The Dividend Cafe - Fedexit: Forget Brexit - June 10, 2016

Episode Date: June 9, 2016

Fedexit: Forget Brexit - June 10, 2016 by The Bahnsen Group

Thank you. But there's going to be a lot of material I'm going to go through now, and we'll get right into it. I'm going to give you an executive summary of everything we're going to talk about real quick, and then we'll kind of flesh things out a bit. A few summary items. Number one, markets rallied really nicely Monday through Thursday as the market unwound the fears from May that the Fed raising rates may happen sooner than expected. Commodity markets have resumed their move upwards. That's the good news. The bad news is that pretty much the only driver of markets right now is the Fed and the fact that oil is over $50. The pitiful employment number, number two, from last week has managed to do two things for

investors a take a June Fed rate hike off the table and be calling to question the idea that we're not in or headed to a recession number three four asset classes have been highly correlated during this stock market rally and for pretty good reason energy stocks stocks, financial stocks, high yield bonds, and emerging markets. A weaker dollar is a decent explanation for where a lot of these asset classes do well together, but shared economic interest fundamentally is a better one. We think that the, number four, we think the Trump-Hillary impact on markets, the pros and cons of each, is likely to take a backseat in the months ahead to the state of the congressional and senatorial races. I discussed this on CNBC on Wednesday, and we provide a link to that interview on the website if you're interested.

if you're interested. Number five, rising PE ratios, meaning a growing valuation investors will pay for stock market ownership, is not enough to prolong this rally. Growing earnings must come too. Q2's earnings season will begin in a month. We'll see how companies have done throughout the second quarter. Number six, the deep end of the pool this week gets into the new buzz around MLPs, the new and improved MLP model, the role natural gas liquids are playing in driving pipeline volumes and therefore revenue, and it looks at the possibilities that exist for further recovery in this sector that is already 50% off of its lows. Number seven, our weekly principle, the plan, is the center of the portfolio, as investment management is a means to an end, not the end itself. A focus on a plan is the best practice of an astute investor,

and it's the lifeblood of a fiduciary advisor. Number eight, the bull in us this week will talk about high-yield bonds, and the bear in us will talk about utility stocks. Number nine, you must read the chart of the week. So since you're listening on the podcast, you have to go to DividendCafe.com and look at this chart of all the charts we've ever published. Print this one, put it on your fridge. It is clearly evidence that demands a verdict. on your fridge, it is clearly evidence that demands a verdict. In the news this week, the May jobs report came last Friday, and it wasn't just bad. It was the kind of bad that caused most of us

to think there was a typo. The ramifications of the report were to ensure that the Fed would not be raising rates in June and cause market participants to wonder if the report was an aberration or a sign of things to come. People were predicting 165,000 new jobs, and we got 38,000 new jobs, though 34,000 were off the rolls because of the Verizon strike. Still, it was a massive miss in terms of new job creation. massive miss in terms of new job creation. Other news this week, Hillary Clinton defeated Bernie Sanders in California and New Jersey on Tuesday night, which gives her the mathematical assurance of the Democratic nomination. And so we now prepare the country for a Trump versus Clinton November matchup with both parties hosting their conventions this summer. In core this week, China, while there is no doubt China loves this reversal of a tighter Fed and stronger dollar,

while their imports of iron ore and crude oil have notably recovered in the last few months, about 10% recovery per month, by the way, other data continues to put a lid on optimism. per month, by the way. Other data continues to put a lid on optimism. China's foreign exchange reserves have fallen to $3.19 trillion, the lowest since 2011. Less and less companies are stating that they plan to increase presence in China. Business confidence is low. Does this sound familiar? Oil, by the way, moved above $50 on Wednesday morning, a level not seen since July of last year. It basically held that on Thursday, staying into the $50 plus change. The oil price move is perhaps the strongest catalyst both the stock market and high yield bond market

have had throughout this rally. Recession watch, one of the consistent arguments from those in the we are not in recession camp, I'm included in that camp, has been that despite concerns about industrial production and manufacturing, the employment picture was just too good, even with its various holes, to be remotely recessionary. The May jobs report, at first glance, calls that thesis into question. In the dozens of reports and hundreds of pages analyzing the May jobs results that I have read over the last few days, I've seen every opinion under the sun as to what it means, sometimes totally conflicting opinions, even from the same firm. sometimes totally conflicting opinions, even from the same firm.

But recessionists are right that employment data is a lagging indicator. So the reasonably benign jobs picture is not a great argument that we're not in or headed towards a recession. Our conclusion that we're not facing a recession is based rather on the current state of bond spreads, the health of financial credit markets, and other such criteria. They're weak and vulnerable considerations though when we look at the margin for error. Slow, low, tepid economic growth can tip into recession a lot easier than robust positive heavy growth can. Those screaming that we are in a recession, they're the ones that have predicted 20 of the last two recessions, as the famous slight goes.

We want to be objective and prepared. The jobs data does bear watching. On the election count, Hillary Clinton clinched the nomination, as we said, and with this long and torturous primary season now behind us, the country gets ready for a summer convention season that will see the race for president take on an entirely new focus. It promises to be a historical race one way or the other and already has set records for the relative unpopularity and poor favorability ratings that both candidates have. We will continue to address the race from a market standpoint throughout the months ahead, with a particular focus on where the Senate and House races look

to impact the overall picture, and how within the weeds the various election outcomes could affect more granular parts of our portfolio. There's a lot of nuances to consider. Questions from readers. So what was your take on last Friday's jobs report? Well, it was the same as everyone else's. When they said 38,000 and put 38,000 on the screen, I thought there was a typo. I wasn't sure if it was 138,000, which still would have been really bad, or if it was $138,000, which still would have been really bad, or if it was maybe $238,000, which would have been huge. But no part of me thought $38,000 was even in the realm of possibility. So even apart from that Verizon strike issue, people have asked how job growth was so bad, and yet the employment number was actually 4.7%, a pretty low unemployment number.

The chart below basically tells the whole story. Simply put, those who have stopped looking for work, either for good reasons or bad ones, have risen so much that it has mathematically lowered the unemployment rate dramatically. So now as for whether or not this takes a June rate hike off the table, I would put those odds at less than 1%. July is still possible, but also much less likely. Our second question comes to us from Mitchell Bonson. What do you think the Fed will really, why do you think the Fed will really not raise

rates this month with that week's jobs report? I am really not even that focused on June in this thinking, which is now a foregone conclusion. I'm once again wondering if even July and September are on the table. Apparently, the market is too. We have a chart in the Dividend Cafe showing you the Fed futures market for a rate hike. But basically, the odds of a rate hike in June had jumped from 5% to 30% in the month of May. Now they've dropped to basically 0%. As of right now, July is only showing a 22% chance of a hike. And even September is just showing a 38% chance.

My, how things change. Next question. You always say, as earnings go, so goes the market. Are earnings good enough to keep this market really going? It is true that not all market rallies are created equal. When markets move higher, just because the P-E ratio of the market, the value that investors are willing to pay for earnings, is going higher, that tends to be less reliable and less sustainable than when earnings themselves are growing and causing stock prices to rise. When both factors take place at the same time, that tends to make for the most meaningful moves in the market. The results of Q2 earnings, which will not begin to come for about a month, will tell us if this rally is likely to reverse, to stall, or to extend. Continued PE expansion is not something we believe in.