The Dividend Cafe - It's the Economy, Stupid

Episode Date: October 4, 2019

Topics discussed: As of press time the market was down significantly on the week, down approximately 800 points on the Dow since Tuesday morning. Believe it or not, Tuesday/Wednesday were the first back-to-back days of down over 1% (each day) in the S&P 500 all year. We need to look at what the issues are in the market, what to expect as we get into the fourth quarter, and look at the variety of issues that actually matter right now in markets and the world economy. From manufacturing to impeachment and lots of politics, we have it all in this week's Dividend Cafe. This Week's Market Drop Manufacturing and Services Sector Data The Trade War's Effect on the Economy Markets and Impeachment Europe is a Debacle Politics and Markets 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. This is David Bonson. I'm the Chief Investment Officer at the Bonson Group, bringing you our weekly market commentary. We're recording middle of the day on Thursday as we now have launched officially the fourth quarter of 2019. And the quarter ended on a high note Monday, the third quarter, ended up having really a spectacular September, particularly for dividend growth investors, and ending up in a positive result for the whole quarter, even after that sell-off that took place in August.

But then literally right into the new calendar quarter, beginning on Tuesday and accelerating into Wednesday, the market took a step back here this week, and we're going to kind of walk through the reasons for that today. So market's still substantially higher on the year, obviously, but the volatility that we have forecasted, I've spoken about a great deal, I think is likely to stay in play until there is trade war resolution. in play until there is trade war resolution, when all of a sudden things are going well, it can numb investors and sort of create a little bit of complacency, understandably, because you feel like maybe some of the worst has been behind you. But when volatility subsides without any resolution to the thing that was causing volatility to begin with, we really should not be surprised when the volatility resumes. And what happened this week, the market dropped to about 300 points on Tuesday and then about

500 on Wednesday. By the way, it was the first time this year that you had two days in a row where the S&P was down over 1% each day. Obviously, we've had various setbacks and things. We've had days where it was down more than that. But two days in a row, that was a little bit odd. I find kind of surprising. But anyways, the news that came Tuesday morning was a really substantial, as in worse than expected, drop in ISM manufacturing data. And at DividendCafe.com this week, I actually have two different charts to kind of graphically illustrate how violent the drop was.

And the drop is a result of the trade war. It is a result of business uncertainty. You have a lot of projects and new goods orders, durable goods. These things are at the heart of what manufacturing is. And if those factors are declining, it is somewhat of a tautology to suggest that manufacturing would end up dropping. And that is what has happened. And in fact, we're getting a reading now that's as low as any that we've had since before the election. Well, then here on Thursday, as in just a matter of a few hours ago,

the services sector released their data and it also dropped quite a bit. And frankly, over the last couple of quarters, even when the manufacturing data was softening, services sector was still looking strong. And it gave the bulls a great talking point to say, well, the manufacturing is weak. It's probably transitory around the trade war well, the manufacturing is weak. It's probably transitory around the trade war uncertainty, but the services side is still holding up. But I think that the overall business environment right now is experiencing enough trepidation that we see this in the services side. Well, the market was up a little bit when that ISM services data came up, and then it dropped about 200 points. Now, as I'm recording, the market's up again a few points.

So you've got a little bit of volatility around it. It's possible that there's been a little tradable number set here on the downside. prediction or the ability to make a prediction as to what will end up happening in the market week by week while we wait for the China trade war results. What I do have a very high amount of conviction in is it represents a big vulnerability in the economy. It represents a big vulnerability in the reasons that we had seen such a strengthening in the economy. And then naturally, there is a lot of political ramifications around it. One of the things I kind of want to focus on in our talk here today is that the impeachment inquiry is going to take up most of the news oxygen. But it is not even a blip on the radar of what I think the markets care about right now.

If you were by chance a Republican staffer in the White House or the Trump reelection campaign, I would be thinking one part impeachment and 50 parts economy in terms of my sort of economic priorities or campaign and administrative priorities. The entire kind of milieu of the economic system right now centers around a couple of different considerations. And people say, well, is the economy good or is it bad? And I've written, talked about over the last several weeks, some conflicting data around all of it. But this isn't a cop-out. This is the reality of what we're dealing with. And I have a little more clarity even right now in being able to say the economy is good,

but has the potential to move the other way and is starting to do so reluctantly around uncertainty. And what I mean by that reluctantly is that the market has, the economy has significant incentives as a result of the corporate tax reform to produce to the past periods for instant expensing to go drive productive projects. I don't believe those projects have been shelved in the sense of, oh, we no longer want to do them or no longer believe they're advantageous to our business or our profit-making capacity, I think that they've been delayed around the uncertainty of the trade war. And I also think that some of it is not just uncertainty and psychological and sentiment. Some of it is actual in the math of trade itself has dramatically declined, both imports and exports. That leads to a necessary lessening

of the need for widgets to be made. So you have a supply chain reality that creates a sort of self-fulfilling prophecy in economic activity. And I think that this is in a tug of war with the fact that A, Europe is a debacle, an absolute debacle. And I talk about this week in dividendcafe.com that as a contrarian, I'm supposed to come and say, look, everyone hates Europe so much. It's a good time to come get in. But the fact of the matter is I can't even say that when the investment opportunity of Europe right now is so distorted by the lack of price discovery because of their just insanely interventionist central bank, their political turmoil, the structural dysfunction between a fiscal union that doesn't exist and a monetary union that does exist and so forth, the risk reward calculus in Europe continues to be very unattractive. But here's who agrees with that, Europeans. And so European dollars are needing a place to put capital. They want to come to the United States. Asian dollars have been looking to find a home

in attractive capital projects. They continue to come into the United States. Asian dollars have been looking to find a home in attractive capital projects. They continue to come into the United States. This is a very difficult time to be fully bearish on the U.S. economy because the fact of the matter is there is a significant TINA. There is no alternative dynamic in terms of global capital that is an attractive resource for the United States. You also have a Fed that is distorting the risk-free rate of capital by pushing interest rates even lower. We right now are back to over a 90% chance after this week, according to the Fed funds futures market, of an additional rate cut, not in December, but now in October, as in a few weeks from now. And then it's about a 50-50 chance of even another rate cut beyond that into December. So if you end up getting a Fed funds

rate that low, you have the argument that cost of capital is being really held down and you have the different supply side benefits for the economy around tax reform. And there is no alternative concept working for United States investors. But those things are all up against the difficulties that we have in the economy right now. So I will tell you that the political environment, and we did a whole podcast on this the other day on my investment committee, the political environment has very, very little to do with what's happening in the market right now. Now, longer term, is there a sense where people say, well, short term, I'm a little spooked by the trade war, and long term, I'm a little spooked by Elizabeth Warren.

Oh, I think that's very possible. I also think it's very difficult to evaluate fears that may exist economically, fears that may exist for investors about Elizabeth Warren without kind of getting a better feel for where the Senate will go. without kind of getting a better feel for where the Senate will go. In other words, the market response, totally divorced from political ideology and totally divorced from emotion, preference, home team bias, any of that type of behavioral reality. The market response to Elizabeth Warren presidency, and let's include a lot of the things in her agenda, has to be interpreted through one's expectation of the Senate. Because a Elizabeth Warren presidency where the Republicans hold the Senate, you could talk Medicare for all, you could talk student loan, free college for all, wealth tax issues. This week she proposed a 75% tax on the amount of money businesses spend on lobbying. So there's all these different things that might seem highly regulatory and bureaucratic and

expensive in the corporate economy. And I think the rhetorical weight that is put on the business sector by constantly bashing corporations or bashing Wall Street, bashing capital markets, bashing Silicon Valley. I think that it is obviously legitimate that investors may have questions about that prospect. But I really believe that the market right now, and this could change, doesn't view it as remotely likely that the Republicans will lose the overall Senate. Therefore, Elizabeth Warren would have that greater path if indeed she were elected towards implementing a lot of these things that I'm talking about. So I do in our politics and money section this week kind of lay out some of the particulars. The Republicans are expected to pick up a seat in Alabama that

is currently held by a Democrat as a result of that Roy Moore election a couple of years ago. There's a possibility of picking up a seat for Republicans in Michigan, although that is an uphill battle. But there's really no other offensive endeavors for the Republican Senate efforts at all. Those are the only two they're trying to flip from a Democrat to Republican. Most of what they have to do is more defensive, and most are likely to hold for the Republicans. Susan Collins in Maine, McSally in Arizona, who was appointed to fill the spot left by the passing of John McCain. And then Cory Gardner in Colorado. Those represent a few states that are probably going to dictate the fortunes of the U.S. Senate. And we shall see what happens. But at the end of the day, I think that

people wondering, hey, do you think 13 months in advance is the market getting creeped out by the idea of a really far left progressive agenda in the White House? And my answer is no, because A, there is still so much ambiguity around where all the presidential race will go. And B, even apart from that, you really have to have a high conviction that the Senate's going to flip too. And most sober-minded analysts at this point, all of this can change, don't view the Senate flipping as the more likely event. So the politics is out there, but the economic outlook is by far the larger driver at this point in time.

And then, in fact, rather than politics being what's driving the economy, I would suggest it's the economy that will end up being what drives the politics. How people feel about impeachment, how people feel about getting a trade deal done, those things are largely going to kind of lead out, excuse me, follow out of how the economy is doing. And so that would be my sort of contrarian take. The economics will drive the politics. The politics will not drive the economics. All right. I politics will not drive the economics. All right. I'm going to leave it there.

Lots of good charts this week at Dividend Cafe trying to reinforce the fears we have in the manufacturing sector, some historical context on things that have taken place in the past when the Fed has cut rates that make it really kind of clear as to why it matters if we're in a mid-cycle or late mid-cycle easing of monetary policy, or if in fact, this is just a typical last ditch, late cycle monetary easing that generally is not accommodative or stimulative at all. And we don't really know exactly. Speaking of that word tautology, the problem with saying mid-cycle cuts work and late-cycle cuts don't is you don't know if you were in the mid-cycle or late-cycle at the time in which you did it. You get to answer that question once you know. Mid and late-cycle

become definable with the gift of hindsight. My projection at this time is it is a wonderful time to be an investor in high quality assets that are returning growing cash flow. interest rates that held bonds a lot, that added to the inverted yield curve and a lot of questions about economic strength, but also presented just the mathematical challenge for income investors that the rate market, the bond market, the cash markets are all providing less and less opportunity and that income investors need some source of yield and that high quality dividend companies represent a great place to get it. But that is not a seasonal prediction. It's not a seasonal or tactical forecast. That's what we believe all the time and just happen to really particularly believe it right now. So please do reach out with any questions, any comments you may have from politics to the Fed, to the trade war war to economic strength.

And then in a couple of weeks, we really get to finally unpack earnings season. Could be very, very interesting. And unfortunately, it could be interesting in a couple of ways. I mean, it could drive markets lower. If you get low expectations that actually are even worse than were expected, they play out even worse, that could be a driver down. That sort of happened this week with economic data. We were expecting some difficulties in manufacturing and ISM services, and it came in worse than the difficult numbers

we were expecting. Perhaps it goes the other way, though, with earnings, which is what has been the trend the last couple quarters. They beat them up, they expect a certain bad result out of earnings, and then it ends up outperforming in markets like it. We have to wait and see how that's going to play out here in the short term. All eyes on China, a trade war, and that's where things are for investors right now. Thank you for listening to the Dividend Cafe, and we look forward to coming back at you next week. Thank you for listening to the Dividend Cafe, financial food for thought.

The Bonsai Group is registered with Hightower Securities LLC, a member of FINRA and SIPC, Financial food for thought. Thank you.