The Dividend Cafe - Inflating Your Portfolio

Episode Date: March 1, 2019

Topics discussed: My Diatribe on Inflation Chairman Powell Talks Inflation The Case For Financials Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Well, hello and welcome to this week's Dividend Cafe podcast. This is David Bonson and I am the managing partner here at the Bonson Group and I want to bring you our sort of weekly commentary. I always fear my ability to jinx things when I say what I'm about to say, but as of right now, recording time, it's really been a very low volatility week in the markets. So again, there's still some more time here on Thursday, and there could be the whole market day Friday and so forth by the time you're listening to this. But where things stand right now, we are literally right dead even on the week.

And I just want you to imagine two months ago me saying that there would be two days of Federal Reserve Chair testimony in front of Congress. There'd be a failed North Korea summit, all the kind of drama in Washington, D.C., and markets wouldn't move an inch in either direction. And by the way, not to mention a real big positive GDP growth surprise that came out this morning, too. So some various potentially bullish things or cosmetically bearish things and no market movement at all. Such is the state of affairs.

things and no market movement at all. And such is the state of affairs when Fed dovishness has been baked into markets. It neuters so much other noise. So I am going to dedicate the entire advice and insights podcast that we do most weeks this week to the subject of inflation and the subject of the Fed's sort of management of inflation in the economy right now. But for our purposes here today, I'm going to just kind of give an overview of that subject and make comments on a number of other things as well, including the China trade deal, tax refunds, that GDP growth number that came out and things like that. Okay, let me talk inflation real quick. The Fed has explicitly stated they want a 2% inflation rate in recent years.

They are targeting, making a goal to create 2% monetary price inflation. And they've been frustrated at the challenges in creating such. But I've always found the admission that a body tasked with a sound and stable currency is admitting to being willing to deteriorate purchasing power in the society by 50% every 36 years. I hope you can follow my math there, but that's what 2% inflation represents, is that half of your purchasing power goes away once a generation. The accurate price inflation target should be 0%, even recognizing that that might prove to be unrealistic or difficult to actually achieve. But that's not the same thing as saying there should be no increase in the monetary base. There should be more money in circulation as an economy grows, and I totally understand

that. But to target 2% inflation is, I believe, unfair to consumers and citizens, and it codifies the need for investors to overcome an annual 2% tax on their portfolios. for investors to overcome an annual 2% tax on their portfolios. Now, I would add my own agenda here, my own ideology entering the conversation that dividend growth investing is the best way I've ever seen to overcome the inflation burden as annual dividend growth of 5% to 8% easily overpowers annual inflation of 2% to 3%. And I would also add that most inflationistas, those permanently fretting about the risk of inflation in the economy, are themselves more concerned about the highly unlikely predicament of hyperinflation, 5% to 10% levels,

of hyperinflation, 5% to 10% levels, and not nearly worried enough about the very, very, very likely predicament of regular inflation, which is perhaps more damaging because of the complacency that exists in confronting it. So Chairman Powell talked inflation this week, and he testified in front of the Senate on Tuesday and the House on Wednesday. It was mostly uneventful, but I want to focus on a couple of takeaways real quick. The Fed appears focused on changing the way that they target inflation. They don't intend to change what that inflation rate they're targeting is. But the nuances of what are being discussed here would probably bore you to pieces, but I got to just give you a little backdrop.

The Fed's engaged in a debate on how to target the inflation they want. Right now, the policy objective is achieving an annual 2% rate. In one year, the inflation rate may be 1.4%, but the next year, the Fed's objective is still 2%, where what's called price-level targeting would call for a target of a price level in the economy in line with annual movement of 2%, so that if the inflation rate ran below 2% for a year or more, it would allow the Fed to let inflation run hot for a while, so as to just maintain a long-term trend line of 2%, not a per-year rate targeting. So that distinction may seem inconsequential, but it's not. It's a big deal. I know I've lost most of you already, but here's the bottom line.

Technical, logistical processes are being considered that would effectively empower the Fed to let inflation run hotter than prior mandates called for, which would have a potentially profound impact on markets, interest rates, and policy. The way in which they affect this change will matter to their credibility. And I should add, nothing in the chairman's testimony or other governor comments that we've monitored suggests this policy adjustment is a foregone conclusion. There's still plenty of, you know, work to do and unknowns around everything. But this just provides you another

aspect of monetary policy to monitor and its implications for investors. Well, what else did they say? I thought this was the most important line from the Fed. We are close to, from Chairman Powell himself, we are close to agreeing to a plan which would light the way to end the process of reducing our balance sheet. We expect this reduction to end sometime later this year. So just so you know, the Fed's reduced $448 billion off its balance sheet so far, undoing that much of the quantitative easing that had been done post-crisis. Keep in mind that quantitative easing was about $4 trillion worth. They currently sit at $3.8 trillion of assets, but bank reserves have contracted over $1 trillion. Therein lies the real rub about

liquidity in our banking system. Okay, speeding things up a bit, let's talk about the trade deal. President Trump tweeted on Sunday night, I am pleased to report that the U.S. has made substantial progress in our trade talks with China on important structural issues, including intellectual property protection, technology transfer, agriculture services, currency, many other issues. As a result of these very productive talks, I'll be delaying the U.S. increase in tariffs now scheduled for March 1. Assuming both sides make additional progress, we're planning a summit for President Xi and myself at Mar-a-Lago to conclude an agreement. This is a very good weekend for U.S. and China. So, you know, markets moved upward a little bit

Monday. They haven't moved much all week. My view continues to be that the market expects some deal to get done that keeps the current tariff levels from escalating further. The details will have relevance in certain pockets and particulars, but the broad macro issue most are looking to is really nothing more than whether or not some permanent de-escalation can be found. And that carries with it the presumption that there was some political face-saving that took place as well for both sides. Here's the list of components of a pending trade deal that I think are most likely to end up being in the final deal.

A Chinese commitment to purchase more U.S. soybeans, Chinese commitment to purchase more of other U.S. agricultural products. Commitment around additional purchases in U.S. semiconductors. And we've talked a lot before about additional purchase of U.S. oil and gas. Chinese commitment to not weaponize their currency, to use depreciation of currency as a policy tool. If they do make that commitment, that could potentially really rally the Chinese currency and push the US dollar lower. A potential reduction of the 10% tariffs that were implemented last year, and then a non-binding, loosey-goosey type commitment

around addressing intellectual property theft. However, I don't think that that's a foregone conclusion. I think it could actually be even tighter than that. There's mixed signals floating right now that there may be some real legitimate enforcement structures in the deal. We will see. So we wait and see. The Chinese-U.S. trade talks continue

to be probably the most important catalyst to markets at the moment. By the way, tax refund stuff, we've been talking about that a lot the last few weeks. The IRS is getting ready to issue a report. I'm going to have more to say about it next week. But boy, is this story ever turning into one of the silliest things I've ever seen. First of all, the child tax credit was doubled from $1,000 to $2,000 in the new tax bill, and eligibility to receive that credit was changed from $100,000 or less of income to $400,000 or less. So it substantially increased the amount who will receive this benefit. And that, of course, this benefit. And that, of course, plays into the credit people end up receiving, and it will drive a much bigger 2019 stimulus in 2018. Same is said for alternative minimum tax. It was effectively eliminated for virtually all taxpayers. It was heavily, heavily slashed. So none of these

elements work their way very easily into the withholding process. So therefore, it impacts refunds. The impact is about $100 billion of tax savings that falls into 2019, not 2018. As I mentioned, the real GDP growth number came in at 2.6%. Only 1.8% has been anticipated. That brings us to a 3.1% real GDP growth number for calendar year 2018. Now, because the Q4 number is still just preliminary, they won't finalize that. But that is a real stunning reversal of the 1.5% to 2% growth number we've been getting for so many years.

reversal of the 1.5% to 2% growth number we'd been getting for so many years. Non-residential fixed investment, which is the category that basically encompasses business investment and CapEx, appears to have really reversed. I need to unpack the data a little better and give you more of an update next week. Real quickly on oil and gas pipelines, they are right now here as we get ready to close February off to their strongest start of the calendar year in history as an index up 15% on the first two months of 2019, better than the 12.8% we saw through this period in 2013. Look, adding to the story this year, even beyond the fundamentals, has been really unexpected dynamic of inside buying. The insiders of a lot of these companies have been buying shares. You have companies that have never, ever bought back their own stock because of their need to kind of protect that

aspect of their capital structure. And now you have companies buying back their own stock. And then you also have streamlined approval processes. You know, at the executive branch and in the Senate committee, it's giving the market confidence that the export of liquefied natural gas is coming. There's some really good information at dividendcafe.com this week. And the reason I'm not going to get into it now in the podcast is there's a couple of charts that go along with it. They really make the case for financials in 2019 and really give some explanation as to what held the sector back in 2018.

I encourage you to check that out. It gets into both the correlation of how financials do to the 10-year treasury yield, and it also looks at the deleveraging, really dramatic deleveraging, that's taken place in the financial sector. And that's versus the non-financial corporate sector, which, of course, has seen quite a bit of releveraging. So with that said, let me kind of close it out.

I do hope you all will have a very good weekend. I hope you'll read DividendCafe.com. And like I said, if you want a little more unpacking of this crucial subject of inflation, what it means to your portfolio, please do go to our advice and insights podcast as well. Subscribe to both. Put them in your in your feed and write us a review and and tell your friends and all that good stuff as we build up our podcast traffic in both of our channels. And have a wonderful weekend. And thank you for listening to The Dividend Cafe. Thank you for listening to The Dividend Cafe.

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