The Dividend Cafe - Great Debate

Episode Date: January 15, 2021

The Crux of the Matter If you believed that interest rates were going to be 0-2% would you invest capital differently than if you believed they would be 5-7%? If you believed that inflation would run 1-3%, would you invest differently than if you believed it would run 4-6%? Does one’s view on interest rates and forward-inflation impact their expectations for P/E ratios (market valuations)? If credit is going to tighten (ease of access to capital and cost of capital), would that alter one’s allocation to corporate credit, private equity, public equity, and a host of other risk asset classes? Would one’s view on the U.S. dollar potentially influence their allocation to domestic vs. foreign assets? And regardless of how one’s views on interest rates, inflation, credit, and currency impacts the decisions, they make on investment decisions, will all of these things impact the expected return on all asset classes (whether or not it alters your weightings in such asset classes)? And if these things impact expected returns in various asset classes, does that have practical significance to one’s financial planning, accumulation goals, withdrawal goals, and other such tangible dimensions of wealth management? The answer to every question above is YES, and pretty much all emphatically so, which means that every person reading this has a real dog in the hunt when it comes to the great economic debate of our time: Links mentioned in this episode: 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, welcome to this week's Dividend Cafe. I am excited to have you here listening to the podcast, watching this week's video. For those who don't know, my name is David Bonson, Chief Investment Officer here at the firm, and we like to give you our weekly best thoughts and macro commentary, which is meant to be a bit different than our daily DC Today, which we do every Monday through Thursday for your reading pleasure. The DCToday.com, where we just give a simple snapshot of markets and a number of other categories each and every day. But the Dividend Cafe today is going to be a bit different.

I think I spent a lot of time last week in the immediate aftermath of what had happened out of Washington, D.C., talking about why a lot of the political issues and particularly that unrest had not translated into difficulties in markets. Markets have really come out strong this year, particularly for those things that were invested in that were out of favor last year. Very, very strong start to 2021 in dividend growth and energy and financials in particular. Well, I don't. So hopefully I answered those questions last week about the disconnection between markets and some of the tremendous and unfortunate actions of what are taking place around the country in a variety of venues. And overall, just political and tribal and divisive climate in which really our country has been in for some time. So I'm not going to talk about any of that. And I think the last 40 seconds I talked about it more than I said I was going to.

Dividingcafe.com, the written commentary this week, doesn't talk about any of it at all. And that's because if there's anything that I know will give people a reprieve from the political and the toxic and the tribal, it's macroeconomics. And I know this stuff is really a great respite and escape for all of you. So if you detect my sarcasm it's only because I'm assuming some of you don't think that's true but I actually do and I make the comment I'm going to talk about the great debate that exists in the economic world we're in right now which is is fundamentally, I'll blow the lead here, is really a debate between whether or not the pressures and headwinds we face are of an inflationary nature or are deflationary in nature.

And I think that is sort of the underlying tension that exists. And I happen to sometimes participate in, but certainly observe a constant dialogue that exists amongst ideological foes, academic opponents, if you will, on all sides of this issue. And there can be some really heated debate and disagreement and whatnot. And yet the behavior that goes along with it, let's just say, doesn't look quite like political fights on Twitter or cable news do. And so I do think that there's a bit of respite from all that stuff that goes into this. But I also think that if I'm an investor and somebody like myself is here to speak to you, whether because you're a client who's paying me or you're a non-client who's interested in what we have to say,

I think you should be more interested in what we have to say, I think you should be more interested in what I'm talking about today than this other stuff because the stuff I'm talking about today, and I'm going to end up doing it as a two-parter with a follow-up next week, is significantly important. And the way I kind of go into this topic is say, do you believe that if we were going to be in a 0 to 1 or 2% interest rate environment versus a 4, 5, 6% interest rate environment, that that would change the way one might want to be invested? Do you believe that the level of inflation, if we had 1 to 3% annual inflation versus 4, 5, 6% inflation, that that would impact the PE ratios that are

so important, the valuations are so important in the stock prices? Do you believe that really, really loose credit, meaning an abundance of access to credit at a low cost of credit, has one impact on risk assets and that very tight credit and expensive credit has a different impact. So if all of these questions seem obvious in their answer, that's on purpose. They are very, very obvious. Rhetorical is not the right word. And so therefore, because I think all of those things I just said fundamentally get down to the question of inflation versus deflation, I guess what I'm suggesting is that this topic very clearly, with only one degree of separation, has tremendous import to your portfolio management and your portfolio mentality.

But I would also say that, let's say you weren't going to change anything in your allocation, no matter what. It was a coin flip. You don't know what the inflation deflation stuff looks like and so your outlook on those various things can't be uh used to to alter how you would necessarily uh impact impact your portfolio allocation well it's certainly i think everyone would agree is likely to impact the expected rate of return. So regardless of what behavioral things may go along with it, what we would expect out of stock market results, if we are going into a period of 5% inflation, is much different than if we stay in a period of 1% inflation, for example. And so I think this has a lot of relevance to how we think about our portfolios, decisions we may make,

and relevance to the actual expected rates of return. And of course, a lot of times the rates of return, rates of yield, rates of cash flow generation, these things drive our expectations as accumulators of capital. They drive our expectations as accumulators of capital. They drive our expectations of withdrawers of capital. And therefore, you really have to think that we have a tremendous financial planning and wealth management implication around this whole topic. So it's not merely academic. It's not merely cerebral. It's not armchair stuff. It has a lot of practical import, but that doesn't make it easy and it doesn't contradict any of our rules about humility. So we have to take a very comprehensive approach to how we look at this. I want you to think back to a year ago now. It was somewhat still pre-COVID, even though COVID

was in China and COVID might very well, and I think was in the United States, we didn't know about it. So the whole kind of COVID awareness and COVID economic impact was still a couple months off. But the interest rates began to go down. And then, of course, really, really went down when we got into March. The 10 year bond yield, we're beginning its descent. So far now, we've seen this year, a year later, 10-year bond yield has gone up. Now, when I say up, we're talking about 1.1%, 1.15%, off of a 0.8%. So it's marginal, but the direction last year of yields was down, and this year the yields have gone up.

The dollar throughout the bulk of last year was declining and at certain periods quite significantly so, at least quite consistently so. And actually the dollar has sort of checked up a little bit here so far this year for a number of reasons. And you look at oil prices, even before the Saudi-Russia debacle of early March, oil prices had begun the year going straight down around both supply and demand realities. And now, right now, we're back to $53 oil here. And I think oil is up 12% or so in the first nine days of the calendar year. So three of the most significant indicators of certain economic conditions versus a year ago, yields going a different direction, interest rates on the longer end, oil prices,

and the direction of the dollar. Well, the thing is, is that they're doing all this for totally different reasons. And one of the suspicions one may have is, hey, are we maybe getting a little inflationary pressure because the dollar and the bond yields and oil prices could indicate such? It's a very fair, very prima facie acceptable question to look into. The thesis that we have is that there are longer term in a more secular environment, far superior, and what I mean by that is not that they're better, but they're more prevalent and more powerful, disinflationary, deflationary forces that are overpowering the efforts.

The money supply has risen a great deal in our country, and that is on purpose. The Fed has tried to increase money supply as a byproduct, not the direct policy tool, but a byproduct of the policy tool of quantitative easing, which is part of what they're trying to do to implement monetary stimulus. The question is whether or not that additional money supply is in and of itself inflationary. And it is our belief, along with the great economist Irving Fisher,

that money supply times its velocity is the key ingredient in the quantity theory of money, the inflation level, price level in the economy. And that the Fed has a lot of tools and the Congress, even with fiscal stimulus, you saw Joe Biden this week has proposed another $1.9 trillion stimulus package. The Fed and the government have tools to increase money supply. They don't have tools to very easily increase velocity, and they do have tools that when implemented can self-reinforce a downward pressure on velocity, which is the negative feedback loop or the deflationary cycle that I believe we've been

in and been in for quite some time, and is indeed my belief that we will be in and have to fight against that lower and slower growth as a result of this deflationary environment. So what I'm going to ask you to do is read DividendCafe.com to kind of see some of these charts, get a feel for some of the vocabulary, what a weak dollar means and doesn't mean. We talk about a weak dollar as a counterpart to other currencies, and we talk about a weak dollar, meaning it buys you less ice cream than it used to. And both are accurate ways to use the expression, but they're totally different ways. And I don't want to see those two things confused. The purchasing power of a dollar is a reference to inflation and impact of inflation. And the weakness of the dollar and as an exchange value is a totally different situation altogether.

And people miss so often in some of the hyperbole exist about dollar conversation, currency, U.S. strength, U.S. prominence, the future, stability, that whenever they look to a lot of the weak issues or really vulnerable parts of what we're doing economically in our country, issues are really vulnerable parts of what we're doing economically in our country. They have to compare it to other countries. And that's what is often neglected. And to say the dollar is getting weaker without looking at what other currencies are doing, and by other currencies I mean what the actions of other governments are doing that impacts their own currency, it misses a significant part of this story. So what we're going to do in part two is pull this together to make the case that we have longer term deflationary secular pressures that

need to be the driver of our portfolios, all the while freely acknowledging transitory and cyclical temporary blips of inflation that can come here and there. And so we refer to these terms right now as how they impact investors. And when in real life, how they affect shoppers can be a very different story because a consumer who goes out and the ice cream might cost a bit more. But more importantly, when there's targeted inflation or a very specific inflation that is a byproduct, usually not a desirable one of policy. And you see it in housing and you see it in student loans, which is really from the cost of higher education and of course, healthcare costs. So how we pull together this narrative of

investors fighting deflation and consumers fighting inflation is something I look forward to unpacking in part two. Read dividendcafe.com, reach out with questions. And if you are bored by this, draft an email, but don't hit send. How's that? Subscribe to Dividend Cafe podcast. Subscribe to Dividend Cafe video with YouTube. Easier way for you to get it, easier for us as well.

And in the meantime, have a great weekend. We have a Monday market holiday. Look forward to coming back to you with the DC Today on Tuesday. God bless. member FINRA and SIPC with Hightower Advisors LLC, a registered investment advisor with 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

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