The Dividend Cafe - Fear is a Four Letter Word

Episode Date: May 7, 2021

One of the questions I get asked the most is, “what scares you right now?” Clients ask it every now and then, or some version of it, but I also get asked in various TV interviews that ever-so-compelling question, “what keeps you up at night?” There is one particular problem with the question I want to address in this week’s Dividend Cafe, and I want to provide a really thorough answer to it. What is the problem with the question, “what is keeping you up at night?” The problem is that the real question the person asking means to ask is, “do you think the market could go down?” It’s a dishonest question, but probably not intentionally so. It’s a couched way of basically asking something reasonably worthless and unhelpful. Why is it worthless and unhelpful? Because the market can always go down, and anyone asking the question knows it, or anyone invested in the market ought to know it. But, but, but you say – aren’t there times where it is extra super-duper extra likely to go down? And wouldn’t that have you worried? The answer to those two questions is, “of course not, other than in hindsight,” and “not at all.” But, but, but, I say – if one ever just asked the question, “are there macroeconomic conditions that bother you, that you really dislike, that even though they don’t foolishly lead you into market timing or false prophesy or clickbait dis-ingenuity, you really are troubled by?” Well, that question I can answer, and I will … 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 the Dividend Cafe, our weekly podcast and video. My name is David Bonson. I am the managing partner at the Bonson Group and I am recording here today from our New York office. And I got to tell you, I wrote the entirety of the Dividend Cafe for the week over the last several hours. I came into it this morning without any of it pre-written. I had a general idea what I wanted to talk about. But by the time I was done writing, I really liked what I'd come up with. But I'm going to have to leave that to readers to decide if it captured what I was getting to. But what I

want to talk to you about today, same thing that I wrote about in Divin Cafe, is first setting it up around the question that I'm continually asked. and it's a really kind of regular question that gets asked, not just of me, but a lot of people that appear on financial media. But it's also a question that comes about very organically and very practically day by day from clients or what have you. Something on the lines of, what are you afraid of right now? What's scaring you? What's keeping you up at night, so to speak? And I think that most people mean well asking the question. I don't necessarily think that it's always the best of intentions when it's asked in a media context

because I think it's intended to generate an answer that will frighten some people and there's some sort of perpetual benefit to fear when it comes to the media from a click standpoint or a eyeball standpoint, what people read, what they watch, what they click on online. Fear sells in the media. And I get that. But I also think that just from a human nature standpoint, that a lot of times when people ask, what are you afraid of, is they want to hear that there's nothing to be afraid of. Or they want to hear, do you think the stock market's going to have to go down? Like, what are you afraid of? like, well, I'm afraid, you know, that the USC's running game isn't very good. Well, I don't think they really want to hear me say that. They want to know if I think the market's about to go down. And I, I honestly understand it. I think it's a reasonable question, probably not consciously fully thought through as to what

all the psychology and all the reasoning is behind it. However, you know, I can never say, oh, I'm afraid that the market could go down and it's keeping me up at night because I always believe the market can go down. And the times that the market has gone down most violently and gravely and severely in my career and basically throughout history have always been in unforeseeable circumstances. You can certainly have periods where there's too much froth and things get too expensive and need to adjust. Those are not always where you have crashes and big, huge adjustments.

And far more importantly, sometimes those things take years till they happen. People are talking about overvaluation and then five five years later, you go, oh, see? So why would anyone be responding to something that may be continuing to reflate up for years and years to come? So that whole thing, you know, is not really the type of category of what might be concerning. And I also think just the word fear at large, if you view it as sort of a synonym of despair, the answer is always no. Because whatever the different challenges are,

I believe this really strongly. I'm not trying to be preachy about it, but I don't do despair. I'm not going to feign despair for clients or for listeners. And I don't want any of you to do despair. That's not to say there's not just horrifically bad things that happen, that have happened, will happen. We understand that.

But the only thing I'm interested in is solving for bad things that happen or for preparing for things that could happen. preparing for things that could happen and talking about being up at night and and and fear and stuff creates sort of this negative context that i don't i don't think is useful i'm not even sure it's really um uh sincere and and i want us to be more thoughtful how we approach those things so then when i get past those kind of qualifiers and setups, you look at the overall environment. And I'm well on the record about what I think regarding the valuations and some aspects of risk assets. And I think there is going to be air that comes out of the tire and certain things. I don't use the word fear to describe it, but that's out there. But far and away, and it's not just like the main thing, it's more or less the only thing with kind of derivatives that come out of it that are related to it, tentacles that are connected to this. risk, whatever, is all centered around this general theme that I've referred to in the past as Japanification, a term that I stole from my friend John Malden, and I continue to believe

he may have stolen it from someone too. But either way, I went to great length with charts in Dividend Cafe today to lay out what Japanification basically has meant over the last 30 years and where I see connectivity in present American economic circumstances to the Japanification lesson that has obviously taken hold in Japan. And it all fundamentally starts with a bubble that blew and then busted. that blew and then busted. And in Japan's case, coincided heavily with the culmination of a really disastrous demographic reality. More and more people dying out of an aging population and less and less people being born, so them sort of having a voluntary self-extinction in their demographic contribution,

not just to their own culture and their nation state, but to their economy. And so you had all at once this deflationary impact of demographics with the disinflationary reality of a bubble that had burst. And so they fed it with tons of government debt, fiscal policy to try to soften it. And they blew up debt from the early 90s at 50% debt to GDP, up to right now 225 percent debt to GDP not counting entitlements and along the way obviously I've thrown the kitchen sink of monetary policy low interest rates no interest rates that they're fed buying all the bonds they can being a liquidity provider all of it and then I and again all these things are laid out in charts today in dividendcafe.com but then basically 30 years from start to finish of of no economic growth so that term of Japan vacation does

describe the backwards view of Japan I I'm not making any prediction. This is just simply what has happened. And I am very open to arguments that the United States made Japanify at a much slower pace than Japan did. And I would view that as a big victory if it were to happen. But I am not seeing an avenue to where Japanification does not play out

in the United States, meaning significant downward pressure over a long period of time on our growth. And that to me is an incredibly negative thing. But like Japan and the real Japanification and the real country of Japan, it doesn't necessarily involve this moment at which they default on their debt or where they have hyperinflation or where their nation blows up into smithereens. challenge of doom and gloomers to provide specificity in both timing and event as to what they mean by this thing kind of coming home and culminating in a real negative result. And I think that the same is true in the United States. I am very open to the idea there being really exacerbated boom-bust cycles in our country along the way. And I've been living through them throughout my whole career. The entire adult life of mine, in which I've been managing money on behalf of others, has been this period of some booms and busts. But there's been longer periods of normalcy than maybe we deserve.

And that's a good thing. But yeah, I believe that the present reality of fiscal debt accumulation that has been used as medicine to treat the various maladies we've had, either from emergency moments, whether it's the dot-com crash or 9-11 or the great financial crisis or COVID. That's all just within the last 20 years. The problem as I see it, I've laid this out many times, is you use doses of fiscal policy and monetary policy to treat the patient when there's an emergency. The emergency goes away and you still keep the medicine going, which A, is not good, and it builds up imbalances in your financial system.

It builds up this boom-bust cycle. It pulls growth from the future into the present, which dooms you to a lower growth environment. And by the way, it also takes away the efficacy of that medicine in the future. Next time you're really sick, if you've been taking the medicine the whole way through, medicine doesn't do any good or in the best case has a diminishing return. That's the case for the United States right now. Our fiscal policy has had a diminishing return and That's the case for the United States right now. Our fiscal policy has had a diminishing return. And clearly our monetary policy would as well. If cutting the Fed funds rate, as just an example, from three down to one or zero in the past has worked a lot

when we've had periods of real financial distress. But then you're already at zero or one. Next time you have a period of financial distress, you can't cut it the same way. And I've been talking about that for years. It's one of the reasons why getting off the zero bound and normalizing monetary policy becomes very important during good times or at least normal times because you need that bullet in the gun or you need that medicine in the medicine cabinet, whatever analogy you want to use for the future. But very candidly, we don't want the pain that will come with any normalization, so we've resisted doing it.

And I understand that. I don't agree with it, but I certainly understand it. But when we talk about what the United States could do to avoid the Japanification, whereby, because I don't want to go into all the things that we're different in. The things that we're different in are useful. They're advantage U.S. I fully acknowledge that. 0.8 kids per household versus 1.8 kids a household. 1.8 is not enough relative to American history and where I believe you need a growing population. You know, economists and demographers, I think, are pretty unanimous in the view that you need 2.1 just to kind of break even.

And I'll let you, by the way, figure out why that is if you're struggling with it. You know, two parents in a household, so you need two kids just to kind of keep the family tree growing. And listen, I don't know where the American culture is going to go, but I do know it is not gone as low as Japan's and at the same pace. Our trajectory is not good and that concerns me culturally and economically. But our banking system is healthier. There's more ingenuity. There's more access to foreign capital and there is more participation in global financial markets. So we have a lot of things going for us that Japan hasn't had. But the Japanification theme is a reference to the particulars of where future growth gets pulled into the present.

the present and on an ongoing basis we're fighting against that lower or slower growth that we've already created as a result of fiscal and monetary policy and we're treating it with more fiscal and monetary policy. That's all I mean by Japanification. Then you get into the practical element of, okay, well, there really is this big, huge debt issue, and how do we solve for it? And my view there being that there's no option that is politically palatable to anybody. And the one thing that no one can really control that doesn't have to go to an election, doesn't have to generate incredibly unpopular social results. A lease that are evident and visible and readily apparent is through monetary policy. So you continue to look to the Federal Reserve as that kind of safety valve. This whole overall environment I'm describing, it isn't that it keeps me up at night.

It's just simply that I'm keenly aware that it is the economic event of our times. There are economists that were famously living through a period of time like Irving Fisher or Ludwig von Mies during the Great Depression and Friedrich Hayek. And even though he wasn't my favorite economist, but certainly a prominent world changing mind like John Maynard Keynes out of World War II. You get into the kind of classical period, neoclassical period. And through the heavy stagflation of the 70s that kind of Milton Friedman had so much to say about. the 70s that kind of Milton Friedman had so much to say about. And then the supply side influence in the 80s with Art Laffer, Robert Mundell, as they brought marginal tax burdens down, Paul Volcker defeating stagflation by stabilizing prices. So there are different economic issues that we've had in past decades

and thought leaders that were around that were policy influencers or commentators or analysts. The reality is my period of time, I believe as an adult who has a keen interest in macroeconomics, who has a keen interest in macroeconomics is this period of Japanification. I think that the debt and deflation consequences of United States policy decisions are going to be what I end up living through, have been living through for quite some time. There's tangential stories around it. And there's other things that could come and replace it. And if one day we've solved for our Japanification problem, there will be other issues that come and go. That's kind of

the whole story of history. Makes things fun to some degree. But my honest belief is that if one wants to focus on anything that is of concern, and yet still uncertain, like there is no just readily available policy prescription. Because even people come to me and they'll say, okay, well, let's just say we get it. We're fully on board with your thesis. And now we understand and we agreed Japanification is the way the US is headed. So now what do we do about it? agreed Japanification is the way the U.S. is headed. So now what do we do about it? I don't diagnose this problem because I have this solution that I believe is going to prevent it. I don't think there are any options, none, that don't involve some pain. And that's one of the great economic problems that I think we face is that we continue to create pain by trying to avoid pain that can't be avoided.

And everybody with a conscience wants to mitigate pain and minimize pain and manage it to the best it can be. But the problem is when we create unintended consequences out of those efforts that are worse than what we started off with. And I think we've done that time and time again. And so my view is that we have tough decisions ahead. But from a portfolio standpoint, which is primarily why people turn to a chief investment officer of an investment firm like mine, the way if they want to listen to what I have to say, it is probably not to hear me wax and wane about economic philosophy, although maybe some like that, and I certainly like doing it. But I have to put solutions on the table around this environment, around the themes

that I think are concerning, that I frankly think most people are not thinking about or are unaware of or would understand if they did think about it. And I don't mean regular people by that. I mean even in the investment industry. But no, I believe that the solution set out of this problem that we're describing is to account for cyclical inflationary realities that will come up via companies with pricing power and the ability to continue raising that dividend and to attempt to mitigate equity beta with the use of non-correlated

assets. Things like alternatives that primarily become fixed income alternatives when in a deflationary environment your fixed income is squeezed out as much of its return set as you're possibly going to be able to get. So this conversion from inflation to deflation from the 70s to where we are now created the mother of all bull markets in the bond market. And now the math got us to a point where it has to end. And that doesn't mean it has to end. And that doesn't mean us to reverse. It just simply means that as long as I'm tasked with making money for clients, not holding money

for clients over a period of time in concert with a financial goal, then I think alternatives become a bit more sensible than the present state of fixed income. And I think that within the equity side, I want to minimize speculation and optimize and maximize real investment through real coherent cash flow generative defensible business models as possible. They're available in the public equity world. and the equity side and then some capital preservation along the way as appropriate to a given client situation. Every single day, everything we're doing is geared towards solving, creating a solution in the investment world for the present state of affairs. And what I'm trying to do in today's talk is lay out for you what that present state of affairs is. And I'm doing that mostly week by week. And hopefully today, some of the

more specific parallels to Japan and the numbers that we've seen historically, just looking at the last 30 years, gives you a little bit of context for why I do think the parallel of Japan makes a lot of sense. But all the while acknowledging where there are some key differences in the American economic system, all of which I view as beneficial. So that's the message for today. I hope that this has not been too much. I do think that you'll benefit from looking over thedividendcafe.com today. And I certainly hope that you've enjoyed listening to the podcast, watching the video. If you're watching the video on YouTube, hit that little subscribe button. We'd love for you to be

able to get the weekly videos we put out regularly. And it's certainly better for you, better for us if you are getting your podcast through a subscription into your feed or your player of choice. So we hope you'll do that as well. Other than that, thank you for listening to and watching the Dividend Cafe and we'll see you next week. Thank you. contained in this research is provided as general market commentary and does not constitute investment advice. The Bonser Group and Hightower shall not in any way be liable for claims and make no expressed 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 Bonson Group and do not represent those of Hightower Advisors LLC or any of its affiliates. Hightower Advisors do not provide tax or legal advice. This material was not intended or written to be used or presented to any entity as tax advice or tax information. Tax laws vary based on the client's individual circumstances and can change at any time without notice. Clients are urged to consult their tax or legal advisor for any related questions.