The Dividend Cafe - Is the Market Being Set Up?

Episode Date: October 12, 2017

Is the Market Being Set Up? by The Bahnsen Group

Welcome to the Dividend Cafe, financial food for thought. Hello, welcome to this week's Dividend Cafe. This is David Bonson, the Chief Investment Officer at the Bonson Group. And we are preparing for earnings season to launch. We kind of started off today with a few big financial companies releasing their third quarter results. And by this time next week, we'll be well into the release of a significant amount of companies in the S&P 500. We're looking forward to what earnings season will represent just in terms of validating the Q3 earnings growth story and then giving us some guidance going into 2018 as to what optimism exists out there in corporate America. You know, speaking of optimism, the market is up

25% since President Trump was elected. And yet the consistent drama from the White House, the tweets, the Mueller-Russia investigation, the legislative agenda disappointments have created a pretty persistent mood of doubt or surprise about stock market strength in this administration. And we've made the point correctly, I might add, time and time again, equity prices follow earnings. 2017 has experienced huge earnings acceleration year over year. And we further made the point, also correctly, that globally synchronized economic growth has pushed risk premiums higher. So we're not surprised that equity prices have moved higher despite the questions around what many following the political scene have expected. But are we facing a setback based on the Trump administration status or are we being set up for another leg higher?

We believe there were really only four major categories by which the Trumpian agenda was a market driver. So speaking specifically to market impact, not broad economic or let alone political kind of ramifications. or let alone political kind of ramifications. Number one was corporate tax reform, inclusive of a lower corporate tax rate, repatriation of foreign profits, expensing of CapEx, and then, of course, dealing with pass-through entities. Number two would have been individual tax relief, lower rates, flatter rates, and AMT repeal, the alternative minimum tax repeal we think fits in there as well. Number three, financial deregulation, both with personnel and enforcement, just a overall

environment that is less burdensome for business. And then number four, an infrastructure, primarily in the energy sector, ability to see more projects and more capital expenditures take place into national infrastructure. Well, we believe that all four of these categories are still alive and well. The latter two are in full effect at a purely executive branch level. Yeah, the political climate may bother some, please others, and sit somewhere in between for many, but the market climate is actually very in line with what one should expect at present. So we talk about markets here, and markets have plenty of risk and reward, but when it comes to the specific impact of the specific aspects of policy in this period of time, we see nothing irrational.

As for the next tweet, well, that's a different subject. Are the votes there for tax reform? Obviously, this is fluid. I do not believe President Trump's feud with Senator Corker kills it, but I certainly don't believe it helps either. it, but I certainly don't believe it helps either. The Senate has for now approved up to one and a half trillion dollars of deficit expansion in the tax bill, which gives them a little room, though that number could come back down. They probably cannot get the present proposed bill in these financial constraints. So this takes away flexibility around playing with like the planned repeal of state and local tax deduction, for example.

That's the biggest pay for that they have. And to the extent that they want to start turning the knob to kind of make that a little less burdensome, it takes away from the dollar amount they have to play with. Equity markets remain reasonably agnostic about this, believing the political noise will all prove to be a distraction. But we're in crunch time. There will be very little room for defections. We still think it's got about a 60% chance of getting through, even in a somewhat modified form. But certainly there's enough kind of hair on some of these things that we're not able to get up to full 75, 80% likelihood right now. I want to spend a little bit of time talking about our case for Japan in the era that lies ahead. We've made the case that Japan's private sector has been in

literally a quarter century of stagnation. And as longtime clients know, we've believed in the deflationary saga thesis of Japan for a long time. But it's been a pretty good call to be out of Japan, frankly, for my entire career. And yet, despite the debt saga that is nowhere near resolved, the bust of the 1990s and the deflationary hangover that has persisted ever since now faces the next chapter in this story, and we see opportunity in select parts of the private sector. This has been the subject of intense research by us for months, and we're preparing to find the best way to execute it. Corporate profits are moving higher relative to GDP. Companies have stockpiled massive levels of cash, and therefore CapEx investment will not increase debt.

So that plays into our confidence about dividend growth. Corporate profits are needed to deal with their budget deficit, and corporate profits are what we want to invest in. And yes, the dividend growth coming from those profits will be a big part of the story. The secular macro story, the economic backdrop in Japan is complicated, but the basic investment concept now is not. Valuations are attractive on a relative basis to other equity options, and the dividend payout ratio is low and climbing. Japanese corporations are very driven by growing their return on equity. Monetary policy has been accommodative. We would actually argue

too much. But on the margin is improving. But there is undeniable underexposure to the Japanese equity space from global asset allocators, particularly U.S. investors. We do have a deeper dive in the subject, including getting into some of the more systemic risks from a Japanese monetary policy standpoint at our marketepicurian.com web property. There's an article I wrote yesterday that went up there. Predicting the unpredictable, you will never, ever, ever be able to trap us into making a short-term interest rate call we know that the smartest risk rate excuse me smartest rate prognosticators in the world have less than a 50 chance of getting these things right quarter by quarter uh guess getting the kind of short-term interest rate call right. And all empirical evidence points to a

certain randomness in the direction of rates that makes even educated guesses futile. We see some degree of wage inflation on the horizon, so far very slight wage inflation, and we know that the Fed will begin lowering its balance sheet next month. We believe Draghi could start tightening in a market-surprising way next year. In short, there's plenty of reason to believe rates could move higher. Would we bet on this move? Or put differently, would we bet against this move not happening? No, we would not. Preparation simply means understanding the positioning of one's bond portfolio and the price implications of rates do begin to move higher. The ultimate outcome for risk investors would be rates moving higher in line with real

growth, sloping the curve more, the yield curve, and this whole Goldilocks economy continuing. We would not be betting on that either. Personnelist policy. It has become increasingly likely that President Trump is not going to reappoint Janet Yellen to chair the Fed when her term ends in early 2018. This comes at a time when a slew of Fed governorships have been unfilled. We'll cover this more in future podcasts, but it's important to issue a kind of statement about this whole deal. It is a big issue, the Fed personnel, and the

direction the administration takes with Fed leadership will have a profound effect on capital markets. Status quo changes tend not to have a big impact, you know, things like when Yellen replaced Bernanke. But a shift in ideology from the Fed would be a big deal. We're not suggesting it'll be good or bad, just different and important. To wrap up this point for now, we would be highly supportive of a Kevin Warsh appointment, who we understand to be one of the frontrunners. Kevin favors a more rules-oriented approach to monetary policy, but we recognize there's a lot of ramifications besides the person himself or herself in charge

of the Fed. Lots to watch there and we will be doing our best to keep you posted. I'm going to go and leave it there. We do love for you to check out DividendCafe.com to see all you missed in writing. We have a chart there about the dividend growth from Japan and other different markets, and a few other segments of the Dividend Cafe that we didn't get time to cover in the podcast or the video that may be worthwhile reading. But in the meantime, reach out with any questions. We're always here to assist and hopefully help you grow your understanding of our thinking,

what we're doing, and your own mindset as an investor. So thank you for listening to Dividend Cafe. Thank you for listening to the Dividend Cafe, financial food for thought. 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 referenced 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

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