The Dividend Cafe - Hurricane Harvey and Your Portfolio

Episode Date: August 31, 2017

Hurricane Harvey and Your Portfolio by The Bahnsen Group

Welcome to the Dividend Cafe, financial food for thought. Hello and welcome to this week's Dividend Cafe podcast. This is David Bonson, Managing Partner, Chief Investment Officer at the Bonson Group. And we have had quite a week. Really the hurricane Harvey damage throughout the state of Texas has dominated the news cycle, and for good reason. And our hearts and thoughts and prayers are certainly with the great people of the great state of Texas. And we just pray beyond anything that there can be quick and productive healing and resolution for all those that are dealing with the aftermath of this really unfathomable disaster.

Watching it on the TV screens is just bad enough, but we can only imagine what things are really like there on the ground. The portfolio impact has created a number of questions and so forth. And for good reason. I spent quite a bit of time this week actually going back and assessing some of the data from Hurricane Katrina. And I do think that it's an uninvestable situation, either defensively or opportunistically. We have seen gasoline prices rise this week for obvious reasons, even as oil prices actually declined a little bit. The inability of refiners to get online means that oil supply is not impacted, but the final product is the refined gasoline that actually gets to market.

So this reduced supply leads to higher prices, but on the natural gas front, reserves were so much higher than they were over 10 years ago during Katrina that there's been very little impact. There's generally a modest and also short-lived bounce after a significant weather event in industrial production and in retail sales because of products that need to be replenished. But nothing that we believe to be material, let alone investable. Damages and impact are so concentrated to the area affected in our large and layered economy that looking for a significant needle moving in some category of the economy is usually futile. So we don't

anticipate any significant impairment or opportunity. We just view it as a human event and a human tragic event at that. Our focus is rather on prayerful aid for those that are displaced. And so what you saw this week was a market as of recording time that's up 120 points or so on the week after North Korea firing off another missile that actually went over Japanese airspace and one of the worst natural disasters in American history. So the ongoing resilience of the market continues to be a story. We'll talk a little bit more about that. Switching gears, let me update you a little bit on what we're dealing with in Japan. Spending 20 years as a bear on Japan has been exhausting, and economically this country is a long roadway in front of it.

Their macro and demographic challenges as a society have not gone away. We remain in significant due diligence about a handful of things causing us to review our thoughts on potential bottom-up opportunities in Japan. Worth noting, the annual dividend growth of their public stock market is now higher than our own here in the States. Over the last three years, they're running about 8.6% per year growth of dividends out of their market versus 7.9% here in the States. The number is closer to 10% per year dividend growth on a five-year basis. So what I'm referring to there is the growth of the income and equity holders receive per

year. And that's the metric, of course, that we follow more than anything else in our analysis of individual companies. So our work continues here, but I will say that we are very interested in a bottom-up contrarian story despite demographic challenges in the country of Japan. A reminder on the danger of valuation relationships. We're always sensitive to the mean reverting nature of valuations that risk assets tend to average up into or down to historical valuation levels when their valuations become distorted north or south from their averages.

But we need to issue a reminder that this is categorically different than those who make investment policy out of the relationship between two asset levels. For example, saying historically gold has been X percentage of silver, so therefore gold should be going higher or lower to be in that historical average. It is not a coincidence, by the way, that I use gold-silver to illustrate the fallacy of this thinking, as all silver investors and gold-miner investors of 2009 to 2017 can attest. But it's one thing to say hypothetically that European stocks trade below their historical valuation level, which may or may not be true. It happens to be true right now, but that's not my point. It's another thing to say that they trade

below their normal ratio of valuation to U.S. equities and therefore are attractive. Why is this problematic? Because relationships can get in line two ways, can't they? If there really were some equilibrium that two asset classes were supposed to trade at in relation to one another, and there is not, who is to say that the more expensive asset class in the relationship could not just come down to levelize things as opposed to the cheaper one going higher? If you and I sat down in 2003 and said, hey, the national debt is currently less than $7 trillion, and the 10-year bond yield is 4.5%, but in 2017, the national debt will be $20 trillion, how high will the bond yield be?

What do you suppose our answers would have been? 6%? 8%? Maybe 10%? We would have assumed that the bond market would have thrown up at the excessive debt and that inflationary forces would have been unleashed. So how do we reconcile a tripling of the national debt with a halving of the bond yield instead of the expected doubling? How have things not only failed to go the way we would have predicted in our hypothetical 2003 conversation, but they've gone the exact opposite direction. Well, we have a chart at DividendCafe.com that shows you visually,

but I'll describe for you exactly the reason. You can see a near perfect correlation between the debt outstanding growth and then the growth of the Federal Reserve balance sheet. So while deflationary forces came with a huge increase in the national debt versus the predicted inflation, the Fed's aggressive monetary efforts with their own balance sheet nearly perfectly coincided with the increase in national debt, serving the purpose of letting interest rates fall rather than rise. Is this a way of saying that the central bank has played the enabler for a profit-get federal government? Well, some questions don't require an answer, do they? Where the debt ceiling

debate does matter, we're on record as predicting that for what seems like the umpteenth time, Congress will, after a lot of posturing and gimmicking along the way, add a short-term extension to the debt ceiling yet again, avoiding the delay of government expenditure disbursements and debt service payments. Secretary Mnuchin has requested a clean extension, no conditions, raise the ceiling, fund the government, and then figure out what needs to be figured out around spending, revenues, and budgets. Many in Congress are sure to grab headlines

insisting that their agreement to do such will be accompanied by a particular condition or allowance, likely more cosmetic than anything else. This periodic episode is not government at its finest, to say the least, but the reason we do not jockey client portfolios around the varying degrees of grandstanding and can-kicking is that bond and stock markets, if they suffer any impact at all, resume normalcy very quickly after the shenanigans are over. That doesn't mean, though, that the incident is free of consequence. The saga distorts prices of insuring U.S. debt, so-called credit default swaps. The CDS market widens around the drama and represents a cost that debt issuers must incur.

Silly political posturing is always annoying, but the somewhat opaque economic impact is downright irresponsible. Right conclusions from wrong premises. One of the most common things we see are investment conclusions we agree with, but for different reasons than the ones offering the conclusion. conclusions we agree with, but for different reasons than the ones offering the conclusion. Of course, we see wrong conclusions from wrong premises and wrong conclusions from right premises plenty as well. There's no shortage of analysis right now offering a top-down rationale for a heavy weighting to emerging markets. A, real growth expectations this year and the next two years are nearly five percent per year, more than double the expectations for economic growth in any other developed region.

And B, there are structural improvements to emerging market economies, more flexible exchange rates, higher foreign exchange reserves, lower current account deficits. And also, valuations are compelling. They're below their average price to book and price to earnings ratios. All of these things, by the way, are true. It's perfectly logical that standard, fair, top-down managers would find them to be a compelling case for emerging market investing. But none of those things represent the foundation for our pro-emerging market conclusions. We like emerging markets to the

extent the managers we use in the space can find individual companies who are creating growth and are doing so with a risk premium we find attractive. We never want to believe that buying a country is even an investable possibility, let alone a desirable one. Economic value gets created by business operators, innovators, and entrepreneurs. We are living in an era where the developing parts of the world are seeing extraordinary business operators grow and grow and grow. And in that bottom-up reality, we find investable opportunity to assist the financial goals of our clients. Well, I kind of need to wrap things up for the week. I really hope you'll go to DividendCafe.com because we do have a significant amount of charts there

this week. We have a little chart on the volatility of Bitcoin relative to the U.S. dollar that I think is just stunning. We have a chart on the home equity line of credit originations and extractions that we're starting to see of equity from people's mortgage through the form of cash out transactions on the rise again, representing a trend that we find concerning and that we want to pay attention to, even though we acknowledge it's nowhere near the pre-housing crisis levels of absurdity. This is the last week for the summer. We are excited, first of all, to be entering the fall, also to be entering football season, and then finally, for yours truly, to be returning to Newport Beach, California, where the Bonson Group is primarily based. We've opened up a second office in New York City where I've been working the last couple months. And my family spent the summer in Manhattan just for the experience with my kids. But not only are

we really happy to have our office up and running here and really, I think, getting some very productive business done. But frankly, it's going to be nice to return to Southern California just from a team standpoint as well. So all that to say, what an incredible first eight months of the year it's been. And we do hope to answer any questions you have any time. If you will reach out and extend those to us we will do our best to respond comments questions we welcome any time in the meantime we get ready for the final trimester of the year and we get ready for USC's opening weekend victory thanks so much for listening to the Dividend Cafe, financial food for thought. registered with Hightower Securities LLC, member FINRA, MSRB, and SIPC, and with Hightower Advisors

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