The Dividend Cafe - Market Outlook w/ David L. Bahnsen - Conference Call Replay - May 3, 2021

Episode Date: May 3, 2021

Latest market updates and news from David L. Bahnsen of The Bahnsen Group 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 as always, Erica, and thank you, Scott, and thank you all for joining us today. We're going to keep the call nice and tight today, probably aim for about 30 to 40 minutes at the most. But certainly as questions come up during the call, send them to questions at thebonsongroup.com. And we will, in all likelihood, be able to get to it here on the call. With that said, I'm going to turn it over to you, Scott. And let's dive in. We have one of our very typical biweekly Monday up market days today. Yeah, David, thank you very much. On the first trading session of May, coming off of a really great month for stocks, broader markets up about 5% for the month of April.

Just kind of curious where you think we stand right now in terms of the broader markets. How are you feeling about things right now? Well, I think it is interesting as we come into the month of May, and this is including today's market move. My screen is, of course, real time. And today, the Dow is up a lot more than the S&P and the Nasdaq is actually down today. But the S&P and the Dow, as I'm looking at my screen right now, the Dow is up 11.69% and the S&P is up 11.66%, a couple of basis points apart from being right on top of each other, with a very different path in terms of how they have gotten there. And so I think that's really kind of interesting. The NASDAQ is much less than that by about four or five percent less but at one point the NASDAQ was forwarding the negative territory

from and it's still negative from its mid-February highs. So we have a lot and I think this is healthy Scott. We have a lot of dispersion of results within the market. The market is not all acting monolithically. It is directionally, meaning everything's pretty much doing well. And if you look to real estate and you look to credit and you look to international, you look to the various major market indices in the US, all of them are doing well, but they're doing well without a lot of correlation. You know, small cap is up. Russell 2000 is up 15% on the year, and yet it hasn't had a positive return, you know, in more recent months. A lot of that was earlier in the year.

So there's been a different sequence of events and a bit of zigging and zagging. zigging and zagging. And yet what you would expect with this accommodative monetary environment and a lack of a lot of other sensible alternatives at the same time, and which is a very low return on safety investments and a lot of liquidity coming into the market, both from fiscal and monetary events. And then of course, the economic backdrop being all healthy as we continue through the COVID recovery. You end up with risk assets performing quite well. It's not a huge surprise to me. Well, and David, obviously we're in the middle of earnings season. Most of the S&P 500 companies have reported pretty strong earnings so far for first quarter. Although we are hearing on the conference calls, executives talking about rising input costs,

inflation, things of that nature. And this actually relates to something that a viewer wrote in wanting to know your thoughts about inflation, because we also had Warren Buffett over the weekend at the Berkshire Hathaway annual shareholder meeting, talk about inflation and warning investors about that. So how do you view inflation right now? What is your reaction to some of the commentary we've been seeing from corporate executives over the past couple of weeks? Well, one of the things I saw that question that came through and I want to clarify something. The question was framed in what I saw as where the nature of the disagreement may be that someone like myself might have with the comments from Buffett or the comments from a lot of these other companies that have

alluded to rising input costs. There's absolutely no disagreement. My writing and my really very expansive work on the inflation-deflation debate is entirely devoted to the secular story, a multi-year and I will venture to guess multi-decade story that deflationary pressures are trumping inflationary ones. I have the advantage of saying this without any predictive component about the last 10 years. We know that coming out of the financial crisis, wild inflationary phobias were presented that did not surface. We know, not forward-looking, but past-looking, that for 30 years, Japan has had disinflation and quite spiraling deflationary pressures through a significant portion of that time. My belief about the current environment in 2021 is very much in line with cyclical

reflationary realities. much in line with cyclical reflationary realities. Input prices got very low in the contraction of COVID, and those prices reflate. And Lord willing, people are invested in companies that have pricing power to pass the impact of those higher input prices on to consumers. impact of those higher input prices onto consumers. The question becomes whether things like that represent a secular inflation that has to do with the broad price level in the society. And if even those input prices do not merely reflate back to their base level at the low point of COVID, but represent inflation over past levels

of pricing. And this is something that's fascinating to me when I look at the just violent move higher in things like copper, is that copper is still not back to like 2014 prices. And so the reality is we're dealing with two things at once. And similar to the old adage about walking and chewing gum, we can do both. In fact, we usually do both and we are doing both right now. Cyclical reflation in a period of secular deflation is not at all contradictory. And it's most certainly what I happen to believe we're living through. But when I talk about cyclical inflation, I think it's a real issue. I think it can be problematic depending on the way someone's priced. But people have to

remember the bulk of conversation that economists, that investment strategists like myself have, when we talk about positioning an asset allocation around our theses of inflation, deflation, and whatnot, the key application, the key implication from that conversation is in interest rates, is in bond yields. And you could also, by the way, extract from that an implication into currency, foreign exchange rates. This is the element that I want to remind people of. If you have a consumer staple company that ends up paying a little bit higher for rubber or resin or timber or the different things that might be inputs in their overhead, inputs in their overhead, there's an impact there into operating margins. However, if the 10-year bond yield stays below 3%, I'm sorry, there's not secular inflation. And I've used this term

inflationista in the past. And I want to be clear, the inflationista is not the person who believes in cyclical inflation in 2021. Someone who believes in cyclical inflation could be just someone who goes to the store and sees that the price of their groceries is going higher. I'm referring to people who for 30, 40, 50 years, and it's really 40 and 50 years because a lot of this started out in the 1970s, that every single thing is believed to be inflation and that they've been fighting the inflation war since 1973. And it is my belief that that view is what is doing a lot of damage to people's macro allocations and constantly expecting interest rates to skyrocket higher would have really basically extracted almost all investment opportunity out of either the equity or debt side of one's

investment portfolio. And so I think that right now, the way I want to juxtapose this in a practical way for people is not only being open to the notion of inflationary recovery in 2021, but expecting it. And I'm using the classification of reflation because I think that's a more technically accurate state right now. But still believing that the macro trends that I've devoted so much writing and speaking time to this year and for some time, those macro trends that have to do with the spiraling effect of increased government spending, creating increased monetization of debt, downward pressure on rates that extracts growth from the economy,

ergo less velocity on money, less loan demand, which puts a very tight lid on inflation. I do believe it's an economic theory. Therefore, I'm subject to being wrong. But I don't believe that it's a theory only that that has been what's been playing out. I think that is a factual statement as to what has caused disinflationary pressures in the US since the financial crisis, and most certainly in a very profound way in Japan and now Europe for quite some time as well. So that's about the longest answer I've ever given to one of your questions, but it needed to cover a lot of areas. Well, no, it was a great answer. And David, I think what you're talking about will likely be seen next week when we get the consumer price index for April.

We're likely to see that short term kind of bounce in inflation largely because we'll be comparing it to now to April of last year, which was sort of the first full month of the lockdown, the March CPI report. You really only had half of a lockdown in March of 2020. Yeah, it depends on the sector. There was a precursor to the lockdown. You're right, as far as a civic lockdown and a population in place lockdown, that was only the second half of March. But I do think that the hospitality sector and to a lesser degree, food and beverage, we're already feeling it even earlier in the month of March. But April is going to be the most violent month of base effect, meaning year over year

comparisons are going to be most distorted in these categories to April than to March. I agree with you. but there were distortions in both. Candidly, there's year over year distortions for every month since COVID until we get the kind of last month of any shutdown. I mean, it's right now, May of 2021, and I'm getting pop-ups now about, oh, good news. We're going to let gyms go to 50% in New York, you know, stuff that you would think would have been months ago. And so there's on the margin, still going to be impact from some of that issue for another year. And David, shifting gears a bit, you know, another sort of theme of the COVID response over the past year has been spending, fiscal spending, monetary spending.

And somebody writes in wanting to know your thoughts about government spending. We've got more government spending proposed for the next year or so with that infrastructure bill. We know you've used the phrase, David, the chickens sooner or later will come home to roost. So what are some worst case scenarios in your view with all the spending that is planned and obviously all the spending that we've seen over the past year? Well, I want to be fair about this because all the spending that we're talking about here happens to be the proposed spending of the new administration. And this isn't just in a sort of token effort at non-partisanship, but this is just economically honest, the excessive government spending that represent chickens which may come home to roost, the expression I'm really fond of right now is the reminder of there's no free lunch, because I have a book coming out by that name later in the

year. So it all captures the same element that everything in economics is a trade-off, and there is no free lunch, that you may think there's going to be the spending aspect here, but what is the cost going to be? What's it going to mean? And how is that going to manifest itself? Which I think is what the question is about. You do have the $2 trillion of the COVID bill that was passed since the inauguration of the Biden administration. You had another trillion that was done in the lame duck. You had the $2 trillion of CARES Act. So there's $5 trillion there, all from COVID, all in the books, all done. It hasn't all been spent, but it's all been passed by Congress. But then you have the proposed spending, which includes the infrastructure bill and now the American Families Act, the two put together an additional $4 trillion.

And there's talk I'm reading today, different reports, that the administration doesn't believe they can get all of that done through budget reconciliation. Even just going through budget reconciliation requires 50 votes, so no margin for error. And there's, there's some challenge in getting that done politically. So they're talking about breaking some of those things up piecemeal where they can get more bipartisan support for certain aspects. The challenge there politically is you do one thing that might get some more Republican support, but then by separating it from something else, you might lose some progressive support. So the sausage making here is not done and not even close to being done. But the question remains, whether they end up spending $3 trillion of the $6 trillion

we're talking about or $5 trillion or whatever, it's going to be some big, huge number with a T in front of it, on top of a big, huge number with a T in front of it from last year, on top of year over year over year budget deficits that have been in excess of GDP growth. And this is the concept, economically, that I want people to understand. It's not political. Economically, like when former Vice President Dick Cheney famously said the words deficits don't matter. And when a lot of people in the supply side movement back in the 80s, late 70s, early 80s, as a means of spurring economic growth, promoted what we called supply side tax cuts, which added to the deficit, but then the trade-off was to be larger economic growth. The concept, which I believe played out quite well historically, was to add to the deficit,

but do so less than what your nominal GDP growth would be. And I personally like the idea of lower government debt and lower government deficits, because I like the idea of a lower size of government, in the sense that I like the idea of a growing private sector, where I think a lot of productive wealth building activities can happen. That's just the economist in me. And there's not even iota of partisanship in any of what I'm saying there. The challenge right now when people talk about the growing debt is a twofold challenge. It is growing debt that is growing at a rate in excess of economic growth. So if the debt growth was lower than the GDP growth, you technically can kind of make that go for a very long time.

Now, you compound the risk of a future recession and handcuff policymakers and things like that. interpreting how this story ends, A, without something so prophetic and arrogant that it discounts the fact that most people have gotten this wrong for many decades. So anytime someone predicts a sky is falling scenario, it's not very helpful unless they're willing to put a date on it or at least a year, or for some of these charlatans, maybe just a decade might be nice, and they get all that wrong. So I can't tell people, A, the sky is falling, if I'm not willing to say when and what that means. What I can say is that there are a number of potential scenarios by which this excess government spending can play out. One of them is the one I think is most likely, which is not by any means me saying it's assured.

And that is the term I've alluded to. I stole it from my friend John Maldon, and he probably stole it from someone else, but the term Japanification. And what I mean by that is a very, very bad thing. And it is true that in Japanification, we're not describing the world falling into the ocean. And we're not describing things falling out of the sky that hit us on the head. So some might say, oh, wow, you're predicting a softer landing to this, but I don't believe that's the case. I think years and years and years of subpar growth, of low, slow, no growth, is a very awful price to pay for the excess spending. However, the combination of monetary and fiscal inputs exacerbate the Japanification.

And I don't necessarily believe that we can merely monetize all the debt away, inflate the debt away as easy as some countries could because of the negative feedback loop that we have seen. Japan has tried very, very hard to inflate the debt away. Our Fed, working in tandem with Treasury, would love to inflate the debt away. If it was Republican leadership with Republican central bankers or Democrat leadership with Democrat central bankers, all of them would love to inflate the debt away. It's a better scenario for them and better politically than the deflationary pressures that central bankers have always felt going back to the Great Depression that they lack the policy tools to fully deal with. However, I am simply stating that I don't believe they can just wave a wand and create that. That's the epidemic

that I think we face is policy uncertainty. And then finally, to wrap a bow around another very long answer, Scott, the uncertainty here is that we're living in a period of profound monetary experimentation. I know what the Federal Reserve Act says. I know the legal relationship between Congress and the Fed. I know what the dual mandate says. And therefore, I think I have some idea of what the Fed can't do. And our Fed cannot do as much as the Bank of Japan has done. The Bank of Japan owns over 60% of all sovereign debt issued by Japan. They own, I believe, over 70% of the Japanese stock market. Our Fed can't buy stocks. Our Fed doesn't have anywhere near the total balance of US Treasury debt on its balance

sheet. I believe they're somewhere in the range of 5 trillion. And we have somewhere in the range of 25 trillion of debt, not counting entitlements and Fannie Freddie. So we're talking about 20% of our debt on the Fed balance sheet and Japan's 60%. That's a huge difference. But I can't make a big prediction as to how all this ends because I don't know that I'm not going to I didn't believe I was going to wake up what is today May 3rd so it was about 11 excuse me 13 months ago I woke up to the news that the Fed was buying high yield junk bonds I did not think I would ever live to see that day I don't know that I'm not going to wake up in six months or six years and hear that the Fed is printing a $1 trillion bill and they're depositing it at Treasury just to hold on to.

Effectively a backdoor, but probably technically legal way of monetizing a trillion dollars of debt. I don't throw that out there because I'm predicting it. I throw it out there because the experimentation is wild right now and I have to be humble and stay in discovery mode. So with that, are there investing implications that you're thinking about right now or is it sort of too early to kind of go in that area, more so focusing on what the economic implications are. Yeah, I've written, I think some of my favorite stuff I've ever written as an economic writer and investment writer, trying my best to serve my clients with my weekly writing and dividend cafe. Some of my favorite things I've written on this very subject, which is that I believe the most important takeaway is incorporating the humility that says one cannot go all in on a deflationary theme or inflationary theme, meaning levering

up a bet. Because first of all, any way to make money on a bet that's one way or the other would also imply a timeline. And that's totally impossible. But I think that the fundamentalist in me that wants to own growing dividend stocks has both deflationary and inflationary hedges embedded. I do not want to own a significant amount of what we call boring bonds, either because of deflationary pressures that mean they're not going to pay us a lot, or if there are inflationary pressures, there's a lot

of capital risk if rates were to go higher. So we want to hold lower duration and more reasonable exposure in treasuries, all things being equal. If the spreads were high enough, I would favor longer duration because I am more inclined towards a secular deflation thesis. But our clients are paying us to make them money, not just hold their money. So we really see no interest other than holding of funds. There's very little tail risk hedge benefit and very little coupon carry available in treasury bonds. So that's a huge investment takeaway that 10 years ago, 20 years ago, an identical investment objective and scenario may have called for double the weighting to high quality bonds that it would call for now. Yet then that money that is not going into high quality

bonds and an asset allocation has to be distributed to either credit, dividend equities, growth equities, which for us are emerging markets, small cap, or in alternative investments. So the takeaway is that we believe investors are going to need and want and do better with a much higher allocation alternatives going forward. Yet the core building block of a portfolio in reflationary times, inflationary times, disinflationary times, we still like dividend growth. Well, and David, on that note, while we're talking about what you're watching in the markets and in client portfolios, somebody wrote in wanting to know your thoughts and your outlook for structured credit, where you see risk, where you see opportunity. Now that we're a year after what I think you would agree with is the biggest dislocation in securitized assets that we saw since the financial crisis really took place about 14 months ago. that we saw since the financial crisis really took place about 14 months ago.

Yeah, it was something to behold. And it was the biggest since the 2008-2009 dislocation. A lot of the cure of the dislocation in 2009 came from TALF and TARP and other Fed interventions. And a little less of the cure came from that this time. You know, the Fed did not purchase syndicated loans. The Fed bought very little CMBS this time, commercial mortgage-backed securities. The only thing they bought were AAAs that were more agency oriented, where the dislocations were more in conduit CMBS and in other vehicles that were more agency oriented, where the dislocations were more in conduit CMBS and in other vehicles that were more fundamentally dislocated. The dislocation that was entirely technical, I think, was in non-agency RMBS,

residential mortgages that were not Fannie and Freddie. Initially, you could argue it was fundamental because there was uncertainty about what forbearance was going to mean and what the impact of housing and mortgage was going to be out of COVID. I think anyone can look at the housing price data and see that this was hardly a housing crisis like 2008 was. Most of the policy decisions, very low rates, very low supply, high regulation around getting new supply, and the income impact out of this COVID recession being so entirely focused on lower income tiers, it actually had the opposite effect. It bid a lot of housing prices up, not down, which theoretically makes the underlying debt that is secured by those assets worth more,

at least a lower credit risk. So because of credit risk transfers, for example, which are old Fannie Freddie debt that got moved to the private market, but they were underwritten originally by Fannie Freddie, and yet now the implicit guarantee of the government's not there. Those, to me, represent the same fundamental story they did pre-COVID. It's just that during COVID, there was a complete and total elimination of liquidity. There were only sellers and no buyers because it's a very niche and small marketplace that created a dislocation. That dislocation is gone. You had stuff that traded at $0.50's now at 95 cents. You had stuff that traded at 80 cents. It's now 103 cents.

Almost anything in the high quality side of securitized credit, if it's below par or below its February 2020 price, we think there's still value in it. But let's say COVID never happened and everything's just priced right where it was before. Then the same thesis is still quite attractive, which is 100, 200, 300, 400 basis point spreads over the safe rate, depending on what asset class you're talking about, for what we consider to be money good assets. Well, there's no free lunch. I just said that. That's the name of my book. I'm going to keep saying that. I never have touted my own books in the past. I'm going to say there's no free lunch more. The fact of the matter is that basis point spread pays us, but it pays us for something. It pays us for a little more

volatility. It pays us for some illiquidity. It pays us for some degree of credit risk that's higher than some of the alternatives. All I'm saying about those risks is that they are compensated risks. And so when I look to the yield to maturities in the structured credit marketplace, I find a lot of good investable opportunity. But it's not free. There's risk to it. It's just risk we're willing to take given the right client scenario. It's not an apples to apples trade for a treasury. Um, it's just that in the grand scheme of things from, from the equity side of our portfolio to the boring bond side, credit can fit in there as well, where there's a greater return, but different risk profile. All right, David, as we move to the end of our discussion here,

give us a quick preview of what's coming up in DC today, which is your daily market missive that's released to clients and really anybody at usually about 6pm Eastern. Yeah, it's a pretty full one today. There's a number of COVID things, a little bit of economic data, not a lot of meat on the bone to report in public policy, but just some of the kind of chatter and potential things that we're hearing. I alluded to already about the way the Biden administration may try to pivot on the infrastructure bill and their hope to get some more bipartisan of an outcome. more bipartisan of an outcome. So there also is something I would really hope would get you to read it on central bank, the Fed. It happens to be a central banker at the European Central Bank, not the Fed, who makes a comment that I kind of provide some commentary on in the DC Today, Today Monday, that I think is very useful at understanding both the downside and the thought process of present monetary policy. And so I'll leave you in suspense on that. And really,

I can't imagine anything more enticing than people waiting on just the tip of their, at the edge of their seat, rather, because of me teasing a comment on a comment from a central banker. That's got to be one of the most just sexy things I've ever said here on the national call. And David, that's why we end with that. I'm going to go back to work, guys. Thanks so much. And Scott, as always, thank you. Erica, we'll turn it over to you to close this out.

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