The Dividend Cafe - Market Outlook w/ David L. Bahnsen - Conference Call Replay - November 1, 2021

Episode Date: November 1, 2021

Today's call focuses on the latest in financial markets and the reconciliation bill. 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. Well, thank you as always, Erica, and thank you to our production team and everyone who helped make this possible. And of course, thank you, Scott, for joining us. I know that we've had a handful of questions that have come in that you are in possession of, and there's certainly plenty happening in the world right now. This is actually quite an interesting week where we have the Fed, we have the political

environment, we have the G20, and we have have earnings season and even some various elections in different parts of the country all happening at once. So I'm going to turn it over to you, Scott. thebonsongroup.com, then the team back office will get the questions and forward them on to Scott so that we can hopefully cover your questions live here on our discussion. But with that said, Scott, the microphone is yours. Well, thank you, David. Great to be with you as always, and an interesting week for sure, an interesting day as well with the Dow hitting 36,000 for the first time ever, albeit for a few seconds, coming just about a year after we hit 30,000, which was November of last year. David, what do you think is driving the action we've been seeing over the past couple of weeks, the rebound in the market from some of the declines we saw in September?

Is it earnings, just broader optimism about next year? What's your reaction so far? Yeah, in terms of the specific things moving markets, it continues to be a combination of things with a couple being more significant than others. And I think that the continued positivity out of earnings results combined with the liquidity environment that is always so helpful to boosting valuations in risk assets. And then that continued theme of TINA, there's no alternative. I think you put all those things together and you can kind of Mr. Potato Head your way into forming a bullish portfolio of conclusions. All three would end up being on the final potato. But where you put different ones might be subjective to different people's perception. It's hard for me to believe

that there's much more that drives equity prices higher than those three things. So those three things are pretty all-encompassing. You have a significantly improved earnings environment that has outperformed expectations and has continued to do so quarter by quarter for quite some time. This goes back, by the way, Scott, to even when they were bad quarters. In Q2 and Q3 of 2020, when half of the world was shut down, things were bad, and yet they were not as bad as it's sort of gotten priced in. So you had kind of outperformance even in a negative environment, and then you've had even better than expected performance in a positive environment. And I refer to specifically the corporate earnings. So that earnings dynamic is, to me and my Mr. Potato Head, the biggest driver of equity

prices this year. But then the second factor being the continued backdrop of Fed support. And the Fed support, we'll talk more about in a bit. So I'll hold my thoughts there. And then the third component being the TINA is, what are the other alternatives? Where are people going to go? Well, there's a few other places they are going. When you do not have liquidity constraints, which most investors do, but when people have a portion of their balance sheet that they do not need to access, when there's more of an institutional mandate that has a longer duration of the assets, private equity has been smoking hot and private real estate investing has been quite dynamic. And so those are exceptions, but they require an illiquidity tolerance that not everyone has.

When you look into what has been a negative environment with a strong US dollar for a lot of international investing, where there's a lot of questions, and also just a lot of jaded investors around Japan and Europe, and then certainly the bond market, many people just don't feel that there's enough opportunity to let their whistle with investment grade corporate bonds or what have you. So US public equities have continued to dominate there. Those three things put together represent the explanation for strong US equity performance. Well, and David, you mentioned the Fed. We have the meeting statement and press conference on Wednesday. Do you expect a tapering announcement? And how do you think markets might react? And also,

we haven't really talked about your thoughts on Powell's renomination, but any thoughts there would be great. Yeah, so let's start with just kind of what I think will happen this week. I do believe, certainly, that there's some taper announcement coming. The question is, is the taper announcement going to say that they're starting to slow down in December or in January? I don't think it really matters much. And is the taper announcement going to say that they will be done tapering? In other words, they'll be done with bond buying

by June of next year, by December of next year. Will they not say yet? Will they just sort of say they're going to slowly taper and figure it out later? I suspect they'll say June, but it's possible they'll go even more dovish than that. Look, Canada last week announced an end to QE with no tapering. They didn't say like, we're going to slow down our bond purchases. They just said, we're going to stop the bond purchases. But what people have got to understand, Scott, is that whether you're talking about Canada or other countries or any possibility of what the US will do, none of it includes the possibility of reducing the balance sheet.

This $4 trillion balance sheet pre-COVID that they've gotten up now to $8 trillion, just to use some round figures, both in the before and after, nobody's talking about them reducing that $8 trillion. They're only talking about tapering the speed at which they add to the $8 trillion, and then at some point, stop adding to whatever that number ends up being. But as far as quantitative tightening, whereas bonds mature, they don't reinvest the proceeds. Nobody's talking about that happening anytime soon. So I still think you're in a remarkably dovish environment considering the strength of the economy, the strength of earnings, the strength of corporate America, access to capital, cost of capital, risk asset pricing. It's dovish in

every sense of the word. And I expect the Fed will try to peel that back just incredibly slowly starting this week. Your second question, forgive me, I'm forgetting. On Powell's renomination. Yeah, yeah, yeah. Powell's renomination is a weird story because we've never really had a situation where the president has waited this long to speak to it. And my own feeling, and forgive me if anyone takes this as me projecting, but I'm just sort of projecting what I suspect is going on without empirical fact. And I'm not projecting it with criticism or with commendation.

and I'm not projecting it with criticism or with commendation. But I have the feeling that the administration has put out people to speak positively, including their own Treasury Secretary Janet Yellen, and people to speak negatively, and kind of blessed both things to sort of take the temperature in the public square and take the temperature from other progressives in the House and the Senate. The Senate side, these votes will ultimately be necessary for reconfirmation. I think the money is still on that he will reappoint him. It's a very peculiar situation because I've made this comment before, but if people believe that now a Democrat president wants to replace a Fed chair who's a Republican who had been appointed by a Republican president, that's not exactly, it doesn't really line up in that narrative. In the sense that, you know, Jay Powell had been a Fed governor for way before, excuse me, President Trump appointed him to be the chair. And fact came in during the Obama administration. And even though he was appointed by President Trump, I don't know anyone on earth who is more

critical of him and harder on him and candidly, really perversely unfair to him than President Trump. So it isn't like this is a situation where President Biden might be trying to purge the field of those that are kind of leftovers from the Trump administration. Nobody in their right mind associates Jay Powell with being a kind of residue of the Trump administration. Now, he could be good at certain things. He could be bad at things. Look, from my mind, there's plenty of both that I would offer, but it's not political. My criticism of the Fed or commendations of the Fed are actually in the lane that they're supposed to function in, which is theoretically a political one. In practice, it probably is more so political. I don't get the politics of what's going on here.

I'm not sure. I do suspect there are politics going on, though. I just am not clear what they are. We know that there are progressives that are very opposed to Jay Powell, not believing him to have been adequately tough enough on bank regulation. I don't think there's a lot of merit to that accusation, but that opinion's out there. But as far as markets go, Scott, who's he going to replace him with? Let's say it's Lael Brainard. You can come up with any other name you want. There's no name on the shortlist to replace him who's going to be more hawkish than him.

They're either going to be him or even more dovish. So markets aren't going to care one way or the other, in my opinion. Nobody believes we're getting someone to come in and start tightening monetary policy. But is there a political reason for him delaying the reappointment? I suspect there probably is, but I don't know what it is. Well, David, on that note, people are writing and wanting to know your thoughts on most definitely of the opinion that they are linked. I don't think they'll end up getting voted on at the same time, but if they ultimately are going to pass or ultimately going to fail, I think both will pass or both will fail. But at this point, it doesn't really matter. On the reconciliation bill, whatever passes, if it does, is an incredibly hollowed out version of where

they started. And some on the progressive side might even argue, you know, kind of token cosmetic. Now, look, if they were going to have a three and a half trillion dollar bill, and it comes down to 1.7, I don't want to ever refer to $1.7 trillion as token or symbolic. It's still a large bill, and some might say still way, way too large. But my point being from where they started and where the pay-fors started, there's no scenario now where those things are still on the table. Senator Manchin's holding a press conference this afternoon. It could actually start even while we're talking. I'm seeing pop-ups right now of them setting the stage for him to come out

and clarify where he is on the reconciliation process and his feelings on the framework. I will be very surprised if he comes out to kind of say, to shock everyone and say, nope, everyone thinks I'm on board, but I'm actually not. I think at this point, he's pretty close to being on board and maybe has a few little specific points he wants to get buttoned up. Manchin and Sinema, Senators Joe Manchin, West Virginia, and Kristen Sinema of Arizona have mostly gotten a lot of things they've asked for altered out of the framework. But we don't have specifics of the framework yet. We don't know what particular taxes are still left. And so there's still a lot more information to get there. So here's the two things we know, and I'll shut up about this. One, if they vote

on the infrastructure bill and the progressives vote, yes, this week, let's say, could go into next week. They've only done so under an incredible amount of back-channel work that indicates they're going to get that final reconciliation bill. So those progressives that said we will not vote on infrastructure until we have a vote on reconciliation, there seems to have been a softening on that stance from people like Senator Bernie Sanders and Congresswoman AOC. However, what exactly is in that final framework? I'm still not totally clear. We are told that the paid family leave is out. We're told that prescription drug pricing that allow Medicare to go negotiate drug pricing is out. The billionaire tax is out. Most of the increases in personal and corporate tax are out. So I think there's going to be a number

of other things that we still have to kind of get through. I want to write about it exhaustively. I do confess, I don't get tired of writing and I certainly don't get tired of reading, but I do get tired of writing about stuff that is conjecture, like every day projecting like, oh, it might have this, it might have that. And all those things have been a work in flux. And so I get why the media has to do that because every day there's a new talk here and a new proposal there. But from the vantage point of someone who's trying to do it analytically and not as mere media journalism, it's kind of frustrating because I feel like I'm commentating on things that are irrelevant. I want to be able to give commentary on what actually happens. And this is just a weird way to pass legislation.

So I guess you probably want a bottom line, listeners. And my bottom line is I would put the odds of a bill getting done in November at 80%. And I'd put the odds of a bill getting done within two weeks at 60%. And that is a all or none deal, meaning that that would mean a bipartisan infrastructure bill passing and then still having a reconciliation bill. But I don't see a scenario where they have the votes to get one without the other. Well, and David, we are getting questions about taxes, of course. And you mentioned the billionaire tax being out, a lot of the corporate and personal tax increases as off the table as well. But anything else you're hearing in terms of what investors maybe should be worried about or

should be bracing for when it comes to taxes? Well, I think the biggest thing people should worry about is not even just investors. And most of what we're here to talk about is investor specific. But I think people that don't have a lot of money in the market, but do have a checking account and try to live their life like a free American, I think it's very concerning that they're talking about a huge pay for being the presumed uncovering of tax fraud by forcing the banks to report without probable cause suspicion or court order or subpoena directly to the IRS of innocuous bank activity. That's not specific to people with a bunch of stock options and complicated investment portfolios. They were starting at a $600 level. They got it up to $10,000.

But they are telling their model, their computer, that they're going to raise a lot of money by nature of unpaid taxes that will now become paid through IRS scrutiny by having the banks report. And I would be conscientious of that if I were those of you listening to the call. And I don't think that's just investor specific. But beyond that, the other pay-fors are a bit of a mystery. I suspect there's going to be some sort of an excise tax on companies buying back stock. I think it's crazy. And I say that as someone who probably benefits if they do it, because I do think it would relatively attract dividend payments to the C-suite versus something that would be more

punitive with stock buybacks. And yet I'm opposed to it just simply because I don't like the idea of capital allocation decisions being altered. Optimally, I want capital flowing in the most organic and freeway possible. I think that makes makes for a bit more efficient of a market. Higher tax on foreign earnings earned overseas by multinational companies is apparently going to be part of the bill. And then we have to see what they end up doing on this prescription drug pricing. And then I suspect a good portion of it will either be scored as deficit spending or will just be actually deficit spending, whether they fudge their way through the scoring or not. Fudging the way through scoring is not a partisan comment on my part. I think that that has happened

with Republican and Democrat administrations. I guess I wouldn't say I don't mean it pejoratively because I kind of do, but I don't mean it pejoratively because I kind of do, but I don't mean a partisan. So that's where I think we'll end up being. And in terms of stuff on the margin on the estate tax, we'll have to wait and see. It's not a revenue creator. The idea of taxing unrealized gains on billionaires every year, it seems to have been laughed out of the system, which is still a great example of part of the legislative process working, that one person cannot just kind of mandate their way to a truly idiotic policy. And then the other pieces that they very much wanted, all reports are that they're kind of hung out there. But there could still be other taxes.

One of the reports I read about quite a bit over the weekend, if you recall the Obamacare tax, it's a surtax on investment income over certain dollar levels, but dividends and capital gains for a married couple at $500,000 were assessed an additional 3.8% tax on top of whatever their marginal investment income tax rates were, which were either 15 or 20. There were two different tax brackets. And so they put a 3.8% on top of that. They're talking about assessing another surtax on top of that on dividends and capital gains

for people over 5 million, people over 10 million, very high income levels. I don't really know what kind of revenue that generates. I imagine the politics of it would allow that to get settled. And then in terms of my own opinion on it, it isn't so much that it would impact a whole lot of people, but I think the precedent is somewhat concerning. And then again, I'm really big on wanting to incentivize capital formation because I think capital formation is so important to the economy. So that could be a surprise negative curveball. Most of the curveballs for markets and investors and then ideologues like me, most of the curveballs have been positive so far. They've gone the direction I would have wanted them to go. That one could be a surprise last minute thing that I don't like. Finally, Scott,

the last piece is SALT. The state and local tax deduction that was capped in the Trump administration bill of 2017 at $10,000. They wanted to get that back in. They threw it out. There were some who said it had to be in. They weren't going to vote for it. About two weeks ago, the Biden administration informed the House Democrats it's going to be out no matter what. back just for two years or to raise the cap level above 10,000, but not unlimited, but let that raised cap be theoretically more perpetual. I don't know if that's true and I don't know if it's door number one or door number two, but that's what I'm hearing from sources I trust a great deal. David, let's shift gears a little bit and talk about supply chain issues, inflation. And then also, we've been talking a lot about oil on these calls.

Oil prices now above, well, almost at $85 a barrel. Natural gas also consistently above $5. You've been talking a lot about the big stream energy sector, or at least that part of the overall energy sector. So update us on all of your thoughts here. Yeah, I think that we are very likely getting to a place where the actual level of pricing and the commodities hits a peak. I'm more confident in that with crude than I am with natural gas. That assumes no significant supply shortages and the demand growth projections happen and don't happen at an even more accelerated pace. The demand growth projections are robust enough as is. If you get higher demand than expected and if you get lower supply than expected, If you get higher demand than expected, and if you get lower supply than expected, then I suppose $100 oil is really on the table. But that would be such a colossal policy failure if it were to happen. I'd be shocked because, first of all, the OPEC countries have the ability to turn on their spigots, the American countries have the ability to turn on theirs, and there's policy ramifications that could push those things as well.

And so as I've pointed out all along, for those of us who are long energy in different aspects like midstream, you don't need $100 oil. And you probably don't even want $100 oil to have a bullish thesis in midstream. The level it's at now is about as high as I think you want it to be. And it could be $10 to $20 lower and not disrupt the thesis. Now, it's obviously very profitable for some of the integrated oil companies, some of the upstream exposures, two of the oil majors that reported their quarterly earnings on Friday. One of them, which is second largest oil company on earth, reported the highest free cash flow

generated in history last quarter. So those prices have been good on the production side. On the midstream side though, I really think it's just more of a volume situation, getting more projects approved, applying for more permits for wells, rigs coming out of the Permian. And that has a much higher natural gas focus, I think, than anything else. So all the thesis is intact. Everything I believe about it is there. And the financial story that I think investors care about continues to be very attractive yields with pretty strong underlying financials supporting those yields. And that's, to me, what I'd be investing in. But getting the stock prices to move or the commodity prices to move,

that's a separate story altogether. Going into the winter on the natural gas side, I think that that demand is going to be very high. And I think that we were overly aggressive in shutting down rigs, and we're paying the price for it now. And so the so-called capital discipline is a great thing in the sense that everybody likes companies to walk and talk with a disciplined approach to their capital management. But I think that it appears to me that they swung that pendulum too far. And to come back to the right equilibrium right now to meet demand

and have adequate supply, they have a ways to go still. So David, with that, are there year-end portfolio changes or considerations that you're weighing and that you'd like to share today? And obviously, we'll be talking several more times before the end of the year as things change as well. Yeah, it's only November 1st. And we generally, for longtime clients of the Bonson Group, know our process on tax law selling that I'm pretty much a stickler about waiting until December to do it. Because if there's a company that I want to own, I want to own it as long as I can. And yet, if there are reasons that we need to capture a tax loss, we want to be able to do so in taxable accounts. Yet, I'm never of the mindset to do that earlier in the year, as long as I have a strong desire to own the name.

And if I don't have a particular tactical swap in mind when I'm doing it. And so we're about a month away till we'd be exercising tax swaps. But if today were December 1st instead of November 1st, I really don't know much of what I'd be swapping. Some people, depending on their entry to a particular position, may have a couple modest opportunities if they were very recent and very unfortunate in an entry level or something. But even then, I doubt it. You just don't have much that's been down this year. And so to the extent that there was the tax loss selling

done last year reset the scales coming into this year, I'm going to be surprised if there are a lot of opportunities for harvesting of tax losses. So you look to portfolio activity we may have between now and the end of the year. There may be some here and there tax opportunity, but I think it's going to be very, very minimal if it's there at all. And then we are pretty aggressive right now where we're seeking to deploy client capital where possible and where appropriate and suitable to a given client situation into more illiquid investments. We have a particular private market strategy from a leading private equity and private debt general partner that we are a big believer in.

And we're looking to allocate a lot of client capital into some of these types of strategies. And those illiquid investments, whether it's real estate, credit, private equity, they're not going to be appropriate for everybody. That's where that liquidity conversation comes up. But that's one of the more meaningful tactical maneuverings where we're talking about a very significant amount of capital we're deploying, high eight figures, nine figures type money. That's our level of conviction to that. And that will be primarily sourced here at the end of the year going into next year. here at the end of the year going into next year. So in terms of any other areas of the market that you're particularly keeping an eye on for the remainder of the year, we talked about energy. What about financials? We're continuing to see strength there. Is that an area of the market that

you still think has legs? I mean, obviously you're bottom up and you're very selective within that group. Yeah. So within financials, we own two banks. One is gigantic. One is kind of super medium. So they're either a very large, large, large, medium-sized bank, or they're a kind of small, large-sized bank. We intend to continue holding both those positions. We have two publicly traded asset managers that are heavy in the alternative space, private equity, real estate, and credit, and hedge funds. And we have two of our largest gains on the year in those two positions. We want to continue holding those. All these names will end up getting trimmed at

the next time that we rebalance, which won't be until 2022. But yeah, our conviction of those names hasn't come down at all. They just happened to have had a great, great year. The life insurer that we own has done very well as well, but it still has quite attractive dividend and capacity for growth of that dividend. So we're really proud of how we've allocated in financials. I think it's been a much more creative way and opportunistic way and dividend faithful way to do it than just buying three big banks. So those are the five names that we own in financials. And that total combined, which like you said, is bottom up. But when you weight the five bottom up names put together, that top down incidental sector exposure, I think is going to stay about the same. the equity sleeve, if one wants to hear it from sectors, I've already been saying it for quite some time, but the only area where I really see things being picked up at a rebalance to meaningfully acquire more shares of a very attractive and reliable space of the market

that has not participated in this year's offense the way our energy, our financials have is that consumer staples. And we own several names in that category that we like a lot that we'll continue to be adding to. The other name that we're really trading on this week, we've already lined it up in the portfolio, and then we've wanted to wait for execution purposes, is just a modest increase in our emerging markets income strategy that exists within our income enhancement sleeve. And we're going to get the cash for that from our preferreds. And so we're going to just slightly lower our preferred strategy and slightly increase the emerging dividend, not just by way of rebalance, but by actual reweighting a little bit. So that's a modest change that affects just some clients who have a kicker

to their income enhancement in their portfolio. But other than that, there's nothing major. Those are thematic issues we're focused on. And I'm sure I'm just sort of rehashing stuff we've talked about before. David, as we move to the end of our conversation, talked about before. David, as we move to the end of our conversation, give us a sense of what's coming up in DC today. This is a long one because I really went to town this morning on it and it wasn't even so much over the weekend stuff. There were a few things I worked on over the weekend that made their way into DC today, but I just happened to have had a pretty robust morning before my day started. And so I noticed that from the economic news, you had ISA manufacturing reporting today. There was a study on return to office that I allude to.

You had the personal income number that actually came out Friday, but it bled over the weekend to today. So a lot of economic front. There's a lot of COVID update. There is all the news happening with the Fed this week, including some news around other central banks in countries not our own. And then, of course, there's the public policy side. So when you add all those things together, Scott, it's a pretty healthy D.C. today. I hope everyone will read it. I hope everyone will like it. I hope no one will

be bored by it. And I hope you'll read to the bottom because I actually put a comic strip in today's DC Today because it was so funny. I had to do it. And I never think those things are funny. And I never include comic strips in DC Today. But this one is worth your read. All right. Well, you said it here, David. is worth your read. All right. Well, you said it here, David. David, thank you as always for your insights. I'll toss it back to you for any closing comments, but thank you again. Thank you, Scott. Of course, appreciate it. And any of you with additional questions, feel free to reach out. You know, we're here to answer a lot going on in earnings season. We're going to continue. For those of your clients, we're trying to put a lot of stuff in front of you right now,

keep you informed as to what we're doing. We have a big announcement coming out in a couple of days. We have the weekly portfolio holdings report that you'll get in a couple of days. And for all of you clients and otherwise, of course, the Daily DC Today and then the Dividend Cafe that comes every Friday. in DC today. And then the dividend cafe that comes every Friday. And so that is how we want to continue serving you by way of content. Erica, I will turn it back over to you to dismiss us. 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 Thank you. referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee.

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