The Dividend Cafe - Is North Korea the Next Big Threat to your Portfolio?

Episode Date: July 6, 2017

Is North Korea the Next Big Threat to 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, Chief Investment Officer at the Bonson Group. And we are extremely excited to welcome you to the second half of 2017. We hope you had a wonderful Fourth of July. And we want to kind of recap some of the first half of 2017. We hope you had a wonderful 4th of July. And we want to kind of recap some of the first half of the year as we get ready to delve into the back nine of 2017. What an interesting kind of week going on this madman in North Korea. Their perpetual nuisances have big implications

geopolitically and therefore market wise. But we we have more than just North Korea to cover, so let's get into it. The first half of 2017, well, the Dow and S&P 500 each returned a little over 8% for the first half of the year, leaving bears shaking their heads and also leaving perma bears set to totally call a major correction for about the 25th time out of the last three corrections. In 2016, the story was U.S. risk assets are much more attractive than any other alternative. But in 2017 so far, the story has been risk assets look good all around, as we bet on a global reflation. It has not just been U.S. stocks and credit that have performed well, but international markets as well,

with emerging markets actually doubling the return of U.S. equities year-to-date. Returns in the U.S. have not been monolithic, with certain sectors and names accounting for a large part of the return, and the dispersion among sectors and individual stocks being quite high. Tech and healthcare are the top winners year to date with energy and telecom the detractors. Industrials, materials, and utilities were the only sectors that they themselves performed within one percent of what the S&P 500 itself did. The 10-year bond yield started the year at 2.5%, came to 2.15% just a week before June ended, but saw bonds sell off big last week to end

the second quarter at 2.3%, a huge move in a week. So duration-oriented bonds had a positive return in the first half of 2017, but gave up a lot of their price gains in the last few days. The dollar was down year-to-date against the euro, the sterling pound, and the yen in what was the genesis of so much consensus that Wall Street analysis has been so wrong so far this year. Please tell me Dennis Rodman is not involved in my portfolio. There's no question that the foreign policy nuisance that Kim Jong-un and the North Korea dictatorship represent has intensified in the past few months, this week's ICBM test launch being the latest escalation. The market belief about North Korea has mirrored the State Department belief about North Korea for about 50 years, both in hindsight proving to be

accurate. That is, they've been a rogue regime, brutal their own people, but manageable by basically paying them off whenever they get out of line. It's a foreign policy that is not allowed for much escalation, but has allowed this regime, formerly Kim Jong-il and now his son Kim Jong-un, to continue poking around at South Korea and other Asian neighbors and violating most conventions and lines set on them. Markets have not responded to Kim Jong-un's provocations because markets have always believed, and have thus far always been right, that their provocations are going nowhere, and one way or the other, the animal will be put back in its cage. The recent escalation

increases concern about a new level of drama in this saga. A military strike by the U.S. on North Korea risks a retaliatory strike against Asian allies that could be catastrophic. Diplomatic talks seem futile. Therefore, the most likely play is that the U.S. continues to pressure China and Japan and other trading partners to economically squeeze North Korea into submission. We do not see a scenario where the West is going to allow North Korea to develop and maintain actual nuclear capability. But we still agree with the markets that the U.S. military intervention idea is a very last resort and that the drama will get played out with the U.S. and China. Getting China to be our partner in economically squeezing North Korea

into submission will not be easy and will require, well, a very artful deal. Has the time come to travel overseas? The first half of 2017 saw strong market returns in the U.S., in Europe, in Japan, and in emerging markets. The valuations remain lowest in emerging markets, then Europe, Japan, then the U.S. So if the U.S. is the most expensive stock market on a valuation basis, doesn't that mean it's time to overweight other regions and underweight the U.S.? That thinking is overly simplistic for a variety of reasons. It requires a basic understanding of what we are buying when we buy stock markets to be able to answer. We are buying a discounted flow of future earnings and dividends. There are a whole lot of reasons in the short term that valuations may fluctuate around their average,

from interest rates to inflation expectations to macroeconomic conditions to geopolitical context, etc. There's absolutely no way to monetize opinions about valuation in any short-term context. If one believes Europe is cheaper than the U.S. now, they must really have thought it was cheaper than the U.S. four years ago, and yet the U.S. return has more than doubled the European market in that time period. The reality is that valuations and valuation analyses cannot trump long-term allocation decisions rooted in risk-reward trade-off. Yes, multiples are lower in certain international markets than the U.S., and yes, that may mean for a higher expected return in some markets long-term. But risk levels, expected volatility, also remain real and vary from market to market for a reason.

Our job is to manage the return needs of our clients and do so within volatility parameters. We make tactical tilts where we feel warranted, primarily around rebalancing moves to capture more shares of underperforming asset classes. But the idea that macro fears in Europe shouldn't be ignored or should be ignored because their PE is lower than the S&P 500 is not just simplistic, it's silly. The elusive correction that buyers would love.

If I gave out candy for every time a client has said to me over the last five years, shouldn't we lay low now that markets are so high? It would look like Halloween. Attempts to time the inevitable correction have been catastrophic for those who have delved into that act of futility. Though fortunately, this describes other investors, not our clients, as we refuse to entertain attempts to do what cannot be done. The reality is that as a long-term accumulator of stocks on behalf of my own portfolio, on behalf of that of clients, there's nothing I like more than a summer correction. A 5-10% drop in stocks would give me cheaper purchase levels and therefore higher long-term expected rates of return.

Even those with no additional funds to invest benefit from corrections due to the reinvestment of dividends that takes place at lower price levels. The arguments for a correction, which have certainly been on the table for quite some time and proven very elusive thus far, are that tech stocks are tired, Washington DC is dysfunctional, and central banks are tightening or in some cases threatening to tighten. The reasons a correction could very well be delayed longer than earnings are rock solid. Global economies are seemingly improving and credit markets are extremely liquid and accessible. For those worried about a correction, I do not say have no fear it will not happen. Rather, I say have no fear eventually it will happen. But don't be a

casualty of market frivolity sitting around waiting. Enjoy it, expect it, but don't be a casualty of market frivolity sitting around waiting. Enjoy it, expect it, but don't time it because you can't. Will the kryptonite for FANG stocks be different than we all thought? FANG is a lazy way to talk about the big tech stocks that dominated in 2015 and had done well again in 2017, but had a lousy 2016. Kind of a loose euphemism for Facebook, Amazon, Netflix, Google. I've spoken and written at length about the valuation challenges that exist with these names and names like them, namely that they're very expensive, and the historical realities that buying the hottest dot after a couple years of torrid growth has often meant sustained underperformance as valuations

revert to reality. But what if the issue with some of these types of stocks will prove to be different than mere valuation? The financials and energy sector have been preferred targets for the left, populist, the media for years. The hip and cool tech sector has largely gone unscathed from any political controversy, cultural clash, or external anxiety. What if these FAANG stocks and their many cousins became the target of regulators, politicians, and even the culture at large? Uninvited scrutiny, whether fair or unfair, is a way of reigning on the parade of valuations. This is a theme I am seeing come up in more and more analyst reports, and it bears watching. Additional areas covered at DividendCafe.com this week talk about India, everything going on in the Indian stock market, tax reform developments

there. We also get into the tax reform package here in the United States. And I have a list of the books I've been reading here in the last month or so. Some people had requested a little more information on that. The chart of the week shows, first of all, of course, past performance is no guarantee of future results. I'm not just saying that for a disclaimer. It's very true, but it does point out that when the first half of the year was up 8% or more in the S&P 500, the second half of the year, the median return was 8.4%, where normally the median return has been about 4.9%. So the historical average has been that a strong first half leads to a very strong second half, where some might kind of expect the opposite.

It has nothing to do with what may take place here, but it was worth pointing out. So we are going to leave it there for the week. Please feel free to subscribe so you get these podcasts automatically at either SoundCloud or iTunes. And definitely check out dividendcafe.com for more information. Thank you so much for listening to the podcast. Look forward to coming back to you next week as we are officially into the second half of 2017.

The Bonson Group wishes you a wonderful weekend. Thank you for listening to the Dividend Cafe, financial food for thought. 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 herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors. All data and information referenced herein are from sources believed to be reliable.

Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary. It does not constitute investment advice. The team in Hightower shall not in any way be liable for claims and make no express or implied representation or warranties as the accuracy or completeness of the data and other information or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice. This document was created for informational purposes only. The opinions expressed are solely those of the team and do not represent those of Hightower Advisors LLC or any of its affiliates.