The Dividend Cafe - If Only One Could Predict the Future, It Still Wouldn’t Matter

Episode Date: September 8, 2023

Today's Post - https://bahnsen.co/3PxghfG Today, I would like to use the last five years to make some broader points about the realities of investing. Evergreen realities are, well, permanent. Yet we find within the last five years some serious bold-faced reiteration of these realities to which I refer (and as you will soon see, there actually is a particular single reality most on my radar this week). So, in this week’s Dividend Cafe, we will look at the last five years and extract from this little short-term window some big-picture lessons that are sure to matter for more than just the last five years. Consider it part “History” (albeit recent history) and part “Investing 101” … Jump on into the Dividend Cafe! Links mentioned in this episode: TheDCToday.com 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. Well, hello and welcome to this week's Dividend Cafe. I am really excited about this week's because not only did I just get done writing it. And sometimes I enjoy recording the podcast in this video when I'm, you know, fresh off of the writing more than when I'm recording a few hours later, because, you know, some of the mental inspiration and so forth can get distracted or diverted. But it's also a topic that I love a lot. I mean, first of all, the whole concept of doing Dividend Cafe around evergreen principles is always hard because there's topical things that come up. And I have a strong desire to bring it back to first principles. If I'm going to talk about something going on in the world with China, something going on in the world with energy

policy, something that just got done happening with bank failures. These are macro topics that come from some event that I like to write about at Diven Cafe. And yet, really what I mostly want for Diven Cafe is reinforcement of permanent principles. So to apply various things week by week and pull into that the first principles that we care about. Sometimes it's a challenge. Sometimes I think I execute it well. Sometimes I don't think I execute it well. But this week I'm just simply talking about first principles. I'm doing an entire Give It In Cafe that starts and finishes with,

hey, we have right in front of us a beautiful reminder of something that I want you to remember today, and I want you to remember in a year, and I want you to remember in 10 years. And I'm going to use the last five years to make a point. If you look at from 2018 to 2022, and then we're coming now into 2023 in this kind of setup here. 2018 was the first of this five-year period, and the market was down that year. 2022 was the last of this five-year period, and the market was down that year. And you know what's interesting is it bookends three other years

in the middle that were up, that were actually up quite a lot. But it also, those two years that bookend this five-year period, they're the only two negative years that we've had in the stock market since the financial crisis. And 2018, it was down 4.3%. I mean, it barely even counts. 2022 was more substantial. But you come out of that massive period of wealth evaporation, of market drawdown, of credit contagion, of economic pain in a deep recession that was the great financial crisis, 2008. And now in the 14 years since, 2023 will be the 15th year, you had a grand total of two years that were negative. And those represent the front and back bookends of this five-year period I want to walk us through.

So keep in mind as you go into 2018, what the context was that we had had nine years of positive stock market returns. And in 2017, the market was not just up, it was up a lot over 25%. And it was up 25% with no volatility. You have a lot of good up years in the market, but along the way, there's volatility. There's the normal things risk takers sign up for, equity investors and public markets in particular sign up for, which is drawdowns, headline risk, downside volatility that comes with it. times. You average in any given year, at some point in the year, from a high level to a low level, a drop that will take place in the course of that. And in one calendar year, some point, there will be a drawdown of over 10% on average, even on really good years every year. And in 2017, the market was up over 25 and the worst drawdown you had all year was 2.9%. You didn't even, ironically, if you look back, by the way, I just remember it because I was at a hedge fund conference when it happened.

That was part of like a two-day drop or something when they announced the Russia investigation and the special counsel being appointed. James Comey had been fired. That little news event got the market to drop a whopping 2.9%. And that was the lowest volatility that we had had. It kind of tied 1995s, if I remember correctly. And you just had a massive year in 2017. So you go into 2018 and basically here's what you're saying as you enter the first year of this five year period we're studying. Corporate profits are picking up immensely. 2018, we didn't

know this at the time, but 2018 was going to be the biggest year for real economic growth we had had since before the financial crisis. We'd been stuck in one and a half percent-ish GDP growth, and we were going to get to three percent-ish GDP growth in 2018. They had just got done passing at the end of 2017, massive tax reform, which resulted in huge reduction of corporate tax profits and was going to result in huge repatriation of foreign profits coming back on shore. There were all sorts of reasons to be highly optimistic. And what all of a sudden happened was the Fed began tightening. And by tightening, it doesn't even count then relative to what we are living in now.

But they brought the Fed funds rate from 0% all the way up to 1.16% in 2017. And then in 2018, they doubled that. And they began doing hundreds of billions over the course of the whole year of quantitative tightening, reversal of the balance sheet. the whole year of quantitative tightening, reversal of the balance sheet. And the Trump administration embarked upon a trade war, largely with China, but also inviting, at least rhetorically, a lot of tensions, even in our trade relationships with Canada and Mexico, with Europe. So 2018 ended up, look, it was only down 4.3%, but at one point it had drawn down almost 20% in the fourth quarter, erasing what had been prior gains. And things were not good. And you get ready to enter 2019 and you say, this trade war is not even close to resolved.

The Fed is saying they're going to raise rates another four to five times. And they're doing this quantitative tightening. Companies like General Electric are having trouble rolling over their debt. Bond spreads had widened five, six hundred basis points. And how could anyone feel good about going into 2019? So what felt good entering 2018 became a bad year. And what felt bad entering 2019 lasted about five minutes. The Fed reversed this course.

They have some sort of cosmetic improvement in the trade deal with China, what they call a phase one trade deal that settled the idea of tariffs worsening. And the stock market had one of its biggest years ever. Basically, let's just call it 30% gains. Again, completely outside of what people could have predicted. The yield curve had inverted in 2018. Everyone loves to tell you how that obviously means the economy is going to recession, forgetting the constant false alarms that can come

about. And false alarms can be two ways, by the way. You can have a recession without a yield curve inversion, and you can have yield curve inversion that doesn't lead to recession. Has happened, and I admit it is the exception of the rule, but exceptions mean that they're not gospel. So 2019 ends up being a robust year for risk takers. It ends up being very contrary to what would have been a headline predictability at the beginning of the year. And the same exact thing was true at the beginning of 2018, only in inverse around circumstances. Then we get to 2020. And I mean, I wish I could do this quickly because I think everyone knows what I'm about to say, but there are a few little nuances in the middle of it that I got to point out. But I mean, obviously no one entered 2020 saying there's going to be a global pandemic this year. Nobody entered 2020 understanding that the pandemic was not going to

be as deep and wide as it would be, but that the societal response would be the incredible severity of lockdowns and shutdowns and compression of economic activity and social activity for that matter. Nobody could have predicted the policy response was going to be so violent with CARES Act spending, transfer payments, direct payments, the PPP, the monetary response, $5 trillion of quantitative easing, holding us at the zero bound and interest rates going all the way back down to 0% and holding that what would end up being two years. So you, within 2020, had a totally unpredictable event with totally unpredictable response,

with totally unpredictable circumstances. And then you say, okay, well, yeah, I mean, I guess the market would go down if that happened, which it did for 36 days. And then the market ended up having a violent rally as the news was getting worse, as the things were not getting better, as a whole slew of circumstances socially, culturally, the unrest that was existing in the society, as the pandemic that was believed to be one thing at one point, and then it changed to kind of another. And then we saw the inevitability that this thing was going to be spreading, markets moving higher and still ending up 2020 with very positive return. Then you go into 2021 and you say, OK, well, not being political here, but President Biden just won the election.

He says he's doing huge multi-trillion dollar tax increases. He's going to repeal the Trump corporate tax cuts. He's going to cut off a lot of these energy things have been done. He cancels Keystone Pipeline. From a social standpoint, you had those just disgusting riots at the Capitol building on January 6th. So things are not looking really good. And by the way, I'll add, not only is COVID not done for a lot of people, but there's going to be two new variants that are going to come, Delta in the spring and Omicron in the fall. And they're going to cause like the entire country will get COVID, right?

And so 2021 is going to be a disaster. And if I also add that the economic growth in recovery will not be what it was predicted to be, it's going to underwhelm expectations for a rebound out of in the reopening that what we had out of the 2020 closures and economic contraction. So everything I just said was true. That is who got elected. That was the campaign promises or intentions and whatnot. That was the COVID dynamic in 2021. And then the stock market was up huge. I think it was 26.89% on the S&P.

So you, again, have a series of circumstances that are negative, that were unforeseen. Nobody knew you weren't going to be able to get restaurant workers to come back to work. By the end of the year, you had significant price increases starting to form. The inflation narrative picked up bigger in the first half of 2022, but it was alive and well in the second half of 21 as well. And very positive market environment. Then we go into 22 and people say, okay, well, now COVID's done. And even if it's not, people are just, it's done. They're sick of it.

It's done. They're sick of it. At this point, even those that were relishing in the perpetuity of COVID dynamics were kind of ready to go pick up a coffee or something. So the fact of the matter is that in 2022, the Fed started off the year saying we're going to raise rates 1% to 1.5% by the end of the year. And everyone thought the same thing. I most certainly thought the same. I didn't know if they'd make it there. I most certainly didn't think they'd go higher and didn't even know if they'd get to their stated place.

And they raised rates 500 basis points. So not only did the Fed surprise all of us, the Fed surprised themselves with interest rates. Housing prices had been up 40% in a two-year period. All housing activity completely stops. And there's a national debate about if we're in a recession or not. We weren't. We aren't still now.

But nevertheless, 2022, you got the NASDAQ walloped as a lot of its excess got defrothed down, I think, 34% peak to trough. And you had the S&P down 25% peak to trough and down 20% on the year. So not exactly a great year. And you can say, well, yeah, but people are predicting it, except for we obviously know they weren't. There were no outflows out of the NASDAQ until the NASDAQ drop was going on. And on the bond yield side, which is where the most carnage took place for 2022, there was no one predicting that level on the long end or short end of the curve of that kind of rate increase and that kind of inversion in the yield curve.

And so really you have to look at it and say, okay, it's 2022. There was this fear of recession coming, but now the Fed's tightened over 500 basis points. We know a recession's coming now, and you enter 2023, and if I say to you, you're going to have three significant bank failures, fourth, if you count one of the largest banks outside the U.S. in the world with over 100-year-old Credit Suisse in Switzerland, but you're going to have major bank failures. in Switzerland, but you're going to have major bank failures.

You're going to have the Fed tighten further still. And the corporate profit decline will continue. Now, I'm going to say more of that in a second. The idea that we'd be sitting here now in the fall of 23, the S&P was at 3,600 in October of 2022. And a month ago, it was at 4,600. Now it's down 100 points or something since then. But my point is same, up 1,000 points when all of the news was bad, and maybe in a lot of cases, worse than expected. Now it wasn't all worse than expected. And that's where this corporate profits point comes because most certainly people were thinking

a 20% decline in profits is very much on the table. I don't think many people thought it'd be a 4%, 5% decline year over year in corporate profits. And that's a lot of the reason markets have done better than expected, but there's plenty of other reasons, too. You had it with a, let's call it 4% 10-year yield. And with a 5% short-term yield, you had multiple in the S&P go back up from 18 to over 20. So multiple expansion, better than expected earnings environment, while there continues to be the economic ambiguity and big double-digit returns in market indices. It just simply wasn't in the cards for 23. Now, it's only September.

Who knows what happens to you now at the end of the year? what happens to you now at the end of the year. But I don't know that you need more than the five-year window to make the point that if I go at the beginning of each of those years and tell you what's going to happen in the year, first of all, no one could have, would have, or did do that. And if someone had, time and time again, the investment outlook they would have attached to that economic macro world outlook would have also been wrong.

You're either going to get the prediction of what's going to happen in the world wrong, or if somehow you get that right, the way in which you invest around it is very often going to be wrong. And there is a general sense in which markets exist to humble us, to confound people, but this is not because of irrationality. This is because of complexity. This is because markets are trillions of activities being coordinated invisibly every second of every day. What I just said was not hyperbolic, by the way. It's not irrational, but it is unpredictable. And so are the macro events people are trying to price in. You say, well, then what am I supposed to do as an investor?

I have real needs that require real financial solutions. And you're telling me the future is unpredictable. And you're telling me the way in which we attach an investment solution to that unpredictable future is unpredictable, unknowable. Yes, I am. I am saying all of that. unknowable. Yes, I am. I am saying all of that. What I'm saying is that it's not necessary to predict these year-by-year activities in the marketplace when one has an economically coherent investment plan that centers around what can be controlled, analyzing, studying, looking into company fundamentals, what have you, while recognizing that there will be interruptions,

there will be disruptions, there will be distress moments, and that you can try to time and predict and forecast and use the internet and Twitter and social media and newspapers and cable news to get yourself in and out of these things, or you can ride through them, believing the statistical odds are exponentially better of a good result, not trying to predict the future and not trying to attach a solution to the future in a short-term period around a particular event, as opposed to the long-term discipline fundamentals that allow you to capture risk premia with an acceptance of

the unknowable being part of that. There's a humility in it. There's a logic to it. There's testimony of history reiterating it. And there's a beautiful result that comes for those who do it. So this is my reiteration, reaffirmation of a longtime principle that has to be understood, just illustrated within its own five-year window. And I'm happy to take any feedback and questions you have, but I hope you get the point. There's two charts, by the way, at DividendCafe.com that I'd love for you to look at if you're not reading online and just simply listening to the podcast or watching the video. A chart of the federal funds rate over time. And so you can look at what the federal funds rate was from 2009 to 2018 to understand the accompaniment that went with

that market period where everything seemed so easy and multiple expansion came so liberally. But then the chart of the day also shows the GDP growth and the stock market performance over the last 30 years in Mexico, in China, and the United States. I want you to look at those things and see a multi-decade reaffirmation of what I'm getting at here. So check out those charts if you can. Thanks for listening. Thanks for watching. And thank you for reading the Dividend Cafe. Be back with you again next week, still here in New York City. Have a wonderful weekend. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, member FINRA and SIPC, with Hightower Advisors LLC, a registered investment

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