The Dividend Cafe - Excited About Dividends

Episode Date: February 15, 2019

Topics discussed: Earnings Watch 2019 Capex Watch 2019 Truth About Tax Reform Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Well, hello and welcome to this week's Dividend Cafe podcast. This is David Bonson. I'm the Chief Investment Officer of the Bonson Group. And we are bringing you our weekly podcast with our best thoughts around everything market, economy, and investment related down in the Dividend Cafe. We do encourage you, if you're interested in a little elaborated treatment of the tax reform, the impact on tax revenues, the impact on the cost to taxpayers. Kind of a bit deeper dive into that subject now, sort of a year after it's passed, at the Advice and Insights podcast.

I did a little special treatment on that subject at our sister podcast, Advice and Insights, yesterday. So I encourage you to check that out. But for the Dividend Cafe, let's jump in. This week, markets, I'm recording on Thursday morning, markets are geared to open up here on Thursday morning, and then we'll see how they close and we'll see what happens on Friday. But as it stands now, markets are up a solid four or five hundred points on the week. I think that the theme we have right now, which is a bit more nuanced than a lot of what is driving market action and a lot of what most investors are interested in, and it's what we've titled Before You Get Excited, Get More Excited, meaning the

good news that's going on right now actually we think understates the more impressive news for us as sort of fundamental driven bottom-up investors and that is the dividend growth that we're seeing throughout these quarterly results. Now of course all eyes are on the earnings season overall and we also would argue that earnings do drive dividends and so to the extent that you can get an increase in cash flow as an investor, it has to stem from an increase in cash flow generation within the company. And all cash flow is earnings, not all earnings is cash flow. Think about that for a second. It's very important. But ultimately, companies making more in profits is obviously the mother's milk of investing. And so that theme of how earnings season has gone pretty well here

over the last month does explain a lot of why markets have moved so positively. We know the biggest issue is in the Fed pause and, you know, reasonably benign expectations out of what will happen with the China-U.S. trade discussions from a macro standpoint. But look, we're going to probably end up somewhere around 14% year-over-year earnings growth, Q1 of this year versus Q1 of last year. of this year versus Q1 of last year. I believe that you will probably see earnings reset now going forward where instead of them being revised downward in expectations, they get revised upwards just simply because the fear of increased input cost from higher commodity prices is subdued right now to some degree. And more importantly, the fear of higher borrowing costs around a tighter Federal Reserve has definitely been subdued. So the earnings expectations have to play catch up, just like

when they go downward, they're usually late in doing so. The very opposite could very well be playing out. But even apart from that speculation, and I freely admit that's what it is, a speculation, we're seeing yet again more dividend increases coming out of the companies that are reporting results. And that is positive in the sense that it generates cash that has a practical use in our portfolio management as wealth managers. But it also gives us an indication about how management feels about their own prospects. And so we get both real cash and sort of symbol of cash sustainability into the future out of this dividends growth. And I think that earnings

beats, meaning when they, you know, earnings beat expectations, stock price advancement, which we've seen plenty of so far here year to date, are lovely. But it's dividend growth that's meat and potatoes to what we're doing at the Bonson Group. And by that metric, it's really been a great quarter. And so, you know, we have to continue watching the earnings. And by that metric, it's really been a great quarter. And so we have to continue watching the earnings. I think that the notion of fourth quarter earnings growing 14 percent. And so, by the way, when I said a moment of first quarter, I mean the earnings being reported in the first quarter about the fourth quarter. OK, them looking to grow about 14% year over year. That strikes me as utterly bizarre that anyone would need to defend that. That is a big number. Now, did we grow 24%

year over year the year before? Yes. And that was the first year in which tax reform had been priced in. Now you have the baseline from which you're comparing earnings as a year with a lower tax reform versus another, right? That's why the first quarter, you know, is going to be a different number versus the fourth quarter, because 2018 was the first year of the new corporate tax cut. But the revenue growth has continued to outperform. Corporate profit margins have continued to outperform. And we think the earnings environment is benign. The other issue I would point you to is CapEx. And I talk about it all the time.

I bore people with it. I don't care. It's important and it's vital. But non-defense capital goods orders in January were down 0.6% month over month. And you have a government shutdown and you have a late year slowdown. We know what happened in December. There's seasonality around this time of year. So the numbers are somewhat antiquated.

But the point remains, business investment went from exemplary a few months back and now have been somewhat muted. And we continue to believe that that business investment, capital goods, capital expenditures, manufacturing investment, pulling through into more productive deployment of capital is vitally needed for ongoing economic expansion. And our view remains that the trade war forced a pause in this sentiment and activity. So therefore, resolution of the trade war is needed to evaluate if that pause was transitory or something to be more concerned about. But on the other hand, on a full year basis,

the incremental increase in corporate cash for the first nine months of 2018 do point to a $208 billion increase in CapEx last year versus a $191 dollar increase in stock buybacks so the narrative you often hear is missing a little on the fact side okay i'm gonna switch gears real quick talk about municipal bonds there's a conundrum right now in that the demand for high tax state municipals was intensified by the loss of the SALT deduction, the state and local taxes being deductible against federal income tax. And so the greater tax liability on the margin at the state level made the tax freeness of the in-state municipal

bonds more valuable. But the other side of this is paradoxically true and factually fascinating. And that is that the loss of the SALT deduction essentially hurts the top line revenue in some of these states. That it makes those in demand, the higher demand bonds become lower quality credit, meaning or stemming from the migration to citizens out of high tax states where they can no longer write off on their federal returns the excessive taxes that they're paying on their state returns. So it becomes a net gain in revenue for those low tax states that are receiving those taxpayers, but it becomes a net loss for those states losing them. And yet it's the states that are losing those citizens and that revenue they represent that have the higher demand and growing demand for municipal

bonds. So you have an increased credit risk up against an increased demand. And that is neither a bad thing or a good thing because there's a part of each. It is more the conundrum that municipal bond investors need to reconcile. Switching gears again, the United Kingdom have a real fondness for evaluating on an ongoing basis the discussion around our friends across the pond in Great Britain. And right now, and now by the time you're hearing this, there may be an update because there is supposed to be a non-binding vote on a couple things later. But what we know as far as the Brexit side is that there isn't any new news and there's a binding, you know, hard Brexit coming if they don't do anything here over

the next six weeks and what they're going to do around or before that remains to be seen but let's just let's just uh talk real quick about the economy in great britain real gdp growth net inflation was up 1.3 percent last year it's a big number, but you have to take it relative to the European Union. Because what we're hearing is that by Brexit, all of a sudden, you know, all the other European countries get stronger and England is going to really suffer. Well, I assure you that the vast majority of Western European countries in the EU would be really, really happy to get Britain's growth rate right now. With Brexit there looming over them.

But unemployment is at a 50-year low in Great Britain. If I do a little dramatic pause there, it's on purpose. Was that what we were told was going to happen? That we were going to vote for Brexit and then unemployment would go to a 50-year low or were we told rather that unemployment would skyrocket higher. Wage growth has been steadily improving. Manufacturing and productivity have been certainly better than critics had anticipated, even if not robust. So the question is, will the post-Brexit UK maintain its economic superiority to the rest of the European Union? I think some of that depends on how the final Brexit particulars are handled. But in theory, our operative thesis remains, where there is greater freedom, there will be greater prosperity. By the way, as far

as the rest of Europe goes, and these statistics I offer up in DividendCafe.com this week. Since 2009, the post-crisis decade we've now gone through, China's economy is up 139%, real GDP growth cumulative. India is up 96%, real GDP growth cumulative since 2009. The United States has grown 34% cumulative, again, a compounding rate that is below 2%, not real impressive, but nevertheless, much less than China and India. But then we get to the final number to compare it against, and that's the Eurozone,

where real GDP growth has grown negative 2% over the last 10 years. I encourage you to go ahead and check out DividendCafe.com. Read the politics and money section. We talk about the new budget deal. We talk about the debt ceiling that is coming up, the ramifications to potential downgrade of U.S. debt. Our chart of the week at Dividend Cafe has a really interesting perspective on wage growth and what is happening with rising wages. And then, like I said, both at Dividend Cafe, written out, there's a little elaboration, but especially at the Advice and Insights podcast, the truth about tax reform.

So I'm going to leave it there for this week's Dividend Cafe podcast. We covered a few different subjects. I hope you got a good overview of this week in markets. I encourage you to reach out to us at adviceandinsightsathebonstonegroup.com with any questions, any time, and any comments. And, of course, you can go make all your positive comments by writing a review for us. And you're out in your, you know, Google Play or iTunes or whatever your chosen listening mechanism is for podcasts. Give us a rating and subscribe and do all that fun stuff. I got to say it every week. Sorry. OK, listen, thank you for listening to the Dividend Cafe podcast.

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