The Dividend Cafe - Current State of Affairs

Episode Date: October 6, 2023

Today's Post - https://bahnsen.co/3LS40QV On August 1 of this year the Dow Jones Industrial Average closed at 35,630. As of press time this morning, just a tad over two months later, it is trading just below 33,000. This is a -7.5% drop in about nine weeks, which we will discuss more in today’s Dividend Cafe. If -7.5% in nine weeks doesn’t seem like that big of a deal, it’s because it isn’t. However, what I didn’t mention is that almost all of that drop has been in the last three weeks (-6% of the -7.5%). The Nasdaq has fared a tad worse with similar timing in the numbers – a peak at the end of July, a slow drip down since, with an accelerated downturn the last few week. The right thing for me to do in this period is probably not write about it. By addressing it I enter the unavoidable territory of contradicting best behavioral practices around market downturns. And yet we exist to offer perspective, point-of-view, commentary, and conviction, and so to not address key market or economic activity would also be problematic. The reality is that a -5% or -7% drop in markets (or more, for that matter) is a par for the course, standard, status quo, always-to-be-expected part of equity investing. I shouldn’t (and won’t today) write as if it is an urgency or source of panic in any investor’s life. The behavioral realities around market volatility should (and will be today) constantly reinforced. And at the same time, there are particulars in this stage of the cycle that I think are worth unpacking. So today’s Dividend Cafe does it all today – it holds in tension the two things I most struggle with on these pages: the macro commentary of current events, and the behavioral wisdom of how not to react to such. Let’s jump in to the Dividend Cafe … 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. It has been quite a wild ride in markets and I wanted to spend just a few minutes with you today to talk about why that has been, what's going on, and just a few thoughts around it. You know, you look at, I want to set up a little context here to explain the tension that I'm very purposely holding as a wealth advisor. The Dow closed at the beginning of August at 35,630. When I began writing the Dividend Cafe this morning, it had gone below 33,000. It ended up going from down a few hundred to up a few hundred. And as I'm recording right now, we're up by 250 points on the day.

And so who knows where we'll end up closing on the day. You've already had a 500 or 600 point swing intraday, but the percentages don't move that much. You're talking about roughly a twenty five hundred point net drop in the Dow in the last two months. And that's about seven and a half percent. But six percent of that is in the last three weeks. And all at once, this is a no big deal status quo, historically far, far, far more common than not. In fact, kind of muted if the total downside within the year of the market were to only end up being around this level, 6%, 7%, 8%. It's generally even more. That is all true and warrants some comment. And at the same time, three weeks of a down 6%, NASDAQ even a little bit more, lots of vulnerability in the overall economic story, questions about what oil prices and bond yields could do. It's clearly more than a headline, more than just a little hype. In fact, it really serves, I think, to highlight

how silly some of the things the financial media does to draw hype and clicks and sensationalism around other stories because here you're talking about things that are obviously more economically complex, have more potential significance, and it's almost like the media doesn't know what to do with it compared to the normal things that occupy some of the scare tactics and clickbait and whatnot. But I want to unpack exactly why this is happening, what I think it means, what I think investors can and can't do about it. So no, a three-week period of markets down 5% or something like that, that shouldn't warrant a dividend cafe. But there are things happening right now that are in

our vein of interest when it is so connected to monetary policy. And this macroeconomic focus, when it dovetails into monetary, is kind of my area of interest. And then it does allow us to do what we're supposed to be doing with Dividend Cafe, which is provide those behavioral reminders about what is really the best thing for an investor to do and not do in some of these various situations like the one we're in now and certainly will be in others in the future. I did say this already in DC today, last Monday. And so I'm repeating it on purpose because sometimes I think just pure redundancy. I try not to do that whole say something 10, 12, 15 times to get someone to remember it thing. But I think three times is probably enough. And I'm not even good at doing

that. You know, I don't like to hear myself repeat things enough that it makes me keep myself from repeating things for you. And probably I should be repeating more. But in this case, why are bond yields going higher? Why are bond yields going higher? That's the question. Why is the long end of the bond yield curve going higher? It doesn't make sense to say it's because the Fed funds rate has gone higher. The Fed funds rate has stayed flat for the last two meetings.

They have not raised the target. And yet the long end has gone higher and higher. And you could say, well, because expectations are going to keep it higher longer. That could play in. But why are the expectations that they're going to keep it higher longer? That's one of the six reasons. So the six reasons, without me getting real elaborate with this right now, is number one, I believe the impact of quantitative tightening is really starting to have a big impact. It's taking away a marginal buyer of bonds, replacing a non-economic buyer, a non-yield sensitive buyer with a very economic buyer, a very yield sensitive buyer,

meaning individuals, households, banks, companies that are buying treasuries, regular investors. They want yield. Central banks don't care about yield. A lot of foreign governments don't care about yield. It's a currency reserve. But when you're talking about regular people, they want higher yield. It's pushed yields higher with the Fed being now a trillion dollars removed from the long end of the bond curve. Quantitative tightening, the surprise additions to the budget deficit, repricing the fact that the U.S. has not gone into recession. In fact, the jobs report today, another 336,000 jobs created in the month of September.

Japan's yield curve changes, having a global impact around global bond yields. Declining Chinese exports. This is a big deal. Less dollars that are being paid to foreign governments that then have to be replaced into treasuries. They're by taking away like the quantitative tightening does with the Fed. Declining Chinese exports leads to less foreign ownership or foreign purchase of treasury issuance. And then finally, the basis trade, which is a more technical thing having to do with the repo market and having to do with hedge funds getting a little funky between cash market and futures market of treasuries. Six different things. funky between cash market and futures market of treasuries. Six different things. Primarily,

I think it's the repricing about recession and quantitative tightening. Those two things are the top of the list. But there is the rate and then there is the rate. And I don't think that we're really dealing with a five and a quarter Fed funds rate. That's the policy rate. They've left it there. That's what is in our society, the primary benchmark around policies to influence or target monetary conditions. The Fed themselves commissioned the creation of something called the proxy funds rate.

It's managed, overseen out of the San Francisco Fed. They put it right up on the website. I have a chart in Dividend Cafe today, straight from the Fed. This is not me interpreting the data, creating the data, or getting all my economic friends together for us to put our theoretical stuff around it. This is their model. And models always can be imperfect, but the point being their data says that the effective rate, what they call the proxy funds rate, if you were to really see what is the impact into the current Fed funds and around economic applications from treasury rates to mortgage rates to bond spreads, credit spreads, and a number of other factors. There's 12 variables that go into this altogether. The proxy funds rate is at 7%.

That means you're getting 150 basis points of tightening above the target rate. I am not giving you inside information. I don't think it's talked about a lot. The media would cause their viewers to lose their eyeballs if they tried to get into this. But this is not between David Bonson and Dividend Cafe listeners. The Fed knows this too. around the fact that, A, bad, the real monetary tightening is 150 basis points worse than the already severe monetary tightening of 525, 550, the current Fed funds target. That's the bad. But then the other side is, well, is that 150 basis points spread in the proxy rate, doing that tightening for the Fed and actually accelerating

the point to which the Fed ends up reversing this period, certainly allowing the rationale for not hiking further and then eventually allowing the Fed to reverse out of current conditions. Who's supposed to answer that question? It's not me. It's not them. It's not anyone else. No one knows. But that really is a two-headed question right now. That what is the impact of the actual higher monetary tightening than we really see in the Fed funds rate, this proxy rate delta of tighter monetary conditions that is real life. What is the difficulty that gets created from that versus what accelerates some form of unexpected future monetary capitulation?

I think that has to be on the table in the way we analyze this. I wrote about this in a summer Dividend Cafe. One of the challenges to the Fed who wanted to create some economic slowdown, as they believe that being part of their anti-inflation mandate, was that there was a significant amount of the tightening wasn't really hurting the corporate sector. There wasn't defaults at any problematic pace. There wasn't a big source of illiquidity because they more or less had a large maturity wall. The levered loan market, so the bond market, obviously in the residential mortgage market, a lot of people, we've talked about this, had fixed mortgages

or had borrowed at least five, seven, 10 years at much lower rates. So that created up until 2024, 25, a period where people were still kind of living off of the prior, more accommodative monetary regime. Yet, even without defaults and even without a lot of credit impairment, you, A, were certainly stopping activity of new borrowing at the higher rates. We've seen the kind of freeze that's taking place in the residential real estate market. And for new project construction, new project development in commercial real estate, it's pretty much come to a total standstill. Private credit can do an awful lot of capital project investment, put permanent financing, but does very, very little in terms of brand new ground up development. So you have a lack of activity in both residential and commercial. And then you have forward looking

concern about the default cycle. Does the Fed stay so tight that then you do get massive credit impairment into 24, 25 and that train coming at you? The problem with predicting a train coming at you and saying, look, I think all this stuff's going to happen in a year. I want to make an action now, is that train could stop tomorrow. That train could go the other way tomorrow. And as I joke in Divot Cafe, that train could get out and ask you to jump on and give you a first class ticket and some free food and beverage. Okay.

There is so many bad things that could happen and so many good things that could happen. And it is all rooted in this instability of the monetary and fiscal insanity that has been beget us, that has beget us. I'm saying that wrong. I'm not going to correct it. All of this is happening with one other wild card I want to throw out there. Oil prices, in addition to bond yields, become not a tradable thing, not a speculative thing, not a short-term thing. I don't care about any of that. Oil prices on speculators, when it goes from $80 to $90 in a month or when it goes from $90 to $70 in a month, that stuff is not what I'm referring to. I'm talking about price levels that go and hold at a place. They have huge economic impact.

And if you were to go and hold below $60, you probably are in a recession. And if you were to go and hold below $75 but above $60, you probably have a real sweet environment of benefit to consumer, benefit to economic margins, and without indicating some significant demand erosion. If you were to hold right here around the 80s to 90s, it's more questionable. If you hold above 100, you're very likely going to usher in a significant recession, create massive inflationary pressures, so forth and so on. But I mean, hold it as in a month. And that's the problem is right now you have a literal war going on,

you have a country, I'm talking about ours, that has the ability to be the marginal producer of oil that is chosen not to be around cultural pressures. You have OPEC Plus, who is the marginal producer, that essentially has grown tired of settling accounts with the marginal buyer that gets to denominate in their currency. There are a number of factors, cross-currents, that could very well put and hold lasting upward pressure on oil. And yet any kind of recessionary indications could put lasting pressure downward on oil. And how those things are supposed to be priced in is beyond me. So the instability in bond yields and what to expect and where exactly that train coming at us about higher yields and where it goes. Can you have three months, four months, one year, a very limited new activity in housing or very limited new project development, commercial real estate?

Yes, you can. Can it go on for a year and a half, two years? No, no. At some point, you know, this thing is facing a fork in the road. And I believe that investors who are trying to guess those things, what insanity in fiscal and monetary will come from the other insanity of fiscal and monetary is a fool's errand. And it's not just that I don't think investors can predict it. I don't think the people in charge of it can predict it. I don't think they have any idea. And I believe that the best possible path towards portfolio success with this current regime is to as much

as possible be insulated from those moments, recognizing the upside and downside risks that exist, that bond yields could reverse and totally reprice risk assets. Things could get worse before they get better. But all within a month, you've had utility stocks get hammered. You've had the long end of the bond curve fly higher with yields pushing bond prices down. So holders of bonds have gotten hit, but buyers of new bonds curve fly higher with yields pushing bond prices down. So holders of bonds have gotten hit, but buyers of new bonds now really like the yields. You get enough of that,

it's self-fulfilling prophecy, we'll start pushing yields down, prices higher. There is just simply no way to be able to guess in the coming weeks and months where this will shake out. But there is a very profitable, productive, rewarding agnosticism around that which we ought to be agnostic about found in dividend growth. And I think that with discounting mechanisms like markets, the trains that everyone knows about generally do not run over you. That is the good news. The bad news is there are always trains no one sees. And my view is that dividend growth is your ticket to the optimal destination. Thanks for listening.

Thanks for watching. Thanks for reading The Dividend Cafe. I will be in New York next week bringing you another Dividend Cafe. And I look forward to whatever questions you may have from this episode. Take care and have a wonderful weekend. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, member FINRA and SIPC, with Hightower Advisors LLC, a registered investment advisor with the SEC. Securities are offered through Hightower Securities LLC. Advisory I'm Matt Levin. performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors. All data and information referenced herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this

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