The Dividend Cafe - From May to June and Not a Moment Too Soon - June 3, 2016

Episode Date: June 2, 2016

From May to June and Not a Moment Too Soon - June 3, 2016 by The Bahnsen Group

Dear valued clients and friends, it was a short week in the market with the Memorial Day holiday on Monday but we saw May end at basically a completely flat level. Flat in the Dow, the S&P was up a little bit and then for this particular calendar week we're down about a hundred points or so as we go into Friday morning. Pretty substantive news this week, and I think some really good questions we addressed. So with that said, let's get into it. Just as a way of executive summary, if you just want to listen to kind of our top five or six points for the week. Number one, while chances of a June rate hike are just 20% according to the futures market. This week's economic data was

mixed. A July rate hike is now showing as a 51% likelihood, again in the federal funds futures market. Our thesis of the last few weeks is looking increasingly likely, but not guaranteed. No rate hike in June. Yes, a rate hike in July. And then we suspect done for the year. Number two, it's tough to be short-term bullish or bearish on oil as on one hand it hasn't broken through $50, but on the other hand, several pieces of information are holding it in place and no significant downside came with OPEC this week. Number three, there seems to be more and more openness to the possibility of a Trump presidency by institutional investors, which is a stunning development in terms of how they're pricing things. Number four,

the market has been flat for over a year now, and of the 20 times that this has happened since the Great Depression, the average return a year later was over 9%. Number five, nothing indicates the need for a professional advisor, and nothing indicates the distrust people have had in this bull market, like the drop in percentage of our population who owns stocks in some form or another from 2007 versus now. We'll talk more about this here in a moment. And number six, dividend stocks as the new bonds is our bullish theme this week. High beta emerging markets is our bearish theme. emerging markets is our bearish theme. In the news this week, OPEC did not freeze current production levels of oil. No one thought they would. And they didn't cut production yet. No one thought they would. And oil actually moved higher after the non-event of their OPEC meeting.

Saudi comments talking up oil really made a difference. But the OPEC meeting came and went. Much ado about nothing. Two polls came out Wednesday morning that show Brexit in the lead, a vote for Britain to exit the European Commission. And a composite of six polls has the measure passing by 44% to 41%, but they're still 15% undecided. This does contrast sharply where it was just 48% to 35%, the 48% being those wanting to stay in the Eurozone, and that poll was only two weeks ago. Mario Draghi, the head of the European Central Bank, announced no changes in their meeting this morning in interest rate policy. The market response was reasonably muted throughout the day. And then Japan, again, has delayed a long-planned sales tax increase just based on their muted economic growth. muted economic growth. In terms of core this week, our evaluation of China, oil, recession fears, and the election. With China, there was a very soft PMI report that came on Wednesday

measuring their manufacturing data. Barely registered any advancement in manufacturing for the whole month of May. Their services sector in fact contracted a little bit. So the reports are consistent with the China slowing growth thesis. It's only controversial if one believes the growth will come to a screeching halt versus a measured incremental slowdown. But really no one believes the growth is not slowing. Chinese equities are not doing well, but this is really disconnected from the economic picture we care about. As mentioned, with oil, it hit up $50 a couple times over the last week, but was unable to break through that level. It also failed to drop much below $50. It's sitting around $49 now, even in the wake of OPEC's inaction, as we talked about a moment ago.

From a recession watch standpoint, the real retail sales figure, the construction figures, new auto sales, and industrial production were all positive in May, above expectations. But the business spending number continues to be the cause for concern, and how company capital expenditures, what we call CapEx, goes in the months and months ahead, we think will determine the fate of our economy. From an election standpoint, I read a report this week from my friends at Strategist Research that referenced their monthly institutional investor survey, about 650 money managers. And the fact that last month, 22% of respondents were forecasting a Trump presidency, and now that number in one month has skyrocketed to 50% is quite interesting. I couldn't say with any conviction that this points to more of a Trump victory being potentially priced in, but I will say that it's now being

discussed across Wall Street as a distinct possibility. I believe we will need to see what happens in the polling if and when Hillary Clinton officially has the nomination, see what happens in the polling if and when Hillary Clinton officially has the nomination when Bernie Sanders is totally out of the race. When that happens, will Hillary get a bounce as Trump did when the Republican field was cleared? That's the next big issue that may impact where markets go from here regarding the election. Questions from readers this week. Are stocks getting to be as expensive as they were pre-crash back in 2007? Well, my answer is that by no measurement we look at, is that the case? Here's what we do know. The stock market dividend yield is higher now than it was in 2007, and yet interest rates are much lower. Generally, you would expect yields to be lower when the

interest rate they compete against is lower. Obviously, yields are lower than they were in the bargain shopping days of 2009. Stock yields were quite high then when stock prices were so low, but there's no comparison to present market valuation relative to 2007. to present market valuation relative to 2007. Question number two, what will cause an eventual recession? Well, our two favorite guesses in this current context when we do end up with our next recession as to what we think could cause it is either, number one, the response of the economy to Fed interest rate normalization, if and when that finally happens. And then number two, global economic conditions slowing enough that tepid U.S. economic growth just proves too weak to counteract contraction around the world in Japan, Europe, China, emerging markets, etc. We should point out

that neither of these conditions or catalysts are presently on the table, but when we do have our next recession, we suspect one or both of these circumstances will be at the center of it. Number three, is this unprecedented to see the stock market be completely flat for a whole year? So, you know, closing prices right now are basically the same level they were a year ago. Well, my answer is that as my mentor Nick Murray pointed out, 20 times since 1930, the market has gone a year without a new high. without a new high. And I would point out that this means 66 times we saw a new year high, a new high made year over year. But the mathematical reality is 20 times in the last 80 plus years, the market was flat a year later, and the average return in those periods is plus 9%. Through May, what are the top performing and worst performing sectors in the stock market

year to date? Through the end of May, the top performing sectors are energy, utilities, and telecom, each one being up over 13% year to date. The worst performing sector, in fact, the only one to be in slightly negative territory is healthcare. Financials are just a tiny bit above 0% themselves. Deep end of the pool this week, where we like to talk about something a little bit more complex and kind of for the more sophisticated investor wanting a deeper dive into the economy. Fundamentally, we see the story of U.S. economic health over the next year being determined by its ability, the United States' ability, to decouple from the global economic challenges which are simply unlikely to go away. The argument that the U.S. will eventually get pulled into the economic mud is that she doesn't have enough growth of her own to really separate from the pack. Low,

tepid growth will give into a global economic slowdown. We are most sympathetic to this view, seeing the impact of low oil prices on one of the nation's only growth industries of the last eight years, energy, and seeing slightly weaker manufacturing. But however, from consumer spending to housing starts to financial banking health, there's plenty of contrary data out there. What isn't disputable is that the U.S. will get no assist from Japan or Europe or Russia or Brazil. And if Chinese softening becomes any worse than already anticipated, we think it will tip the scales into a mild recession. But U.S. ability to be separate from those global realities would be the best way to buck this. And for that reason, we're obsessively monitoring macroeconomic data here in the United States.

This week's reinforcement of a permanent principle, we hold to the permanent principle that the decisions and behaviors of investors will always and forever determine their ultimate financial result. Behaviors of investors will always and forever determine their ultimate financial result. One of the great reinforcements of the need for improved investor behavior under the prudent management of a fiduciary and trustworthy professional advisor is found in what I'm about to share. But frankly, it also argues for why there very well could be a resurgence in equities in the next couple of years as well. And that is that too many people have not participated in the great recovery post 2008. And many could very well come back in. The chart in our written commentary this week shows

65% of the U.S. population of adults was in one way or another invested in the stock market, either through mutual funds or their IRA or 401k back in 2007. The number had been between 60% and 62% for a decade. Well, the number has dropped into the 50s in 2009 and still sits here today after one of the biggest bull markets of all time at only 52%. The tragedy here is that this very large segment of the population exited equities when they did, and the further tragedy is either that they didn't have the guidance to stop them or that perhaps that very guidance was there but didn't stop them from that misbehavior. In terms of the bullish indicator this week, what we like about the investing universe, if there's one theme I feel I've been talking about at least for a decade

that's now become very common in the halls of investment speak. It's the concept of stocks as the new bonds. Dividend income is not just attractive now because it comes with the potential for appreciating asset prices, though it does. The actual dividend yields themselves are higher than bond coupons. And of course, the dividends can grow unlike fixed income. Pfizer is an example this week, raised debt capital and their bonds are paying meaningfully less than their own stock's dividend. We see stuff like this all the time now. People not having to pay for the right to stock appreciation, but getting paid for the right to potential stock appreciation in the form of a higher dividend than what the bonds are paying. Yes, we're bullish on this new paradigm, and yes,

we believe it's here for a long, long time. We would point out, by the way, I'm using Pfizer as an example here. We don't own that stock. As far as the bear in us this week, we really can't emphasize enough how concerned we would be about high beta emerging markets. The various things that trouble U.S. economic outlook and U.S. markets are the same things that trouble traditional emerging markets, and yet there the trouble is on steroids. The point is to diversify risk, not lever it up. U.S. companies with low foreign sales or no foreign sales are dramatically outperforming the multinational space. Should China pressures reassert themselves? Should commodity prices reverse?

Should the U.S. dollar take off to the upside again? And yes, you could argue all three of those things are highly correlated. We believe the high beta part of emerging markets would be heavily impacted. So therefore, we want to focus on great value in the emerging market space with attractive growing dividend yields and more defensive balance sheets. The junkier parts of emerging markets are really unappealing. In terms of our switching gears outside the world of investments, what are the most popular financial concierge services we offer at the Bonson Group? Certainly the answer is tax planning and then estate planning, probably in that order. Ben Franklin taught us that the two guarantees in life are death and taxes, so it makes sense that those would be most commonly used and needed. But we would add to your consideration that there are a variety of concierge services outside of planning

for death and taxes that more and more clients are finding appealing, we'd love to talk to you about. In our chart of the week in the written commentary, we have a chart showing all of the market crashes going back several decades and the recessions that took place around those. And you basically see time and time again, the bear markets in the stock market happen in concert with recessions. For this reason, evaluating economic fundamentals is smart and relying on market noise and sentiment is not. The quote of the week from Billy Graham, I feel sorry for the man who has never known the bracing thrill of taking a stand and sticking to it fearlessly. Moral courage has rewards that timidity can never imagine. Like a shot of adrenaline, it floods the spirit with vitality. The month of May was a normal month in the markets, some up periods, some down periods, some flat periods.

And at the end of the day, the net result was slightly up. But there's a lot of questions coming into June. The odds still seem to us to suggest the Fed will not act this month. But there is a full court press going on to prepare markets that if they don't go in June, they will go in July. Data may very well change that, but I doubt it. It's so interesting to see, once again, how many of the laggards from last year in the stock market are the leaders this

year and vice versa. This is a heavy rotation market. The overall market not moving a lot, which is bad for index investors, but sections of the market doing well before other sections of the market replace them. We love you reaching out with questions or comments of your own. We hope that you will take advantage of that and we just wish you a very, very good weekend. Thanks so much for listening to the Dividend Cafe podcast.