The Dividend Cafe - Market Outlook w/David L. Bahnsen - January 31, 2022

Episode Date: February 1, 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. Hello, welcome to another one of our national video calls brought to you here by the Bonson Group. For those who don't know, I'm David Bonson. I'm the Chief Investment Officer here at the Bonson Group. And we like to do these calls every couple of weeks to just sort of bring to you a live Q&A about everything happening in the market, what's on our minds, how we're approaching things. And to do this for coming

up on very close to two years now, I've utilized the services of Scott Gamm at Strategy Voice Communications to kind of guide us through this discussion. And so, Scott, we get to do this now in what is the last day of what has been one of the most exciting months in quite some time. I talked an awful lot about how little volatility we had in 2021. And now 2022 looks set to prove me wrong. So I'm sure there's plenty on your mind and I'll turn the microphone over to you, my friend. Well, David, thank you. Great to be with you as always. And yes, this month, I think in addition to the volatility, there have been a lot of themes that have really come into the forefront that you've really been talking about, maybe even warning about for quite some time. So I think

it'd be great for you to just kind of organize your thoughts and just kind of give us your latest view on how everything has been and is right now shaking out in the market. Yeah, the answering what has been happening in the market is a lot easier than what will be happening in the market for the obvious reasons of the verb tense being used. The events of January are more or less a microcosm of what we would have anticipated. And I wrote about extensively in the white paper that I wrote the last week of December that we published in the first week of January, kind of foreshadowing what we thought would happen throughout the calendar year of 2022. So if you look at what's happened in these last 30 days, you see a really big sell-off in some of the riskier,

frothier, more speculative parts of the market. You see certain parts of the market perform really well in the midst of broad index dropping. And so it speaks to there being more of a rotation than a risk-off environment. You see more defensive sectors doing better. You see a continuation of the energy sector, which had done very well in 2021, being the only sector that's actually up, as we're sitting here recording, for the month of January. I expect that to hold for the next couple of hours.

And not just that energy was up in an environment where most sectors were not, but it was up huge. And so it was not only a relative standout, but an absolute standout as well. You see high correlation amongst a lot of the frothier parts of the market. They can seem on paper to be different, but our argument would be that they're highly correlated because what made them all perform well was not idiosyncratic. It was one in the same with each other, namely momentum, froth, excess, speculation, popularity.

speculation, popularity. And so why should the solar industry and the crypto industry and the innovation technology industry and small cap growth and IPOs and SPACs and all of these things be trading together? There's different risk-reward characteristics, different underlying fundamentals, certainly, across the board. And yet they all went up together and they've all now gone down together. And that high correlation is because of the truth of the matter, that the only reason they went up together was not their underlying fundamentals, but their shared identity as a shiny object that was attractive to people for the kind of novelty and speculation opportunity that it presented. So all of these themes of January played out. But I can't say with 100% confidence that it continues this way. My own macro thesis is that we do parlay into a period of the hottest dots of 2020 and 21

being shunned for a bit. They may get some little recovery rallies along the way and lure in some people that think they're bargain shopping. But yeah, I think on a more structural basis, the rotation from growth to value is underway. I had a theme. You heard me talk to the Wall Street Journal and other publications, actually, and interviews that you and your firm set up, where I talked about the fact that FANG was being treated monolithically and really wasn't. And I talked about the fact that a lot of people seem to have gone out of the most speculative parts in 2021 into big cap technology, like as if the FANG arena was less speculative or less valuation prone than some of those other

elements. And I think that that was true enough in the sense that there's better cash flows, better brand names, better market caps, but there was still a shared story of high valuation. And the largest search engine company in January did okay, relatively speaking. The largest maker of phones and apps and really the largest market cap company in the world did okay in January, relatively speaking. They're both down, but not quite as much. But then you saw the most well-known streaming media company get hammered. You saw distress come into some of the social media companies. E-commerce has really not done well for quite a while. So I think that that theme is a more practical way for me to express my views on FANG going forward, that I expect there to continue to be people that see it as a safe harbor until they don't. And there will be a point at which they won't. High valuation is high valuation. And the high valuation reaper comes for everyone eventually.

everyone eventually, but that it will be a lot of dispersion amongst those names, that there will be some doing better than others. And the correlation that they have with one another, I think has already broken apart. And that makes the kind of stock picking within the FANG world even more important. So a lot of themes we've already been talking about that we kind of laid out as year-long conversations, and they just seem to be moving at the speed of light in January. Yeah, very well said. And this idea of those mega cap tech stocks acting as one group, as you mentioned, is something you started to ID. That was really not the case back in June of last year, kind of before it was really obvious. And of course, now investors are seeing that. David, does this month of January remind you

of any other point in history or throughout your investing career that maybe we could learn from? Or are there any takeaways from history that you think applies to this month? Or are there any takeaways from history that you think applies to this month? I don't. I think that that adage of history rhyming but not repeating makes sense because there are certain rhymes to this. In most recent history, January of 2016, which was the worst January in the S&P of all time. Now, I don't know if January of 2022 is going to beat that record or not. Well, I guess I'll wait to even look at that math for a few more hours because we're in the middle of

the trading day on January 31, as you and I are sitting here talking. But in January of 16, you had people saying, oh my gosh, the Fed's going to raise rates four times this year. You had people saying, oh, my gosh, the Fed's going to raise rates four times this year. And Goldman, I had just come from an event in late 2015 with some of our taxable fixed income managers at Voya. I had had a dinner event with former Fed Chair Ben Bernanke. Yankee. So across the sort of intellectual apparatus of Wall Street, I didn't find an exception to the rule that we were entering 2016 with the expectation of significant Fed tightening. Now, the catalyst in January of 16 was the Fed tightening concept combined with an event-driven moment, which in that case was China, and concerns about them changing their own currency policy and it having a big negative effect on global trade

and global economic productivity, well, that didn't last very long. By the middle of February, there had been a lot of white flag surrendering and central banks and countries changing policy and sort of capitulating. And then we ended up going that year, the whole year without the Fed raising rates at all. And that, of course, was the election year. And so there's a lot of things that then don't align. And I will say this, if this ends up being a really good year in the market or a better year than it feels like right now, it's not going to be because the Fed decides not to

raise rates because the Fed's going to raise rates. And in January of 16, that was a cause of market distress. There was concern about the level of Fed tightening. And a lot of the relief came when there was global coordination about not tightening. So I guess you could argue then that the cause was the same, was similar, not the same in 16 and 22. Some of it was the same. But what is going to be different going forward is, look, there's no way. I think you

could see 2022, the Fed not tightening as much as people think. But no, they're not going to go the whole year without raising rates like they did in 16. So there are some similarities that, again, are more in the rhyme category, but not the repeat category. That was also a presidential election year. This is not. You can look back to other moments of intense market distress. And because I think this is valuation oriented with some of the frothier things in the market having to get revalued, not just simply because of very, very, very modest. By the way, so far, not even starting yet, Fed tightening, but to the degree there's going to be some tightening of the balance sheet and some increase of rates still to a negative real rate level. It's just a bit different than some of the other market corrections that we've had.

I think that the last time that there was a part of the market market corrections that we've had. I think that the last time that there was a part of the market fairly valued that was still appetizing to investors like myself, and a part of the market that was overvalued, and really, obviously, we have to say, grotesquely overvalued, was the NASDAQ in the beginning of 2000. And you came out of a 1999, where I think 44 of the 500 companies in the S&P had created over 100% of its return. And yet it was a huge year up for the market with not even 10% participation getting there. It was so overweighted and valuations for the NASDAQ were so extreme. Here's the rhyme versus repeat portion. There's a ton of highly valued stuff that started to come off. A lot of it already has. Some of these innovation tech ETFs that got so popular,

they're down over 50%. However, the big names in March of 2000 also got hammered. Some of the huge names in the technology ecosystem that were not worthless dot-com names that did have revenues and balance sheet and profitability and reputation, they went down substantially as well. And a lot of the big, huge e-com companies were left for dead and then ended up now becoming some of the biggest companies in the world. The difference this time is I think you could see a real repricing of the NASDAQ and a real repricing of the technology sector. But you're not going to have those big, huge names get crushed to the same degree, 50%, 70%, 80% drops. That's not going to happen, in my opinion. And so that's a big difference. But that doesn't mean

you can't have 20%, 30%, and 40% drops. You could have a repricing just to correct valuation that gets to that level. But I would say the similarity to us is I don't see any reason why a lot of the large cap value names have to drop in proportion with these NASDAQ names. Just like in March of 2000, you can have one sector of the market drop a lot and another sector actually do real well. And that's what is called a rotation. That's what we used to experience very frequently. And then since the financial crisis, we've gotten that out of our minds. We're used to thinking of every risk asset going up or every risk asset going down. And in immediate market response to COVID, to Brexit, to an election thing, to a trade war, to China posturing about something, to Greece falling

into the Mediterranean, to European Union solvency, the flash crash. You go back to what started as this massive credit crisis in 2007, 2008, and every bit of market gyration we've had since, it pretty much sold off the whole market and pretty much rallied the whole market in either good or bad moments. But before that, rotation was very common. And that's what I think 2022 is likely to create is is an area in which some stuff goes down and other stuff goes up it's not binary well and David when you talk about 2015 we were grappling with the first rate hike since the financial crisis now in 2022 we're positioning for the first rate hike since the start of COVID, so to speak. But in 2015, you had a lot of stock market volatility, same thing with 2016,

as you mentioned. And there was talk at the time or chatter that perhaps the Fed was delaying interest rate hikes for fear of upsetting the market or for fear of volatility. And they actually mentioned the phrase financial conditions in some of their commentary. I'm wondering, though, if you think that the Fed is still concerned about stock market volatility, as they grapple with this next rate hike, because now in 2022, inflation is such a concern where it wasn't such a concern in 2015. So I guess the question is, how is the Fed looking at stock market volatility now? Well, I don't think the issue then or now is volatility. I think it's overall health. And the Fed rightly understands that market volatility is different

than market health. Up and down gyrations don't need to scare the market much. So having a bunch of 5% moves doesn't affect the Fed. But in the fourth quarter of 2018, where I will also remind everyone there were no inflationary issues there either, but the market dropped 20%, 19.8%, and the Fed crumbled immediately. Look, in 2015, I will grant you that they raised rates. But they raised rates one time by one quarter of a point after seven years of the zero bound and a full year after they had ended the tapering of QE3. So they announced tapering in June of 2013. They didn't really clarify it till October of 13.

They didn't start doing it till December of 13. And then they continued buying bonds all through 2014. Well, look, two things are true at once here that make this a little difficult to analyze about the relationship of those events to stock market. Stock market was up in 2014, Scott. It was up in 2015. It was up in 2016. But from the middle of 14 to the middle of 2016, there was actually a two-year period where it was pretty flat. So even though full calendar year returns to those three years were positive, one could read it a bit differently. But here's a very important thing have to unpack. And that was the late 2014 collapse of oil prices that put huge disinflationary pressures in the market. And that came coincident with the dollar rallying 20%. So the Fed basically

had all of its tightening done for it in the currency, in a forex sense. That dollar rally was a major problem. There was nothing they could do about it, but it did cause them to chicken out. So when you're asked about the stock market, I don't believe from Greenspan to Bernanke to Yellen to Powell, there's been a Fed chairman or woman who won't chicken out by the stock market at some pain point. But the stock market's not the only one. High yield bond spreads and the dollar, okay, credit spreads and the dollar have got to be on that list because we have historical precedent from 1998 with long-term capital management and the Asian crisis and the Russian crisis, which happens to be a moment in

time. I've studied a lot historically. I think one of Greenspan's weakest hours, all the way up through current events over these last, let's call it 25, almost 25 years, we have seen the Fed capitulate from some market event, and it's not always been the stock market. We have precedents of it being equities at some points, but also credit spreads and also dollar. David, curious about your thoughts on last week's trading action, which, you know, we don't need to really get, I guess, get too much into the weeds on the short term, day to day trading. But I think it's important because we saw so many swings last week, both downward swings, and then last Friday, a huge upward swing. And I'm wondering if you have any take on,

I mean, obviously, we know downward swings make people nervous, but even upward swings, probably not the greatest sign either, right? I mean, that's not normal, so to speak. So any takeaways that you'd want to share from what you saw last week? Yeah, well, I would just say it wasn't only last week. It was the week before as well, where you had almost no correlation between what happened in the futures markets overnight and how markets opened or no correlation between the direction of futures and how markets closed. The market could be at one place at 10 in the morning, 11 in the morning Eastern time and a totally different place by three or four. So you had wild outside of market volatility, what we refer to as the futures market that

exists either after market in the evenings or pre-market in the mornings. And then you had wild volatility within the cash market of the daytime market trading hours. And of those 10 days of the last two calendar weeks, I think nine out of 10 of them showed some level of this erraticness. And so I don't expect emotionally people will think this way,

but I think intellectually they should. A big up day in the market that follows erratic behavior and foreshadowing and things should be thought of as a negative. The market being up a lot and then going down quickly might feel bad. And the market being down a lot, then going up a lot might feel good. But both things are actually the same thing, which is a directionless market, not rooted in fundamentals, not finding a kind of coherent

stability to formulate long-term trading positions. What's a long-term trading position? It's where a real investor has an outlook that they express in the form of an investment. They do it at size. And so it gets reflected in market pricing. None of that's going on at all. None of it. What's happening is computers trying to clear out trades,

reduce some margin, reduce risk, pick up some, even out. It's all very short-term minded right now. And so you will get a little clearing of the field at some point, but I have no confidence in anything I see in the market out of short-term activity right now that would lead me to be concerned about anything or be excited about anything. My source of concern and excitement is always about the things I do see that are longer term in nature, but they're not market action. They're not market price oriented. So coming off of this volatile month in stocks, what are you and your investment committee doing from a, I guess, client point of view? Kind of what's next and what are you watching? We're bottom up investors, Scott.

And so our investment committee had a consumer staples name that we decided to exit. We exited everything at a great price. And now we have some cash we want to put to work. And we're doing the research on a couple names that we may be adding to the portfolio. We have a couple names that have gotten to price targets that we want to trim some positions down. And a couple names that are below price levels we want to add to them. So we're methodically, slowly, diligently preparing for a portfolio rebalance that will not increase our net equity exposure and will not be decreasing it substantially.

On the margin, it might decrease it a bit just as we rebalance with some credit or boring bonds or alternatives or other asset classes we deal with. But within some of our portfolio silos, even apart from macro asset allocation, we're just trying to kind of get our composition of companies and convictions right. That's our focus. And that's the advantage that bottom-up fundamental investor, cashflow-driven can have, is that we don't really have to be connected to the insanity. Now, by the way, we're recording January 31. You may recall what we were doing January 31 last year, because we were sitting around wondering what these meme stocks meant. And people that were

on chat boards were going after short sellers and what kind of disruption that represent in the market. All those meme stocks actually hit their highs on that day. And then they came way down. They ended up going back up later, not back to new highs, but they ended up rallying at different points throughout the year. But my point is, even a year ago today, there was just crazy things happening and I didn't care about them. They didn't affect me or my clients because we're not going to participate in that. We're not going to participate long. We're not going to participate short. It's not in the orbit of what matters to us as investors. And so right now, I feel the same way. Now, let's put aside

the shiny object issues that I've written about, talked about a lot. What is our overall view of the market X shiny objects? I don't think any of it's cheap. Even some of my beloved energy names are at prices that don't make me think screaming value. I still think they're fairly valued, but I don't look at some of the energy companies that we owned at a certain price that are now more than double that price and feel about it the same way. Midstream energy is one thing I'm very grateful for. At those yield spreads and these valuations, these improved fundamentals, the improved credit metrics, I still feel like there's great value there.

But for the most part, we are dealing every day with the burden not of being shiny object investors. We have the peace of knowing we're not shiny object investors. But we have the burden of still investing in an expensive moment in valuations and believing that the negative real rate that cash guarantees is an unacceptable option for our clients. And so we have to be diligent, careful, set expectations the right way. We think we're in a single-digit positive return environment for equities if things go very well. go very well. There's no scenario by which I expect double-digit positive returns from major US equity indices this year. And that's just a byproduct of the valuation level that they entered the year with and the earnings environment we expect we'll be in. We're only

about a third of the way through earnings season. We'll get a lot more information. I'll have a bit more of a feel for how Q4 earnings get reported in Q1 the next time you and I are on the call together. By then, we'll be 70%, 80% through earnings season. So I want to let that play out. I know people want to ask about Russia, Ukraine. I continue to believe. I actually have a line in DC today. Now, I guess by the time people are hearing this, it'll be Tuesday, and this will be in the DC Today from Monday. But the good news is that I think some of the sanctions and things that we're likely to see out of the White House response and Congress, we'll have to back them up there, are not likely to be very market sensitive. Now, the bad news is that the sanctions and things aren't likely to be very Russia sensitive

either. I don't think it's going to move the needle a whole lot. So there's either a good or bad there, depending on your point of view as a market actor and your geopolitical viewpoint. But you get my idea. So that's where we are right now, Scott. Those are the things we have our eye on. And I believe a lot of the things people are talking about, you know, what the Fed will do or how the midterm elections go and so forth. I think

most of those things are very, very unlikely to be the big needle movers in the markets in 2022. in the markets in 2022. And David, just a few other short-term events, items. We have a jobs report on Friday, obviously backward looking at the month of January. We'll have more inflation data next week with CPI. How are you watching those? And I guess for whoever, you know, for the investor, the viewer watching, you know, how would you sort of rank those reports in terms of importance to one's investment outlook? Well, all of them are important. But the reason why some are more important than others is the ones that are susceptible to having a surprise. why some are more important than others is the ones that are susceptible to having a surprise. Something can be an important data point, but if it's already known and it's not going to change from what is known, then it becomes less important. And that's the case with kind of the jobs environment. We're at full employment by the Fed standard. We have too many job openings,

but that's different than too many unfilled jobs, meaning people that can't get work, that there's not availability that is more of a recessionary condition. We're in sort of an anti-recessionary position now. However, the price data, which we're talking about as inflationary readings, it won't be January's. It won't probably be February's, but there's some point coming. I wrote about this in the white paper. It was one of my themes of 2022. There's some point coming in which the inflation rate is still pointing to a very high number, but it's a lower number than it had been. That's where all of a sudden, I think you get to see the real Fed, the truth serum Fed, where they will take an elevated above their inflation price target, but yet nevertheless,

one that is below what it had been, referring to a disinflationary pressure as the rate of inflation goes down. And I think start to use that as their off-ramp towards their stated hawkishness. And I expect that will come in some point in Q2. And so when you start seeing data that is still elevated inflation, but disinflation from the prior elevations, that's where I think you'll start to see a different level of Fed communication. But as long as CPIs and PCEs and these other readings we see of price levels, PPI and so forth, as long as they're giving people headlines that talk about 5%, 6%, and 7% and highest since 1984 or 1993. As long as these headlines are out there, the Fed's going to play it cool and say, oh, absolutely, we're really targeting price stability.

But it's when they get a data point to provide some sort of cover, that's when I think the Fed we know comes back. All right, David, great to have this conversation after such a volatile few weeks for the market. And thank you for your insights. Look forward to speaking again real soon. Scott, thanks again for the thoughtful questions. And thank you for fielding the calls And thank you for fielding the calls for me when some of these press outlets call. You do a great job with that. I guess our listeners and viewers often don't know when they see me in the Washington Post or Wall Street Journal that it's generally those outlets are calling you and you're facilitating. And I think that you and I getting 30,

45 minutes like this to talk common sense and me getting 30, 45 seconds to talk with a reporter, hopefully it's all doing the same thing, is wherever I have a chance to be contrarian, to be countercultural, but to be a truth teller, that's what I want to be. And, you know, when we have a view that's consensus, I'm going to share the consensus view. I'm never going to go to a non-consensus view just to be non-consensus. And a lot of our views right now are consensus. But I also want to not just tell people what we think is going on. I want to tell them why. And I think the best why for the month of January is rooted in an evaluation narrative and not some of the other things that have been out there.

And hopefully that'll provide for a bit more cogency in the way people think about markets throughout this year. So I'll leave us there. Please, anyone with questions, follow up. We are pretty good about writing back quickly and thoroughly. The email is questions at thebonsongroup.com. So I'll go ahead and leave it there and look forward to being back with you in a couple of weeks in the same forum. And with that, we'll bid you adieu. Thanks so much. advisors, LLC. This is not an offer to buy or sell securities. No investment process is free of risk.

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