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

Episode Date: March 22, 2021

Zoom Replay of National Call 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. Scott, thank you for joining us and I'll let you kind of take over here. I know we have a few things that we're going to go through. I believe we're off our normal schedule because we missed a week or something around the Bonson Group's office move. So we're kind of back into our rhythm now and plenty has been going on. There's plenty to talk about and I'll let you sort of drive the conversation topics. I know some questions have come in and we encourage anyone who has more to email those questions at thebonsongroup.com. Feel free to send them in real time, and we'll try to attention them here on the call. But we'll keep this one nice and short today, and hopefully you'll get a lot out of this.

Scott, off to you, my friend. Well, David, thank you so much. Great to be with you as always. And we are on track, David, as you know, for a positive quarter, first quarter for stocks. So we've got a couple more days left in the first quarter, which is obviously quite a different landscape than one year ago this week, where we saw the March bottom in stocks as the market was pricing in all the COVID-19 driven economic trauma. And I'm just curious, sort of your takeaways. We've done a lot of reflecting over the past year as to what has happened and what will happen.

But I'm just curious if you have any other thoughts you wanted to share on this week of the anniversary of the COVID-driven stock market crash. Yeah, you know, Scott, I thought about that as I was thinking about our call today, that if we wanted to, we could have turned this call into a whole kind of one-year recap conversation. And yet I'm giving a talk tomorrow night that is just that. And in fact,

everyone will be invited to participate. There'll be a live link. They can listen to the talk. And obviously we'll have a replay and stuff like that. And so I'm going to try to avoid the temptation to turn this into a whole kind of one-year recap, because there are a few key takeaways that I think are evergreen, that are permanent principles for investors, that are really important out of the COVID moment and out of the memory of where we were a year ago. I'm going to focus more of that tomorrow night. But it is very interesting to think about the fact, you know, the genesis of these very calls and you and I doing this together for clients began a year ago in the midst of this very moment. And obviously, it's quite a different world. I've talked about this a little bit in

Dividend Cafe that ironically it's an entirely different stock market. It's an entirely different economy and certainly on the COVID side it's entirely different too versus a year ago as we were like literally shut down nationwide. But that is the one thing that has lasted much longer than anyone could have expected. The stock market pain ended up only lasting a matter of a few weeks. The economic recovery began right after the second quarter. So you had the drop at the end of Q1 and then an utter bloodbath in Q2, but really a V-shaped pickup from into Q3 and so forth. But the fact that there continues to be a lot of restrictive behavioral issues around COVID, even as multiple vaccines are now approved and in heavy use, even as we have now vaccinated just tens of millions of people in the country and

are well on our way to herd immunity, we still are dealing with the COVID aftermath. And I think that's a fascinating thing about all that has transpired over the last year, socially, culturally, politically, economically. So the amount of takeaways from this moment are vast. And yet, for the most part, there has been very few categories that things were not much better than had been expected or feared or where they could have gone. And I think that on the economic side, the market takeaway, that's a real blessing out of this otherwise really awful experience in American life. Yeah, absolutely. And here we are on a day like today with the S&P, you know, pretty close to 4,000, which would be, you know, pretty incredible if we were to see that

in the next couple of weeks, it's certainly possible. And, you know, David, I'm just wondering, because, you know, obviously, we've gotten through a lot of the COVID issues, obviously, there's still stuff out there. But inflation is now sort of a newer concern, or at least a concern that is now being more widely bantered about in the media, but just among market participants. And I'm just curious when we've talked about this before, but what your overall take on inflation is as we look to the post COVID world? Well, I think that there's two different dimensions to what people mean by the question and two different dimensions to the way I would choose to answer it. Because I think a lot of people think they mean secular inflation and a sustained period of rising prices throughout the economy where indeed there is too much money

chasing too few goods and services. And yet I think more often than not, the way that the question ends up being rationalized or explained or kind of developed, it is from the premises in the question generally evident that what people are referring to are various bouts of cyclical inflation or potential cyclical inflation. And one of the things I'm encouraging a lot of people to do, because there's certain anecdotal evidence right now, people look at a big increase in lumber prices. They'll look at copper prices. And you can look into various aggregate summaries of airline prices or food prices and pick a bottom number from March or April or June of 2020 and look at what this price move higher has been and say, how in the world could we not believe there to be inflation? and say, how in the world could we not believe there to be inflation? And the answer, of course, is that one is doing their math off of the highly and overly deflated and disinflated number that came out of the contraction post-COVID.

And so I think to get a better feel for where commodity prices are and where consumer prices are, one actually does their data a great service and their process a great service to look to a lot of the pre-COVID highs of these numbers to where we are now, recognizing there was a big drop down and then a big move higher, but smoothing out for some of the noise that has taken place in this situation. No matter what, any period of inflation I've ever studied, and I expect this to be the case forever, when you've had periods of systemic inflation, there were exceptions that were more disinflationary. And when you've had periods of very low and muted inflation, there were exceptions where there was high level of inflation, particularly in asset prices.

So I don't expect this to be any different. lives of a lot of people listening right now have always been home prices, healthcare costs, and higher education costs. And at different levels, I expect price inflation to continue in those categories. And yet, when you look to the CPI, when you look to the the PCE and other metrics that are attempting to find a broader index of aggregated price level, it's very difficult to find any measurement that gets you much above 1.6%, 1.7% year over year inflation. Whenever I talk about inflation in the 1% to 2% range that we've really been living in for a very long time, I do not mean that to say it's benign for investors. I think the Fed targeting 2% inflation, not saying we don't want it to be more than that, but saying we want it to at least be that. I think it's immoral. I certainly think it's bad

policy. So I don't say this as a defender of inflation. Quite the contrary. However, I do think people need to understand the disinflationary forces that we're up against and the greatest measurement we can ever have to really understand where inflation is. When you think that there's conflicting indicators, you see grocery prices doing this, but energy prices doing that, rents doing this, and you're formulating your own instinctive view about the price level, the reality is the bond market has been the greatest indicator to tell you what's really going on with inflation. And the utter collapsing of bond yields, not now, we're not just talking about my adult life, but even through a good portion of my childhood. Again, secular periods of bond yields coming down. Along the way, there were

gyrations and there was interest rate volatility. But the downward pressure on bond yields has come with a radical taming of inflation into a period, post-financial crisis, of systemic disinflation and a debt deflation cycle that is very akin to what the Japanese have been fighting for multiple decades. And that's my thesis as to where we are now, that the excessive levels of debt we have in the economy are creating deflationary spiral events that will be coupled with cyclical inflationary events along the way. So that's very much my view now. And when someone says the 10-year just went from 1.5% to 1.6% isn't that inflationary, I say the 10-year just went from 2.5% to 1.6. They're taking a start point that was when the economy was completely shut down. But ultimately, we still have from financial crisis, through recovery, through various

events that took place over the last decade, and now through COVID, we still have had significant downward pressure on bond yields. And yes, the Fed has held down the low end of the curve, but the yield curve now has steepened substantially. And that, I think, reflects the greater economic growth that the bond market is expecting out of reopening, out of a post-vaccinated and immunized society. And the pent-up demand that will come there with, I think it's reflected in bond yields. But a 10-year at 1.7 could tell me we have better economic growth hopes than we did when the economy was shut down. we have better economic growth hopes than we did when the economy was shut down. But 1.7 on the 10-year doesn't tell me anyone's expecting 5% price inflation. Yeah. And somebody writes in, David, with an interesting wrinkle to this conversation, which is, can inflation be narrative-driven? Meaning the more we talk about it, the more business owners and producers preemptively raise their prices.

And so perhaps, you know, I guess it's the chicken and the egg type of situation in that sense. That you get a self-fulfilling prophecy. I've heard the theory before. I'm not a subscriber to it, but I understand where it comes from. Ultimately, I think it underestimates the efficiency of market makers, that producers and consumers have an incredible commitment to their own self-interest and that the trillions of market events that are going on as consumers are willing to pay what they're willing to pay and bargain shop the way they're willing to bargain shop and producers are trying to meet supply and demand realities, that you

always get downward pressure on prices out of competition. get downward pressure on prices out of competition. And to the extent one wants to pre-price in inflationary expectations, they have to do that up against the downward pressure of competitive reality. And so too much overthinking inflationary pressures becomes very difficult in a market economy. I don't doubt that that dynamic can happen on the margins, but I do doubt that you can end up with more systemic inflation out of such. Well, and it's interesting because there's been a lot of talk about how rising bond yields may be a threat to stock prices. And we've certainly seen days over the past couple of weeks where that has been the case. But as we mentioned at the top of our discussion, we're on track for a positive first quarter in stock prices, even with that 10-year treasury

yield rising so much year to date. And so I'm wondering if it's a similar dynamic to another topic, David, that you are always asked about, which is, you know, what does the market think of stimulus? And your response to that is, well, the market hasn't cared about stimulus really throughout this entire crisis. So it's always risen even with the promise of stimulus. So is there a connection there between those two themes in terms of how the market is reacting? Yeah, I actually do not believe that even on those days of market volatility we've experienced that anyone could prove it's been a byproduct of fears of rising rates or the reality of rising rates. And let me explain that because there were days

that the bond yield moved up and stock prices had some decent downside volatility. And yet, it lasted a day at a time. Okay, you right now, as is at 32,750. It is up 6.7% on the year. The S&P is very close to 4,000 at 3950. It's up 5% on the year. And even the NASDAQ, which has given back a lot of gains, is up 3.8% on the year. And so what you got was not markets trading in correlation to the bond yields, whereas bond yields went higher, markets went lower, and then bond yields dropped and markets recovered. You had days where the markets dropped, and then you had the days where the markets went right back higher, but bond yields did not go lower. So you can't have one sided correlation. Establishing cause and effect where it's only out of 50% is totally fallacious.

Ultimately, I would argue that the amount of days, which, by the way, for people who only look at their monthly statement and are not following all of this all the time and not necessarily looking online and so forth. There's not a lot of people that do that anymore. But to the extent there are some, it just so happens that the heightened market volatility was at the very last day of January and the very last day of February. And it lasted one day and maybe two days in a couple cases. The days where we had more significant volatility, and I think at one point I had counted 17 market days, you had a decent move higher in the Dow. It wasn't just like 10 points.

You had an up day in the Dow combined with a down day, and again, a decent size down day in the NASDAQ. It's incredibly rare. And a fair amount of days, including this month, where it was pronounced disparity between the two. Triple digit move in the Dow higher, 1% type move or greater down in the NASDAQ. That spread between the two indexes. What's sauce for the goose is sauce for the gander. Interest rates cannot be said to be really scaring investors in some stocks, but not

scaring them in other stocks. The far more plausible explanation, and anyone who knows me knows I am a religious devotee to Occam's razor, that the simplest explanation, if it isn't always the best one and isn't always the final one, it should at least always be where one starts. The simplest explanation is that we are in a rotation, that we are in a reversion to the mean where things have been higher valued, they are repricing, and where things have been lower valued, they've been repricing. And I think that's really been the story of equity markets is the way in which what was unloved has become a bit more loved. You look at the energy sector's

performance this quarter, a lot of financials, and that what had been really loved, a lot of those so-called work from home stocks, a lot of the more frothy parts in the technology space, those things were repriced. That's the more common and self-evident theme to me versus stock correlation to bond yields. Well, and just another thought on that note, if you look at the low in the S&P so far in 2021, that coincided with the week where we were talking about volatility around a well-known video game retailing stock versus bond yields. So that's just another point in the broader point that you're making right now. And you make a really good point, Scott, that that particular event in that week, nobody should ever attempt to extract rhyme or reason from markets when there's certain things that are just clearly to anyone with eyes and ears broken. And when you get certain dysfunctions in the market,

there's enough interconnectedness, there's enough high frequency participation, there's enough technical reality around ETF construction, that any number of things can kind of shake things for a bit. They don't last long and markets have an incredible efficiency to them that's been more and more pronounced in an age of better technology and whatnot. But when you get kind of that funkiness, which is the technical word they taught us. And I think that those dysfunctions and periods of mechanical breakdown are impossible periods to try to extract a rhyme or reason for what's going on. And David, you mentioned the rotation a moment ago. Anything else to say on that in terms of whether you expect that to continue or sort of

what's the next frontier of that rotation, which to your point has played out pretty significantly so far this year? I very much expect it to continue. I do believe it will continue throughout this calendar year, but my real belief is that we're very likely in a multi-year playing out of this. That's been the historical reality that so-called shifts from the leadership of value to leadership of growth and vice versa have generally been as much as decade-long realities, five, seven-year minimum. This goes back for 30, 40, 50, 60 years. But they don't happen in straight lines, and I don't expect this to be a straight line either. The zigs and zags of market behavior will continue in 2021,

but do I think that the stronger trajectory is that there will be a greater price performance in higher quality aspects of the market with more fundamental value-oriented metrics than in companies that stock price performance has largely been a byproduct of multiple expansion. I'm firmly committed to that thesis. Yes. David, somebody else writing in wanting to know your thoughts on the potential for higher capital gains tax and what that means for stock prices. and what that means for stock prices? Well, look, higher capital gain tax would be a negative for any capital asset, which would include real estate and include stocks in a sense that the value of assets and the return one presupposes is extracted from one's assumption of a value at the end.

And when the value at the end has been diminished by a tax liability, you have created a lower return in the ownership cycle. In this particular case, there's a whole lot of hair on this that makes it a lot harder to evaluate right now. We don't know what the policy will be that is proposed. We do not know what the policy will be that gets from proposed to modified. will be that gets passed. And once you get a past policy, how much of that has been priced in along the way and how dramatic it ends up being versus not being is a big question. There's no point in me hiding the ball. I am a big believer in the concept that if you want more of something, you tax less of it, not more of it. And I think we want more capital formation in our society. And I think increasing, this is another really important element around growth. People think that if they buy a stock at 10 and it goes to 20, and then after taxes, they're going to have 19. But then if taxes go

up, they're going to have 18. And I'm making up the numbers to make the point. And so that lost one and for the additional tax is the problem here. But it isn't. It's a problem. It's probably not a huge one on the margin. The way I'm hearing this tax bill is going to come down the pike. probably not a huge one on the margin the way I'm hearing this tax bill is going to come down the pike. But it is a problem. But the far bigger problem is anything that incentivize people to hold non-growing assets. You want dynamic financial markets. You want capital formation around new growth and moving into a new investment, I think is a negative to the growth trajectory of the economy. And so where higher capital gain taxes become more punitive to people that are looking to alter that aspect of their asset ownership, it can be very disincentivizing. And I think it's a bad idea economically. So I do see plenty of negatives

that could come out of it, but I don't think it's possible for the... Let's put it this way. When I talk about the Dow at 32,750 right now and the S&P very near 4,000, there is no market actor buying Dow components at these prices and S&P components at these prices that does not know that there's a very good chance of some higher capital gain tax rates going into next year. tax rates going into next year. But it does beg the question as to how much higher markets could be. And it also begs the question as to where we're going to end up going. And I think ultimately, the devil will be in the details. And if you had to rank that on your list of worries right now, from a market point of view, is it too early to tell? Or how are you thinking about that priority-wise? I'm glad you said from a market point of view, because if I got to list it in all of my worries, even outside of market worries, it would go much further down the list. The answer is a little complicated. Isolated to just what will happen with the capital gain tax rate, it's not very high.

I pretty much expect that they're going to pass something that puts the capital gain rate above a million dollars of income at the ordinary income rate at some date out into the future. And I'm also equally confident that that will end up being repealed at some point very nearly thereafter when there is different administration to do so. I don't think it'll last, and I don't think it will happen imminently, and I think that the population of people it impacts will be minimal, but I do think something will happen. But again, I assume the question is not just where that isolated, nuanced, particular tax policy comes, but on the broader level of where corporate tax rates go, where other

adjustments to the tax code may come, where that ranks in terms of keeping me up, that's a bit different. I would be far more concerned about the economic impact of anything that on the supply side is disincentivizing. Higher capital gain rates on the margin do that. Higher income rates on the margin most definitely do that. I want more labor and I want more capital formation. I want more growth. And so a higher tax on labor and a higher tax on goods and services, a higher tax on productivity takes away some of those things that I think the economy needs. And then you combine that with the possibility of greater tax scrutiny on LLCs and S-Corps, eliminating some of the things that were done for LLCs and S-Corps and that deductibility factor on these pass-through vehicles, then all of a sudden you start getting to something that is not just someone with $4

million of income selling a certain stock, but then you get into a family with $250,000 of free cashflow from a family-owned business and them running into a greater tax impediment. And I think that's a far bigger concern. So I guess my long answer here, my long-winded answer is on the very small, narrow train, not a lot of concern in particular. Not that I'm happy with it, but it's a bit different than when you broaden it and look to the whole broader tax portfolio of the new administration and where they may take things, then it is a bigger concern. Why not be really, really upset about it? I just simply continue to hold on to the belief that some of the most concerning elements are not politically doable in a 50-50 Senate. And that was the other thing we had talked about at the start of the year and even before that, after the election was, you know, gridlock in Washington and just your take on the likelihood of certain policies to get passed that may be viewed negatively by markets.

And look, the $1.9 trillion stimulus bill got through the, quote unquote, moderate Democratic senators that represent those kind of swing votes out of Montana and West Virginia and Arizona much easier than I would expect it. I thought they had a lot more leverage for some horse trading than they ended up using. And yet there's a big part of me that doesn't think they'd be so pliable on raising taxes. I think raising taxes is a bit more politically fraught with risk than giving away checks. David, let's also talk about what you're writing about today in DC Today, which is your daily market commentary that's released every day at about 6 p.m. Eastern. Yes, it's quite a full one today. I'm looking forward. I always like the ones over the weekend. Gives me a chance to kind of really double up on some of the stuff. There's a lot on the Fed today, Scott. They made a ruling on Friday. I'm actually a little mystified by.

I don't think, I think it was 50-50 which way they were going to go. And I don't want to get overly complicated here, but there's something called the supplementary leverage ratio, where essentially the Fed has always had capital requirements for member banks to keep them in line with what their capital ratios needed to be to protect the systemic safety of financial system. And I think that's entirely appropriate. And what they've always done is weight the level of capital ratio requirement to the risk level of the asset, which I also think was entirely appropriate. But because certain assets could potentially have proven to be more risky than had been anticipated, and mortgage bonds that were heavily held on bank balance sheets

back before the financial crisis are a great example of this. They created something called a supplementary leverage ratio, where even apart from your risk-weighted requirements, we're going to throw another 5% capital holding requirement on anything in your reserves and your balance sheet, including treasury bonds, from in your reserves and your balance sheet, including treasury bonds, which have no risk of default. And I think that a year ago, when there was a need to protect bank balance sheets and make sure capital ratios stayed intact, and not disincentivize bank lending, not to mention disincentivize bank participation in buying treasury bonds when they were going out and issuing $2.2 trillion of CARES Act debt. They waived that supplementary leverage ratio for a year based on the circumstances.

And obviously, all the banks' balance sheets have stayed very healthy. They have multiples of more tier one capital than they've had in a long time. There's a lot of liquidity. The loan loss provisions were way overstated. Their capital stewardship has been really A-level. And now a lot of the banks have said, look look thanks for suspending this for a year but uh isn't it time we just get rid of all together it's kind of a silly thing given what the whole genesis of it was and what the what the need for it but there are some on the very far progressive left that don't want any alleviation of capital ratio requirements and felt that, no, this thing needed to come back in and

5% reserves against treasuries is appropriate. So I think the Fed was in a difficult pickle. And what they basically ended up doing is saying, no, we're going to bring that ratio requirement back on. And the banks were kind of hit because of that on Friday. But then they said, however, we do recognize that it's not a perfect system. So we are going to come back and make a modification as is appropriate. So I talk about this in D.C. today a little bit, what its implications are. You know, there's a whole lot of things that will make the Fed stay a big part of our conversation for a long, long time to come. Another thing, by the way, for listeners that don't necessarily hear so much about the deep end of the pool, the weeds of what I might get into sometimes with policy or with the Fed,

but are always interested in basic housing policy related issues, As I do walk through in DC Today, a really interesting set of metrics as to what the average home price appreciation has been over the last generation. But then what that number is, once you adjust for how far mortgage rates have come down, and then what that number is once you adjust for inflation. And you end up with a really set of interesting housing metrics. All of those are charted and talked about in DC today.

So looking forward to this afternoon's issue getting out there. All right. Great stuff, David. Thank you as always. I think that's a good place to leave our conversation for today. Thank you for always. I think that's a good place to leave our conversation for today. Thank you for your insights as always and looking forward to our next call. Well, thank you, Scott, as always. Look forward to our next call as well, which I reckon will end up being what I think it is Tuesday, excuse me, Monday, April the 5th, which will be the day after Easter weekend. We'll next come with you. We intend to keep these bi-weekly calls going until our clients tell us that they're sick of hearing from us. So

we'll look forward to our next call. Feel free to send any questions or follow-up items you have out of this call our way and all attention to those directly. And I mentioned the speech I'll be giving tomorrow night around this year, the COVID moment. I'm not going to bring Erica back on to dismiss us with her out. I think I can handle this on my own today. Thank you, though, for joining us. Thank you to Scott Gamm for his work and all the production team at Bonson Group

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