The Dividend Cafe - Grown-Ups and Unavoidable Tradeoffs

Episode Date: July 10, 2020

This week’s Dividend Cafe is a long and juicy one – lots of topics, lots of practical subjects (see list below), and plenty for the wonky types and those who loathe such verbose diversions. But what is most important to me in this week’s Dividend Cafe is that it addresses the issue I believe is most necessary for grown-ups to deal with in this day age: In this week’s Dividend Cafe we will: • Recap the week that just was in markets • Make the case for a market change in the near future – not one defined by all going down or all going up, but rather one defined by a shift in leadership, away from the popularity group and into the more fundamental group. • Set the table for a “two-act play” around how we evaluate the economy – the lockdown recession and recovery from such; followed by the “aftershock” phase that deals with structural ramifications from that first phase • The burden of where rates are now and where they have been • Ask what has happened to oil prices in 2020, and why! • Take a look at what the real issue I have with bonds is as I look out into the future • Note the threats hanging over FANG • Look at what to expect out of the earnings season that begins this week • Ask where are we with the U.S. dollar, and what becomes the more investible equity space when the dollar declines? The answer may surprise you. • Provide a little history on the quarters and years that follow strong quarters. It’s rare to get such universally compelling data. • Provide our weekly economic report card of the good, bad, and ugly out there, with a special look this week at manufacturing, services, air travel, and more. • Do Politics & Money • And in the Chart of the Week, let you decided if we are inflationary woods, or a deflationary jungle 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 and welcome to this week's Dividend Cafe podcast and video. My name is David Bonson. I'm the Chief Investment Officer of the Bonson Group. I'm sitting in my New York apartment early on a Friday morning, getting ready to walk to my New York office where I've been working all week. And I'm excited to bring you this week's message. There's a number of different topics we're going to cover. I'm going to try to cover in the podcast as much as I can that is dealt with in the written Dividend Cafe commentary this week. But these are getting longer and longer. There's more and more topics that are inspiring me.

There's more and more things that I think are relevant to cover. But this particular week, there's also a sort of emotional connection to the burden that undergirds a lot of what I'm writing about. And what I mean by that is there's a lot of rational discourse around the challenges that we face today. People have arguments, most of which are very good, very valid, related to uncertainty in the economy, uncertainty around government policy, concerns about the outcomes of the November elections. Obviously, as we write about every day at our COVIDandMarkets.com missive, there's continued questions about the health pandemic. And so you have this sort of environment where it's very rational and very understandable that one has fear regarding what to do with the portfolio as we navigate through these times. And that's not just the typical bullish-bearish debates,

where then one could come in and make their counter-arguments and try to come to a point as to why the bulls are wrong and we should be bearish, or the bears are wrong and we should be bullish. as to why the bulls are wrong and we should be bearish, or the bears are wrong and we should be bullish. Where my view right now is that there is no opportunity, there's no room, there's no choice to say I'm bullish or I'm bearish at this point in time. And to the extent there is, it could be banter. It could be fun. It could be academic.

But on a practical basis, we're living in a dynamic in which people are in need of cash flow. And we are not over a 40-year period. See, we look at the impact of inflation over a lifetime and say, look, you have to be able to outpace inflation because look at how your purchasing power has eroded over a long period of time. That's all true enough. But we so often ignore the reality of, well, right now we're ignoring the reality of how quickly the nominal interest rate has come down. And I don't want to be fancy about any of this. I just want to make it as simple as could be.

Ten years ago, which I don't know anyone who thinks was ancient history. All right? I have a fourth-grade son who was born ten years ago. This is not that long ago. at that time, one could achieve four times the income level that they could achieve now in municipal bonds, corporate bonds, treasury bonds. Okay? The reality is that pension funds are underwritten, assuming that they're funding them, which they often are not, public pensions that is, to a 7% annual rate of return. Most insurance companies

have underwritten their future liabilities to an assumed discount rate on their present assets of at least 5%, often 6%. The cash flows that retirees will want into the future, maybe they're not 6% or 7%, but they're not 0.6% or 0.7% either, 3%, 4%, 5%. 0.7 either, 3, 4, 5%. So we have this situation in which it's a very crude expression, but it's one that has a lot of import, that one of my mentors, Nick Murray, taught me many years ago. You cannot commit suicide because you're afraid of getting murdered. You cannot commit suicide because you're afraid of getting murdered.

The reality is that we have to navigate a plan through the world we live in right now because people still have to have either a growth rate, an accumulation rate on their assets, or they have to have an income stream for the roughly half of investors who are withdrawing from their portfolio. In many cases with retirees and so forth, you're literally using it to eat. And so I don't believe there is an easy solution. And I think that people's willingness to talk about this as if it's not a tension between risk and reward, as if it's not a tension between cost and benefits, as if it isn't a choice between a number of difficult issues and predicaments. See, we're in denial. And the

reason I think that we do this with investing so often is because we do it with so many other things in society it's what this entire thing is right now with COVID is an unwillingness to admit that there's not a great solution we're going to have so let's figure out the risk reward trade-offs as it pertains to having an open society and protecting the most vulnerable among us. This notion that the kind of unconstrained vision of society you can have it all is what's gotten us into this mess. But I cannot allow that for my clients. I cannot manage money for the people who we at the Bonson Group serve as a fiduciary for and pretend as if there is an easy alternative that is devoid of any risk or trade-off. Trade-offs are the key here.

So right now, as I look into the world around us, I'm desperately seeking to understand what some of those trade-off dynamics are. So much of it revolves around government spending, government policy, government indebtedness, central bank reactions, accommodations, and a lot of it has to do, of course, with individual client comforts, emotions, reality, psychology, and so forth. And so my job is to be a truth teller and to earn the trust of my clients by constantly telling the truth and where the truth is uncomfortable,

sticking to it. Now, if that means I lose the client, I lose the client. That's what it's got to be. That's what it's been for my whole career. It's what it will be for the rest of my career. It's how everyone at the Bonson Group feels, by the way. We'd rather lose a client for telling them the truth than keep a client for telling them a lie.

So this is the truth right now. It's a very volatile market, and that volatility is not necessarily going away anytime soon. And when it does go away, it might be because things settle at a lower level, not higher. Now, I believe that right now there's a lot of strength and resilience in the market. There's plenty of upside factors. If you look at this week, market was up 450 points on Monday. It was down 400 points on Tuesday. It was up 200 points on Wednesday. It was down 350 on Thursday. And as I'm sitting here talking right now, it's about flat in the pre-market on Friday. So we're kind of roughly even, maybe down a tad on the week. We were up 800 points last week. So people go, oh, well, the market's worried about

the election. Well, it's okay. There's a lot of uncertainty around the election. I'm worried about the election. You're worried about the election, one way or the other. Well, guess what? The polls didn't change Monday to Tuesday, or Tuesday to Wednesday, and yet the market's swinging 300, 400 points a day. Oh, well, COVID right now, you see these new surges of cases in Florida and Texas. It's very true. But those cases in Florida and Texas were worse on Monday than they were on Thursday. And they were last week, they were way worse in Arizona than they have been this week.

And the market was up 800 points. You see what I'm saying? The market is not taking a fixed fact on a Monday and pricing that in Monday, and then the fact changes Tuesday. The markets are dealing with just an overall role of skittishness, an environment of volatility. And I don't know what changes that anytime soon. What you do have is an economy that is going to be at a better place in the future than it is now. I can't help you if you don't agree with that. That is not a bullish comment necessarily, because the economy could be at a

better place than it is now and still be in a very bad place. Structural unemployment could be higher in the future. Structural unemployment is most certainly going to be for some time higher in the future than it was six months ago, pre-COVID, when we were dealing with some of the lowest structural unemployment we'd ever seen. So we are going to be dealing with a lot of these back and forth dynamics. And we're doing it in an environment where there's an incredible amount of liquidity in the marketplace and a central bank that I would not bet against their willingness to do even more. Now, there's a diminishing return on putting a whole lot more liquidity out there. We don't necessarily need more liquidity. We've seen that in the corporate bond market. Mortgages, structured,

securitized credit vehicles, syndicated loans. Is there more they could do in those spaces? There is. Would risk assets rally if they did? You bet they would. You have a dollar that they're trying to weaken. It was strengthening a bit,

and it seems to have rolled over. You have copper, gold prices have done pretty well. Could the dollar weaken? Would that benefit risk assets? Probably it would. Benefit emerging markets quite a bit. There's a chart in Dividend Cafe this week you need to see. So I don't know how one could have

an overwhelming amount of conviction in a two month three month six month period time to say i want to be much more in risk or i want to be much more out of risk i i think this is a really really sensible conclusion that we've drawn at the boston group they're in a range bound volatile market for the short term and that because our client goals are long term we have to take long term perspectives. And long term, I think interest rates are woefully under what they need to be to pay clients bills, to accumulate capital at the rate clients want. So therefore, we have to find solutions that we think are going to, within a risk comfort level, get people where they need to be. And the sustainability of dividend income is right now at the best premium it's ever been because there's a lot of companies that are not

going to sustain their dividends. There's a lot of companies that haven't sustained their dividends. But those that are, those that can, those that will, they deserve to be paid up for. Some of them are trading at a discount to their fair value, not a premium to fair value. So those are the areas of investable opportunity we have to look at, but not pretend it's risk-free. Because the risk that comes along with it is price volatility, it is execution risk, it is uncertainties in the global macro environment. So a couple of things that I go through in Dividend Cafe this week. I want us to think about the economic environment that we're in as a two-act play. That the first act was, look, this was a recession that they forced us into as a result of shutting down the economy. So airline traffic went down 99%.

I'm still not really sure where that 1% was, but there was somebody out there traveling. Restaurant reservations went down 100%, or maybe it was 99.9%. I remember there was some restaurant in Oklahoma or Kentucky or something. And so that became the severe shock and awe recession, and then you get a kind of recovery out of it

and start seeing things move back higher. And the ISM non-manufacturing, as far as services sector, starting to push a little bit higher in expansion territory. We've already talked about tremendous improvement in the mortgage data and home sales data. The restaurants and airline traffic is moving in the right direction. I'm really impressed with the numbers. Some people say, oh, well, it's still so far down.

Well, of course it is. I'm sitting here in New York City right now. The restaurants aren't even open inside. It's out on the patio, it's 90 humidity i don't i just i don't understand what people are talking about those things are slow burn to get back and they're going to be okay but the economic recovery and the the crash that preceded it are part of this phase one phase two then becomes the the not i don't want to use the word hangover, but it becomes the kind of aftermath of what that immediate action-reaction phase one was.

Longer term, what are the jobs that were taken out of the economy that aren't coming back? What are the changes that become more systemic, structural, that have to get repriced? There's a repricing that has to take place in the economy. Well, the phase two, okay, people have been cartoonishly trying to forecast what phase one stuff would look like. And I've said this before, I want to reiterate it. I'm not critical of anyone getting it wrong, because everyone's going to get it wrong, because it's impossible to forecast. But with phase two, it's really not much different. We just don't know. We just don't know. And there's a lot of bandwidth.

There's how good it could be, how bad it could be, and the various outcomes that are in between. But I think that that phase two becomes the kind of second act of the play that is very important for us to look to. that it's very important for us to look to. So in terms of just a couple of the things that we go through at DividendCafe.com this week, I'm looking down at the actual commentary on my screen. If you're interested in seeing kind of the tremendous comeback in oil prices,

first of all, just the violence of the chart that I show is amazing. How far down things came, how far back things have come, and now where we look out into the future for the demand side, we know what has happened on the supply side. Market forces pushing down production in America. OPEC Plus pushing down production, Saudi and Russia primarily, to avoid a supply glut.

And then now demand has to come soak that up. And you have the possibility, if you get any kind of inflationary spike, if you get any demand that is equal to or better than expected, there's no way supply can come back on quick enough to not see a big move higher in prices. Really interesting dynamic there. I talk about bonds quite a bit this week. And I want to make this comment from an asset allocation standpoint. Because I said in my opening comments why the interest rate environment is one where it's changed the rules of the game for people.

interest rate environment is one where it's changed the rules of the game for people that cannot go to what are considered traditionally safe assets and get the same cash flows that they're accustomed to getting. But from the vantage point of an asset allocator who's managing a whole global portfolio, it's also true you cannot go to bond market and get the same zigzag effect you used to be able to get. I read a piece this week I thought was very interesting that more or less long-dated bonds serve the purpose of like a global macro now where you just are going to get no return, and then if things all of a sudden go to hell in a handbasket in stocks, maybe you'll get a big spike up.

So it becomes like a tail risk hedge, but you're not getting paid for it along the way. And no one's willing to put 30, 40, 50% of their portfolio in something that won't pay them 99% of the time, just so they have a shock and awe hedge 1% of the time. And yet, you could argue that's really where the whole asset class of long-dated safe bonds are going and so I have to think about the fixed income universe from the long-term cash flows that it doesn't generate any longer and the the function it plays inside of a portfolio a lot of people have determined that these kind of big tech companies, there's four or five of them that are ruling the market right now, and some would say ruling the universe.

Some of them, you know, you could, they certainly do have a rather universally significant and ahistorical role in the overall society. But the question is, do these things become the leaders of the market forever and ever? Is the NASDAQ's percentage to S&P being back to those 2,000 levels? You know, on an apples-to-apples basis, is this ratio sustainable? What I do know is it's not timeable. You could have made an argument five years ago this should have ended, and it's gone and gone and gone.

The earnings of those four or five biggest companies have doubled over the last five years. That's a big deal. But the valuations have gone up 500%. So the bid that investors are sentimentally offering into those four or five names is far outpacing the actual organic earnings growth of those names. So what could prick that bubble? Government intervention, the monopolistic nature of some of those companies could get pinpricked by the government. There could be a new shiny object that comes along that investors like more,

start pulling capital out of what they're right now willing to flood capital into. Some of these companies could just simply get beaten, new technology, new company, beaten, new technology, new company, or they'll just die of exhaustion. Just the air just comes out of the tire eventually when it gets too full. I don't know what it will be, and I don't know when it will be. I do know that it will be. History has told us that, 400 or 500 years of history. So I think that it's very important for those that are managing risks and rewards, managing tradeoffs, managing cost benefits.

The reality of tradeoffs suggests that one needs to be conscientious of those potential valuation concerns and where we want to be instead. So we're going to go into earnings season now here next week. It's a little bit more valid of an earnings season than the last one. The last one, you're sitting there getting a report on earnings from Q1 when for the first 10 weeks of Q1, things were normal. In the last two weeks of Q1, the world had shut down. And then people were done projecting going forward. Now you're going to get all the results from a Q2 where for the bulk of Q2, the entire economy was shut down. And now perhaps some companies see a little daylight

to project what they see going into Q3 or Q4. So I think there is going to be a little bit more optical enlightenment, if you will, in this earnings season than was last, but it's still very, very limited. I think you're at least one quarter, if not two quarters away from getting something kind of reliable and meaningful to where a normalized operating earnings environment can return for corporate America. I said I was going to go through all the things I went through in Diven Cafe this week, but I kind of touched on a lot of them, but I'm certainly skipping over some. And I really like the people listening to the podcast to go to DivenCafe.com because I like the charts that are there. I think there's sort of something about the written word that I always have a preference for, although I don't get to dictate consumer preferences. So if you prefer the podcast, I get it.

But I will kind of leave us there and land the plane now. We're living in a very difficult environment. It is a disinflationary environment right now. There's concerns about inflation that are out there. It's a period where you're going to have record-breaking economic recovery, but it's coming off of record-breaking economic collapse. Political, medical, cultural difficulties are around you everywhere you look.

And the option of hiding in safety is the least attractive it's ever been. So we have no easy answer, but what we do want to do is actively, thoughtfully, objectively construct solutions for investors that within the rules of engagement for their own set of trade-offs can get them on a risk-reward basis, get them where they need to go. And that's the way I think everyone should be thinking about this right now, because it's going to be quite a ride.

And so I hope that this has been helpful for you. I welcome you to reach out to any questions. Please join us for our national video call on Monday. All the information is available online if you'd like to register for that call that we do every two weeks. And in the meantime, if you're a client of the Bond Circle,

please reach out to your advisor if you have any questions at all, if you want to client of the Bonsai Group, please reach out to your advisor. If you have any questions at all, if you want to revisit or just re-understand how your portfolio is addressing the tensions and trade-offs in the world we live in, we'd be happy to go through that with you. It's one of the most important things happening today. But the most important thing happening today is the loved ones in your life. Go enjoy them this weekend. Thank you for listening to and watching The Dividend Cafe. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC,

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