The Dividend Cafe - Earnings Season Provides Some Gifts

Episode Date: April 26, 2019

Topics discussed: Sentiment vs. Fundamentals When you pray that past is not prologue Real Estate vs. Stocks in Recession Getting QE right so we can get the next five years right 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. This is David Bonson. I am the Chief Investment Officer and the Managing Partner of the Bonson Group, and we're bringing you our weekly podcast covering oh so many topics. I'm actually recording it just a few minutes here before I'm going to be leaving New York City. I have been here for nearly three weeks and pretty much talking in front of a microphone quite a bit about the subject of dividend growth investing,

largely as a result of the book on dividend growth investing that has just come out that I authored. And now I will be talking about dividend growth investing for the next 20 years, but without a microphone in front of my face, because it's what I talk about all the time. There's no better place to talk about that in the Dividend Cafe. And that's, of course, what we do week by week, where we try to give you a little overview of what is that in the dividend cafe. And that's, of course, what we do week by week, where we try to give you a little overview of what is happening in the markets, what's happening in the global economy, and what our perspective is on all those things and more. And so I, this week, have quite a few things to kind of go through. Um, I'll try to make it quick. There's a little bit more by way of charts this week,

uh, in the dividend cafe, we could commentary. I mean, we always have some, if nothing else, we always have a chart of the week, some weeks who might have, you know, a plethora of them this week, I wouldn't call a plethora, but there's a high enough quantity that I'll encourage you to check out the dividend cafe, uh, But there's a high enough quantity that I'll encourage you to check out the Dividend Cafe website where all those charts will be and you can read through a bit more. But in terms of just the basic overview commentary that those of you who prefer to listen to it in audio form want to get, let me jump into it. Because everything is right now around earnings season and earnings season is a microcosm of what actually matters in markets. Because long-term, earnings are exactly what matter in markets.

45% of companies have now revised their earnings expectations to the upside. So you have this total reversal of all the downside revisions that have been taking place. These revisions are particularly heavy in the energy and the financial sector. Now, it is early enough. I don't want to, you know, draw systemic conclusions of what we've seen so far in earnings season. The fact of the matter is I'm going to do so anyways. an earnings season. The fact of the matter is I'm going to do so anyways. Look, the revisions do tell the story that those downside revisions that were taking place a few months ago now appear to have been really overdone in their downward guidance. And it's interesting because, you know,

January was not exactly ancient history. But 36% of the S&P 500 has reported earnings so far. So there is still two thirds to go. But right now, the total expectation for year over year earnings growth, quarter one this year versus quarter one last year, is now flat, where just a matter of weeks ago, the expectation was for a 2.5% decline, and that itself was better than what had been as much as a 4% or 5% decline. So the ball is moving, and that's a positive thing for equity investors. And in fact, that reversal of downward revisions is very much the reason for market pricing in April. One of the most frustrating debates for me in all of finance is whether or not sentiment trumps fundamentals or vice versa. And there ought not be any debate about the fact that there are certainly periods of time where sentiment completely overwhelms fundamentals. And there also should not be any debate that in the long run,

fundamentals win out. The fundamentals are understood in the context of investor sentiment, but the longer the timeline, the more smoothing of sentiment there is to interpret and apply the fundamentals. Legendary value investor Ben Graham used to say, rather famously now, in the short run, markets are voting machines, and in the long run, they are weighing machines. The relationship between time and the impact of fundamentals on asset performance, particularly stock market performance, is heavily correlated. When you pray that past is not prologue, this is one where you really want to look at the chart I've posted at Dividend Cafe. New home sales, single family, have picked up slowly but surely since 2010, recently arriving back to the level, and slightly above it by the

way, that represents the median level of home sales volume for the last 50 plus years. Now, the rather significant event that took place from 2000-2007, where that level of home sales volume peaked far and above any precedent in history, does not represent a new level to be re-achieved for anyone but the pathologically insane. The reason is not only not necessary, but not good for housing sales volume to re-achieve those levels is because there are not enough people that can afford such. And people buying something they can't afford is actually not good for the economy. Let me know if you need any further explanation on that. And like I said, do check out the chart there. The alternatives refresher we all need. What is the reason we incorporate alternatives into a client portfolio allocation. We create an alternative to equity market volatility,

traditional assets in the portfolio, so as to create zigs and zags that counteract one another and pursue a better risk-adjusted result than we might otherwise find. Therefore, to have an alternative to equities, it behooves one to find alternatives that are actually alternative to equities. High beta in one's hedge fund portfolio may perform well if beta is performing well, but it isn't an alternative to your equity beta to merely mirror it in another form. The objective in intelligent alternative investing is not to beat the market, but to non-correlate to the market, meaning low beta. Seeing the recent tick up in so many hedge funds in their equity beta reinforces as to why this is so important

in alternatives, that selection matters, and that is the dispersion of results. The high, the delta between high performing alternative asset managers and low performing alternative asset managers is massive. You have a certain bandwidth from the best performing to worst performing in kind of traditional equity management. And it's very narrow. There's a lot of room for value to be added, but it's all within a kind of bandwidth that isn't very wide. But when you get into the asset classes of hedge funds and private equity and real estate, it's massive. And so with such a high dispersion of result and so many managers creeping into the

higher beta area, which sort of defies the objective of alternative asset investing, it really makes the argument for manager selection, for due diligence, for ongoing monitoring, strategy oversight, implementation, these things being really value added in the whole process of being an alternative investor. Speaking of real estate, by the way, I love a chart I threw at Dividend Cafe this week about the correlation between real estate and stocks during recessions. It's largely believed to be very low. and our belief and the testimony of history is that the correlation between real estate and stocks can be low at all sorts of normal periods of time, but that during recession, it actually

skyrockets and the two tend to perform very, very close to one another during recessionary periods. But as a chart of the last four recession shows that I put at DividendCafe.com, there is one recession and only one that sort of bucks this trend. And that was the recession post dot com and post 9-11 in the early part of the century. And the correlation was very, very low because real estate did real well and stocks did real poorly in that period. And the reasoning for that is rather clearly now, in hindsight, an outlier and not normative. And that is that you had an unprecedented amount of monetary accommodation, low interest rates, a total collapse of underwriting standards, heavy securitization of mortgage-backed securities, infinite access to mortgage credit, all those events that we

know about now that became the kindling to the financial crisis, they managed to years earlier help real estate skirt that one recession. Until it didn't. The bubble formed, the bubble burst, and we know what happened. I will argue that that one incident was clearly an exception and not the rule, and that the general rule of thumb of real estate being a highly correlated asset class of stocks during recessionary periods remains in effect. Our emerging market thesis is emerging. Look, a tighter U.S. financial policy framework in 2018, a tighter monetary policy that was combined with threats to global trade, served to hit emerging markets with a pretty heavy punch. And since both of those catalysts are theoretically in the opposite

stage of where they were, let's say, six to 12 months ago, it warrants a look at the asset class, emerging markets, stocks, bonds, and currency, because monetary policy expectations are now much more accommodative, and valuations are well off their lows of four to five months ago. But in emerging markets, they do remain very competitive, very attractive, especially relative to other risk asset historical levels. Getting QE right. creating inflation as critics fear that the buildup of excess reserves was a backdoor way to monetize the debt and that it would boost asset prices and economic activity, which would boost the overall price level in the economy, what we call inflation. I've long argued that the majority of inflationistas were not so much getting something wrong

as they were just actually not understanding what QE really was to begin with. The combination of zero interest rate policy and three rounds of quantitative easing did not serve to increase the money supply. It did not serve to raise the price level. Rather, it created a low cost of capital that depressed returns on savings and stimulated corporate borrowing. This was not only inflationary, but arguably disinflationary. But the problem is that the low cost of funds did more than stimulate activity in the corporate sector. It also enabled additional government spending that crowded out the private sector, which is a disinflationary activity. It benefited struggling companies, which compressed the margins of their stronger competitors, a disinflationary activity. And most of all,

by enabling further government borrowing, created more debt. Debt is a drag on growth, and dragging growth is disinflationary. More than anything else, the many years of aggressive monetary policy we saw post-crisis served to exacerbate misallocations of capital and sovereign nations as opposed to consumers and home borrowers, but the challenge is the same nonetheless. Our positioning ought not be in trying to guess when we switch from deflation to inflation, something no one seems to have done remotely well, but rather in finding investments driven by cash flows and pricing power, which weather either season well and do not depend on monetary assistance to thrive. Politics and money real quick. Joe Biden, former vice president, has announced he's entering the race in the crowded Democratic

primary. Name recognition alone will keep him at the top of the field, at least for a little while. We'll see how early fundraising goes. I'm going to hold off comment on what a Biden candidacy might look like just to kind of see how his initial couple of weeks go in the campaign. A really, really good chart of the week at Dividend Cafe talking about cap rates in real estate and their spread versus treasuries and what that's looked like historically and where we are now. So I'm going to leave things there in this week's Dividend Cafe podcast. I'm going to remind the Dividend Cafe podcast listeners that our sister podcast, Advice and Insights,

is right now going through a series on my new book on dividend growth investing, each podcast being about 15 minutes long, covering two chapters of the book per podcast, where I just go through and discuss the content of the book. I read some excerpts and I think it gives people that are more fans of the audio absorption of content, a way to kind of participate with the book without reading it. So advice and insights, just do a search in your podcast listener and you'll find that. And it's a hopefully fruitful discussion of dividend growth investing at our advice and insights podcast. Thank you for listening to this week's Dividend

Cafe podcast. We look forward to coming back to you next week with yet another. And in the meantime, reach out with any questions. from an advisor to 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. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance. This 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 opinion, news, research, analyses, prices, or other information contained in this research is provided as general market commentary. It does not constitute investment advice. Thank you. 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 solely those of the team and do not represent those of Hightower Advisors LLC or any of its affiliates.