The Dividend Cafe - Indications of a Bear Market, or Something Else??

Episode Date: June 29, 2017

Indications of a Bear Market, or Something Else?? 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, Chief Investment Officer of the Bonson Group. And what a fun week we're finally having here in capital markets. It looks like we might actually get three days in a row of triple digit volatility, which has been an unheard of phenomenon in the market for the last six to nine months, it would seem. But as I speak, we're down close to 200 points on a Thursday, although we're starting to kind of come back. We'll see where it all ends up. And we were up 150 points yesterday, and we were down 100 points the day before.

So market all over the map for a lot of different reasons. But let's kind of look into that a little bit. I mean, essentially, I think that a very commonly uttered explanation about this movement is that it was the GOP Senate announcing Tuesday that they were deferring on an Obamacare repeal-replace vote, and that caused the decline. And then it sounded as if maybe the Senate was regrouping on Wednesday, and that caused the rally back.

Kind of silly analysis, if you ask us. We think it is dubious because really the droggy sentiments regarding European Central Bank had a far bigger impact than a kind of political sideshow, the bulk of which, by the way, the market has a lot of confidence as to how it's going to play out, whether it takes two days or two weeks. But the political gamesmanship, notwithstanding the fundamental side out of European central bank monetary policy, is that there may very well be a sense of which this divergence in central bank activity between the Fed and the ECB is coming to an end.

And if the Fed gets a green light to tighten at a more aggressive pace as a result of Europe going in that direction, we'll talk more about that in a moment, that becomes, I think, a much bigger mover in the markets. But then you get into kind of Thursday sell-off, and it was largely driven in NASDAQ names and big technology names, which would indicate a totally different cause and effect to begin with. When I listened to the Draghi speech, and especially reading all the analysis about it, it really did feel like I was in a different universe from what I heard versus what I was reading about the speech.

It did not sound to me like they're planning to aggressively reverse years of hyper-accommodative monetary policy. Rather, it was a very nuanced message around quite complicated topics. We don't need Mario Draghi to tell us that the monetary approach Europe is taking is going to be different when they're at 2% economic growth, which they're on their way to, versus the 0% growth they were at when a lot of these aggressive bazooka-type approaches were taken in their easing of monetary policy. The zero-bound economic emergency has dissipated, and with a climate of economic conditions that can at least be called better than prior catastrophic levels,

their unprecedented aggressive posture towards monetary policy warrants adjustment. But we think that, like our own Fed, the new normal for central banks is still lower for longer and err on the side of easy versus tight. The key most are missing is that the markets act on expectations, not the news itself. The expectation is now that the ECB will be moving towards some form of unwinding of their aggressive quantitative easing and interest rate compression. At some point, in some way, that's why the euro is hitting new one-year highs. In fact, longer than one year now. So why do we care? Well, I've argued for at least two years that the single biggest thing holding U.S. interest rates lower from a market standpoint and a central bank policy standpoint was Europe, to a lesser extent Japan.

There was and is a ceiling in place for how high treasury rates can go when our European counterparts are sitting at negative rates or zero-ish rates. Any re-acceleration in European growth lifts the ceiling for our own bond and rate market, and therefore means this drop in yields we have seen the last few months is likely closer to an end than a beginning. We still believe global growth is fragile enough, both in real life and in the perceptions of policymakers, that they are not about to be overly aggressive anytime soon. But overall, we at least see the floor coming higher for bond yields as Europe and the U.S. get more harmonized around the idea of a pickup in growth and modest movement towards respective normalization. This matters to our bond positioning and expectations for sector performance in the stock market.

and expectations for sector performance in the stock market. The repeal and replace is on hold for now as it pertains to the GOP Senate actions, but we think it will probably be a couple weeks and not much longer than that. You know, you never know. I mean, Senator Majority Leader McConnell has acknowledged they're a bit short of the votes. The meetings continue. But we think that ultimately there's going to be some bill that doesn't fully appease the conservative right or the moderate centrist, but represents some kind of symbolic momentum boost.

And what that does is more impactful to tax reform than it even is to actual health care policy just because of the way in which the bill has had to be watered down to get the votes necessary to pass it. But as far as the tax reform side, we don't think there's going to be agreement between both parties anytime soon, but a path towards tax reform is definitely becoming clearer. Getting the health care bill done provides a lot of numerical cover because of the way in which it remedies some of the the deficit side, but the major issue politically is getting a budget resolution done to open a reconciliation window that would change the votes needed to avoid a filibuster threat from 60 down to just simple majority of 51. And the great threat of the border adjustment tax, not only as what we believe was bad policy but politically toxic, is largely removed now. Very few advocates for that idea are still remaining.

The leaders of it have thrown in the towel. So, yes, some knobs will still be turned on a final reform package. There'll be more political twists and turns. But by Q1 of next year, we do believe a tax reform bill is going to get passed. The reason this is so important to us is that we think there will be a need for tax reform in order to see GDP growth, earnings acceleration, top-line revenue growth move much higher than what the market is already priced in. One interesting angle I'll share with you real quick is Senator Pat Toomey in Pennsylvania is proposing expanding the window from 10 years to either 20 or 30 years.

That would enable the Senate to be able to vote on it, even if it were deficit enhancing, without, and as far as how long the sunset would have to go. So you recall President Bush's tax cuts only could go for 10 years because they were scored as if they were going to add to the deficit. could go for 10 years because they were scored as if they were going to add to the deficit. But if Senator Toomey gets traction with his idea, it would enable 20 years or longer, which is really a much more pro-growth approach because it's how much time would be taken for business investment, business confidence to get monetized in the economy. It could be very interesting.

There's a lot of material at DividendCafe.com this week about high-yield bonds, including stuff that has nothing to do with high-yield bonds. We're talking about high-yield bonds as an indicator of risk in the market. We're talking about high-yield bonds and what they mean for capital structure and where that affects return on equity and what that means to overall equity investors. It sounds a little complex, but it's really not. We really encourage you to look at some of that information.

And then most importantly, there is a section about bear market checklist, kind of some of the indicators that have existed in the past, indicating things getting into tumultuous times and the length of a bull market in stocks, and we would encourage you to look at that. So go to DividendCafe.com. In the meantime, have a wonderful weekend.

As always, thank you for listening to The Dividend Cafe. Thank you 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. 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 of risk, and there is no guarantee that the investment process or the investment opportunities reference

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