The Dividend Cafe - Dividends, Energy, and Crypto

Episode Date: July 23, 2021

I do something a little different in this week’s Dividend Cafe – I cover three topics, and pretty separate ones from one another at that. In my mind they are all connected – but lots of things are connected in my mind that may not make sense to others. In this case, I see them as distinct topics yet connected in the sense that they all are part of our investment worldview at The Bahnsen Group. The challenges to dividend growth in index investing, the particulars around the Energy sector in 2021, and the inconvenient truths about bitcoin – these are three separate topics, but they are all topics we have thoroughly developed beliefs about, beliefs that are an off-shoot of our foundation. And we dive into some COVID stuff that is alone worth the price of admission – chart-filled and everything! So view it as one topic with over-arching connectivity, or a three separate topic week, but either way, this is a Dividend Cafe you will be glad you read. 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 video and podcast. I have a few different things I want to talk to you about today. It won't be a particularly long one. I think I've gone pretty long the last few weeks, but I kind of went in a few different directions with Dividend Cafe this week. And they're all intertwined to some degree, but I don't think the way that they're connected is readily apparent other than maybe inside of my own head. So let me kind of get into it and see

if these takeaways are helpful for you. I think all three are, even if not connected, even if just independent of one another, helpful and important investment reminders. And that is, after all, why we're doing this. OK, a chart hit my desk this week that kind of blew me away, which was the income year over year from the S&P 500 is currently on a trailing 12-month basis down 1.6%. And that's sort of the byproduct of a lot of the dividend cuts that took place and dividend suspensions that took place out of COVID. Then you were feeling those cuts and suspensions by summer and into fall.

And so now we're in this heavy 12-month trail period where there was a reduction in income out of the S&P 500. And you also, in the same chart, see that the growth of the dividends in the S&P, even though it had always been positive since the financial crisis until this last year when it actually went below zero, it has been declining pretty much every year. The rate of growth of income coming from the S&P 500 has been declining every year since the post-crisis rebound back in 2010 and going in 2011, around that period. The thing that makes that most striking is not just that you've been getting a declining rate of growth in the S&P 500. It's not even just that you actually got income reduction

in this last year. And it's not even just that the current yield for someone who comes in and buys the S&P 500 right now is 1.27%, which is basically within a couple basis points of exactly what the 10-year government treasury yield is. So you have very low yield. You've had an incident of negative year-over-year growth of income. And you've had declining rate of growth of income. And so all three of those things are noteworthy. And none of those are even the thing I think is most striking, which is that this declining growth

in the percentage of income one's receiving as an S&P 500 investor comes at a time that the profit growth has been record setting. They're coming out of the financial crisis. The profits out of the S&P 500 have more than tripled, they will soon hit the actual quadruple level from their low number, their trough post-crisis, to their current number. We're very close to about four times in terms of what the aggregated profits are. And yet, you have a declining rate of growth of those profits being distributed. So you would think that best case, you would still be getting, or excuse me, worst case, you'd still be getting profit growth and dividend growth in line with

one another. How do you get growing profit growth as a percentage and declining dividend growth as a percentage? Well, the answer is obviously it's math that companies are distributing less of their profits to shareholders. And generally, as profits are growing, you get scale where there's the ability to distribute not just more profits because you made more profits, but a higher percentage of the profits because less of the base money is needed for additional working capital, for debt reduction, for M&A, for the various things that one may fund with after-tax profits. And so I think that this speaks to a phenomena taking place throughout much of the S&P that is very problematic, which is less concerned with returning capital shareholders and more interested in stock buybacks. And that's at a period of time where the S&P has exploded in price.

And so therefore, deciding to elevate what money you want to put in the stock buybacks right at a time that prices are much higher, valuations are much higher, not lower, when it would be more opportunistic to do that, when shareholders could actually benefit from them doing that more dramatically. Now, one could say, and they'd be right, they haven't really returned that much of the stock buybacks to shareholders, because most of the buybacks have really gone to offset employee compensation, executive compensation, stock option exercises, restricted stock grants, things like that. And people would be right. But then that undercuts the other argument, which is, oh, they're not returning capital to you by dividends because

they're returning capital to you by shareholders, by stock buybacks. They're not returning capital by stock buybacks. And if they are, it seems to me it's being done less opportunistically. And so you're kind of damned if you do, damned if you don't there, right? My view is that this all speaks a very low yield right now, a declining year-over-year income, a declining percentage of dividend growth, and doing all this while they are basically walking into a misallocation of capital. By not returning more to shareholders when profits are at their juiciest, they're setting themselves up for what is historically, time and time again, proven to be wealth erosive M&A and other such misallocation of capital decisions.

It all speaks to me to the primary need for a very intentional approach to dividend growth. And even with good intentions, those intentions then have to be followed up with the appropriate levels of research, due diligence, and execution of wisdom. But indexing is by definition, the absence of research, due diligence, and execution. The whole value proposition of indexing is removing those things from the process. And I think that's fine. In a period of a robust, rising tide, lifting all boats, bull market, I think indexing, you don't need that research, due diligence, and execution.

And yet, for the dividend growth investor, the reality is that those things are vital to avoid decline of income, to sustain a growth of income that is at or above the profit growth level. Having a dividend growth level that is there with the profit growth is necessary not only to monetize the shareholder, to reward the shareholder, to feed our bank accounts for withdrawers, or to feed our dividend reinvestment, our share repurchase reinvestment for accumulators. It's there because it speaks to the whole integrity of the process of companies that have a mindset of being aligned with shareholders, of rewarding shareholders.

So I do think that this entire exercise speaks to the vital importance of active management around dividend growth, of a process, an intentional commitment, and the ability to execute with wisdom. Now, another thing struck me about dividend realities out of the index this week, which was that the energy sector, I'm using as an example right now, because it's the most extreme mathematically, is 2.3% of the entire S&P 500. And yet it accounts for 8.5% of the dividends that are paid from the S&P, where then inversely technology is about 28% of the index, and yet accounts for maybe 17% of the total dividends. And really, you have four of the five largest technology, excuse me, three of the five largest technology companies that pay no dividend whatsoever and that are massive contributors to the index, the cap

weighting. So what's my point here? Well, time and time again, you see certain higher income, higher dividend sectors, financials, utilities that have a lower weighting in the sector but make up a higher percentage of the dividends from the index, that's because that misweighting is not a misweighting. It's by design. The construction, the methodology of the index is based on higher weighting to these higher capitalization sectors. Well, how can you avoid that disconnect with something in your portfolio being 2% but then it's kicking off 8% of your income, you can overweight the thing that's 2%. And it's going to increase that

income or wherever the sector may be. The index forfeits the ability, an index investor forfeits the ability to do that, to make that active decision that could be opportunistic for their dividend growth aspiration. So there's charts in DividendCafe.com this week that reinforce this. But I think, again, it's not just my undying religious worldview commitment to dividend growth, but it's the commitment to how that worldview cannot be optimized apart from the active approach that we, of course, swear by. I'll close quickly with a couple other things.

Absolutely, straight from the Federal Reserve, fundamentally crucial chart at dividendcafe.com this week about the break-even price of crude oil for the bulk of our U.S. shale producers. You have oil that was at $35 nine months ago that went to $79 a few weeks ago. It's right now $71, $72. And you have break-evens that are in the mid-40s to high-40s now, the bulk of the Permian Basin and the Eagleford. And you do have break-evens in some other shale regions as high as the mid-50s. But the mid-50s used to be the lowest end, and you had places that could barely make money in

the high 60s. So anytime oil got into a certain range of oscillating, rigs had to go off. People start losing money. They had to get in front of it. We have a margin now that not only do I think oil is incredibly profitable on the margin at $60, forget the $71, $72 right now, but I can make an argument it's more profitable because demand goes higher at the lower prices. And so you may have a lower margin, but you have more volume accumulating more profits. This is a technological breakthrough that has led to, first of all, much cleaner emissions

out of the shale industry, but also much more profitability. That's a more important consideration. When you think about where cash flows are going to be in the midstream sector, the pipelines that transport it, and in the upstream sector, those that are exploring and producing and drilling, you are going to see break-even points continue coming down. And that is, to me, the unique value proposition right now. The energy sector is not just where the price of oil happens to be at this point in time. We've now created a cushion. I do want to, though, also take a moment to talk about COVID. And even though that's what the daily writings of DC Today are

really for, and even though I honestly do not believe what I'm about to say is necessary to say in the current environment, I think it may be helpful to a lot of you to hear it. And I particularly think those of you that go to dividendcafe.com to see some of the charts I've put up are going to feel this a little bit more substantively. The reason I say it shouldn't be necessary is that we really are now testing the point of ridiculousness at how emphatically clear it is that the market and the economy have seen through to a completely different level the realities of COVID for a long, long time. And I think most of us thought, even those who are most inclined to keep this COVID conversation going and a lot of the number tracking. And in a lot of cases, I think it was sensationalistic fear mongering.

And in other cases, it could have been totally well intentioned. But nevertheless, you just have seen the market time and time and time and time and time again continue to shrug off what has been now a year-long obsession with cases. And there have been periods of time where cases were growing and then hospitalizations and mortalities followed. Everyone can have different opinions on what the proper policy response would have been out of that. But I think that at any point in which there was concern that our hospital system was going to become overwhelmed, that becomes a potential market story and obviously a societal story, and same thing around the mortalities.

But to the extent that then the number and the focus has stayed with case growth and allowed that to be treated as a story in and of itself, not as a potential precursor to a real story, but just the mere existence of cases has been one of the most disingenuous and inaccurate, and I think in a lot of cases, explicitly dishonest parts of COVID coverage for a long time. So right now, as we see a mostly, not entirely, but mostly vaccinated or naturally immunized adult population in the United States, and then you are seeing some spread of this Delta variant primarily with unvaccinated people or with younger people who are barely showing any symptoms whatsoever, and you see a pattern of so ever. And you see a pattern of virtually no movement at all in severity. And severity being a combination of hospitalization at an ICU level or, God forbid, mortalities. Well, one of the

things I did in Divin Cafe is try to explain, see, I don't believe the case number has mattered for a year. But people could totally disagree with me about that. It's not going to hurt my feelings. But what I've done at Dividend Cafe with the charts is show the levels of vaccinations for those who are most vulnerable from the coronavirus and why, to the extent that there are people unvaccinated and there's concern about Delta variant, it is so disproportionately with the younger and less vulnerable part of the population that this trend of growing cases and not growing mortalities is going to continue. Because the fact of the matter is that the people most likely to die from COVID have mostly been vaccinated,, God forbid, had previously already achieved, had COVID. And of course, we had all the awful fatalities last year and in the beginning part

of this year. So you do have real numerical support for where the vaccine levels are very different by age group, reinforced even at the nursing homes. Now, all the resurgence in COVID and a total lack of change at the nursing homes and in severity and particularly mortality. Look, I think that the fear would be, is this going to impact states reopening and so forth? And I don't think I can do much if there is going to be a bad policy response in different places. I'm skeptical that there will be. There may be a bad policy response that's pretty marginal and superficial in token. There's a lot of people that love token responses that are not very productive. But when you're looking at a 93.8% state reopening level in terms of economic

reopening activity, I don't think that there's any appetite to go back on that. And I don't think there's any science that suggests that it's going to help. And I think that it also is not going to lead to really extreme levels of human tragedy because of the fact that we have more successfully protected the more vulnerable in the population. People can have different opinions on the policy response stuff and all of that. My point is to talk about the market, talk about the economy, and why the market has time and time again said, oh, we just saw five clickbait, everyone's going to die headlines, and the market went up 230 points. What's going on? The reason is that the market has known what apparently has not been allowed to really soak into public consciousness for a very long time. And that is that the fatality rate is much lower than feared, the vulnerable much more identifiable than feared.

And yes, those two things, by the way, are the good things. The bad thing is that it's been more infectious than feared, than hoped. However, that infectiousness that has led to more people getting COVID has not led to those things like hospitals being overrun and that worst case fatality level that would have ended up having that economic and market impact. So to the extent that I don't expect this chatter to die down anytime soon, I think there are people who have an incentive to keep the conversation going. And that conversation primarily, to the extent it borrows on data points,

some of them might be lies, some of them might be totally misunderstood or manufactured, but a lot of them won't be. But they will be data that is being used without proper context. And that is cases devoid of the real severities and mortalities and ICU-sustained hospitalizations. So no one listens to Dividend Cafe for medical advice, nor should they.

But to the extent this overlaps with the entire narrative going on right now in the market, I thought it was important to dip into. So OK, we've covered dividend growth. We've covered the energy sector. We've covered the current COVID delta discussion. And then the final thing that I discussed this week is Bitcoin, 55% drop from peak to trough, and that's fine. It's gone way up, way down. A lot of people are content with the highly volatile and speculative nature of it. My only point was to say that the theses for ownership have largely centered around inflation fears, inflation, government failures, crazy erratic behavior from policymakers.

So now in this period of time, you have the highest deficits in history, the highest total aggregated national debt in history, the highest new spending bills passed in history, the highest new spending bills being proposed in history. And this massive amount of monetary stimulus, at the same time, the Bitcoin's collapsing 55%. When inflation has been discussed in the last three months, I've talked 1,000 times about how I don't agree with all the discussions on inflation. And I think a lot of the inflation discussions have lacked proper nuance and context. But my point is, this has been the great inflation scare

of the last few decades for a lot of people. And Bitcoin has dropped 55%. So I have no opinion at all what it does next, because I don't have any opinion on what any speculative asset does next. I don't have any opinion on what any speculative asset does next. But to the extent one has viewed Bitcoin as this hedge against crazy government policy and inflation fears, it just doesn't seem that those things have aligned. So anyways, that's my take. I've covered a lot of different ground this week. I like every now and then doing Dividend Cafe where I get to jump around the court a little bit.

Usually, I'm all focused here in one lane. But this has been kind of fun. So I'm going to leave it there. I hope you've enjoyed dividend cafe. I hope you're going to rate us, rank us, spread the word and all those good things. But in the meantime, have a wonderful weekend. Reach out if we can do anything whatsoever. Thank you for listening to and watching the dividend cafe. 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 services are offered through Hightower Advisors LLC. This is not an offer to buy or sell securities.

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