The Dividend Cafe - Dividend Cafe - Happy New Year Edition 2019

Episode Date: January 4, 2019

Topics discussed: Fear of a Melt-Up?? Yield Curve Inversion and Recession Risk Are Computers to Blame? Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Hello and welcome to this week's Dividend Cafe podcast. And with that, welcome to 2019 and happy new year. I'm sure for many investors, getting out of 2018 is fine. What 2019 will hold is sure to be the subject of a lot of punditry analysis and forecast in the weeks ahead including from yours truly looking forward to bringing our 2019 forecast to you next week at our advice and insights podcast but there are a few other nuggets I want to cover this week here at the dividend cafe and so even though the 2018 comprehensive recap analysis

is not going to be available till next week, it just, you know, it takes me more than 48 hours to do all I want to do. Next week will be a better week for it as well, because I think a lot of people are still finishing up their holiday week and vacationing and so forth. But, you know, I want to get everyone fired up for 2019 and give you a feel for where we stand about the economy and global investment markets. So welcome to the new year. Let's pick it back up and kind of give you a rundown of what exactly took place this sort of abridged market week. As I'm sitting here speaking now on Thursday, getting ready to go to press, the market's down close to 400 points. It was up about 265 on Monday.

We were closed on Tuesday. And then it was down 400 on Wednesday and came all the way back and ended up about 50. So, you know, this huge 800, excuse me, 450 point net swing. Look, so as we stand now, we're kind of even on the week maybe down a little bit something like that and who knows what happens from now this is sort of what we're used to for a variety of reasons um that i can very easily unpack for you but the fact of matter is you don't have any stability in the markets when you're down a few hundred to believe you're going to stay down a few hundred you could pile on another 400 points down or you could reverse back 400. And that's sort of the

nature of a lot of what's going on in the current technical craziness. But look, none of the major questions that actually matter have been answered. The Fed, China, oil prices, earning season is not going to launch in terms of the fourth quarter results for a couple more weeks. So I don't expect any real clarity or calmness anytime soon. Let me cheat a little bit about next week's recap of 2018 and just kind of, you know, give you the mental note to make. The S&P ended, the S&P 500 stock market index ended 2018 down on the year 6.2%. The Dow ended the year down 5.6%. So pretty close response in those two market indices. In December alone, those two major market indexes were down 9%. So both entered the last month of the year up a few percent and closed the year down about 5 or 6 percent, over 6 percent.

So it gives you an idea what the kind of bloodbath was that we had in December. But interestingly, the bond market actually did end up in positive territory. The aggregate bond index just by 0.1% ended positive. And that's an index that blends treasuries, investment grade corporate bonds and agency mortgage bonds, which is like your Fannie and Freddie type bonds. So they barely avoided a negative return. So what you have is an index that was positive in stocks most of the year going negative in December and an index that was negative most of the year going positive in December. And it's funny, I talked about, I think it was a week or two ago, about how it had been 50 years since you had had a negative return in both the Treasury bond and the S&P 500 since 1969.

And then yet again, we avoided it. That kind of indicates how hard it is to do that. But all the relevant details, particulars, subsets, and so forth of 2018 will be covered at greater length next week. Now, let me talk to you real quickly about the volatility in the market. In 2017, we had eight days all year where the market was up or down more than 1%. In December of 2018, we had nine days. For all of 2018, we had 64 days. So eight times more days year over year with a 1% move up or down in the market, up or down volatility. Gives you an idea of how low the 2017 volatility was and how much more normal and intense the 2018

volatility was. Now, equity investors who just lived through the fourth quarter, and particularly December, are probably not remotely thinking about a violent reversal to the upside in equity markets. They may be hoping for it, but they're not holding their breath. They're maybe just hoping for some degree of stabilization and maybe some modest movement in a better direction. And our base case is certainly not for a melt up in equities and stocks anytime soon. But is the possibility of such a thing ridiculous? It's not probable, but it's certainly not ridiculous. And I want you to consider the following macro possibilities. Number one, a Fed that announces a dramatic swing towards dovishness, primarily centered around a pause on their balance sheet reduction program.

Number two, a sweeping substantial globally received trade deal with China. And number three, a flood of capital that comes into the business sector, a flood of capital spending that drives productivity growth. How each of these things are more likely to play out in 2019 and how we want to be positioned around potential tailwinds and headwinds will be covered in next week's sweeping discussion of the same. But a melt-up is certainly on the list of possible 2019 actions, although I think all three of the above catalysts would be needed to spark such. At thedividendcafe.com this week, we have a chart that I think is pretty powerful at indicating how low the chances of an imminent recession are.

Borrowing from a study from the New York Fed, Estrella and Trubin had done many years ago, and applying that methodology, Goldman Sachs has done a really interesting report on yield curve inversion and why the odds right now of an imminent recession are very low. You'll have to look at the chart to see it. Let me ask you a question. heard in the press or around just various sources of chatter, the idea that the computers are responsible for this recent market sell-off and enhanced volatility, that algorithmic or high frequency trading is at the heart of what's happened in capital markets last few months. Because I hear it all the time and I worry that people are taking this more seriously than they should be. I don't intend to give the subject a lot of attention in the time, and I worry that people are taking this more seriously than they should be.

I don't intend to give the subject a lot of attention in the annual white paper I'm working on. Now, look, on those days of accelerated selling or buying, where markets do seem to lose connection to the real world, I'm quite certain that computer trading exacerbates what's already a highly volatile environment. exacerbates what's already a highly volatile environment. I think more so it's the heavy volume of ETF ownership, exchange traded funds, that make for self-fulfilling prophecies within markets. You know, the need to have to go create more cells to meet redemption needs and create more buys to meet purchase needs. It's something that technologically and technically and mechanically always catches up with itself, but can create some anomalies in the real time. But do I think, in a more sustained way, that computers are distorting values and actual prices for long-term investors? I do not. Not until provided far better proof than what's been offered so far.

So far, what we get is very long on rhetoric and short on evidence. This much should be said, though. Whatever inefficiencies or potential problems may be exacerbated by algorithmic trading are not likely understood or foreseen by regulators, whether it be for a sustained period of time or for a day or even for just minutes. Any disruption to capital markets is a disruption to capitalism, and it should be addressed. Disciplined investors are removed from the risks of computer-driven dislocations by nature of their timeline and process. But that certainly does not mean any systemic risks

building up in our technological evolutions should not be addressed. If you ever needed a reminder that markets exist to provide the deepest embarrassment to the greatest number of people possible, consider the following. Treasuries are flooding the markets right now, 23% of all fixed income debt outstanding, as larger U.S. deficits need to be covered with even greater Treasury supply. And at the same time, the three largest holders of U.S. Treasuries, the Fed, China, and Japan, are either shrinking their holdings, in the Fed's case, or not buying a greater amount, China and Japan. And what has been the response to this rather concerning development? Well, Treasury prices have rallied

and interest rates have actually collapsed, so go figure. The fact of the matter is supply, demand, and balances are but one factor in treasury bond pricing, and growth and inflation expectations matter a lot. Now, this is not to say that we forecast rates to stay this low all through 2019. We do not, but it is a reinforcement that capital markets are complicated. They possess third and fourth order effects that are hard to forecast and are never to be taken at face value. The chart of the week in divinacafe.com gives you the S&P 500 broken out quarter by quarter. And you can see the different up and down movements of the market throughout the year and then what happened at the end of December there and so forth.

So check that out. But then more importantly, next week, a lot of really heavy content coming to you to recap everything 2018, look back on our forecast and positions of last year, and then provide the same for 2019 and give you our sort of intellectual framework for what we're doing on behalf of client portfolios going into 2019. So with that said, let me leave it there. Back to the volatile market we go. Have a wonderful first weekend of 2019.

We look forward to coming to you next week with more from the Dividend Cafe. with more from the Dividend Cafe. Thank you. All data and information referenced herein are from sources believed to be reliable. Any opinion, news, research, analyses, prices, or other information contained in this research is provided as general market commentary. It does not constitute investment advice. The team at Hightower should not be in any way liable for claims and make no express or implied representations or warranties as to the accuracy or completeness of the data 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 team and do not represent those of Hightower Advisors LLC or any of its affiliates.