The Dividend Cafe - Is The Trade War Really Over?

Episode Date: September 13, 2019

Topics discussed: One can be forgiven for assuming the trade war ended in looking at the market. On August 14 (one month ago) the Dow was below 25,500. At press time this week, the Dow is at 27,200, so nearly a 2,000 point recovery in one month (and back to the market level we were at before the re-provocation of the trade war leaving July and entering August). How is this possible? This "cycle" has played out several times over the last 18 months. Where markets go from here really depends on whether or not “any progress is made.” My goal is to unpack some of that this week in the Dividend Cafe. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. end of trading market hours on Thursday. So by the time you're listening to this, it'll be Friday and we have another pretty good size week up here in the markets. Not just in terms of what the market has done this week, but now I got to give it to you in terms of the net total aggregate movement and where we're sitting at the moment. There's some significance there because with the Dow at roughly right now, 27,300 and it hit roughly 25,400 at its low point in the middle of August. You've essentially recovered almost 2000 points in the Dow in three weeks. And net, net, net. And you have right now gotten back on the S&P above where we were at that prior spot, you know, late July, going into August when the trade war re-escalation began. So you had a very quick movement down in markets as the reigniting of tensions with China and the subsequent currency fears and the avalanche of interest rates collapsing around global negative bond yields.

You recall these weeks. Hopefully you recall the podcasting and the written commentaries and things that we did around all of it. And yeah, let's say that was about two or three weeks of that direction of roller coaster activity. And now it's been literally two weeks, three weeks at the most of reversing it. Why? I mean, you know, I guess one could argue paying attention the last week or two, it feels like the trade war has ended. And I'm sitting here in front of me with just a printout of my DividendCafe.com commentary, the weekly article, a lot of charts, a lot of information. And I'm going to be talking through a lot of that stuff here for those of you watching this and listening to this. But the fact of the matter is that the trade war didn't end,

but the fact of the matter is that the trade war didn't end, yet there's clearly a different change in tone. And one of the things that I posted at eventcafe.com, oh, a month ago, was a graphic kind of showing the cycle we've been in. And literally it had been three, if not four times, where the market was at a level, the administration talked tough on trade with China, markets started dropping on those fears, there were hints of a resolution, markets started moving

higher, and then the market would rally on news that, oh, there was going to be a summit meeting or there was going to be a reconciliation or some kind of trade deal is in the works. Then some time would go by, no progress would be made, and that circle would repeat itself. And I do think that we've simply kind of moved from where we were in that cycle from one side of the circle to the next. Right now we're kind of sitting there,

sitting here with a different expectation as far as the trade situation. The president said that he wanted to give a goodwill gesture to China around the 70th anniversary of the People's Republic. So he was delaying the onset of tariff escalations a little bit more. There is talk that there's been some substantive discussions at a more deputy level with some of the trade negotiators i think that a lot is riding on the meeting that is presently scheduled in washington dc in october between beijing and and american uh trade negotiators so where do we go i mean it's hard to to say, but I want to make something very clear here.

Regardless of what one thinks about how this is all playing out, the idea or going to play out, which I'm going to argue in a second, I have absolutely no idea. argue in a second, I have absolutely no idea. I do believe that there are other geopolitical factors at play, that there are various complexities that make things difficult. Beijing does appear to have increased their purchases of agriculture from the U.S. as of late, perhaps sizably so from some of the data that we're studying. No question that currency exchange adjustment is stabilized, even though it moved in a direction Americans didn't like. It has not gotten worse and leveled off, and that's made a lot of people happy. Certainly, it's made markets, it's calmed markets. And as I brought up a moment ago, this event that will take place in October is a big meeting. First of all, if the meeting will happen, we don't know that we'll end up going through.

Something could break down there. But also, I really do believe that there's a big question mark around what will come out of that meeting. I will present to you right now, for the the first time here on Dividend Cafe, the two scenarios that represent I think option A or option B. Of course, there's the possibility of option C, but I don't think so. I really think in a broad sense, it's going to either be that you come out of the meeting with a clear demonstration of an off-ramp for both sides to bring down this trade war. That you get some kind of clarity that there's going to be an agreement and how both sides are going to be able to save face. People will disagree as to how good of a deal it is for one side or the other, how comprehensive it ends up being.

But I'm just getting at it will, in my opinion, some deal gets done that is face-saving and indicative of where we end up proceeding. Or you get another can kicking, another cycle of moving around that circle again, perhaps even an outright breakdown. And that just leads itself to replaying this whole thing again and enhancing downside market volatility. So listen, there's alliances with Europe that are relevant to the trade war with China. There is this geopolitical tension and military tension that's been on the table in North Korea for quite a long time now, but particularly in the midst of the Trump administration,

that has a lot of impact on the stuff with China. We know about the Hong Kong issues have been going on for the last six weeks, very relevant to how things have played out in China and the trade war. Frankly, I think that the trade war helped build a little leverage, ironically, for the president in getting China to stand down on some of the potential escalations of the Hong Kong matter. We know that there's all kinds of currency impact at play. Yes, in the China-US dollar exchange rate, but frankly, in the US dollar and Euro, in the US dollar and yen, in various emerging markets. All these things play in. The US and Japan consummating their trade deal. What the Fed does. Their meeting

September 18th, where they go with this, has an impact. There's a UN meeting talking about China's human rights violations later in September That could have an impact Trade representative Robert Lighthizer has a presentation to the WTO at the end of September That could end up moving things There is tensions politically in the US There are tensions economically in China. And all of these things mean it's a multi-layered, unpredictable, complicated situation.

And what I'd be prepared for is more volatility, or at least the possibility of more volatility, even if there is an extended period of calm over the next maybe few weeks, is there a possibility of a very, not just a happy ending, a very happy ending for investors here? There is. There is. But would I bet huge on that possibility? I would not. I need to be humble enough as an investment manager to navigate all the places this can go. And what I think I'm going to read to you right now from the conclusion we put up in our written commentary, that this is really the best we can do. That anyone who right now is stating with a high degree of confidence how exactly it's going to play out, they're taking risks that I find

inappropriate. Look, the outlook for corporate profits has been fine, and actually it's been better than expected. Should the outlook for corporate profits turn south, whether from the trade war or not, it will not bode well for market valuations. Now, a Fed rate cut may impact this to some degree positively by lowering borrowing costs, but we still favor less cyclical opportunities and more defensive ones. We want to be exposed to the right balance of risk assets, yet take a neutral position in the short term, a balanced position in the short term as to how it may play out. Volatility ahead is absolutely likely.

So it sounds like we're really walking both sides of the fence here, aren't we? Well, that's because we are. That's because I'm aware that we could very easily see us go in that circle again and start replaying the president tweeting again. Things are broken down. China's the worst. Tariffs are awesome. We're going to 40% tariffs this time. And then on the other hand, you could very easily come out with an agreement or the look of an agreement in a month or two months or three months. So it is very difficult to put a lot of conviction into an overly defensive or an overly opportunistic viewpoint right now. There's a lot on the line.

Net of the benefits of corporate tax reform, we believe that the cost of the tariffs will be $72 billion to the American economy next year. will be $72 billion to the American economy next year. And that is after $55 billion. So you would really have had a significant benefit from corporate tax reform that gets washed out and then some by the incremental cost, the de-stimulus of the tariffs. In the meantime, what's kind of coming out of this trade war? Are we seeing a whole lot of jobs come back at this point to Ohio, Michigan,

and Pennsylvania? Well, of course not yet. But frankly, we are seeing a lot of jobs, at least a lot of trade, increase year over year, percentage increase with Vietnam, Taiwan, South Korea, India, Mexico, even as we are seeing a decrease in that trade with China. So I believe that it's imperative that we recognize that this is a serious situation, but not take that to mean a most bearish conclusion. I just mean certainly not take it to a most bullish conclusion. In hindsight, do I wish that we had unloaded even more of our cash into stocks in the last few weeks? No, not really, because we did unload some at lower prices. I think we had good timing around some of these things on a valuation basis.

And yet the fact of the matter is we still wanted some dry powder if you get another leg down. We want to be fully invested. We just want to mix that across stocks, bonds, alternatives. And cash's yield is going lower as the Fed is cutting rates and as the global rate environment is going south. So we don't want to get a 0% return sitting on the cash. But we also want to be in a position to purchase with some dry powder as the potential for increased downside market volatility exists. And there's no way to time it perfectly. Market volatility exists and there's no way to time it perfectly. But I have to say that I do believe sticking to the disciplines of asset allocation have worked very, very well for quite some time now, not just in this most recent incident.

Let me switch gears real quick to the concept of negative interest rates. You got a tweet from the president this week about the Federal Reserve. They should be lowering interest rates to zero percent or less was his quote. He threw in that he called them boneheads as well. So where do I go with this one? Listen, how are negative interest rates working for our friends in Europe right now? Well, they are highly market distortive. They are a dishonest measure, but they also don't work. They crush demand as banks have to cut back on lending. The banks have less of a deposit base to lend from, less of a profit margin, less of a return on equity. They crush his return on equity. And they create panic because savers aren't stupid.

They realize that deposits may not be safe and it creates environment of distortion and therefore instability in the economy. You get a low savings rate that is offsetting the low borrowing costs. And so in the aggregate economy, you're either getting a wash or a loss from the stimulative effect of negative interest rates. The negative interest rates are not existing for any other purpose than to help over-indebted nations service their debt. So they are, this is a really important statement. It's going to sound silly, but I mean it the way I'm saying it. They are deflationary in that they are caused by deflation and they cause deflation, which is the most vicious of vicious cycles. So you tell me if we're in a bubble or not in some

of that bond category, $16 trillion of bonds trading at a negative interest rate. The value of those bonds has skyrocketed. We issued bonds at a negative interest rate, right? They've traded down to negative interest rate from the excessive amount of buying with, of course, non-existent money from central banks. And I can only tell you that's a greater dollar amount than you had in the entire dot-com explosion and the mortgage meltdown put together. It's a big amount of money globally, but it's not floating on the economy. You don't have bonds at negative interest rates sitting in your accounts,

but you have bonds transacting country to country, helping to monetize the debt, helping distort markets and helping distort economic behavior. So is that a bubble? Well, it may not be mechanically a bubble, but in terms of the impact it has, very distortive. Okay, a couple of side issues, then we're going to wrap it up. The Trump administration's come out with a really impressive plan to kind of rid the federal government and the taxpayers of Fannie and Freddie, Fannie Mac, Freddie May that we put into stewardship conservatorship in 2008. So I bring up these companies or government entities because some resolution around their positioning in the mortgage market, I think, has the potential to be a real transformative event that we're awaiting more details for what capital cushions are going to have to be and so forth.

Politically, it's worth noting in thedividendcafe.com this week that you actually have this positive job growth all over the country. But in recent months, you've gone negative in job creation in Pennsylvania, Michigan, and Wisconsin. Three states that President Trump won in 2016, but won by less than 1%, obviously integral to his reelection efforts. It'll be interesting to see if there is going to be negative job numbers in some states versus very positive job numbers nationally, how that may impact the election. And then finally, in the chart of the week, I really want you to pay attention to how the energy sector has delevered since 2015 when they faced the collapse in late 2014 of oil prices and debt levels at the time. Energy sector net debt was 33% of total S&P net debt. It's now 21%. So you've had a significant move down in the debt levels as a percentage in the energy sector.

Why do we care about that? Why do we like that? Makes them more nimble, more defensive, higher quality, better balance sheets, and overall more durable. And yet we believe that the pricing level does not reflect the fact that the energy companies are in a healthier position. And we think this is going to bode well going forward. At least it's worth understanding. So covered a lot of ground. And I'd love for you to reach out with questions, comments. Certainly we want to send you a copy of my dividend book, The Case for Dividend Growth.

If you would be so kind as to write a review for our podcast, send our way the review and your address and we will send you a copy of the book. In the meantime, thank you for listening and viewing the Dividend Cafe. And we look forward from New York City next week to from the New York office, giving you another look at all we care about in the market and the economy and the trade war and the election and the Beltway and the Fed, all the things. Thanks so much for listening and viewing the Dividend Cafe. Thank you for listening to the Dividend Cafe, financial food for thought. Thank you.