The Dividend Cafe - In Theory but not in Practice

Episode Date: May 10, 2024

Today's Post - https://bahnsen.co/4afqiVW As I finish up this writing Friday morning the Dow is tracking for its eight consecutive day in positive territory (I have little doubt that my mere typing of that sentence likely jinxed it). The market reversal from April into May can be credited to a combination of: Renewed acknowledgment that regardless of when the Fed begins cutting rates they have made it reasonably clear they are done hiking rates, and Marginally improved financial markets liquidity in the present tense and with a vision to the future around the tapering of quantitative tightening, and A good fundamental backdrop for corporate profits with another earnings season in the books reflective of enduring margins, reasonable forward guidance, and revenue growth in line with expectations It is a bad time to be a market timer. But I don’t think anyone can even time when it is a good time to be a market timer, so maybe I am just repeating myself over and over. Anyways, we know what time it is at The Bahnsen Group … … and it is time to jump into the Dividend Cafe. 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. Well, hello and welcome to this week's Dividend Cafe. I'm glad to be back here in the studio in our New York office and prepared to go through a few different things with you today. It is actually, as I'm sitting here recording, it appears we're on track for our eighth day in a row of positive movement in the Dow. Now, you know, we still have a few hours to go Friday, so I'm quite confident that I have jinxed it by even saying that. But there is at the very least been already seven days in a row. And so many are asking, what has caused this kind of reversal of sentiment as if, you know,

two weeks of market action versus what had been maybe three weeks of market action before that qualifies as a reversal? I just loathe this interest in the short-termism of the moment. But nevertheless, I think it's fine for the idle curiosity of the fact that there was, you know, a roughly 4% to 5% downward pressure on markets in the weeks of April. And there's been a roughly 3% to 4% upward pressure on markets here since we came into May. And I will tell you that I think there's three

things at play. One, I mean, the timing is just almost too coincident at the Fed's meeting, whereby they did not raise rates or cut rates as expected, but nevertheless, kind of maintained the posture that rate hikes are off the table, that they see the present level, that we're getting pretty close to having been at this Fed funds rate this July, which is only a couple months away now. It will have been a whole year that this represents the peak of the cycle for monetary tightening. But I would add that there's also been, and someone had asked about this a week ago, and I'm answering it a little more fully now, marginally improved liquidity in financial markets as a result of the Fed's expressed vision to taper their

quantitative tightening. And I think that that enhancement of liquidity in the marketplace, either as a present tense condition or something that gets priced in out of forward that there's been a reasonably healthy fundamental backdrop for corporate profits, that the earning season, which has now more or less come to a close, did end with pretty high margins being maintained, revenue growth in line with expectation, and a pretty strong maintenance of expectations for full year corporate profits. You take that fundamental backdrop, attach it to a reasonable optimism that even though the Fed is going to be later to cutting rates than some had started the year expecting or wanting, that they're not putting rate hikes back on the table and, in fact, have begun easing

financial conditions, if not yet with the rate, but with the balance sheet, the so-called quantitative tightening. And so I think all of those elements explain kind of where we are, trying to time our way around those things. I mean, even someone who is explicitly critical, those things, I mean, even someone who is explicitly critical, consistently explicitly critical of market valuation and the hope for market multiple expansion as a means of driving an investment result like myself, I've never believed that valuation is a timing tool. valuation is a timing tool. I think valuation is a very poor timing tool and nevertheless relevant factor in long-term expected investment outcome. So you do suffer right now from a valuation issue for a good portion of risk assets, but the fundamental backdrop in the meantime, that can often serve as a catalyst to correcting those valuation issues has been benign. And then couple that to not worsening

financial conditions, and in some cases, marginally improved financial liquidity, you've gotten this kind of move back. It's not been a good period for market timers, but I don't think there's ever a good period for market timers. I think that timing what's a good period for market timing is the same thing as market timing, and it's not something that people do very well. So let me just cover a few other things that I want to get to before I go a little deeper into quantitative tightening in this fed aspect this week. I just want to repeat a mantra because I've been heavy on this theme of valuation and because I am committed from the core of my being as a matter of ontological commitments

to dividend growth investing, that I really believe this summary that I'm about to offer is a very helpful way to think about the framework between those that are viewing a higher PE ratio or price momentum or the popularity of buzz around a high valuation growth sector of the market becoming an even higher valuation area of the market. That being one school of thought and our own, sometimes at varying degrees of self-awareness, and then our own school of thought, which of course is very committed to cash flow growth. More or less, I believe that our investment philosophy, it comes down to trying to get paid the company that we're invested in and that the alternative of price momentum and indexing linked to multiple valuation expansion, it comes down to trying to get paid by other investors. And investment return can come by another investor. It can come from the company,

but ours is very self-consciously tethered to attempting to get paid by the investor. It can come from the company, but ours is very self-consciously tethered to attempting to get paid by the company. And I think there is a good and useful framework in summarizing the two schools of thought around that distinction. Quantitative tightening. Before I get there, let me talk about Chairman Powell for a second. I've been critical of Chairman Powell where he has, throughout this tightening cycle, alluded to some elements of the Phillips curve, to some elements of, you know, watching employment to make sure it doesn't, you know, get, it doesn't stay good, doesn't, you know, get better, that type of language, and alluding to the tradeoffs between unemployment and inflation that are embedded in the Phillips curve. I've been critical because I disagree so fervently with that idea that people having jobs is inflationary.

And Chairman Powell at the Economic Club in New York luncheon I attended with him last October stated that the Phillips curve appears to be a model that has worked at certain points of time and is not working now. And I didn't really understand what kind of model that is that works sometimes and doesn't work others. And of course, it's my view that it's not any kind of model at all. And that even when there are times where, look, you can have periods of time where unemployment is high and inflation is low. But the notion that these things are intertwined in a state of tension is categorically untrue. And that what puts upward pressure on inflation is downward pressure on unemployment, I vehemently disagree with. I think you can have low unemployment and low inflation all at once. And the Phillips curve that posits these are

intentional one another, I think is absurd. And in fact, I actually think that the greatest antidote to inflation is the production of goods and services that therefore requires more people to be working. But I digress. The reason I bring the subject up is to compliment Chairman Powell in this sense. I think he has said some of the wrong things about the Phillips curve. And even without mentioning the name, I think that there have been moments in which he has posited the theory that inflation and unemployment have to be thought of in that way. But in practice,

I don't think he is doing it. The fact that he's coming up on almost a year now, the fact that he has begun to kind of thaw the conditions in financial liquidity that have been so tight. And again, going from $60 billion a month to $25 billion a month in quantitative tightening. It's not exactly hyper loose, but it's looser than it was all the while unemployment has stayed in the threes, somewhere between three, six and three, nine for a long time, very low unemployment. And I think that, that what I'm referring to this is a Phillips curve in theory, but not in practice. And, you know, he could reverse course, he may not stick to it. But I will be surprised if the Fed takes a tighter posture.

And I believe that that's being done all with a healthy employment backdrop. That's not Phillips curve practice. And Chairman Powell should be recognized for it, even if I really kind of consider it table stakes to sensible monetary policy. So on the subject of quantitative tightening, and then I'm going to direct you to DividendCafe.com for some of the other components I cover this week because there are a lot of other things that I'm not going to have time to do here on the podcast or video.

I really believe that quantitative easing was done after the financial crisis because the policy tool they were most aggressively using to facilitate easier monetary conditions was the interest rate. And they had cut it to zero. And so they said, OK, well, we can't really go any further. So how can we add to the easing of monetary conditions when we're already at zero if policy rate is our only tool? And they said, well, quantitative easing helps us pile on. It's a way to be even more accommodative in monetary policy when you're already the most accommodative you can be with tool number one, the interest rate. So you move to tool number two, which was the balance sheet. Yet quantitative tightening, you say, okay, was it just inversely true? But see, not really, because you can always get tighter with a higher rate and higher rate still.

You can't get lower than zero when you're easing, but you can get higher than five and a quarter if you're tightening. In fact, we've been higher than five and a quarter a lot. Now, it's true that this five and a quarter is tighter than many other times in history where five and a quarter in the sense that we had been used to 15 years of the zero bound. And there is a, you know, I think a kind of societal expectation right now, also much higher levels of leverage, both at the sovereign level, a much, much higher government indebtedness and at the corporate level as well. And so you have to take all these things in a relative context. But I would say that if they were simply trying to use quantitative tightening to get tighter

monetary policy, they could do so with a 6% Fed funds rate. I believe that quantitative easing was done to pile on monetary easing, but quantitative tightening has not been done to pile on quantitative tightening. I think quantitative tightening was done to leave themselves in a position to do more quantitative easing. That effectively, once that balance, you got to $9 trillion, they felt we got to get this back down to $6 or $7 trillion if we're going to use it again. And even $6 or $7 trillion is a lot higher than the $4.5 trillion we were well after QE1, QE2, and QE3 at the point of the COVID moment. We were still at $4.5 trillion, not at $6 or $7. But nevertheless, I think that they view quantitative tightening as a way of resetting the optionality for quantitative easing.

And that something may come up, some issue that I do not need to or have to or want to predict what it may be, but just merely saying from the testimony of history, there will be some financial moment that comes up whereby they decide they need to ease with the balance sheet again, and they would rather have a few trillion of room relative to where they've been. That's my view of the case. And it's why it speaks to them. Even when they're holding the interest rate at five and a quarter, you see them starting to limit the level of quantitative tightening. Now, as long as they're doing any quantitative tightening, they're still technically a net reducer of their balance sheet, albeit at a very slow pace right now, Down to $25 billion would only be $300

billion a year. And that wouldn't even, by the end of this time next year, get us below $7 trillion on the balance sheet. But I think that they kind of got the first trillion and a half done pretty easily. And they recognize at this point that there will be difficulties. This calls for probably more dividend cafe coverage of the overall issue of the Fed's balance sheet. It is complicated. It is wonky. I've probably already lost some of you and that's never my desire, but this is important stuff I have opinions on, but that's the framework I wanted to leave for you today. You got to check out dividendcafe.com to see a chart of the industrials versus technology and what our view on that is. The just general critique of conventional wisdom about Japan versus China

versus other markets, what the economy has done, what the markets have done, and just getting that kind of historical context. And then a really fascinating chart of the week that I think speaks to and against doomsdayism message, but something I want everyone to see that maybe just maybe is another element of some green shoots in the economy, in an economy filled with some concerns. There is an optimism in the chart of the week that I want you to check out regarding new business applications. So I'm going to leave it there for the week. I'll be back with you next week. I will be in New York most of the week, but I'm back in California at the end of the week. So

I will bring you Dividend Cafe from the Newport Beach studio next week. And in the meantime, thank you for listening. Thank you for watching and thank you for reading the Dividend Cafe. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, member FINRA and SIPC, and with Hightower Advisors LLC, a registered investment advisor with the SEC. Securities are offered through Hightower Securities LLC. Advisory services are offered through Hightower Advisors LLC. This is not an offer to buy or sell securities. No investment process is free risk. There's no guarantee that the investment process or investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance

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