The Dividend Cafe - Italy, The EU, and U.S. Markets

Episode Date: June 1, 2018

This week, David covers a week of compressed volatility in markets ..... Topics discussed: Political climate in Italy Implications for the EU, Sovereign debt and US markets Structural impedements to growth in Europe Further evidence the bull market has not ended The Fed and easing regulation Tariffs Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Hello and welcome to this week's Dividend Cafe podcast. This is David Bonson, the managing partner and chief investment officer at the Bonson Group. And it has been another interesting week in the markets. Do I say that every week? I bet I do. I think I say it every week because it's almost always true, and then even if maybe one particular week it isn't true, it's sort of like a habit, and so it just kind of flows. So whether or not you find it interesting, there's plenty of things to talk about, and that's what we're going to do on the podcast this week. So let me set up a couple things real quickly. I'm going to try to just sort

of recap the things that are most on our mind here this week, and I think I can get this done for you listeners in under 15 minutes. Generally, we go about 10 to 12 minutes, and hopefully that scratches your itch. I'm going to plead with you to read the dividendcafe.com weekly commentary. It's not that we're trying to get more subscribers or anything. It's literally that I believe there are charts there week by week by week and certain written commentary and a sort of written elaboration and articulation of our perspective that can't get recaptured merely in the podcast. that can't get recaptured merely in the podcast. So if you are interested at all in reading and viewing such things, DividendCafe.com will always kind of be my, as just an addicted writer, will always be my favorite medium of communicating with the outside world,

our investment perspective. But in terms of other podcasting, the Advice and Insights podcast I'd direct you to if you would like coverage week by week on a single topic, not trying to cover the whole globe in 15 minutes or less, but usually about a 30 to 45 minute deep dive week by week into a particular topic. And this week, that topic at the Advice and Insights podcast was on Italy, and something we're going to talk about here in just a couple moments, and the distress in Europe, and kind of what it's all represented to the market, and the US investors in particular. So we'll share some of that and overview here in Dividend Cafe,

but I do think you'd enjoy subscribing to Advice and Insights as well. So yes, we did come out of Memorial Day weekend. Market was closed on Monday, and then we had a pretty severe down day on severe down day on Tuesday. And the reason for that being this kind of elevation out of the disruption of the weekend political events drama in the beautiful country of Italy. So you have parliamentary form of government, the two ruling parties on a lot of issues are very, very conflicted with one another. One is very far left and one is very far right. But they're both very anti-establishment. They're both very populist. It's not a perfect analogy, but you could consider it sort of like the Bernie Sanders wing of leftist American politics and the kind of Breitbart, like far right Trumpian

populist wing, you know, there are a lot of issues in which we have overlap, you know, kind of a distrust of certain institutions, disdain for large corporations, for example, things of that nature. So the analogy is not perfect, but the point being they in Italy, in a far-left party and a far-right party, have found some common ground. And that common ground is at direct odds with the individual who serves as president of the country. And so in their form of government, they suggest people that will go serve in their quasi-cabinet and then the president can veto it. And that's what happened is these two parties who together in parliament make up over 50 percent suggested somebody to be the new economy minister, which would be reasonably equivalent to United States Treasury Secretary. And the president vetoed it and then suggested his own person, who they shot down.

So you can see it's a kind of heated deal going on there, and it gave rise to the idea that Italy is going to make an attempt, if they have this kind of special election around new party, new leadership, that there could become a sort of quasi-referendum around staying in the euro at all, staying in the euro currency, staying in the European Union, things of that nature. So it then creates more volatility, more uncertainty, and so forth and so on. I wrote a rather extensive piece about this subject and did a more extensive podcast to unpack it further. And so I do have to kind of direct you there to marketepicurian.com

for the written article and to Advice and Insights podcast. But let me give you the nutshell now, because that's what you're kind of listening for. that's what you want here and that's what I'm going to give you. First of all, the long-term thinking here and the short-term thinking are going to be very different. I mean, in the shorter term, we're seeing the sixth or seventh flare-up of markets in the last eight years in response to some Europe-driven commotion. But let me make a couple actionable comments as it pertains to the way these things manifest themselves in the U.S. Say what you will about alleged U.S. interest rate risk. At the slightest huff or puff of global fears, the United States Treasury bond market instantly becomes the safe haven of

choice. Our bond market rallied this week big as yields dropped in response to global capital flowing out of Italy and elsewhere and right here in the United States. And so there's sort of a reiteration, a reaffirmation of the principles of asset allocation at play, which I've talked about already this year, sometimes being somewhat ineffective in the present environment because the thing moving stock prices was the very same thing moving bond prices in the same direction. That was fear of rising interest rates. bond prices in the same direction. That was fear of rising interest rates. So in terms of this reversal of downside volatility that we saw the very next day, okay, so you had this big down day Tuesday and then a huge up day on Wednesday. It's so predictable because I think there's this sort of perpetual fear that exists and then people capitulate and then usually they get like a week before they regret it. In this case, they didn't even get 12 hours. But once again, trying to respond in U.S. equity prices to unknown things taking place in Europe was very questionable if at all exposure to U.S. is very unwise.

Now, the euro itself, the currency, it barely even budged, even as we were told markets were responding to the possibility of a full crisis in Europe. So neither the VIX, the media, or American stock markets can ever trump the currency markets as a bellwether for what's going on underneath the hood. We have global risk was blowing out. The euro would not have moved 0.7%. It would have moved far more than that. Finally, the idea of U.S. financials being the place to sell off when Europe's financial

stability is called into question really does strike me as 2010 thinking. I think a lot has changed since then. And I'll make some comments in a moment as to what I think that is. So yes, check out our deeper dive. Look, do I think the idea of Italy leaving the euro is a legitimate possibility? It is. Do I think it's in the short term? No, I don't think that there's even a 50% chance in the short term. But unlike many southern bloc countries that are victimized by Europe's monetary but not fiscal union, Italy's debt is mostly owned by Italian entities, 72%, meaning they're less reliant on international markets. entities, 72%, meaning they're less reliant on international markets. The populist forces in Italy have momentum. Any number of catalysts could force this moment. I think fundamentally

long term, a breakdown of the euro is inevitable. But in the meantime, there are tension points that could boil over in Brussels. I think there will be an eruption that impacts currency, bond yields, et cetera. But as far as this being the moment at which the full euro exit were to take place, I think we're a ways to go. Now, as far as the argument for investing in U.S. markets versus Europe, I've been really critical for a long time of the simplistic framework that said, well, U.S. has gone up more than Europe. U.S. is valued higher than Europe. Therefore, Europe becomes a better bargain. If one feels that way without looking under the hood at what is driving U.S. markets to be valued more, what is driving the price performance difference? And then I think they're missing the point.

We have a chart at DividendCafe.com showing the U.S. manufacturing PMI moving really, really impressively up. And yet in the same period over, let's call it the last nine months, the European manufacturing activity is dramatically moving lower. So you get a kind of relative sense. That's one indicator. There's many others as well. But I think that the fundamentals are just dramatically different. And a lot of that has to do with the headwinds that are structural in Europe. So what else do we want to cover?

The dollar is moving all around. The greenback did decline 5% in the first two months of the year and now has had a violent rally up. And that rally has actually put the dollar in positive territory versus a basket of other currencies. actually put the dollar in positive territory versus a basket of other currencies. I would say that currency agnosticism is still and always will be the best way to manage portfolios. The dollar will have periods where it's rallying, periods where it's not.

You have to have more of a currency outlook when you're taking large foreign investments versus domestic when you're denominating in your own currency anyways. But as far as growth expectations, there have been modest disappointments in Canada, Japan, especially Europe, UK, on a macroeconomic basis. And so that's caused the dollar to rally a bit more. Overall, I think the dollar just from a valuation standpoint is still high, but this particular trend within the trend is who knows when it could end. Great chart, by the way, at DividendCafe.com this week showing Bitcoin, the whole NYC, for God knows why, formulated a Bitcoin index.

You can look at that since its peak back around 20,000 in late December and now sitting in 7,000s. And then you look at the S&P during the same time. You had what we all, as market investors, felt like was real volatility, but you put these two charts next to each other and you have a different feeling of what volatility looks like. Okay, well, I'm going to leave it there because I didn't leave myself enough time to go through everything else.

I really encourage you to look at the chart, courtesy of my friends at Strategas Research, that has a whole checklist of things that would indicate the end of the bull market. And they go through nine different indicators that both in the year 2000 and the year 2007 ended up being in existence. And then, of course, we saw the market deteriorate, the bull market end, and a bear market ensue out of both those points. And in nine out of nine cases, those criteria are not on the table right now. I think that's a chart worth looking at at dividendcafe.com. On the politics meets markets front, that kind of beltway bull and bear section. Listen, a couple things real quick.

The Federal Reserve did announce some of their plans for alleviating pressure on the small banks, mid-sized banks, this so-called Volcker Rule, which put regulations in place around proprietary trading. It isn't so much that they're allowing it again, where firms can start using their own balance sheet to trade risky capital. It's more that the process by which firms demonstrate their compliance has gotten a lot simpler, a lot more effective. And so a lot of banks are happy with the fact that there's been kind of a thoughtful reorientation around Dodd-Frank regulation, And the benefits accrue even larger to smaller community banks and things like that. The market movement down on Thursday, which happens to be at the

point that I'm live recording right now. So markets are open and down over 250 points, a direct response to more tariff trade talk out of the administration. If everything that was being said was legitimate, I think you'd see the market down a lot more than it is. We also do have a weird day. And I hope some of you catch this because some of you find these nuances interesting. The Dow shows on my screen as I'm talking right now real time at down 260 points, which is over 1%. But the S&P only shows is down 14 points, 0.5%. The NASDAQ only shows down as 15, which is 0.2%. It doesn't happen a lot, but you have just a total disconnect across the market. So is the market down 265 points? Yes, it is. But would a typical investor feel like it is? Probably not, because there's

apparently some Dow component, maybe one or two, that are just creating a disproportionately different response in the Dow than the rest of the market. All the markets are down, but it isn't quite as severe as it may feel at down 260. The S&P is obviously a broader barometer with 500 stocks when the Dow only has 30 the S&P is down half a percentage point at this point that could change at any time by the time you're listening to this obviously has changed my point being the trade and tariff talk as long as it continues it's going to keep generating more skittishness and that seems to be something the Trump administration is willing to live with for now. And then when all is said and done, I think most market actors have determined that they have no idea what's really going to happen because all of it has so far ended up being repackaged as negotiations and tough talk to kind of help position us with our trading partners and so forth and so on.

So I'm over my 15-minute timeline. I hope you enjoyed listening to Dividend Cafe this week. I hope you'll subscribe if you haven't already in your iTunes or Google Play or whatever your podcast listener choice is. I do hope that you will write us a good review, and we will look forward to talking with you again next week as we enter the beloved month of June. Thank you for listening to Dividend Cafe. Thank you for listening to the Dividend Cafe, financial food for thought.

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