suppressed by excessive indebtedness. These are the long-term issues

that we're dealing with, and the shorter-term issues continue to be the supply constraints. And when someone says, well, you can call it short-term, but I don't think it's three weeks, I think it's three years. Someone else says, yeah, I don't think it's three weeks either. I think it could be six months. Everyone's speculating, turning a knob here, a knob there, and nobody knows. And that includes me, includes you. I do think it's not going to be three weeks. And I also do think it's not going to be three years. But beyond that, you know, that's not very helpful. So where does that leave us now? Tremendously important in a period of time that's trying to find its way around productivity that will not be distracted by shiny objects.

The shiny objects are things that are invested in for no other purpose than this sort of economic belief that the price will be higher. sort of economic belief that the price will be higher, that is not tethered to an internal rate of return, to an activity, something that enhances quality of life, something that is a pure financialization that I invest in it because I believe that someone else will pay more for it. And that can go on for a long period of time. But in a period of time where we are attempting to solve for a productivity challenge, it is incredibly important to me that people avoid what could properly be defined as bubble-like behavior, Ponzi-like behavior,

things that extract their economic or investment opportunity from nothing other than the belief that others will find it to be so. And rather find economic investment opportunity in things that deliver an intrinsic value, that deliver an internal rate of return, that represent goods and services and knowledge and ideas that are embedded in in the economy and human activity and building um profit growth and enhancing quality of life so that makes me very skeptical about speculative um uh shiny objects if you will that are more faddish in nature more more tulip-oriented for those who have studied the history of manias. And it makes me much more fond right now, even more fond than I've been,

of production-oriented parts of the economy. The industrial sector, the material sector, the energy sector, there are companies in there that I think might warrant higher weighting when you consider society's growing need for what they're doing. And so the investment applications are being even more skeptical through a period of more temptation about what could be described as bubbles, Ponzi-like speculation, and instead be more focused and even indeed increasing weighting to those things that will have to serve as the engines of a supply-side solution to our current economic travails. I hope this is all helpful.

There is a chart in divinityconvey.com I want you to look at, and then the quote of the week is one of my favorite quotes that I've ever put in DividendCafe.com. And I'll leave you in suspense to try to drive you to look at that. Thank you for listening to this podcast. Thank you for watching this video. I'll come back with some Thanksgiving reflections before Thanksgiving day of next week and then we'll be back on track with a full Dividend Cafe in the beginning of December at the end of that week after Thanksgiving. But reach out to us with any questions you have in the meantime. There's a lot of complexity in these subjects you've probably had to put up with a

little more jargon than I normally like to have, But I do hope I'm helping to give some perspective on what is a complicated world and a complicated economy. And nevertheless, a set of economic challenges and opportunities that are very important for investors. We're going to continue working to that end. We thank you for watching and listening to The Dividend Cafe. Have a wonderful weekend. Fight on. We thank you for watching and listening to The Dividend Cafe. Have a wonderful weekend.

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