The Dividend Cafe - Looking Beyond One Week

Episode Date: February 14, 2020

We cover the market action of the week (at least up until press time) this week. And yes, there are plenty of thoughts and ideas around the present investment environment ... But I also think you will find this week's Dividend Cafe to feature some longer-term reflections on the economy, on long-term challenges that drive so much economic behavior. 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, a podcast and video. This is David Bonson. I am the Chief Investment Officer here at the Bonson Group. And recording here for the last time in our current New York City office, we're getting ready to move into our big new offices with multiple people and so forth here. The move starts over the weekend and we'll have like real studio there as I do out in California. It'll be much better when I'm recording the podcast here in New York. But in the meantime, there are things to share and I think this will

get us by just fine. I'm recording the middle of the market day on Thursday, and the market had been down about 200 points. It's now down less than 100, so it's come back a bit. But coming into today on Thursday, the market had been up about 400 points or so on the week. So where we stand now, we're up a good 300 points net net on the week, probably a little more. And that could go lower from here, go higher from here. But the point is that the movement higher in markets has continued. That has not happened as a result of a huge alleviation of fears around coronavirus.

It's largely happened around a shrugging off of fears around coronavirus. In fact, a lot of the kind of uncertainty and conditions news reports wise have worsened, not gotten better. So that whole situation continues to be obviously very distressing from a health epidemic standpoint. But markets have chosen to not let that hold them down. postulate this week at Dividend Cafe is a lot of it is the earnings side, which has been kind of neutral, not bad at all so far this quarter, but not necessarily allowing for kind of a breakout. But then really, as you've gotten a little deeper into it at this point, near the very end of the earnings season from fourth quarter, it's quite obvious that we're going to outperform earnings expectations from a consensus expectation standpoint by well over 2%. There was an average projection of about

0.3% negative earnings growth that analysts were expecting. And it looks like we're going to end up between 2% and 2.5% positive earnings growth. So again, about a 2.5% reversal from what had been expected. And that's become more evident and solidified in the last couple weeks. And that's given a little bit more optimism and confidence to markets. Additionally, the forward guidance from companies for their 2020 full-year projections have gotten better, firmed up a bit. And that's even with some of the kind of hesitancy that exists right now around various things from coronavirus to the Democratic primary and so forth. So if I were to dedicate my time this week to just talking about what's going on in the markets this week, it would be mostly how the markets just clearly want to continue going higher. That's generally what you expect when you're getting positive

earnings revisions, when you're in a low inflation environment, and when you have low interest rates making other asset classes less attractive. Are things going to get too frothy? I mean, I would expect that they will at some point. But in the meantime, I'm not sitting around shocked that risk assets are continuing to go higher. Resilience, as I've written about in more recent weeks, is a defining hallmark of a bull market. Markets do shrug off bad news or uncertain news out of a spirit of resilience that defines bull markets when you're really in one. And we've been in a bull market for a long time, no matter how many people have voluntarily chosen to miss out on it. Now, does that suggest then that all the things that have been working are what will continue to work? No. And one thing I kind of did this week in Diven Cafe that I'm really proud of

is work through this idea about declining interest rates and make a comparison to the bond market and high growth stocks. Because there's really nothing that re-rates and re-values, re-prices high growth stocks more than declining interest rate. You have this high multiple, but that high multiple becomes even more valuable for fast-growing companies when the interest rate, the risk-free rate, what we would call the discount rate in finance, is declining, okay? Well, we know with bonds that they go higher in value when interest rates drop. And I've made the point over and over again that that happened rather suddenly and significantly last year and made for quite an above-average return in bonds, but that it would be difficult

to replicate just because of math. Now, of course, rates can go even lower in bonds and that would push returns up higher, except for at this point, that really can't happen without it being in response to other bad things. So why do we own bonds at all? It's because of the risk of bad things happening. It's a defensive asset class. We're not sitting here owning and saying, hey, I have a projection on a 1.6% 10-year bond rate going to 1%. And so therefore, we're putting a high offensive opportunistic investment allocation into fixed income. Rather, it's the fear of other things happening that bonds become a sort of buffer against. OK, well, so bonds benefit from dropping yields and high growth

stocks do. But then now, if you believe that the risk reward likelihoods are skewed against even further lower rates from here, which is different than rates staying low. I certainly am very much in the camp that rates are likely to stay in a low range for a long, long time. However, the idea of the trajectory continuing to go lower and lower, which would be pushing higher and higher ratings and valuations around high growth stocks, strikes me as a very odd assumption. And then if you own it like we do bonds for defensive hedging type purposes, well, that would strike me as even much weirder than someone would be owning the riskiest and frothiest of growth stocks for defensive purposes. Obviously, that would not be the case. So it does effectively argue for the notion of these high growth, high valuation stocks coming up upon the end of their day, unless you do get just this continual

collapse of yields, which to me is only likely to happen if you have other macroeconomic events that are very negative, which would then offset that benefit with high growth stocks. So it suggests that one who's in the equity markets ought to be very focused on value. And by value, I mean things trading at an attractive level relative to the kind of discounting of their future cash flows. And we measure that through dividend growth. Other value investors measure it through a kind of measurement of future earnings and so forth and comparing it to present stock price. But my point being, there's a little bit higher quality regime that has been out of favor relative to big growth, especially in the tech sector for quite a while. And we think that would make a lot more sense here, regardless of whether that switch gets

turned in a week or in six months. We're not making a timing comment at all. I believe that DividendCafe.com this week is more economic in a long time. I always try to nibble a bit for readers who are interested in such things. I know that if I gave into my own instincts, I would write a 30-page dividend cafe every week that was entirely macroeconomic. It's much more interesting to me and I think more important to our clients as far as long-term investment objectives. But I also get that a lot of people

want to be reading about more current events. And so, you know, to the extent that our view, we don't ever compromise sharing the short-term noise, we don't think has barely anything at all to do with what long-term investor objectives and outcomes will end up being. Our job is not to avoid talking about the short-term noise. It's just to always be reminding you as to how little the short-term noise actually matters. But I think that behavioral response to short-term noise matters a lot, and it's why we obsess over it. But then I think long-term structural decision-making matters. over it. But then I think long-term structural decision-making matters. And you look in the last 30 years at those who saw a secular decline in bond yields as being a big boost to real estate, being a big boost to bond prices, and being a big boost to equity markets, with the exception of the

first decade of the 2000s, there was a structural theme that became very profitable for investors. When you look at those who looked at the emerging markets reality and the advent of greater globalization, particularly out of Brazil, Russia, India, and China in the first 10 years of the new millennium, that brick and the EM theme was very profitable, particularly when joined to a weakening U.S. dollar during the George W. Bush administrations. They were not cyclical and were not temporal. They were not by any means noise, but were in fact very secular and structural themes that became quite investable and important. the monetary policy interventions and their role in dealing with the debt crisis and their role previously in dealing with the systemic financial crisis. And what I think has effectively happened is that the central bank used tools as a policy response to the financial crisis. I believe them tooth and nail that their objectives were some sort of sensible

response to the emergency of the moment. It doesn't mean I agree with what they did, but it does mean that I am sympathetic to what their motives were. And yet, I think that what happened is that they validated in the minds of some of these central bankers certain tools that now with no sane person claiming we're still in a financial crisis and suffering through the same secular and systemic undermining forces that we were over 10 years ago, yet a lot of these tools remain not just still at play, but being used heavier than ever. And so you sit here now almost 12 years after the financial crisis, and we are dealing with literally a zero interest rate policy and significant amounts of bond buying in a very high Federal Reserve balance sheet. buying in a very high Federal Reserve balance sheet. And so I have to ask myself on behalf of my clients why we're doing this if indeed we're sitting in an environment where there is such a healthy economic backdrop. And yet, obviously, we are not experiencing the same crisis that we previously were. My own belief is that it's indisputable

that it comes down to fiscal policy issues, meaning the vast amount of federal debt that has been put onto the balance sheet of the United States taxpayers has put us in the same position that other sovereign arenas have had to deal with, most notably Japan, the European, they're not going to go cut spending and cut entitlements and do any of the things that may help alleviate the pressure on the balance sheet. And so I am very concerned over a 20, I mean, let's just call it 10, 20 and 30 year period. I'll call it 10, 20 and 30 year period in terms of how macroeconomically these things will play out. And I believe that bond yields are one of the most misunderstood things in all of finance because I hear people constantly talk about how mysterious it is that governments have spent so much money. Bond yields have come so much lower. And I don't believe it's mysterious. I believe that ultimately a long bond yield is itself a reflection of inflation expectations. And inflation expectations are largely determined by the velocity of money, by how much money supply is going higher. And then

that money supply that is going higher is turning over in the economy. And that as Irving Fisher taught us, the whole price theory of money relies on velocity as the driver of inflation, where there is no velocity, there is no inflation expectation, ergo lower bond yields. And right now, you have very low velocity, collapsing velocity of money, even with a very high excess reserves in our banking system, even with very high balance sheet of Federal Reserve, even with very low, low, low interest rates stimulating economic activity, we're not getting that velocity. And it is my belief that, and again, Irving Fisher would certainly agree with me here too, the great early 20th century economist, you're not getting that velocity because of excessive

indebtedness that is itself a deterrent towards that economic activity. It's compressed growth, towards that economic activity. It's compressed growth, compressed productivity, and has resulted in very low velocity, which then means low inflation expectations, which then means low bond yields. So you can say, okay, if I rewind your podcast and listen again, I might be able to follow the chain of thought here.

If you don't want to rewind the podcast, you can just read it in Dividend Cafe where I kind of map it out a little more visually. It isn't very complicated. And I also don't think it's controversial. I'm very confident in the way that we are presenting this. However, the challenge becomes once you accept that bond yields of downward pressure, government indebtedness is the great economic issue of the next 20 years. Then you have to say, what are you going to do about it?

And that's where I think the stage can be properly set to address investment allocation and where growth will come from, where value can be found, what low rates means to risk assets and what it means to savers, to income investors in that kind of macro secular context. So read dimmingcafe.com this week if you want some of it unpacked. There's some great charts as always. And I do hope that this podcast itself

is giving you a little of that econ 101 that I want to be giving every single week. Reach out to us with any other questions. We'll see what the market holds next week. It'll be a short week again with another holiday on Monday for President's Day. But with that said, earnings season now more or less behind us and ready to move into the next chain of events. Obviously, a lot more conversation will continue to center on the Democratic primary.

I unpack a lot of those things at DividendCafe.com. We know that there is not great clarity right now around where the primary is headed. Bernie Sanders still up there top, but a lot of momentum behind three different not Bernie candidates. And it's totally unclear as to exactly how this thing is going to break one way or the other. as to exactly how this thing is going to break one way or the other. So markets are not taking their P's and Q's from the primary, but maybe some disagree with me on that. Okay, I will leave it there.

Please reach out. Any questions, any comments, any time. And please share Dividend Cafe podcast with your friends and family and colleagues and so forth. Give us a nice review at iTunes or Stitcher, wherever you listen. And thank you again. Reach out. Take care. Thank you for listening to the Dividend Cafe.

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