The Dividend Cafe - Market Outlook w/ David L. Bahnsen - Conference Call Replay - August 16, 2021

Episode Date: August 16, 2021

Join David L. Bahnsen, CIO and Managing Partner of The Bahnsen Group and Scott Gamm of Strategy Voice and Associates with answers the important questions from investors. Links mentioned in this episode: 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. Thanks so much, Erica, and thank you, Scott, for once again joining us. And I am sitting here. I'm actually not in the studio in our new New York office. They're still installing some equipment and things. And so I'm set up doing this by Zoom inside of our brand new conference room. And it's my very first time sitting in this conference room. And so who would have guessed that my first meeting in the new New York conference room would be with hundreds of people all over the country. And of course, Scott, I imagine you're not too far from me right now yourself, but let's

jump into it and try to go around the horn today. A lot of thoughtful questions have come in ahead of time. I'll, we'll, Erica will be sending you some more as they come in throughout questions at thebonsongroup.com. For those of you who want to send a question in real time, we'll try to get to it before we wrap. Scott, tell me what I'm in for today. Well, David, thank you. It's always great to be with you. And that's right.

We have a lot of questions that came in on a lot of different topics. So we'll try to get to everything over the next 40 minutes. And David, I think it's obviously worth starting with the broader markets, which were down somewhat considerably this morning. But obviously now, as we move towards the close of the session, the markets have recouped a good portion of their losses. But obviously, we had big gains in the market last week. What are your thoughts on some of the geopolitical headlines and, and sort of crises we saw over the weekend with Afghanistan and how relevant that is for markets. And do you think that's what markets are reacting to today?

Yeah, let me, let me answer as comprehensively as I can about the Afghanistan matter. But first just sort of throw out a little preface on the market. I think you're right. As we're sitting here talking, the NASDAQ is only down 67 points, which is about half of a percentage point. And it had been down a full percentage point, about 130 points. The Dow was actually up by just a decimal point or, you know, down one or two points right now. And the Dow had been down about a couple hundred.

Um, but it, this is a pretty good time to remind everybody, um, that down 200 in the Dow at a 35,000 Dow would be like if the Dow had been down 60 points back when we had a 10, 11, 12,000 Dow, you know, for a long time, that wouldn't, that didn't get much attention back then. And, and, you know, anyone's capable of doing the math here themselves, but, um, at a 25 to 30,000 Dow, which we spent, um, the bulk of the Trump administration in those numbers, then it would be like a hundred and something point down day. So even when the Dow was down earlier today, it was really quite insignificant from a percentage standpoint. And I think that when you take it against the day before's movement, the day before

that, you start looking at two, three days. There's been a number of days where we've had some 200 or 300 point drawdowns, and yet we weren't even lower than we had been three or four days prior. I've commented on a number of client meetings, in a number of client meetings that I've had in the last couple of weeks, where we have been deploying cash at moments of maximum drawdown intensity, those days where the market has had some of its worst days on the year. I commented a number of times that A, we've just plain not had very many of those. And B, it really has been uncanny how many of those days were followed by all of those losses being recouped. And the right word for us to use is drawdown.

But I think people are used to hearing the word loss. I, of course, don't call it a loss because the market going up and down doesn't lose anybody anything unless they're dumb enough to be selling while it's happening. But a drawdown is sort of an awkward word, but that's just the word we use in the business. But yeah, I think you've had five days where the market was down over four or 500 points. And four of those days, it recouped it the next day. And in all of them, it recouped it within two days, three days. This has just been a really remarkably unvolatile year. And it's more remarkable, even beyond the history of volatility

that we're not up to the average line with this year. It's even more volatile based on the expectation, based on the feeling or the perception, the headlines, COVID, geopolitical, just national mood. I think people expect that things are going worse than the empirical reality would suggest. Your other question, though, is a real important one. It's about Afghanistan. And I am going to be addressing this at the DCToday.com at the end of the day.

I don't think that what's happening there right now immediately, which is dramatic, and it is really, really profoundly important, is market sensitive at all, short term, term, and market oriented. Okay. Longer term, I think it is. And then once you get past the market categorization and look into geopolitical or even domestically political, obviously, this is just a nightmare, an unspeakable nightmare for the Biden administration, optically and so forth. And we'll see how they go about navigating it. My understanding as the president, we'll be addressing the nation here in a couple of hours. And so we'll see what comes of that. But the reason I say not a market story, besides the fact the S&P is flat and the Dow is up 10 points right now, is that I think it is very localized in terms of

its ability to transcend into earnings effects. I don't see this having a spillover effect. Where it becomes more market sensitive is if it were to affect the risk premium on the oil side. But this is Afghanistan we're talking about, which is a poppy economy, not a petroleum economy. And so if this same exact thing were happening, where radicalists and jihadists were taking over a country that had a lever on world oil supply, which is the bulk of Middle Eastern countries. It just happens to not be Afghanistan. I think that's a bigger issue. I think that even the fact that it's happening in a neighbor to a neighbor country in the Middle East is still a pretty dramatic reinforcement of the need for the U.S. to take control over its own energy independence. And to the extent that that were to become more reaffirmed or whatnot, it could be

a positive story if it were to kind of light a fire under folks about the notion of U.S. independence. But what I believe is the sort of soft impact, more indirect, longer term, is just in the general sense of any apathy that is introduced into the American politic around external threats. That I believe you cannot have market prices discount unknowns about future terrorist attacks, let's say. And so that's why this can't be perceived as a short-term market event. And yet longer term, do I believe that markets are enhanced when the world is safer and that markets are threatened, the risk premium is elevated when the world is less safe? Of course, I believe that.

And I would debate that with anybody who wants to, because I love winning a debate. But listen, this is not something that we could try to price into a day-to-day investment activity. And markets clearly agree. But that is not another way of saying this isn't a significant event. It's a very significant event. And a lot of people have a lot of different opinions about what has happened in Afghanistan, what should happen going forward.

I'm just simply speaking to the base reality right now that on a go forward, it appears that there is a group that is anti-democratic and anti-capitalist and anti-West, anti-America, anti-Israel, that is effectively right now retaking control of the country of Afghanistan. And David, one quick follow-up question when it comes to the oil markets, and I don't want to make too big of a deal about, you know, intraday, one-day moves, but traditionally, when we have geopolitical tensions, oil prices would tend to spike. And we're seeing the opposite today, even with Brent, which is down today. Any thoughts on that dynamic? And if that's something that you expect would continue that

relationship, presuming we see more geopolitical tensions out of the region over the coming months? It's just a really important reinforcement of what I just said about this being Afghanistan and not Iraq, not Saudi Arabia, not Kuwait, not an oil exporter. You're right. The sand touches the sand of some of these countries, but this is not at this point into the Straits. And I've been reading about this very early this morning before my run. I do believe it could get to a point where canals, straits, other peripheral activities become involved. But it's not there yet. And it's not close to being.

That really actually would take longer. But then when you talk about the inverse, oil has a funny volatility to it. If markets went up or down 1.5% a day, that would be quite volatile if equity markets. Oil prices that have traded between 65 and 75 for about six weeks now, as I'm looking at my screen, WTI is down exactly $1. Brent is down less than $1. Brent is down less than $1. That's not particularly noteworthy volatility. I think probably seven of the last 12 days have had the same or more, and we weren't facing a Taliban related event. So I don't think the oil activity is related to Afghanistan, but I do agree that it reinforces the reality that there are geopolitical events in the region.

And the region, OPEC, not OPEC+, but OPEC, meaning ex-Russia, have a significantly higher percentage of global oil market share than they did now a couple years ago, based on the COVID-driven and current policy- driven diminishment of the US oil industry. So there is relevance there that I don't want to discount, but I'm not surprised you're not seeing it in the daily market movement right now. Okay. And David, let's move on to some other topics. So somebody writes in wanting to know your thoughts on how dividends would be effective or would be affected in the event of higher corporate tax rates. Higher corporate tax rates. So there's kind of two different questions there. There's corporate tax rates. And then I presume people would be curious what higher dividend tax rates would do to dividends as well. People would be curious what higher dividend tax rates would do to dividends as well. But interestingly, that actually is one in the same in the sense that the dividends are paid from after-tax earnings.

And so the reality is that a higher corporate rate affects earnings and therefore affects dividends. So if a company makes $100 after taxes and now their taxes go up, so they make $95, but they were paying a dollar of that hundred before in a dividend, and now they're paying a dollar of 95 cents, their yield effectively, their portion of after-tax profitability going towards the dividend actually went higher, even though the investor isn't receiving any additional dollars. But I do think it's worth noting that when the corporate tax rate went down, there was a higher amount of capital that went out in dividends, but not above trend line. Dividends were already growing anyways, in line with corporate profitability. You had debt reduced. You had a bit of pickup in M&A.

You had acceleration of stock buybacks. And then you had some companies that were not traditional dividend payers pay out a bit more. And then there were higher wages. There's just no question about that. That's not a political comment. It's a pretty mathematical one. So the use of cash that came from additional kept earnings was really quite diversified. Dividends were one of them. But I guess my answer would be that I think any degree of higher taxation affects dividends,

but I don't think it affects dividends any differently than anything else, meaning it also affects stock prices. It also affects stock buybacks. Just on the basic non-controversial sense that there are now less earnings. There is less money that would be kept. There was $100 before and there's $95 now. So it is not a dividend sensitivity per se, but it is an earning sensitivity. per se, but it is an earning sensitivity. Now, that gets to the question of what I believe is going to happen regarding that very corporate tax increase. You will recall, we spent most of the year being told that a corporate tax increase was going to be part of the infrastructure bill. And now, as it turned out, the Senate passed infrastructure bill doesn't touch corporate taxes.

Now there is a new, much larger spending bill that is being batted around and will begin debate in the couple months ahead. A budget resolution had to be passed to open up a reconciliation window. But we don't have a bill yet, but we know from the White House and their agreement they've made with some progressive Democrat senators that that's their intention is to ask for a 25% corporate tax rate in the new bill. And the new bill's fate is very much up in the air for a lot of reasons. They had originally said 28. Now they're saying 25. So there is a much smaller impact. But then an amendment was passed in the middle of the night last week that would

extend full expensing of R&D deduction, where it was scheduled, totally apart from either of these Biden-era bills, from the initial Trump tax cut, R&D expensing was scheduled to go to a five year amortization starting in 2022. And what they're proposing is to give full expensing on it. I've been arguing this way for quite some time. You're kind of getting a higher corporate tax rate and not higher corporate taxes because of the trade-off. Now, that's not linearly true. It's not equally applicably true across all companies. But my point being that we really are not looking even at the worst case of what's on the policy table at much of a impact in corporate taxation as has now been kind of congressionally and legislatively altered. And David, we also have several questions about bonds. So I want to get to those. First, someone writes in wanting to know your view on municipal bonds, particularly in a state like New York. Yeah, so there are kind

of just as we talked about in dividendcafe.com on Friday, very extensively, it's the most I've ever written about bonds for a lot of reasons. We view the bond asset class as something that requires people to separate the bonds that trade as principal protected, high capital preservation, low volatility, and sad to say, very low interest payment, whose primary source of upside is in left tail risk hedging circumstances, and primary case of risk is simply duration risk, should there be a dramatic move up in interest rates that would affect these bonds that we call boring bonds, separating those from credit, bonds that we call boring bonds, separating those from credit, where there is an underlying credit fundamental that will move the price up or down. And because of that economic and credit sensitivity, you have a higher risk level that therefore earns you a higher coupon,

a higher yield to the investor. And we view those two things as really quite distinct asset classes. investor. And we view those two things as really quite distinct asset classes. They share with the word bond the fact that there's a maturity date on both. But other than that, we believe there's very little in common. So to your question on municipal bonds, the only distinction, we believe municipal bonds also have boring bonds, which by the way, is the bulk of the municipal bond world, and then credit, ones that are more credit fundamental sensitive. Where the taxable bond world has a massive world of high yield corporate debt, of structured credit, of mortgage oriented bonds, of levered bank loans. There's a lot in the universe of what we call credit in the taxable bond space. In the tax-free bond space, there's much less in credit and it's much more inefficient. But there are junkier credits in the municipal space. People

remember the tobacco bonds, Puerto Rico bonds. There are unrated bonds that don't have any credit rating that follows that might have a little more yield attached to them. But as far as the boring bond universe, your A-level credits, AA, AAA, the municipal bond world just has an incredibly low default rate. We like it. And in New York, the tax sensitivity, the tax impact by getting a state tax freeness out of New York issued bonds, it offers more benefit to New York taxpaying residents. New York taxpaying residents. California, of course, is in a similar position. But the question simply becomes, is the after-tax equivalent, the after-tax yield equivalent for mini bonds attractive relative to other counterparts in the boring bond world? So I'm making up a number here, but if someone is going to pay 50% in taxes and they can get 3% from a boring bond that's taxable, or they can get 2% from a muni, then you have to kind of compare what that would look like after the tax impact, right?

Well, of course, all yields, muni, tax tax free and taxable, all yields have come way down. And so are the spreads that are available from boring munis still relatively attractive versus treasuries and high grade corporates? The answer is yes, a little bit, but not as much as they were. There was a higher spread in the muni space a year ago, nine months ago, et cetera. Munis, though, do tend to be much more inefficient than treasuries and then heavily liquid, high-grade corporate bonds. Pretty much the only people in the world who own muni bonds are high net worth, high income individual investors in the United States that aren't international buyers generally of city of Chicago bonds.

There aren't foundations or endowments or 401k plans, pension funds, IRA accounts, generally are not buying tax-free bonds for obvious reasons. So you have a smaller marketplace, largely mutual fund driven, and that can create opportunities and inefficiency with municipals. But at the end of the day, if one has an after-tax yield of 1% from a treasury and after-tax yield of 1% in a New York AAA muni, we view them basically the same, but we have to do our analysis, not on the coupon, not on the yield to maturity, but on the after-tax relevance. And the after-tax is going to vary client by client. And David, just speaking about the broader bond market, because this is an important element as well. Some of our past calls, we've talked a lot about the 10-year treasury yield, which has made

somewhat of a slight rebound over the past couple of weeks since our last call, now at about 1.25%. Any thoughts on that and kind of where you see yields going for the rest of the year? Yeah, I think the 10-year this morning had gotten back to 1.45%. I mean, I'm sorry, 1.25%, right? From 1.33% last week, had been as low as 1.12%. So you have this range. I talk about this in DC Today today. I think that 100 to 150 strikes me as just logical because it most certainly reflects the sad reality of low growth expectations. It reflects the reality it's been reflecting of low inflation expectations.

And yet it doesn't reflect recessionary conditions. negotiations um and and but when i think you said we were uh two weeks ago maybe we were um 10 basis points lower um you know you you the yield curve is still steeper than it was a year ago by by by a fair amount by about 30 basis points i believe but again that low end is the easy part it's at zero. So more or less the steepness of the curve, even though the two year or something could move, it really comes down to the longer end. And if the longer end, like a 10 years coming down, then that yield curve is flattening. And that really reflects growth concerns and fear of a policy mistake and all that kind of stuff, where if we

can get that tenure a bit higher, it provides a little bit of steepness in the yield curve. Those that depend on such insurance companies, banks, they benefit there. But more important than the effect it creates is what it signifies. And what it would signify is basically that we're not facing recession. We expect some growth, but we expect low growth. And David, let's also talk about the debt ceiling. Somebody writes in wanting to know what you think about it and the debate in Congress about whether or not to raise it once again. Well, my own personal opinion is the whole thing is a joke. I'm a fiscal conservative and a bit of a hawk on controlling the size of government, but all that notwithstanding,

on controlling the size of government, but all that notwithstanding, whether we were going to spend $5 trillion in a year or $2 trillion in a year, no matter what one's personal opinion is on what the size of government ought to be, the notion that we have a congressionally mandated limit on debt that we just always break, and it's always there just to vote right through it. I can't stand tokenism and why we keep this thing lingering that nobody cares about and no one takes seriously. I don't think there's any threat to the market that we're going to get up against our debt ceiling because anytime we do, they vote to extend it. It may take one day or one week, or there may be five headlines in the New York Times about it, or there may be two headlines. But no matter what, they're going to obviously just vote to extend. And so what is the point of continuing to have

this man-made artificial policy constraint? No one cares about it. So I don't think they ought to have this debt ceiling issue. But to the extent of they're going to have one, I just think they should have it and follow it. But they're not going to. So the elimination of the tokenism would be my preference. And then, of course, if anyone ever asks, I would love to

right size the government and see something that was in our overall expenditures that I thought was more appropriate of the needs of the country and optimal for economic growth in the private sector. But no one's asked me that either. So in the end of the day, do I expect there's going to be real big market scare around this little charade going on right now about the debt ceiling? I do not. But that doesn't mean the media won't talk about it. It's just I think that the media has done this every time since 2011.

And 2011, they got away with it because they didn't know what they were talking about. The markets dropped substantially in the summer of 2011 because it looked as if Europe was falling into the Atlantic Ocean. And there was entirely existential fear going on around the Greek debt and how the European Union, this is well before Mario Draghi's famous whatever it takes, you know, sort of bazooka policy intention, there was incredible uncertainty about European sovereign debt in summer of 2011 and what US bank exposure, US banks that were not even close to healed from our own financial crisis of 2008, 2009. And there was a lot of questioning in the summer of 2011 as to what was going to happen with all of these things that were totally systemic.

And at that same time, Congress and the Democrats and Republicans were fighting on debt then. Moody's came in and downgraded U.S. debt rating from AAA to AA+. And then we got to listen for a week or two saying, oh, look at this market volatility around the debt downgrade. The whole thing was insane. And I remember it was yesterday, which by the way, it was literally 10 years ago from just this summer. It was summer 2011. Ever since then, Scott, we've had five or six times up against these debt ceilings, and the markets have just completely yawned about it, shrugged it off every time.

But every time, I think the media has tried to make hay around it. This one is particularly ridiculous, because right now, in one second, the Democrats can extend the debt ceiling without one Republican vote. It's just that they have every right to do this, but they have a political reason why they're going to try to do it a different way. And then either the Republicans or Democrats will blink, but they obviously can extend it because they have the votes to do it. So you're not dealing with conflict with different party control. Okay. So I believe not dealing with conflict with different party control.

Okay. So I believe that not only will the debt ceiling be extended, not only is this whole thing a kind of embarrassing byproduct on the way our country does business, but I also believe that even in short-term market volatility, I expect it to be minimal. And yet, as I say that, I cannot promise that the media will cover it that way. And David, when you bring up 10 years ago, August 5th, 2011 is when the US credit rating was downgraded by S&P. Yes. My wife and I were very close to celebrating our 10-year wedding anniversary. We were going to be going out of town for an entire week, which is something we never, ever, ever do. And I had said, for the

first time in 10 years of marriage, I'm going to unplug for the week. And so even though we were going before anniversary, we were going to celebrate our 10-year anniversary by a few weeks out of the country. And because of that market volatility, Europe situation, and as you said, the debt downgrade happened, but the S&P dropped 19.8% from peak to trough. It did begin recovering shortly later, and by the end of the year, ended up positive. But that particular batch of volatility forced my wife to lovingly suggest that I not go a week without working. And in fact, I did not. David, I feel like that's happened before. When you go on the few vacations that you go on, there's market events that interrupt things.

Markets never sleep. And since my wife is here in the New York office today working, I fear she will hear this and come in and comment herself because she certainly agrees with you that it does sort of seem like this has happened more than once. All right, David, give us a preview on what's coming up today in DC today. You talked about it before, but what can we expect in a few hours from that? I'm going to cover a bit on the updates around this Afghanistan stuff. I definitely want to unpack further just kind of the particular things around bond yields.

There is a bit of COVID update, housing. It's one of those DC days where I don't go super deep in any one category, but I cover all of the categories. It does seem to me lately, the DC Today has been one or the other, where there's either been a very long public policy section and maybe less or none in some of the other categories, or then there are days where literally every category, which is housing, Fed, public policy, economic data, COVID, and markets, where every category gets a little bit of love. Those are actually the days I prefer, but when you have like last week, the major legislative things going on and so forth, it tends to overweight one category over another. I actually believe it's a reasonably boring time in markets. We are done with the

second quarter earning season results, basically 96% or something. And now we won't have another earning season. The third quarter itself is what we're actually living through now, not reporting on. And so we'll have the second half of the third quarter, which just started today, play out for the remaining six weeks or so. And then you won't get another earning season into October. There is a pessimist in me. There actually is barely ever a pessimist in me. I don't like pessimism and I certainly don't like pessimists. But there is a part of me that is wondering if this will be one of these quarters where the markets are tired of underestimating earnings growth. So they finally catch up and then fully price in expectations of earnings growth and forward

guidance around such, and then end up getting a bit disappointed because so far it's really been several quarters of a pretty profound underestimating of earnings creation. But we'll see. I do recall feeling that way in many, many quarters post-financial crisis that we were continuing to outperform earnings expectations. And oh, isn't this point coming at which we hit peak margins where market analysts finally get ahead of it, not behind it? And it really just didn't come. There was just sort of this continued outperformance from the corporate profit side of things.

So I don't know what to expect there. It isn't totally material to the way we would allocate a client portfolio anyways. But those things linger out there. And it may not be the thing that you're going to hear in the news cycle today, and not from the Biden administration and their press conference here in a couple hours. But obviously, there are questions around this $3.5 trillion bill. And there's questions about the infrastructure bill. And one of the things that I will allude to in DC Today is I've written maybe seven or eight times about the tension of some of the progressives in the House Democrats saying, we will not vote for the bipartisan infrastructure bill until the Senate

has passed the $3.5 trillion spending bill. And I've mostly taken the view that I think is pretty politically sensible, that they won't go through with that, that they just simply cannot deny the Biden administration, this legislative victory, and that when some of the real far progressives in the Senate voted for the infrastructure bill, it doesn't give them much cover to not vote for it. However, it kind of inversed now this weekend with seven or eight House moderates saying the opposite, saying they may not agree to vote on the $3.5 trillion bill unless the infrastructure bill has already been passed. And so what's interesting is that both sides have the

leverage, just simply because the margin is so thin. It isn't like one can out-muscle the other. Speaker Pelosi needs both to hold her caucus together. And of course, it's possible both are bluffing and it's possible that they do end up getting a compromise. But there's some trickery there that's going to be difficult to navigate. And the House is out of session right now. They don't come back until next Monday, the 23rd. So this is going to kind of dangle out there for a little bit. It's very hard to handicap right now, Scott, how it plays out. The thing that I think is the most likely is not assured. But I do think the most likely is that a bill gets done and that that bill

is just nowhere near as onerous as many had feared. But what that means, you know, does a three and a half trillion come down to two trillion, come down to one trillion? And what's the point at which it becomes palatable enough for moderates, but then in that palatability to moderates, it becomes impalatable or unpalatable to more progressives. That's a real political tension. And I just simply don't know how it's going to be resolved. But I have good advisors that I talked to on this stuff very heavily. I have good sources on Capitol Hill. And so it's going to be covered extensively in the D.C. today for the next couple of months.

Yeah, a lot to unpack there, David. And I think for now, it's a good place to leave our conversation for today. Markets are flat, S&P exactly flat, Dow up slightly. And we look forward to another call, David, in a couple of weeks. Well, I look forward to it as well. I believe, let's see, two weeks from today will be August the 30th, the week before Labor Day. So we'll kind of consider our next call, the last call of summer. And in the meantime, for those who have been listening here, either live or to the replay, you're more than welcome to send additional questions. And I always make every effort at the end of my day

to write back to people who have sent in questions, clients first and non-clients second. And with that said, Scott, appreciate your thoughtful questions here today. And why don't we turn it back over to Erica to dismiss us. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, member FINRA and SIPC, Thank you. This is not an offer to buy or sell securities. No investment process is free of risk. There is no guarantee that the investment process or investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.

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