The Dividend Cafe - Market Outlook w/David L. Bahnsen - January 10, 2022

Episode Date: January 10, 2022

Topics discussed: Tech Reckoning Sector Positioning for 2022 (Tech, Energy) Tax implications for 2022 Inflation in 2022 Dividend growth investing in 2022 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. Well, hello, everybody, and welcome to our first national video call of 2022. I've already made clear I'm not saying Happy New Year anymore. We're past my few- day window into the new year, but we are nevertheless still into the early parts of January. And it's a good time to bring back our friend Scott Gamm and allow him to drive a conversation around the new year, around the the key events from 2021 and where they left us positioned into 2022. Because I did write a basically 20-page white paper on this very subject, we're going to use that to kind of

help guide a lot of the conversation. So some of the themes and ideas sound familiar. If you've already read the white paper, that's on purpose, but we'll try to extrapolate a little more information out of that. Last week, my investment committee did a podcast discussion around a lot of these things, but I think Scott and I are going to drill a little deeper right now. And we're also going to kind of interact with some of the things that we know are on your mind from the questions that we get and so forth. So enjoy this video podcast. Enjoy the incredible consistency and continuity of the Bodsley Group that our friend Scott Gamm now is coming back and we're going into our third calendar year together, which I couldn't be more thrilled with. Scott and I go back now. Let's see. I guess in terms of when I first

met Scott, it would have been about six years ago now, formerly with thestreet.com and then Yahoo Finance and now working with Strategy Voice Communications, being a part of the Bonson Group here on these calls. And Scott, thank you for joining us for yet another year. And let's bring in 2022 together, shall we? Let's do it, David. Appreciate the kind intro and great to be with you as always. And David, we're going to talk about that white paper, which I highly recommend people read it if they haven't already, because none of the content that we'll produce is a substitute for that, which I know you worked very hard on. David, one of the themes you talk about in the white paper, but something you've talked about for quite some time is this tech reckoning.

And that kind of leads into what the market is facing today. And I know we like to start these calls with some of the current market action that we're seeing while still taking a more long-term view. But what is your reaction to some of the declines we're seeing in the tech sector? Because we're nearing correction territory in the NASDAQ, not quite there for some of the other indices. But is there something that sparked it in your view over the past week or so? I don't believe that there was a particular catalyst because I've been of the mindset, as you know, for quite some time that when the catalyst is valuation excess, there doesn't need to be a catalyst. You just sort of sit around waiting. And that makes the person who believes it's going to come even more vulnerable because it doesn't necessarily

come right away. And it's why I've always been quite humble to not attach a timeline to it, but more point out the economic laws at play that when things get far outside of historical valuation averages or ranges or bandwidths, that reversion of the mean is a pretty common element of finance. And I think we're seeing it now. But one of the mean is a pretty common element of finance. And I think we're seeing it now. But one of the things that I'm really very conscientious of, and you'll recall, Scott, me, in fact, even in interviews that you set up with whether it was different conversations last year at the Wall Street Journal or NBC or what have you, making the distinction between FANG as a proxy for big tech and then some of the work from home, newer, cooler, hipper tech, I'm not totally sure that all these

things belong in the same bucket. What I do believe always belongs in the same bucket from a behavioral finance standpoint is what we call shiny objects, things that are bought because they're very popular. They've got a bunch of attention. They've usually just got done having great returns. And then they bring in a bunch of new capital and they become totally non-fundamental in their investment thesis. And yet often the momentum and the popularity can push them up substantially. And throughout my entire adult life and my entire professional career of investing, these are the things that I've hated the most. These are the things that have blown people to

smithereens the most. And yet during the period where shiny objects maintain their shine, Yet during the period where shiny objects maintain their shine, people can love them and they can hate the people playing the role of Jeremiah like myself. When you talk about the NASDAQ is approaching correction territory, it's fascinating, isn't it? I think as we're sitting here talking and who knows what the NASDAQ will do by the rest of the trading day, it's right near getting to a down 10% level. It's at the lowest point it's been in three months. That's all happened in about six days. It isn't quite as of the time I started recording at 10%, but it was at down six or seven, and I think it's getting now down

to the eight or nine range. And yet, 40% of the companies in the index are down over 50%. Now, that is simply stunning that you're effectively talking about an index that on its individual weightings, half of the companies are down half. And yet, nobody is talking about that. are down half, and yet nobody is talking about that. So there has been a reckoning, and the reckoning was not catalyzed by taper talk a month or three months later. It was not catalyzed by interest rates going up. These are largely not levered companies. It is the overall reality, the valuation stretches eventually stop stretching and the trees eventually stop growing through the sky. And that's what's happened. But it hasn't so much happened in FANG. Now, the FANG names more or less are down so far this year, but I've never

thought FANG was due for a 1%, 2%, or 3% correction to the extent that my belief is mean reversion and therefore multiple contraction. In theory, that would call for a much higher valuation correction. But as I've been talking now for a long time, I'm not at all convinced it all happens at once. I think you saw last year, one of the FANG names barely up on the year and one of the biggest years for the market in a long time. One name was just up so-so. You had a couple of names that did do better than the market. So that sort of breaking apart from the monolithic behavior of FANG into something much more dispersed, that is a very realistic theme. And then do I believe ultimately that valuations are stretched there and end up

correcting? I do. So whether we're talking about just NASDAQ overall, whether we're talking about the really most stretched things that became very popular during COVID and that so-called innovation tech and these ARK-related strategies, those things, they're already getting hammered. It was me prophesying it at some point, but right now I'm just observing it. The question becomes what the ultimate outcome is for the remainder of the shiny object ecosystem, because shiny objects don't normally correct 10% or bear market 20. Shiny objects, when the shine comes off, there's usually a pretty significant destruction. objects, when the shine comes off, there's usually a pretty significant destruction.

FANG is an entirely different category from the NASDAQ of 1999, because you just simply had way too many companies that had no business being in business back then. We have plenty of those now. They'll get dealt with. But some of the FANG names are the most profitable names in human history. So they need to have their valuations corrected. But they still remain quite powerful. I talk about in the white paper the uncertainty that exists, Scott, around the legislative environment. I do think it's mostly a headwind. I think it's mostly a risk as opposed to reward enhancement.

However, I don't know how that plays out. Will there be bipartisan support? What will end up happening? Will all these things be equal? Are antitrust concerns going to be different than privacy concerns, which will be different than child protection concerns? There's a lot of different reasons people get flustered with some of those names. And then will the solution prove to be something that ends up helping? Because it ends up creating just an impediment to their competitors, but their moat is already too strong for what Congress or regulators may end up doing. I don't know, but I think that the theme of a rotation in the market as opposed to just an all-risk asset decline, I think that's a much more likely

situation. It was what I grew up believing generally happened. All the bear markets I'd studied from 20th century, and most certainly the first one I ever lived through when dot-com blew up, they were not risk-off. They were rotation corrections, where you had things get killed, but other things were actually up. And somewhere along the line from financial crisis all the way through, you've just had risk off and risk on. And we're so used to thinking of a high correlation amongst all risk assets. And part of me believes that maybe that is ending and we're coming back to a more traditional rotation understanding of risk assets.

came towards the beginning of the year after 2017, which was very similar to 2021, in which the market rose, what, 20 plus 20%, call it, with very little volatility? Or is this something that's just sort of par for the course and maybe a little bit different? Yeah, I think 2017 and 2021 have a lot of similarities. There was economic expansion. There was a resumption of economic competence for different reasons. In 2017, it was supply side. And in 2021, it was more demand side. 2017, it was a result of the belief of tax cuts and deregulation coming in the new administration.

2021, it was post-COVID vaccine. The world's not ending normalizations. So you had similar environments, but for different reasons. Where 2018 and 2022, though, should be expected to be different is, again, in the reasoning. 2018's early year correction was entirely trade war driven. early year correction was entirely trade war driven. And in 2022, excuse me, in late 2018, Q4, S&Ps basically got down 20% for a minute. That was much more Fed driven, where they were tightening the balance sheet and hiking rates quite a lot, and as well as projecting future rate hikes quite a bit. Remember, the Fed had been tightening in all of 2017 as well,

and the markets were on fire. And they had been tightening in 2018, and the markets spit and spat and spurted, and then you had trade war stuff. And it made it very difficult to get cause and effect because the market could go down and you have what I used to call, what did I call them? The twin towers or the twin, there was some sort of twin rhetoric I used to use about the fact that you had the trade war and the Fed tightening happening at once. And when you have two significant market events happening at once, it makes it very difficult to identify which one was the bigger factor. And usually, it's some combination of both. So now in this year,

the Fed's back in play. We know they're going to be normalizing to some degree. I consider that an overwhelming positive. But it definitely tightens a bit in the liquidity of the system. And it theoretically alters the pricing or rating of risk assets. But I just don't know that it's all the same as 2018 because that trade war dynamic, there's other things that are more idiosyncratic that make it a bit different. And David, when you say the Fed pulling back stimulus or normalizing somewhat is a positive. It also reminds me of something else you said in the white paper, which is that the Fed's impact on markets is often overblown, overstated. Talk to that idea, because I think people might be surprised to hear that. Well, let's talk about the Fed's impact on bond markets. People always have brought up this idea

that the Fed is the key player in the long bond. And then the Fed leaves the long bond entirely for years at a time and yields don't go up at all. And so right now we've seen the 10 year go from 165 around Thanksgiving to 178 this morning. It's barely moved. It's inconsequential. You know, from the time that they started doing quantitative easing in late 2008, early 2009, you know, the tenure had already come down dramatically over the prior generation. And so I'm very much in the school of thought for some time that the role of QE in long bond expectations is substantially overstated. And then unfortunately, the bigger message in low long bond yields is low growth expectations. yields is low growth expectations. And so I think that the Fed's role with equities is always being talked about as if the immediate response to markets is the factor and not the one week, one month, three months, six months, one year response, which gives you a chance to look at what investors are doing and not computers and day traders.

Look, the Fed has had six periods, seven periods in my lifetime of going from a rate cutting cycle to a rate hiking cycle. And in all but one, the market six months later was higher by an average of 8.1%. The one time six months later, the market was down, the S&P was down 1%. So as long as someone's timeline is apparently more than a quarter, the history is rather clear that people overestimate the Fed's role. And why is that? Why is the Fed hiking short-term rates, never hurting equity markets in these six-month

periods of the historical dimension I'm talking about? Well, because the Fed is generally only raising rates if there's strong economic growth and strong profits, strong margin expansion, all things that we're seeing. And those things would be counter cyclical to market distress. They would be bullish for markets from a fundamental standpoint. Markets have to deal, Scott, with valuation this year. They have to deal with profit expectations. They have to deal with margins in the face of rising input prices. And yes, if the Fed shocked over levered companies, and all of a sudden their cost of borrowing go up, then those things would be vulnerable. But there is an incredible amount

of cash on balance sheets. Most companies cost of servicing debt is lower, not higher. sheets. Most companies' cost of servicing debt is lower, not higher, because of the tremendous benefits that the Fed offered the balance sheets of companies over the last couple of years. And I think that the Fed has also put themselves in a position of being very hesitant to surprise markets. So even if all things being equal, the market would love a liquidity machine forever and a low cost of capital forever that was constantly driving a higher rating of risk assets. The fact of the matter is the markets have had every opportunity to understand

that that doesn't last forever. And I bring you back to the, we had huge recovery in risk assets in the post-crisis era. There were a couple of little delays along the way in 2011 and 2015 around either European distress or China distress. But then knowing the QE3 was coming to an end at the end of 2014, and knowing that the Fed was either done cutting rates or was about to start raising rates, you still had positive market returns, and in some cases, really positive returns in 2016, 2017, and so forth. And so I just think that, yeah, the empirical and historical data is very clear that

people underestimate, or excuse me, overestimate the concern of the Fed relative to what really matters, which is the profit-making capacity and growth capacity of well-run companies. Yeah, well said, David. Let's also talk about sectors beyond tech, because something you bring up in the white paper, there's a chart that I think people should take a look at, just the top performing sectors of 2021, energy, real estate, tech, but also financials. How does that performance, especially energy, up some 47% last year? How is that sector positioned for 2022 after such a run last year? Well, if today were December 31, 2022, that energy would once again be the top performing sector. It's actually kicked off the year with a

bang. Obviously, it's extremely early in the year year but energy is going to have the highest revenue growth year over year of any sector now of course that's obviously been getting priced in for quite some time and it reflects the base effect of where energy levels were a year ago but no I continue to believe that there is a lot of opportunity last year upstream the more levered and more risky areas of drilling and exploration and production ended up doing much better than I would have expected and much better than the market expected last year and yet there was still really robust performance from both the midstream area that we're heavily invested in and even downstream. I expect that this year energy does very well, but that rating those three upstream ends up not being the top performing of those three aspects of the energy market,

that the production side ends up being probably reversed. And I would expect midstream and downstream to do better. But in all cases, you have really improved the financial performance of the individual companies in this space that have de-levered, that have optimized and rationalized their capital expenditures. optimized and rationalized their capital expenditures. And again, counterintuitively, a lot of the more hostile policies that they face are helping because most of the policy attempts of the new administration are hurting potential new companies, new competitors, and actually, therefore, boosting up the incumbent assets and the incumbent strength of legacy operators. And so we remain quite bullish on energy. Financials have done remarkably well,

even without getting a lot of steepening in the yield curve. Now, you may get flattening. But so far, financials, I think, are responding well. And it will depend what the Fed ends up doing on the yield curve, because the long end's obviously gone up a bit. Will the short end be raised? The Fed has a lot more control, obviously, on the short end than they do long end. And that could make for a steeper yield curve.

But in the past, when tapering has happened of quantitative easing, you've actually initially gotten a flatter yield curve. But my argument would be that financials are not as dependent on that yield curve. I think it is asymmetrical. It provides a little kicker to companies that are more net interest margin dependent. But right now, a lot of financials are just doing well from their more advisory businesses, investment banking, wealth management, asset management. These more fee sensitive businesses seem to be doing very well. Yeah. And obviously, David, we've talked a lot about the midstream sector for the past year.

And I know you guys have exposure to that space through an actively managed ETF. That's right. We're a big believer there. It served us well that diversification, this was not so much an element of being a midstream investor 10, 15 years ago when everything was an MLP. But now there's different tax policies, there's different territorial realities with Canadian assets. And so the things that could move the sector beneficially or not, there's different levers from the Canadians to the C-Corps in publicly traded corporations, which is a large part of the midstream sector now. And then, of course, the still persistent MLPs. There's

different tax realities in there. And we want to be diversified around those things so that we kind of hedge away those idiosyncratic risks and just focus on the health of the sector. So by getting best-of-breed names and operators that are really creating great cash flows out of superior balance sheets in all three sectors of midstream energy that I just mentioned, we think it's more diversified and ultimately hedges out some of the risks that we don't want to deal with. And it is a space that did very well last year. And we expect good things in 2022 from the midstream energy sector. David, also something that came up quite a bit last year, uncertainty around tax policy.

It got a lot of attention. I'm sure people broadly thought that there was something they needed to do with their portfolio to prepare for such an event that clearly proved to be a move that maybe was unnecessary and potentially dangerous because there were no tax changes last year and really no sign of any looming tax changes. Talk about that and maybe how people should be thinking about taxes in 2022, or maybe they shouldn't be thinking about it at all in terms of any types of changes. Yeah, I mean, you got a new administration. They took back the Senate, albeit by the, you know, with a tie through the unexpected outcomes in this runoffs in Georgia. And they still have the majority party in the House, albeit at a tighter range. And for the

first six, seven months, there was a pretty high approval rating for the new president. And it was single party rule. And there was no tax changes that took place. Now, you're in a midterm election year. People are debating as to how much different the majority could shift in the House. But most are of the opinion that the majority party will shift. There's debate as to what that margin will be. Very good possibility, but by no means a sure thing that even the Senate majority party will change. And the approval ratings of the current president have dropped substantially. And so how in the world do people believe you

get tax changes now when you couldn't get them last year? So those things have been priced out entirely. And as I wrote about in the white paper, and as I talked about so many times last year, the reason for it was the just simple reality of lawmaking in our country and the divided nature of the electorate that a 50-50 Senate with a couple moderates in there was not going to allow for some of the severe things people were doing. You talk about some of the things people were doing last year may have been dangerous, but I would argue that a lot of the things they were doing were just simply expensive.

You're going to see a big increase in tax revenue when we start getting the reports in 2022 from 2021 receipts, because there was a lot of forced capital gain transactions that people were going through to try to advance of some things that they thought could happen in cap gain or a state or step-ups or unrealized gain taxation and, uh, or marginal rate, uh, changes, none of which came to be. So yeah, I'm not concerned about tax changes in, in 2022. Um, I will, I will tell you though, a lot of people are saying, well, if Republicans win back the House, which it looks like they're going to do, could we be looking at tax cuts in 23? But people got to remember, my argument works the other way, too. More or less, one party has to have a majority across the chambers because nothing gets done bipartisan anymore, nothing. And you're not

going to get a tax cut done with a different party in the White House and the Congress. And last year, we saw that even with the majority party, when the majority isn't big enough, you can't do it. And arguably, the 50-50 Senate was as non-majority majority as it gets. as non-majority majority as it gets. But yeah, I think that markets are going to more be responding to what it says about the tenor of the country. And then does 2022's electoral political realities give any foreshadowing to what the country might expect into 2024? That's where I guess I would be more sympathetic to the idea

of the politics having a market sensitive component. But for the most part, I expect that we'll see different things than the Beltway dominate market news in 22. Speaking of the Beltway, of course, we have the midterm elections this year. I suppose it's too early to be even thinking about that, but is there a message to investors you'd like to share just in terms of how to be thinking about that as we get closer to November? Yeah, I think, I mean, I don't want to be redundant. I do think what I just said about 2022 midterms being more market relevant in what they foreshadow for 24 is probably the biggest lesson I'd want to share with investors. Some of it will depend on what happens.

You know, if the Republicans take back the House and do so by 20 seats, then I think it's fair to just say, yeah, this is kind of the norm of what happens with the opposition party in a first term president midterm election. It's what happened in 2018. It's what happened in 2010. It didn't happen in 2002. But as most people know, there was a very different set of circumstances there in the popularity that President Bush had at the time post 9-11. And it happened in 94 in the Clinton administration. And so as a general rule, that kind of movement could just be considered par for the course, both politically and certainly market wise. If you get a very substantial move, then I think you start looking at it as, is there a pretty strong cultural political wave that looks like it carries into 24 that might allow

people to start forecasting some things into the future? But yeah, I'm not in the political prediction business, thank God. David, let's also talk about inflation, which was a big topic and worry throughout 2021. We have another inflation report coming in a few days for December. So we'll see what that says. But generally speaking, how are you looking at inflation for 2022? Do you think it will subside? Do you think some of the supply chain issues will be less of an issue this year than perhaps last year? Well, yeah, I'm very confident that a lot of supply chain issues will be less of an issue this year than perhaps last year? Well, yeah, I'm very confident that a lot of supply chain issues will be less of an issue than last year. And then I

think there's room to debate if we start seeing some of that alleviation in late Q1 versus mid Q2 versus early Q3. I mean, one way or the other, I think by the end of the year, it's a pretty safe prediction that a lot of supply chain issues and labor shortages have mostly resolved. And I think there's room for debate as to whether or not that even becomes dramatically better at a much quicker pace or something a little less sanguine. And because I believe that was the biggest cause of inflationary pressures last year. There's a lot to be said about how that impacts the inflation rhetoric. One of the points I make in the white paper is that regardless, I don't see inflation staying as prevalent as a news story because I think the rate of inflation will be declining. And that's one thing I've seen my whole career in a period of

disinflation is that prices can still be going higher, but it changes the narrative and the way people think about them when the rate of their price growth stops going higher and when the rate of their price growth actually does start going lower. me is a very likely scenario in 2022 that we return by the middle of the year, late year to more disinflationary reality. So the secular monetary inflation, I continue to be in the Japanification camp that in fact, most of what our fiscal and monetary policy does is, if anything, more deflationary. And yet, there were massive demand surges met with massive supply inadequacies that provided a really, really big hiccup to that period. And yet, I continue to believe very unfortunately that the excessive indebtedness of our economy and of other global developed economies is highly unlikely to allow for the inflation forces that I think a lot of politicos would actually like to see. So therefore, I would be expecting more disinflationary pressures. Nevertheless, that still involves higher prices. I'm certainly not predicting until the next recession negative price growth, but I'm expecting

lower positive price growth than last year's price growth, therefore disinflation. year's price growth, therefore disinflation. And David, we've talked about how dividend growth is a great inflation hedge. But obviously, that's not why you're focused on that part of investing. It's just quarter your philosophy. But one thing I did want to end on is just your updated views on dividend growth, because we can talk for hours about the differences between 2021 and 2022 and what to expect going forward. But I think one constant would be dividend growth as sort of a focus and something to just kind of keep at the center of our minds as we invest going forward. Yeah, I would actually say that the inflation part of it is not the entirety of the core argument and core philosophy we have around dividend growth, but I do think it's one

of the components. When I wrote my book, The Case for Dividend Growth Investing, I tried to take all the arguments and aggregate them into a worldview of dividend growth investing piece by piece. One of the chapters was exclusively on the way in which dividend growth outperforms inflation and provides investor protection against the erosion of purchasing power that comes from inflation. But when you look to the ability to insulate yourself against market volatility, which I expect to be higher this year than last year, for those withdrawing capital, I think that's one of the key arguments. And I think that's one that people are going to very much appreciate this year. For accumulators, if you

can get real substantial volatility this year, especially prolonged downside volatility, where there's a good period of time of dividends reinvesting at lower prices. I always love that mathematical contribution that makes to one's total return over time as a compounder of capital. But fundamentally, the same thing I said in the book, I'll close our call with, of all the different factors from inflation to taxes to alignment with management to withdrawers to accumulators, compounding, all of those things,

the biggest argument I would make is that these are fundamentally better companies. The companies that have predictability of cash flow and those that are able to consistently grow dividend, that they are making decisions with capital that is with real money around what they actually believe as opposed to the way that so much other corporate management takes place where people are not voting with their checkbooks on their own outlook for their own business. That, to me, is a key component. Most of the risks people see in 2022 are what?

Valuation-centered. You tend to have more modest valuations in the dividend growth space. And then they are worried about what Fed tightening does to over-levered companies. Most dividend growth companies are what? Already a superior free cash flow and already less levered because they're more balance sheet responsible, balance sheet strong companies with more fiscally palatable capital ratios.

That I think is somewhat relevant tactically in 2022 around dividend growth. So thanks for letting me close with that. I didn't know you were going to go there, but as you know, I can sit and talk dividend growth all day. I mean, that's my baby. That's always going to be what we want to bring things down to. And to the extent investors are always, but especially in a period where there's more vulnerability, more eyebrows raised, more questions about politics, about the Fed, about valuation, about all the different things in the news cycle, the more people stay focused on the true objective of our equity philosophy, the better they're going to do.

objective of our equity philosophy, the better they're going to do. Yeah. Well said, David. And I know those themes will continue to come up throughout 2022 as we continue to follow the markets. And I think, David, that's a good place to leave our conversation for right now. But many more topics were covered in the white paper, including housing, which we didn't really get to talk about, but that section was great. So encourage everybody to read that. And David, thank you so much as always for your insights. Appreciate it. Thanks as always, Scott, for your help in driving this conversation. Enjoyed it thoroughly. Anybody listening who has further questions that this call may have provoked, direct them to questions at thebonsongroup.com. We write back to every single one and we try to even post some of them

in our daily The DC Today, found at thedctoday.com. Thank you for listening. And we'll come back to you in a couple of weeks with another national video call. But we really do appreciate your support. And we're here to answer questions, keep you as informed as possible about dividend growth, about our look at the Fed, our philosophy of markets. And we look forward to managing through whatever 2022 produces with you together. Thanks so much. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, member FINRA and SIPC, with HiTower Advisors LLC, a registered investment advisor with the SEC. Securities are offered through HiTower Securities LLC. Advisory services

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