The Dividend Cafe - Human Nature and Your Portfolio

Episode Date: September 7, 2017

Human Nature and Your Portfolio by The Bahnsen Group

Welcome to the Dividend Cafe, financial food for thought. have quite a few fun things to go through with y'all today. It's been a very interesting start to September in a lot of different ways, and I don't think too many would have anticipated these kinds of weather issues, both from the Harvey disaster and then now what has branched into Florida and so forth, and then also the market response to a lot of these different events. It's really kind of intriguing. You have the energy sector rallying quite a bit around what seems like enhanced market volatility. It should be the opposite. You have bonds catching a very nice bid as interest rates have dropped further. And then the entire debate around risk on, risk off. Certainly Tuesday, a big down day in the markets and more discussion as to what this North Korea threat represented. And I'm going to cover a couple of things later as to why I think there's

a lot of wrong diagnosis around that. But let's get into these different topics we want to cover. The first one is actually most important, I believe. And I don't know, maybe by the time I'm done going through it, I might just end the podcast. I doubt it. But it's that important. And that's sort of the heart of the matter. A recent newsletter from a mentor of mine I've been reading for every single month, without exception, as long as I've been in the business, provoked this. And it's not anything different than stuff we've talked about over and over and over again for a couple decades.

But really, there is a nugget of wisdom that is absolutely central to everything we believe and everything we do at the Bonson Group. The successful execution of an investment plan will always and forever be a result of behavior, not intellect, of temperament, not complexity, of wisdom, not knowledge. We work and work and work in capital markets and have a very hard time believing any financial advisor studies more than we do or cares to be informed and prepared to the degree that we do. And yet all the content digestion and content creation in the world could never hold a candle to the need for proper behavioral guidance and decision-making. It is the core of our value proposition, aiding our clients in the not always easy task of avoiding the big financial mistakes.

We're fighting a war against human nature in our daily calling to assist clients in achieving their financial goals with battles against media influences and doomsday bloggers being peripheral battles in that greater war. But human nature will lead even intellectually rigorous investors to do the wrong thing at the wrong time. We're determined to win this war, but we're going to win it with our client's trust that stems from our own trustworthiness. Now with that heart of the matter laid out there, let's talk about Tuesday's sell-off. And there is something painfully contradictory about following a sentiment of long-term behavioral disciplines over emotional responses as the primary determinant

of investor success with a discussion of one measly day in the market. However, I present this information not to play into the silly discussion of what one day's market action means, whether it was a 200-point down day or a 200-point up day, but rather to demonstrate the very point that these things are not actionable and often dangerously discussed events. If one watched the news Tuesday, they may have concluded that we were down 200 points because of the hurricane damage, which would be odd since it was over a week late. If one watched the news Wednesday, they may have concluded that we were up because of the hurricane.

All of a sudden, it turned into a positive around higher energy prices. One may have concluded that it was North Korea because a nuclear war is only good for 200 points down. I don't know. Or concluded it was all the challenges with President Trump's agenda, and you know, we've heard all that story. Do you want to know why the market dropped over 200 points Tuesday? The answer is that the market doesn't need any reason whatsoever to do so. The market is a complex, layered, multifaceted organism responding to trillions of data points

second by second and has never provided anyone clarity on why it does one thing one day and another thing the next day. Traders unwind trades. Speculators get beat one day and vindicated another. But by the way, never are all speculators getting vindicated at once or all traders vindicated at once. Otherwise, there wouldn't be any beating or vindicating to talk about, would there? There's always two sides to this, trades and stories. A market in a meaningful bull run like this one will have days to go down. And if it helps you to assess blame to North Korea or a hurricane or to USC's need to stop Stanford's rushing attack,

I say have at it. Just don't actually try and do something about it. The bond market right now is a bigger deal than the stock market. Let me explain what I mean by that. The issue of the 10-year bond yield is a big deal. One cannot have equities rallying behind higher growth expectations and have bond rates falling due to low faith in growth expectations. I was recently on CNBC and one of the other guests made a comment that I found to be pretty astute. We have a bond market which believes the inflation data but doesn't believe the growth data. And I agree. I think that the prudent positioning right now is to maintain defensive bond weightings biased towards the risk of interest rates going higher, but not dramatically so. In other words, growth is

strong enough for a 2.5% tenure right now, and it's only 2.1 or so. But inflation is not high enough for a 3% bond yield. As for the risk that rates drop further, well, that's always there, especially in risk-off circumstances. And it's why bonds belong in some small degree to a properly asset-allocated portfolio. I want to talk a little bit about Japan right now because we're in to a properly asset allocated portfolio. I wanna talk a little bit about Japan right now because we're in to a very extensive research project around whether or not we A, wanna take an exposure into a place that we have really wisely and consciously avoided for almost 20 years.

And then if indeed we want to, how we want to, what that instrumentation would look like to gather that exposure. One thing that would kill my interest in this project in a second is if it remotely struck me as being a consensus viewpoint. Being late to a position everyone else has already adapted, which is by the way the investment practice of choice for about 90% of investors and even advisors, is a surefire way to deteriorate results. But the data here is quite remarkable. In 2013, over $150 billion net came into the Japanese stock market from foreign investors. Another $23 billion in 2014. But in 2015, it dropped to just $3 billion.

And in 2016, the net number was negative $40 billion. So now in 2017, things are looking up. And what are the inflows into the space? Just over $2.5 billion. So now in 2017, things are looking up. And what are the inflows into the space? Just over two and a half billion dollars. So there's been negligible interest in Japanese equities from foreign investors for quite some time. Now, fundamentally speaking, earnings per share in Japan are up nearly 30% over the last 12 months. The caveat is that we're comparing a number that's against an extreme trough in earnings. In other words, the earnings are recovering against such a really low point that it is subject to overstatement.

The validation of the thesis I'm exploring, which is that Japan has breathed out the hangover, which is well over a decade long, of its great deflation, and that individual operators could represent attractive secular dividend growth stories for U.S. investors, is ultimately going to come down to A, proper affirmation of the fundamentals around earnings, cash flows, and dividends, and B, comfort and competence that the central bank intervention of the last year is not the sole horse on which those hypothetical fundamentals ride. We have more work to do. I do have a section at DividendCafe.com this week that lays out the idea of Japan potentially being a certain kind of

a risk hedge as well, but only a hedge against one particular type of risk. And I'll let you read about that and see the chart at DividendCafe.com. It has to do with rising U.S. interest rates. The jobs data last week was a little disappointing. Only 156,000 jobs created in August. We were expecting 180,000. Pretty soft report overall, but again, August is notorious for revisions. So we're going to look for more data in the months ahead to kind of get a feel for where we think the labor market stands, particularly around wages. feel for where we think the labor market stands, particularly around wages. You know, we're concerned about where we are in the credit cycle. We're looking at bond spreads quite a bit. We do believe that the high-yield market in particular at one point had gotten too rich, and we exited our position there. And subsequently, indeed, it did. Spreads did widen out, and the high-yield bond market slowed off to some degree.

So in a sense, it sort of looked like from a tactical investment move that we made a really smart, well-timed decision there. But I think the bigger issue is we're looking at those high yield bond spreads to understand more about the credit cycle and understand more about the risk environment that we find ourselves in. the risk environment that we find ourselves in. And looking under the hood, we actually see that high yield spreads have not really moved all summer in industrials, materials, and even financials. The real spread widening you see indicating a softer high yield credit market is all in the energy sector. And there's a chart demonstrating this in dividendcafe.com. We're definitely watching the emerging market debt asset class quite a bit. And it is along these lines that I want to make a point I alluded to earlier in the podcast. This idea that North Korea and that geopolitical risk is driving risk on, risk off across capital markets obviously makes a lot of

sense in theory. You get a madman talking about nuclear war, you would think you would be subject to some sell-off in risk assets. But what we're supposed to believe here is that high-yield bond spreads have widened because of this North Korea fear, and that U.S. equity markets, even though they're still awfully close to all-time highs, they've certainly experienced some stock-like volatility over the last month or so, and that that's all happening with North Korea as a risk-off game changer. But emerging markets' debt has continued to rally. Their yield spreads have tightened, not widened. It's a direct contradiction to the idea that Korea is driving risk fears. Think about the logic of saying, I'm afraid a nuclear flare-up will hurt my U.S. stocks, but I will pay more money for the debt

of the country right next door to the nuclear flare-up. I mean, all things being equal, to the nuclear flare-up. I mean, it just, all things being equal, we view traditional factors driving asset prices right now. Inflation expectations, currency fluctuation, economic growth, and then, of course, stocks and earnings. And to the extent that all of those things are subject to volatility, we should expect some price volatility,

price volatility that have largely escaped us in the months and quarters preceding that. I'm going to close it out there for the week. I do encourage you to check out DividendCafe.com. I encourage you to add this podcast to your weekly subscription with your iTunes or SoundCloud or wherever you listen to it on. But look, we're in a really, really engaged time of year right now because we want to get our asset allocation

positioning right going into the fourth quarter of the year. We want to be very tax sensitive around a lot of the events of the year. We want to continue to manage risk and reward trade-offs thoroughly. And we're meeting with every portfolio manager we work with in our big annual due diligence trip here in less than a month. And so these are good times for us to be engaged in capital markets. Overall, we encourage you to just turn off the news and listen to Dividend Cafe. Thanks for listening to the Dividend Cafe, financial food for thought. The Bonson Group is registered with Hightower Securities LLC, member FINRA, MSRB, and SIPC, and with Hightower Advisors LLC, a registered investment advisor with the SEC.

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