The Dividend Cafe - Market Outlook w/ David L. Bahnsen - Zoom Replay - February 22, 2021

Episode Date: February 22, 2021

David L. Bahnsen joined by Scott Gamm to discuss the market happenings of the day. 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 as always, Erica, and thank you, Scott, for joining me here again. I'm going to turn it right over to you. For those of you that have already dialed in, we're going to keep today a bit over, you know, right around 30 to 40 minutes. Not one of our really long ones, but we'll cover everything we need to. Send in questions, like Erica said, questions at thebonsongroup.com. My partner, Daya, is live, just sitting there grabbing your emails and sending them over to Scott as they

come in. So, you know, Scott, I know you got a few things to drive us through here and I'm at your beck and call. Let's talk markets. All right, David, let's do it. Great to be with you as always. And yes, we've actually already been getting some great questions, which we'll get to in a moment. But I think, David, as we always do on these calls, just starting off with your broader temperature on where things stand in the markets right now. What do you think is the biggest story in markets right now? Is it stimulus, interest rates, earnings, a combination of all three?

In a real immediate short term, it is bond yields moving higher. I want to make a clarification that some may not even agree with just in my vernacular, but like the interest rates versus bond yields, they're kind of one in the same, but they're a little bit different in the sense that I think most people do refer to interest rates as like the some relevant borrowing rate. And the Fed funds rate is not going higher. It hasn't gone higher. It's not going to go higher for a long time. So really, we kind of are talking about bond yields, which, of course, are interest rates, but it's the longer end of the curve that's moved a bit. And so to put that into perspective, we're talking about a 10-year that has gone to 1.3% from about 1%. And we're talking about a 30 year that has gone from about 1.5 to 2%, okay? A little over two. So you do have the longer bond yields at a higher level here.

And a lot of that's been going on for a few months. It's kind of moved more basis points higher in the last few weeks. Financials have all made new highs. I don't just mean back to post-COVID highs, but I mean higher than they were pre-COVID. That's a really important development that the areas of the market that were hurt by a very flat yield curve now have benefited from that steeper yield curve and a lot of other fundamental things that have gone into their positioning. But when we talk about interest rates, you start hearing people say, OK, well, bond yields going higher means higher inflation. I think that's probably a separate conversation. And what I want to look at a bit differently than just the mere movement of bond yields in recent weeks that is to some degree kind of impacted different sectors of the stock market. at different sectors of the stock market. And David, I think, you know, to your point, I guess the year to date change in interest rates is pretty sizable from a percentage standpoint, or however you want to measure it. But we're still talking about pretty low bond yields, just even on a year over year basis, or on a historical basis, right?

Yeah, so there's all this all this discussion in my world about what's the level of the 10-year that starts drawing people out of stocks into bonds. And Maria Bartiromo asked me that question on Fox Business this morning. And I said to her, I thought it was kind of laughable to think that we're talking about actually pulling investors out because they didn't like bonds at 1%, but they really like them at 1.3%. The difference is not that it's going to pull flows from stocks to bonds. It's that it re-rates the value of stocks. On certain multiples or valuations, the competitive rate to bonds has a re-rating effect. And I think the valuation argument is legitimate. I don't think that the flow argument is, but it becomes more compelling if the 10-year were to pass 2%. And I think the magic number

is probably about 2.5%, which is roughly double where the yield is right now. And I just frankly don't think it's going to happen. But I agree. I think that there's some question as to how we want to understand these things on an absolute basis as opposed to relative basis. And to your point, we can talk about how the 10-year is 30% higher, but when it's from 1% to 1.3%, that's a lot different than if the 10-year had been at 4% and all of a sudden it got to 5.5%. You see what I'm saying? The numbers in a small starting spot are very different. And you bring up a great point about flows, because I remember that issue coming up back in 2015, 2016, when the Fed was first raising interest rates after keeping them near

zero since the financial crisis. And that fear of flows out of stocks never really materialized, you know, in that era of the Fed. It doesn't mean it won't materialize in this era, but I guess we've been down this road before. Yeah, but one of the things that will help people to get the story right about flows, and it would have helped the media to get it right, is if they understood that flows never went down when even when rates and yields were very low. The one thing that's been very consistent since the great financial crisis is hundreds of billions of dollars of flows into short-term bond funds, whether it's ETFs or mutual funds. So flows didn't go reverse when yields were really low. And inversely, there's no reason to think that they would change when yields go higher. FOSA has just been good into bonds because they're highly liquid asset class and people have needed that sort of liquidity and money market substitute throughout their portfolios.

And they've mostly kind of gotten away with it. Now, it's funny you talk, the Fed raised rates in 2015 just once at the end of the year, a quarter point, and then didn't raise in 2016 until after the election, after telegraphing that they were going to raise four times. What I think was making a difference then, and then we're talking about real interest rates. We're talking about the real Fed funds rate, the real short-term borrowing rate that the prime rate works off of, the LIBOR works off of, that mortgage rates work off of. This is a very actionable interest rate in the economy. And at that point, what you saw was a dollar strengthened like crazy. And you had a lot of flows out of emerging markets. You had a lot of flows out of developed international. And the expectation was built in of a hawkish Fed strengthening the dollar and then having an impact on capital markets that still didn't really end up hurting the stock market for more than about a month or two in early 2016. My belief is that that's the furthest thing from my expectation right now. The 10-year and 30-year are acting in

concert with growth expectations around an economy that was shut down and then is now less shut down and will someday not be shut down at all. And that someday is coming quicker than people have thought. I think the 10-year and 30-year year pricing in growth, but that the short term aspect is still very much anchored to zero bound because of Fed intervention. to something somebody wrote in. And we kind of addressed this already, but I just love their question. They write, with interest rates on the rise, causing the TINA effect to weaken,

what will be the impact on dividend growth paying stocks? A TINA, of course, being there is no alternative. Well, as I've talked about quite a bit, I don't believe that the greatest impact of potentially higher rates is on dividend growth stocks, especially those that kind of traded a more reasonable and historical level of market multiple. I think it's primarily on those stocks that have a higher valuation, a higher PE ratio, things like that, because then the slightest bit of re-rating has a disproportionate impact to their price as a result of valuation. This is where yield spread

becomes important. I assume, I don't know this, but I assume what might be embedded in the presupposition of the question is that if dividend stocks were yielding, let's say, 4.5% and the 10-year was at 1% and now the 10-year is at 1.5%, doesn't that mean that there's a little bit of difference in the yield available that starts to make the dividend stocks less attractive? But see, as we just talked about on a relative basis, I don't think there's anyone who likes a 350 basis point spread that doesn't also like a 300 basis point spread. In other words, a good diversified portfolio of dividend growth stocks that has a yield at a wide premium to the S&P 500 or to the 10-year has a lot of built-in cushion against some of the movements with rates. And of course, that's the whole point of dividend growth is we're

not stuck at a fixated yield. The actual absolute level of income grows from the organic free cash flow growth of the companies. And for people who are familiar with your work and who are watching this call and who have watched past calls, they probably know this already, but for anyone new tuning in, the dividend growth stocks, David, that you invest in, that you talk a lot about, have a 30, 40, 50 year history of dividend growth. I mean, that's a pretty long span where we're going to have crises during those decades. we're going to have, you know, crises during those decades. We're going to have times of rising bond yields, falling bond yields. I guess, would you separate the whole dividend growth idea from whatever bond yields are doing?

Well, totally and completely. The only thing that I think is important is that over time in a secular rate environment, there's no question that a lower yield or a higher yield kind of becomes an anchor to where, you know, these companies are competing against. So if I, throughout the society, we had an extended period of time of a five year, excuse me, a% 10-year bond yield, then these companies have to kind of price their dividend in concert with that higher rate expectation. And what I think has happened over the last 15 years is now a company can pay a 4% yield that previously would have been somewhat mundane. And right now it's over two times higher than the S&P or than the 10 year. So you do get a kind of anchoring effect over time. But your point is the far more important one, which is the ability of these companies to just

continually grow the dividend regardless of where we are in a rate cycle, where we are in an economic cycle. And of course, not every company in our dividend portfolio has that 30, 40, 50 year history because some of them are newer companies and things like that. But let me give you an example without saying the name of the company that I kind of talk about in my weekly portfolio report that goes out to clients that is going to it's going to come out on Wednesday. But I wrote it over the weekend. This company has grown their dividend for 50 something years now. It's a really

large blue chip household name, but it is going to pay out $1.68 in dividends this year. In 1986, as I was getting ready to enter high school, it paid out $1.6. Excuse me, the stock price was $1.68 adjusted for splits. Okay, so in the course of time since I began high school, the company is now paying out 100% cash on cash every year, and the stock price is up 3000% over 35 year period. I don't bring this up because it's an exception to the rule. I bring it up because it's the rule when you get the math of consistent dividend growth over time. Now, not everyone has a 35 year timeline. And there's all kinds of other things that have to play in, like the sustainability of that dividend, the durability of the company, and so forth. But my point is that these types of things, those stories, and a whole lot of other companies

and cultures, business commitments that are involved in the landscape of what we're trying to do, those things are far more powerful than the ups and downs of bond yields. And I think this speaks to one of the great arguments for dividend growth is that you are going to have transitory economic things. I don't know that anyone could have guessed that the bond yields in the 70s were going to get as high as they got, or that the bond yields right now would get as low as they got. But certainly we all know that there's going to be cyclical realities to any economy. And I think that of all the different things that go up and down in good times, bad times, the ability to have one of the most important things in our financial lives, not go down mainly cash flow from our portfolio. These dividends, I think, is a really stabilizing force in the way we think about our

own financial management. And let's now talk, David, about, I guess, the other side of the coin, because when we talk about the 10-year treasury yield signaling economic growth or some sort of optimism post COVID, we should also bring up a couple of risks with that. So one is pent-up demand, rising inflation. And then later on, we did get a question about your take on rising debt levels. So maybe we can talk about that as well. But let's start with with rising inflation and kind of what risks you see there. Well, for any who read Dividend Cafe in recent times, I make a very important, particularly this last Friday, I make a very important distinction between pent up demand and inflation. There is a demand component that can become inflationary. Inflationary simply means that there is a greater amount of money than there are goods and services.

In theory, if demand is organically and naturally growing, the goods and services available to meet that demand grow, and that is growthy, but it is not inflationary. It's an example of a productive growth. And so I think the distinction between productive growth, non-productive growth, between a growth of money supply that is not being met with goods and services to soak it up versus what I think we're dealing with now is a really important distinction. But let's separate out the inflation discussion for a second, talk about the pent-up demand, talk about just that economic growth thesis.

I am very much on the side of those who do believe that we have a lot of pent-up demand in the economy, that there is a lot of slack, that it represents the difference between our potential output and our actual output, and that that slack is going to get met, that we're going to see that GDP growth increase. And the reason is that we have a whole lot of folks in the economy that have not been taking vacations or going out to eat or other things that play into economic inputs, and that

they're about to start doing it. And in some cases, they're going to do it like on steroids, you know, a bigger vacation, an extra vacation, more consumption to reward themselves out of coming out of this just sort of insane period we've been in for about 11 months now. As I wrote about, though, in our white paper at the beginning of the year, my question is not about the kind of wait and see moment we're in now in the economy or the pent-up demand phase that I'm forecasting we go into from there. My question is after that. It's more six months out, nine months out, 12 months out, that when we've already kind of exhausted the discussion of the COVID contraction and then the COVID recovery, and we're just sort of in a non-COVID

discussion about the economy, I think that's a much more open-ended question and has a lot more uncertainty around it than we have right now. But as far as the immediate outlook, I would take the under on anyone wondering, you know, when the economy is going to be more fully reopened and when day-to-day living is going to be more normal. I think that the declining COVID metrics and the success of vaccine distribution and the psychology of the population right now is all heavily biased towards sooner than later economic reopening. And then with that, David, we know we've got a lot of debt. We know we're about to get another potentially $2 trillion stimulus package adding to that debt.

But then as we talked about at the top of the call, interest rates are low. So perhaps the cost of carrying that debt is pretty low. But I guess how are you viewing our national debt right now from an investment point of view? And are there any economic implications as well? Yeah, I mean, this is much more of a secular question than it is anything cyclical or transitory. We do not have high levels of national debt merely because of COVID and the bills that were associated with it. If there had been no COVID, we still had a $21 trillion national debt with a pretty fierce commitment to running another trillion dollar budget deficit last year. And so regardless of what would have or whatnot around

the election, what party is in and so forth, there seems to right now be a bipartisan national appetite for some level of trillion dollar deficits and in the COVID moment, obviously even higher. And that's on top of what is far well over 20 trillion in national debt. And the economy is not growing at the same rate that the debt is. And as the debt gets added, you're getting a diminishing return from the debt, which is what you expect. And so I think this becomes a really important claim on future growth. secular sense, whether we're talking about with COVID or without, the overall debt levels become a very negative story for economic growth. But because of the way we're choosing to treat that, which is with a whole bunch of monetary stimulus, it has so far become a positive story for asset prices because it has led them to try to meet the burden of the debt with more stimulative and accommodative monetary policy, which primes the pump of credit

and lowers the cost of capital, which then increases the valuation as the risk-free rate goes down to effectively zero. This has been the case at different degrees ever since the great financial crisis, and now it's the case on steroids. So I think that you have that tale of two cities, which has, by the way, a lot of cultural or social implications as well, certainly political ones. But economically, it's not at all inconsistent to believe that you get a slower growth in the economy long term as a result of what this is. And at the same time, in the short to intermediate term, a boost into risk asset prices. The only precedent that we have is not a perfect one, and that's the country of Japan. The reason I say not a perfect one is there are a lot of

demographic differences and a lot of economic differences in our two countries. But my view is that the debt level is not going to decrease. There is no appetite to change that trajectory. All they can maybe do is buy themselves some time. And that we're going to live throughout the next couple of decades, and it really could be longer, trying to treat this and slow it down and play with it and experiment with it with varying degrees of monetary policy. And so we live in a great period of uncertainty around central bank experimentation. And that's sort of been my outlook for some time. And it's something I'm pretty much dedicating the rest of my adult life to studying and understanding. So, well, that is secular. You weren't kidding when you said secular.

What do you do then? I mean, is it TBD in terms of what you do from an investing point of view? Is it just kind of continue on as has been the case? Or do you think you'll start to see some changes in how we invest because of the national debt? I guess, when do those two worlds collide? No, I think they're colliding now. And it's the dividend cafes that have come out so far this year have all kind of centered around some version of this story. And it brings me back to my really strong belief in trying to neutralize the deflation inflation debate and the debt debate, the Japanification story by focusing on bottom up operating performances and free

cash flow growth that comes out of companies with pricing power. And so you can actually, I think, reasonably insulate yourself from a lot of these things, as opposed to what a lot of investors are trying to do, which is take a view as to what is going to happen and have a very thematic portfolio around it. And I would be opposed to that strategy because I believe that most people will take a view that is wrong or they will execute on their view in the wrong way. And I don't think that it is the best risk adjusted solution to try to forecast economic growth in light of these circumstances, inflation, deflation, a lot of these circumstances. And like I said, you don't have to be right just

once. You have to be right twice. You have to be right about what inflation is going to do. And then you have to be right about how certain investment strategies will respond to that. And I can't tell you how many people have gotten that wrong. The entire phenomena around gold out of the 1970s is largely a story of people believing that they were going to debase the currency. And more or less, it's true we moderated inflation to some degree. But obviously, inflation didn't go away. And yet, gold as a strategy to combat inflation, woefully underperformed for the better part of 40 years. And I think and I think that some of the stuff I read from really, I consider some of the greatest macro economists in my Rolodex. I just believe they're pretty much right on a whole lot of their

macro themes are falling. But then when they apply it into what one ought to do, I'm really skeptical. I mean, maybe 50-50 chance, but there's a big thesis right now about buying Asian sovereign debt, that buying Chinese government bonds or even Asian denominated currency, that that's going to combat against some of the stuff

we're talking about in the US. But I can't even begin to list how many things could go wrong with that thesis. And just on a risk adjusted basis, not only is it, by the way, boring as hell, but it's not, to me, the most stable way to deliver a consistency around either one's accumulation of wealth goals or their delivery of cash flow, their return of capital goals. So I'm not trying to just talk my book here. I'm trying to explain where my book came from. And I don't mean my physical book, but the way that we manage money. Dividend growth ought to be a pretty neutral way to be positioned around this stuff. And the key phrase in this is pricing power. Overly indebted companies can't be reliable dividend growers. So we have to avoid that kind of thing. And overly indebted countries,

companies that have pricing power can kind of remove themselves from some of those concerns. That's the thesis that I'm trying to give in a few minutes to what is really a few decade type, you know, challenge. Well, and I'll just complete that thought for you, David, because you have your investing book for clients, but you actually also do have a book, a real book about all about dividend growth and your philosophy there. Yeah. And that book was written before COVID. I wouldn't change a single word of it right now in the COVID moment. And the changes in national debt changes in budget deficits, bond yields are, are different. You know, the kind of transitory realities of a global economy

have played out in a couple of years since I wrote, wrote the book and they will continue to, but fortunately for me, I intentionally wrote the book around evergreen principles. And fortunately for the Bonson Group, our investment committee has put together investment strategies that are based on evergreen type principles. write a daily market piece, the DC Today, because I have so much conviction around what my responsibility is to be studying things in real time and understanding things and where necessary repositioning. But as far as the underlying principles of how to obtain a return on capital, I really do believe that that book and the philosophies that we've formulated over many years represent the right solution for our clients.

If we move to the end of our discussion here, David, what's going on in Texas, we'll shift gears a little bit. Your reaction there with the weather conditions there, your reaction there with the weather conditions there, it's getting a lot of attention. I guess any energy sector implications or any thoughts there? Well, you know, some utility names are distressed as a result of what's taken place and some commodity prices and companies levered to commodity prices have done very well from out of it. Similar to the whole point I sort of just got done making, I would never want to base an investment view on a one-week news event, whether it's natural disasters, weather events, often geopolitical events. These are the kind of things that are really important

in the news cycle, but tend to not be very important in the even intermediate term of one's portfolio. But I certainly believe that this does point to a lot of issues in the commodity cycle and in the need for the infrastructure necessary to deliver on a coherent national energy policy. And I suspect that, look, the idea, I don't think a lot of people, I can't remember who I heard say it, but there's not a lot of people preparing for earthquakes in Chicago. And you don't generally think of the type of freezing winter conditions that they had last week in Austin, Texas. It gets very cold, but the types of snowstorms that they endured last week are usually reserved for other parts of the country. So I believe that out of these events tend to come the necessary adjustments in policy and preparation to try to deal with it better the next time.

But from an investment standpoint, no, I do not believe that one ought to be going out and selling a whole bunch of one thing or buying a whole bunch of another. I just hope it reinforces what was very true before last week as well, which is that we have a need for more investment into energy infrastructure and the ability to deliver natural gas safely and consistently is best done through pipelines. And we need more pipelines, not less, to be able to do that. And I'm right now not even referring to crude oil. I'm referring to natural gas, which is something that has all the economic upside of being able to be exported to a lot of places around the world. And so I'm not presenting this as a new theme for us. You could go back to stuff I was writing on this in 2013, 2014. I believe in pretty strongly that whether it's ports, terminals, production

capacity at the rigs and wells, and then certainly pipelines taking things away, I believe that we just need more and better infrastructure. David, we talked a lot about interest rates and bond yields at the top of our discussion. We are getting a question right now about that. So I just want to go back to that for a moment. Somebody writes in, given the current steepening of the yield curve, even though rates are still pretty low, would you consider mortgage REITs relatively more or less attractive right now? More attractive, although they've already had a heck of a run recovering post-COVID. It's something that we implement in our income enhancement strategy and use a particular best of breed mortgage REIT that survived.

A lot of them didn't survive. You know, they're very levered vehicles and many just got, you know, basically murdered during the COVID period last spring. But we took a position in a best of breed mortgage REIT, but only in the income enhancement. You know, you're not going to get growth of income, but you're going to get high income and where someone's willing to use some of their risk budget into that yield premium. We like it there. And certainly in a period of yield curve steepening, you get a leveraged effect in that upside,

but it comes with corresponding risk. There's no free lunch. David, give us a preview of what's coming up in DC today, which is your daily market commentary that comes out about six o'clock Eastern every day. Yeah, I got I got a few hours to wrap it up. But actually, on the Monday one is always a little easier because I generally do spend some time on it over the weekend. And this weekend was no exception because I was traveling to New York City on Saturday and then was in the city by myself on Sunday. And so I kind of have a little bit of a head start coming into Monday morning. And so there is some extra information around

COVID. A lot of time spent in the last couple of days just analyzing some updated numbers, some vaccine data, some really quite staggering information around some of the new strains. And I just have a very optimistic bend right now on where we are headed. bend right now on where we are headed. And I'm providing the data in DC today to sort of rationalize a lot of that optimism. But again, from the Fed, housing and mortgage rates. On the public policy front, there were a couple interesting developments over the weekend. I do think that Neera Tanden's nomination at OMB will probably end up being the first and maybe the last, but the first appointment to blow up on the Biden administration. It's not a foregone conclusion. You know, you only have one Democrat senator so far saying he's an opposite. I think there might be more out there. But if they are able to sway one Republican, it could still

survive. But it looks like my early forecast when President Biden, when President-elect Biden first nominated Ms. Tanden, my forecast then was that she'd end up being the sort of sacrificial lamb that I thought was going to be a very tough path to get through. At the time, it was not based on Republican opposition, but it was based on what I thought some of the more progressive opposition to her might be. And I still think that that is out there, but it does look like mathematically that this will end up going down. And so that is an interesting development on the policy front. At the same time that they are preparing to get the stimulus off to the House for its discussion, eventual vote, the Senate parliamentarian is going to rule, I believe, tomorrow on whether or not to allow the minimum wage increase to be a part of this bill through budget reconciliation. And I can't even imagine that the parliamentarian will allow that.

But and then even if he or she does, and forgive me, I just don't know if the Senate parliamentarian is a he or she, but either way, you are likely to see that if that is allowed to go through budget reconciliation, then a really kind of messy situation because I don't think the votes are going to be there for it. Where apart from that kind of thing, I think the votes are there to get this through on purely partisan ground. And I just can't imagine why they'd want to complicate that. So I think we're a couple of weeks away from seeing 1.7, 1.8, maybe even the full 1.9 trillion of this stimulus bill passed into law. All of those things are discussed in D.C. today. All right, David, we'll be looking forward to that and I'll toss it back to you as we close out today's discussion. Thank you so much for your insights. you as we close out today's discussion. Thank you so much for your insights.

Well, thanks for guiding us through. And for any of you who had other questions, feel free to send those to questions at thebonsongroup.com and I'll make a point to respond back to you personally. And I think that right now we're in one of these precarious positions where everyone kind of feels like something should be happening in the market, but it's actually just really done quite well. It's been reasonably steady. And I think that most people now are beginning to price in the reality of an economy that's headed towards healthier conditions. But as I wrote about in the white paper, my forecast for a better economy this year, but not as good of a market this year relative to last year, I do very strongly suspect that we'll end up having some market volatility that lasts more than a day or two, which we really haven't had for quite some time. But of course, good investors know that they're prepared for it. Right now, I guess the

difference is you can kind of identify what you think might be the catalyst for it. But my view is that you never need to identify the catalyst. Markets endure such volatility and even corrections from time to time because they do. And that's just sort of the nature of the beast. But look, there might be other things more specific on your mind. Scott allowed us to go through inflation, deflation, debt, bond yields, interest rates today. But other categories of things are on your mind. I invite you to reach out. It's what I'm here to do.

So thank you again for participating in the call. And I'll send it over to Erica to dismiss us. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, Thank you. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary and does not constitute investment advice. The Bonser Group and Hightower shall not in any way be liable for claims and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein.

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