The Dividend Cafe - Market Outlook w/ David L. Bahnsen - Conference Call Replay - Apr. 19, 2021

Episode Date: April 19, 2021

Replay of our National video call, April 19, 2021, covering the market performance, energy, and potential changes to the tax code. DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Thank you, Erica, and thank you, Scott, for joining us. Thank you all who are on the call, either by video or telephone or those that are listening to the replay later. But for those of us right now live, I will turn it over to Scott. Scott, it's one of those very rare days, actually, since we've been doing these calls now for 13 months where the market is down as we're in the middle of recording.

Nothing too bad. The NASDAQ's down a little over 1%. As I'm talking, the Dow's only down 160 points, which there's going to come a time when people realize that 160 when the Dow's at 34,000 is not what 160 was when the Dow was at 10,000, let alone less than that, but for so many decades. less than that, but for so many decades. But be that as it may, it still has a certain sound to it. And we haven't had very many down days as of late. But I'm all yours, Scott, to steer the conversation where you want. And of course, audience in real time, you can send in questions, as Erica said, questions, plural questions at thebonsongroup.com. Scott, off to you, my friend. Well, and David, thanks so much. And you already nailed it.

I mean, just on Friday, we hit record highs in stock. So understandable to have a minor pullback today. But you were referring to the trend anecdotally that we noticed that on days that we've done this call over the past year, the market tends to be up. orderly that we noticed that on days that we've done this call over the past year, the market tends to be up. So we'll see if we can continue that trend by the time this broadcast is over. Maybe we can get into the green across the broader markets. But David, I think that brings up kind of a good starting point, a question that we got from somebody, which is with the Dow at 34,000, do you see 30,000 or 40,000 coming next? And I

think that's a good place to start here. Yeah, I guess that's a better question than if I see 35,000 or 33,000 coming next. We're literally right at 34. And so 1,000 point up or 1,000 point down, it would be like asking me to call heads or tails. Statistically, that's really true. Any thousand point move at this level, up or down, it would be a coin flip in terms of odds of direction on the direction. is 34. I think that if one wanted me to put money on either 30 or 40 or none of the above, I would take none of the above. In other words, I think it's very possible that we won't see 30 again, but I wouldn't bet on that. And I do think it's very likely we won't see 40 for quite some time. Well, let me start with the 40. That's just based on, at 34, the forward expectations of market earnings,

and the Dow is, of course, a much more diversified and a little bit less exciting of a market index. It's actually a lot more like the real American economy with its exposure to industrials and financials and materials and other sectors that receive a higher weighting in the Dow than they do in the S&P 500. And I think that they have a more important role in the economy and in society than the weighting they get in the S&P 500 would reflect. And so I like the Dow's sector weighting in that sense. I don't like the methodology of how it's priced around the prices of the individual stocks, which I think is really silly.

But my point being that to get to 40,000 with earnings expectations, you basically are 6,000 points away. And we can do the math that we know we're 17% to 18% away from 40,000. And earnings are not going to grow 17% in the next year. going to grow 17% in this next year. And whatever earnings growth we're expecting is already priced in a forward basis. And even that forward basis has the market multiple up quite, shall we say, handsomely. In the S&P's case, about 20, 23 and a half times earnings. I think that you are very likely to see the Dow stay in a trading range for some time. But we got to be honest, and I'll do the math in my head here,

but I think that any kind of 10%, 11%, 12% drop, which is what it would take for the Dow to get to 30,000, is really pretty benign. I don't think anyone likes a few thousand points coming off the market index. 10%, 11% is something, but the market is on average had an intra-year decline of 13% or 14% every year forever. Some years it may be 8% and some years it may be 16%. But my point being, it would not disrupt things to see a 10%, 11% drop. So the long answer to your short and I think reasonably simple question is, I would probably bet that we don't see 30 or 40 anytime soon. But if I was going to pick that one was going to happen this year,

I'm more inclined for it to be 30 than 40. And for all you really intelligent listeners, of course, that's the answer. When you're at 34, if you have to bet one, you bet the one that's closer than the one that's further away. If anyone needs help with that math, reach out to me and I'll walk you through it. Well, David, and just to your point on the benignness of a drop to 30,000, I mean, we only hit Dow 30,000 five months ago. And then if for people who've been following this,

prior to COVID, just prior to COVID, that was kind of the level we were about to hit. And that was considered a big achievement for the market. So perhaps, you know, to your point, we don't want to see a 10 percent drop in the market. But 30,000, you know, is still a pretty elevated level in the market, perhaps. Well, it is. And I'm fond of saying that to people when they'll ask like, oh, what do you think about a certain thing that feels kind of bad happening? And I'm looking here at the chart of the Dow. And you're right, I remember it being in Thanksgiving season in November-ish. So I think the question would have to be, oh, if we went all the way back to where we were in November,

did you feel like your financial goals and realities were in jeopardy four months ago, five months ago? Most people would probably say no. By the way, the market recovery during COVID, if you put a chart of the March 2020 through current, and you put a chart of the 2008 drop, and then the recovery began in 2009, and you put those two charts on top of each other in terms of the shape of the post-drop recovery, it's really quite identical. And there was a drop in 2010. The market began recovering in March of 2009 and it had a really heck of a year, much bigger from its trough to the end of the year, but even on a full calendar year, because remember we spent the first two months in a week just collapsing January, February and early March of 2009.

But even on a full calendar year basis, it was something about 25%. And trough to peak, I think it was 38% or 39%. But in 2010, we did have a double-digit drop in the markets. By the way, we had it in one day. I believe it was May 12, 2010. It may have been May 9th. Somebody can correct me if they want, but there was that flash crash day. And it's a day that I remember very, very well. I tend to remember a lot of these things quite vividly. And throughout that period where the gravity of the Greek debt situation was becoming very apparent to markets,

gravity of the Greek debt situation was becoming very apparent to markets. We didn't really hit kind of the peak of European debt distress until the summer of 2011, which point the S&P dropped 19.8% and then rebounded just dramatically after September into the end of the year. September into the end of the year. But in the middle of 2010, so that's kind of the season that we're going into now, meaning a year plus a couple months after this initial recovery, the market had a double-digit correction. Everything about 2010 and everything about now is different. I don't know why. That's why I don't put these charts that I look at in my DC today because I kind of think it's irrelevant. But I just want to remind people that corrections in the midst of recoveries are not odd. It would be incredibly odd not to have it.

And oftentimes a good buying opportunity, depending on kind of where you are in your financial trajectory or your goals. And David, with that, another question we're getting within the universe of dividend paying companies, are there any industries or sectors worthy of overweighting at this time? Well, I don't know where the question came from, but let me do the question, ask her the courtesy of kind of backing up a little bit to make clear how we view these things at the Bonson Group. Because we are bottom-up stock pickers, meaning when we make a decision to buy XYZ Company, we did not make it because it was in the ABC sector. Now, we may decide when we're looking at XYZ, we already have way too much of ABC from a risk standpoint. And we may like XYZ, but then say, hey, you know what?

We really ought to like it even more because we're so underweight, the ABC sector. So the sector consideration could play into it. But the decision to like a company and believe it belongs in our portfolio, and then to purchase it, and then where to weight it, those things are based on a conviction in a company, not a top-down, we like tech, we don't like energy, we like industrials, we don't like energy we like industrials we don't like utilities that type of thing that's what is referred to in our business as top-down portfolio management and we certainly recognize that whatever we choose to do from a bottom-up

stock picking standpoint is going to be impacted by top-down considerations. Last year, everyone wanted tech. And last year, no one wanted energy. And this year, tech has had struggles and utilities are kind of stuck in pause. There are realities around the utility sector or around the technology sector or whatever the case may be. But we don't want to buy an entire sector of companies that we 100% of the time will believe is filled with companies that are probably really viable and attractive and companies that are not. In other words, we want to do the work necessary to discern

the companies that fit our philosophy and we think can help execute on a client's financial goals. philosophy and we think can help execute on a client's financial goals. And so rather than just say, let's go buy the whole sector, we're doing the bottom-up analysis. So that's the preface to the answer, which is that we're looking at company ABC and company XYZ based on the fundamentals of the company, the valuation relative to the growth opportunity, and defining its defense and its offense around its dividend growth. What management is saying to shareholders with its use of free cash flow and its prospects as a business enterprise based on its growth of the distribution they're offering

to shareholders. This is something that is deeply philosophical to us and obviously something I've devoted my career to. Now, with all of that on the table, do I think there's going to be a lot of dividend growers in the technology sector in the year ahead? I do not. The few that I believe will be growing dividends, we own, and they happen to be older type technology companies. But do I believe there's going to be attractive driven growth at lower multiples with some of the names we own in consumer staples? That's an example of an area that A, is a pretty perennially defensive sector, kind of middle of the pack and its return expectations, generally not the worst performer and generally not the best performer, which we love.

And generally the names that we own, and there's a lot of names in that universe that are good dividend growers. There's a lot of candidates for our computer screen. that are good dividend growers. There's a lot of candidates for our computer screen. But then also one thing about 2021 is that one could talk about the huge run in technology last year, the incredible outperformance of consumer discretionary

since the economy began reopening. We could talk about how financial started to catch a bid when bond yields came up, recovered off of really just stupid low prices of six months ago. We could talk about the ferocious rally that led all sectors in the first quarter of this year in energy. But see, consumer staples isn't in any of those conversations. So we like that it's been relatively unnoticed, has not tanked, has not rallied, and has the other bottom-up areas that we like. But saying that doesn't do me any good unless I find companies to attach to it. So real estate, the REITs, Real Estate Investment Trust, offer some of these interesting opportunities.

Utilities, particularly if you have a more negative or bearish view of the market. If the Dow is down 10%, Scott, I fully expect utilities to be the best performing sector. Just because that's generally true. It's very rarely that utilities are top performing sector when the market's doing well. They're a much more defensive sector for that purpose. performing sector where the market's doing well. They're a much more defensive sector for that purpose. And then I think that we are probably looking at the consumer staples named around that out. But I don't want to ignore industrials. There's some great names we're looking at in the industrial space as well. And then in terms of other names that we own, if we thought they were

fully valued, fully sold, overvalued, or if there was a need to remove them from the portfolio, we would do so. So we still have the same conviction in some of our financial names, energy names, things like that. But overall, I at least appreciate this much about not only our methodology, but also the question. I like the idea of investors being discerning and selective right now, the question, I like the idea of investors being discerning and selective right now, maintaining some approach that is going to be more active than passive because I do think that the risks are greater in a passive acceptance of current weightings and realities versus trying to make some active decisions when you have multiples this high. Yeah, multiples this high coming off of, as we said earlier, a record day for the broader

indexes just this past Friday. And David, you've said that a couple of times. Do you mind if I make a point on that? I think I put this in Dividend Cafe. Actually, it was in dc today last thursday markets did close at a high on friday they appear to be off a couple bucks on that today um i believe thursday was the 21st high day for the dow this year um and the s&p was right behind that uh 18th you know all-time high or something like that.

So to the extent that we talk a lot in our business about highs, closing highs, new highs, all-time highs, I just have to constantly reiterate a point that I think is really clear once I say it, but it's sometimes hard to kind of contemplate until I say it, which is that every number the market has ever been at was at one point, it's all time high. Yeah, no, well said. And David, when you talk about sectors that people should be watching, or at least dividend stocks within those sectors. You mentioned energy. We're getting another question about your outlook for oil prices, given how COVID-19 seems to be getting better in some areas of the world. It's not good in other

areas of the world. What is your outlook for oil prices, which are just a couple bucks shy of their 2021 high from a few weeks ago? Yeah, I mean, that's a good question. Basically, when you look at the COVID reality right now, there is almost a tale of two cities, except for it's more than two cities. It isn't like US versus rest of the world. It's US with unbelievably positive COVID realities. The UK also in a similar situation with really heavy vaccine participation in their AstraZeneca treatment, which has not been approved in the United States, but has been wildly successful in the United Kingdom. And then in a country like Israel, I have a chart in DC Today today that is just surreal how heavy their vaccine participation has been and how directly correlated, in this

case, inverse correlated their COVID cases are to a point of really almost seemingly eradicating coronavirus from Israel. But, you know, we're picking on European Union a lot because they've had a tough time with vaccine rollout. They didn't buy enough up front. They didn't have an Operation Warp Speed to prepare for distribution. A lot of the nature of the European bloc bureaucracy kept them from distributing with the efficiency I'm sure they would have wanted. But now a few months into it, it isn't really just a story of tough vaccine distribution in Europe. Some countries have really outperformed others. I think Italy has done a better job than France, for example, things like that. So the numbers are a bit disparate. But it's really

quite difficult. And for understandable reasons, in terms of supply chain, in terms of transacting with the major pharmaceutical companies, in terms of setting up both manufacturing, production, and distribution facilities. It's the emerging markets. You look at like India, for example, which is a gigantic country. It's a very poor country, though, in the context of when we're talking about France, Germany, United States, England, and Israel. India is a very poor country per capita, relatively speaking, and they're having a very difficult time. But interestingly, not all of the emerging countries are. And so some are in a different position than others, not necessarily related to vaccine penetration. Sometimes they just simply haven't had the infectiousness that others have.

Sometimes they just simply haven't had the infectiousness that others have. So I'm sorry, the question was on oil demand. Oil prices, where do you see them going this year? Well, and oil prices are basically going to be a byproduct of supply and demand, of course. And that is all interestingly up in the air around some of the things we're talking about. I mean, on the margin, robust demand growth in the United States and Europe is going to be a bigger factor. But if you have significant diminished demand for oil in India because of extended COVID problems, that's worth a few dollars a barrel,

which is our marginal dollars to the oil producers and to the exporters of oil. Most of the excess supply, and by the way, I shouldn't say that, it's all of the excess supply right now of crude. You recall the just absolutely gigantic storage levels of oil from about a year ago, April into May. So we're still not quite at the one-year mark. But basically, we're down to about 15% of that excess storage that we had a year ago, meaning 85% has been worked through, has been worked through to some degree by an increase in demand, but mostly by the decrease in supply capacity as diminished production came about from market forces in the US and from OPEC plus choosing to lower their production. China is the only country that is holding some of that excess supply.

And so they're not in need of imports right now, but that'll wear off too and represent another boon to supply and demand trade-off. So I don't anticipate oil getting below 50 this year unless you just have a really unexpected pause or reversal in economic momentum. But I also don't really buy into that argument that we could end up seeing 90 or $100 oil because we are so behind in getting our supply back online and demand picks up quicker than expected and the supply is not ready. It's definitely possible. There's a lot of complexity in turning on our rigs and keeping up with the variables around supply and demand pricing, but I don't expect it. I think it's very unlikely.

buy and demand pricing, but I don't expect it. I think it's very unlikely. So it's a pretty broad range I'm offering, but 50 to 75 continues to be the range I think that WTI trades in. And we're right in the middle of that pack right now. Let's see where we are here. I think that we're sitting at $63.48 today. And to be totally honest with you, that's probably about the best number we could be at. Because I know some of the producers might like 68 more than 63. But there's a point into the 70s or something where demand starts to fall off because the price gets too high. demand starts to fall off because the price gets too high. And at 50, consumers love it, but it's a lower profit margin for those producers.

This kind of middle of the range level here does not get violent enough to stem demand, and it is perfectly profitable on the margin for producers. And, you know, David, you've written a lot about this, but, you know, that's one reason why you're focused on the midstream part of the energy sector, so to speak, just in terms of investing opportunities for clients, which we can talk about as well. Yeah, I mean, in turn, and so, Scott, repeat the last part of the question for me.

It cut out on my end. Well, it was more of a comment just that within the energy sector, a priority for you, for clients, is the midstream's part of the energy sector, right? Transporting oil through the pipelines, perhaps more so than the EMPs. Yeah, that's right. And so when you have a couple of the major integrated companies that are really, really large oil and gas companies involved in downstream, midstream, and upstream activities, you're kind of more commodity price neutral and you're spread out across the whole energy infrastructure. But when you're on the pure midstream side, you're even more agnostic on the pricing and you have more exposure to use of natural gas,

to use of liquefied natural gas, to the exporting of liquefied natural gas, where America becomes a seller and other countries in the world become buyers. And then you are tethered to use of crude oil as more companies use pipelines to transport it to their downstream destinations, transport it to their downstream destinations, refiners, and so forth. And that's what a lot of the MLPs and the oil and gas pipeline companies do, amongst other things too, such as storage. And some of the bigger ones are increasing their exposure to the renewable space as well. So you've teed this up nicely for me. We are most heavy of all the aspects that we're invested in in the midstream side but the midstream side has had challenges of its own it's just that those

challenges i very selfishly have enjoyed in the sense that they've provided a higher yield than i think is the natural market rate for a longer period of time than has really been rational. And it will go away as prices go higher. Yet, to the extent that there's not a great plan to sell some of those assets, then it will just simply lead to lower yields in the future. But they're still going to be very attractive and still at a premium. But I think that the oil and gas midstream space is really attractive right now. And by the way, it's had a heck of a first four months to the year. Yeah. And David, I do want to touch on tax policy as sort of the last topic we discussed for today. Obviously, this is

a complex topic and we could do hours on this, but what are you hearing on the tax front? What do you think people should know about any potential increase in tax rates in the coming year, let's say? Well, I've tried to write about this as much as I can in DC today. And I hope that some of these nuggets have been useful. You know, I hear everything that you all hear in the press reports or that the White House announces about certain things that they intend to do. The only thing so far that has become an actual proposal, not conjecture, not discussion, not rumors of what is going to end up being proposed, the only tax increase that's actually made it to paper, and it's only from the White House in a proposed bill

that now the Senate and the House have to wrestle around with, is this idea of the corporate tax rate going from 21%, where it was set in the Trump tax bill at the end of 2017, and going to 28%. That's what the Biden administration has proposed. And I wrote pretty early on that I didn't really believe that they thought they were going to get 28. The 28 seemed to me from a negotiation wisdom standpoint and tactics, more likely

a starting spot to get them to a 25 spot. And what 25 would do is check a number of boxes. Number one, they can still say to a more progressive part of the base, we raised corporate taxes. There is an audience out there that wants to hear that. Number two, not be as disruptive to the economy or corporate profits and economic growth and recovery as an increase to 28 would be, let alone to the 35 range that the number was at before. But then number three, be more politically feasible in a 50-50 Senate when you can't afford to lose one single Democratic senator, and you can only afford to lose three Democratic congressmen in the House of Representatives, congressmen or congresswomen

in the House of Representatives. And I think that's an even bigger deal. And I think that's an even bigger deal. I actually named names today in D.C. today. There are five Democratic senators that are saying they don't actually think so. I think that more likely the Biden administration sort of knew that these three, four, five, six, whoever they are, were going to be on that side of things and that they would say 28 to get them to 25. The other question, though, that is out there is on the tax of American multinational companies on foreign profits. It's at 10.5% right now, Scott, and they're proposing raising it to 21. I'm not totally clear what's going to stop that. It's very hard politically for either side of the aisle to make a big case against raising taxes on foreign profits earned. Now, that's not because you can't make it economically. I can make it economically. I actually think it's a disaster to raise taxes on foreign profits earned. I'm only speaking politically that people like the idea of sounding a bit more nationalistic here and kind of punishing the multinational companies for these foreign profits. I don't know that it'll get done at 21%, but I think that some of the multinational companies with a lot of foreign profit generation

have some exposure there. But again, until the Senate and the House are wrestling with these things, more of the Senate than the House, There's a bit more gravitas and leadership and economic muscle that will be there in the Senate side for policymaking. With the House, they have to run for re-election every two years, so it tends to be a lot more political. But I would keep an eye on that. And then I am very, very, very much keeping an eye on what will end up happening with the 20% deduction currently available to some but not all select industries or sectors that qualify for it. 20% deduction of income to LLCs and S-Corps and sole proprietorships and partnerships, so-called

pass-through entities that pass their profits on to their owners. And that deduction is not a special favor. It was just simply done to keep their taxability in line with what had happened with C-Corps three or now almost four years ago with the prior tax change. But if they were to take out that deduction on pass-through entities, essentially penalizing small businesses for being an LLC instead of a C-corp. That's really what it would amount to. Then I think that that's a really problematic decision for the economy. I put in Dividend Cafe Friday, it's $1.03 trillion of net income that is a result of pass-through entities in our economy. It's a big deal.

Well, and David, anything to say on how the market prices in some of these developments or headlines or rumors? Because we know, I mean, you mentioned 2017 to 2018, sort of the last era of tax policy debate, we know the market had a huge surge throughout 2017, potentially pricing in the tax cuts that we saw towards the end of 2017, early 2018. And then, of course, the first part of 2018 was tough for the markets. So I don't know if there's any parallel to what we might see for the rest of this year. But if so, it'd be great to have you expand on that. Well, we have to say, though, to be totally intellectually honest about it, nothing we're talking about is new or unknown to the markets.

Whatever point a few days after November 3rd that markets knew Joe Biden was going to be president and whatever point markets knew that the Senate was going to be tight, we didn't know if it'd be a small Republican leader, a small Democrat leader, a tie game for a few weeks, and you had the Georgia thing and all that. But my point is, the political realities have been known now for four whole months. And as we talked about just 10 minutes ago, we're at all time highs. So the threat, but I believe markets in that reality are pricing in more than just tax policy. They're pricing in economic recovery. They're pricing in the relative attractiveness of renewed corporate profits growth in a world of 0% interest rates, but also they are not necessarily believing that that 28%

corporate tax rate is coming or that the higher capital gains rate is coming or what have you. So our economic advisor in the Bonson Group, Larry Kudlow, and I have talked about this several times recently, that there is a need to differentiate between what the market expects will end up happening realistically. It can't know all the details versus where the worst case scenario is. The market's very unlikely to price in a worst case scenario if the worst case scenario has a 15% probability. And if a kind of middle of the road scenario has an 80% probability, that's easier for markets to price in. Does that make sense? And so to me, when we talk about what's going to happen with capital gain rates, with individual tax rates, the market's not looking to those things that are really very unknown right now.

And the Biden administration has not even put out a plan on that. On the corporate tax side, when you have the 50th vote of the Democrats in the Senate saying he's not going to vote for 28%, and you get both of the senators, Warner and Kaine, in Virginia saying that they're not comfortable with 28%. And you get both of the senators, Warner and Kaine, in Virginia saying that they're not comfortable with 28%. And you get Sinema in Arizona and Tester in Montana. The markets don't believe 28% is going to happen. And I don't believe 28% is going to happen. So the market's been pricing in 25% and then a higher R&D deduction. So the realities of businesses are all different. But for a lot of businesses, going from 21 with a lower R&D deduction to 25 with a higher R&D deduction is going to be a tax cut.

Some, it'll be a tax increase. Some, it will not move the needle. But the markets have just an incredibly efficient way of pricing that stuff in, Scott. Yeah, well said. And certainly something you'll continue to write about in DC today and Dividend Cafe. Anything in particular, David, you're focusing on in today's note? Yeah, today's note is pretty robust as most of my Monday additions tend to be. I get a lot of writing done over the weekend and then I come into Monday morning and I just can't help myself with so much reading things from over the weekend. I like to translate as much as I can into the Monday DC Today. So there's a lot in public policy. There is a lot on the tax side and there's a heck of a lot on the COVID front to just really keep as much thorough and exhaustive information out there as possible. All right, David, we'll look forward to that in a couple hours.

And in the meantime, I think that's a good place to leave our conversation for today. But thank you for your insights as always. Well, thank you as always, Scott, for your work here. And if anyone has any questions, feel free to send them directly to us. We'll look forward to addressing those. And with that, Erica, I'll turn it over to you to dismiss our call. This concludes today's conference call. Thank you for attending. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, member FINRA and SIPC, with Hightower Advisors LLC, a registered investment advisor with the SEC. Securities are offered 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.

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