The Dividend Cafe - High Drama as Trade Talks Continue

Episode Date: October 11, 2019

Topics discussed: Some day-to-day volatility in the market unsurprisingly surfaced in markets this week as we were down 100, down 300, then up 200 the first three days of the week, all around various chitter-chatter as to where China-trade talks were or were expected to be or were rumored to go or whatever ... This is a frustrating Dividend Cafe to send because I have no choice in terms of the timeline but to submit it before we have gotten real reports on how the trade talks have gone Thursday, and yet you will be receiving this Friday and of course by now there may very well be some updated report as to how the status of such talks. Of course, by early next week, I will provide an interim Dividend Cafe to give an update on the state of affairs ... The trade talks are the largest macro issue to watch right now, as once again the futures market has all but fully priced in another Fed quarter-point rate cut (at the October FOMC meeting at the end of the month). But markets are likely to respond to earnings results as the new season kicks off this coming week. Expectations are again reduced so how companies report revenue and profit results from the quarter that just was, and what sort of guidance they offer about expected results in the quarters ahead, are very likely to move the needle (in the overall market level, and of course in individual company results). This week's Dividend Cafe is really focused on the economy, the Fed, politics, and earnings. We look at a preview of earnings season, the idea of a QE4 coming, a deeper dive on economic indicators, and of course, Politics and Money. Grab your coffee, and jump on into the Dividend Cafe ... Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Actually, I have to come back next week, but I should say I get to come back because it's one of our favorite weeks of the year at the Bonson Group. We'll be doing our annual money manager due diligence trip. It kind of starts at the end of next week, and then we'll go through the week following. But there were some reasons I had to come out to the city this week, and there's a lot going on right now in the market. out to the city this week. And there's a lot going on right now in the market. I'm recording middle of the day on Thursday. And I wish I could record a little later because I'd love to give you something more real time or updated around the trade talks that are taking place right now with the negotiation teams from both the US and China. But the reality is that it's just impossible to time it exactly. And I suspect that probably more substantive news will come late on Thursday and possibly even on Friday.

And so it just is impossible for me to be able to kind of time all that out perfectly. You know what I mean? The update right now, though, is that we really do have a lot of optimism baked into the market that they're going to get some sort of, you know, mini deal done. And I suspect that what a mini deal could entail is, most importantly, an end to these escalations around tariffs. I joke in Dividend Cafe this week that when you're in a ditch, stop digging. And I think that even just a kind of like knowledge in the market that at least for the time being, we're done with it getting worse, I think would really be a productive thing for markets. But beyond that, what would help enable a cessation of escalations, a ceasing of escalations, if you will, is a purchase agreement

from China for U.S. agriculture and energy products. It's something that apparently had been very close before that the president felt that China had kind of reneged on earlier, The president felt that China had kind of reneged on earlier, particularly on the agriculture side. I think that some form of a cancellation of any of the legacy tariffs that the president has put on going back to the earlier part of 2018 would be particularly useful in a short-term type deal. And then some of the talk that's really come up a lot in the last 24 hours that I spent a lot of time this morning kind of trying to wrap my arms around is the idea that they may have an agreement to incorporate currency issues into this. And so that there may be some, even an agreement that caps some kind of depreciation that China would be allowed to subject the Chinese currency to relative to U.S. dollar. So I don't know that any of those things are going to happen.

I don't imagine we get any kind of little short-term deal without at least most of those things. It, frankly, could be much more robust than that longer term, but this would be the bare minimum, I think, to kind of hold things over. So pessimistically, I will say that I think the risk-reward is somewhat asymmetrical. I think that the idea of some type of a deal, maybe along the lines of what I've outlined, is what the market's hoping for, kind of expecting to some degree, not completely. But then I think that if something really falls apart, I don't think the market has that priced in at all. So we very much have the possibility of a big drop in markets in the days ahead if things take a big step backwards. The Market's clearly not expecting that, though.

It's hard to see how we get a huge leg up if they do get a deal, unless there's just a lot of surrounding language that, in fact, they are going to address national security issues. They are going to address technology, intellectual property theft, supply chain, that a lot of these things are not going to be hammered out here in the next 48 hours, but that they feel like there's a path to getting that done. Those are the issues that kind of creep back around that I think hold markets in suspense because they want some certainty around the longevity of an agreement.

So you have kind of two things at play, and I put a chart in our chart of the week this week from the IMF, their estimate of what the impact of global GDP growth. And I've been really focusing on how it's impacted U.S. GDP growth. My argument that I really have quantified in past issues at Divinity Cafe is I think that we're at a point now where the impact of corporate tax reform has been entirely eroded by the impact of the trade war in U.S. economics. But I really do think that the global impact is far worse, and I don't say that as a good thing. Potentially, if things were to go forward as they're presently tracked to go in 2020, I think it could take as much as $800 billion off of global GDP growth. So a lot on the line around getting some trade resolution,

both because of US interests, but also because of just the shorter-term economic and market impact that I think is important to a lot of people. Now, I kind of skipped going straight into the China trade issues, but I do devote a lot of time in the Dividend Cafe this week to the earnings season. And my partners on the investment committee last week basically did a podcast that I encourage you to listen to with our projections, what we think the ramifications are. But really, the theme I would like to share with you now is that it would be very interesting to me if for the third quarter in a row, a projection of modest earnings of negative earnings growth year over year ends up being slightly positive. That is what has happened in the last two quarters. Now, both last two quarters,

they're projected to have kind of a reasonably small amount. The consensus view right now is for almost 3% year over year deceleration in earnings growth. And I won't be surprised if the market ends up squeaking out equal earnings growth, earnings level to where it was a year ago this quarter, or even slightly positive growth. The question mark is around technology. I think that's what moves the needle the biggest. It's the biggest weighting in the S&P 500. And there's so much volatility around the way earnings can come in with tech companies. So that's probably what will end up making the difference between negative 2% or positive 1%. But I really love some of this work I did. I encourage you to go to Dividend Cafe to look at a chart that I provided where I break out the earnings growth of the last few quarters of 2018,

all the quarters of 2019, and the projections into 2020 and separate out these three sort of phases. The past robust earnings growth that we had a year ago was exactly why the market had been up so much in 2017. ago was exactly why the market had been up so much in 2017. Then the kind of flattish and modestly positive earnings growth 2019 is why the markets had sold off in fourth quarter of last year. And then yet we see expectations for pretty sizable earnings growth, high single digits, low double digits in 2020. That's the question mark. That to me is really what we have to be focused on, is are the markets setting themselves up for a big disappointment? Or in fact, are we going to get that kind of earnings growth? In which case, you go from being slightly overvalued in the market to slightly undervalued. If you get that kind

of earnings growth in 2020, that brings the multiple down and really kind of indicates that the economy is advancing better than people had expected. So the earnings season is going to begin this coming week. A few pretty significant companies that report in the week ahead, blue chips and things like that, particularly some in the financial sector. But then it's really the week after that that it goes full bore and the week after that. So the kind of last couple of weeks of October, you get the vast majority of S&P 500 companies releasing their earnings. It's really hard for me to get into some of this Fed stuff in the podcast because I feel like I do a better job writing about it than

I do speaking about it. And I'm not even sure I do a very good job writing about it. And in my defense, this stuff is very complicated. And I think a lot of you don't care about it. And I don't think you should care about it. And it's very technical and very boring. There's a lot of conversation right now about the Fed saying that they intend to kind of increase their balance sheet again. And a lot of people said that's called quantitative easing. Are they actually doing a QE4? And there are some distinctions that are important as to why they're doing it and how they're doing it that I think justify not calling it quantitative easing. Now, I want to be clear.

I don't have any doubt personally that the Fed would, in fact, go to another round of quantitative easing at the first signs of a real recession. But in this particular case, they're talking about a sort of organic increase in growth of their balance sheet that is more instead of – how do I say this? They're going to stop shrinking the excess bank reserves. Then that enables their balance sheet to grow more in tandem with the need for liquidity in the economy as banks are drawing and not drawing capital. And it's kind of the normal process of how they would manage their balance sheet before 2008. sheet before 2008. The whole reason we call it quantitative easing and it became QE1 is because they were doing something so abnormal. OK, so now I believe that they are looking to because of these problems in overnight funding, because of a few, you know, sort of outlier events that that created the need to shore up liquidity. They are looking at increasing their balance sheet slowly

but surely. By the way, this is sort of an admission that they overdid the tightening of the balance sheet, that they regret having done so and that they underestimated the impact it would have in the reserve system. They thought they had built up enough excess reserves that it would allow for proper currency in circulation. But then what happened is the Treasury Department kind of surprised them with a lot of significant withdrawals after the government shut down. And they were caught without adequate liquidity, and it ended up affecting the repo rate.

Now, I think I lost most of you already, so that's okay. I'm going to move on. This is the point I want to make. We're not going to quantitative easing round four at this time. The Fed is reversing some of the real tightening activity in their balance sheet that they did a year ago. And you can go back and listen to how much we were talking about it and why we thought it was more bearish even than them raising interest rates. And as I say that, I do not want investors disappointed that they're not going to QE4 right now because I think QE4 would be a very, very bad idea

and a very unnecessary idea. And I think they will end up going to it at some point in time. I think that they feel that the notion of very consciously and intentionally manipulating their own balance sheet is a productive way to go about doing things so with all that said I try to give the other side of some of this economic data in some charts. I talked last week about the manufacturing number, ISM turning negative, worst data point since 2016 in manufacturing. But then there was the IHS market manufacturing index that showed a slight increase. One is based on sentiment.

One is based on activity. So there's kind of a push-pull going on there. I think there's more of the difference between one being a leading indicator and one being a lagging indicator. So I would take it as a pessimistic indicator. But net-net, you can look at both sides to it on the manufacturing data. The other aspect is in the small business optimism index. index. One of the really, I think, compelling counter arguments to some of the negative business economic data that we've had in the last six months has been that the small business optimism has remained high. And yet that now, with the most recent reading, has turned lower.

Still on an absolute level, a higher place than it had been going back a few years, but nevertheless, significant drop in the more recent months, actually having caught up with the small business index as well. So that entire theme, which is that we want to see business confidence leading to business investment and that the trade war and the uncertainty from the trade war is stripping away that appetite is back in play. One of the things that I will sort of conclude with here is the obviousness in my mind of what makes sense for investors in this period. And when I say this period, what do I mean?

I mean a period where people are really screaming for pretty much just two things. There's very little that you hear from either institutional or individual investors in this environment. One is that they want safety, some degree of relative protection in the context of the issues that are out there, market multiples being high, long economic expansion that may very well be in its later innings, the uncertainty around the trade war, the political questions in 2020, the geopolitical questions that are out there. So you have a desire for something at various ranges of what it means to different investors to have some defensiveness and protection and then of course people are screaming from the mountaintops so they need income interest rates are so low they're negative in most places around

the world they're very very low in the 10-year bond yield in america very low dividend yield in the s&p 500 and and so I think that all this is just sort of the most, you know, besides the fact that we're talking our own book, which I freely admit and I'm proud of, I cannot believe what an environment this is suggesting for dividend growth, that you do have a relative defensiveness compared to other investment approaches, not devoid of volatility, but certainly less exposed to intense market distress. And then you have higher income than the S&P's dividend yield, substantially so, substantially higher income than the 10-year Treasury bond, than fixed income can offer.

And then on top of that, you get a growth of that income to boot. So I will reiterate our belief that there's no period, no season where we think dividend growth is unattractive. But we do think right now it has a particular attractiveness that we really want to emphasize. So that's about it. If you're looking for something to kind of cheer you up, by the way, markets on the week down about 100 Monday, down 300 or 400 on Tuesday, up a couple hundred Wednesday. And as I speak here now, up over a couple hundred on Thursday, but the market's still open. So you're ending up kind of near a flattish place on the week, more or less back to where we started. Again, up and down around will they, won't they on a

trade war deal. Yep, that's where we are. So I think that if you want to be optimistic about where things stand in the market, you hopefully believe that improvement in the trade talks is coming. And then here's the biggest thing I will share. And I love this chart at DividendCafe.com that I found this morning and put in. And that is a skyrocketing amount of bearishness from consumers about stocks, expecting bad things in the stock market. And that kind of exuberance that from time to time takes place is very, very concerning to people that know how these things work. And likewise, when you see the level of bearishness get back to a place that hasn't been since 2011 in sentiment around equities, I have to tell you

that it really is a contrarian indicator. So please do read dividendcafe.com a little bit more on the political environment. We have a link to an interview I did on Fox Business this week about the prospects of Elizabeth Warren presidency. That's something we're going to be talking about. As long as she stays high atop the polls, we're going to have to keep talking about her impact in markets and so forth. Other than that, though, we will be doing a special dividend cafe early next week when we get some better indication as to how things have come out of the China talks that are taking place as we speak. Secretary Mnuchin and the team of

negotiators meeting with the Chinese negotiators on a potential trade development. The world is waiting. We are waiting. And in the meantime, I hope you have a wonderful weekend. Thank you, as always, for listening to and viewing the Dividend Cafe. Thank you for listening

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