The Dividend Cafe - Market Outlook w/David L. Bahnsen - November 15, 2021

Episode Date: November 15, 2021

Market movers and shakers discussed in today's episode. 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. Welcome to our still going bi-weekly national calls. Scott Gamm and I are going to continue doing these pretty much every two weeks as we have been since March of 2020. I think there's been a couple weeks where we got a little off of the schedule. The only difference is that we're just going to sit here and record it and then make it available right away on YouTube, on video. We'll distribute through DC Today, put it out as the Dividend Cafe podcast, everything

we've always done. But rather than also tie that to the simultaneous live broadcast, we figured it's easier. We're just seeing that the traffic for this has grown a great deal. There are a lot of people listening to the podcast, watching the video. But the amount of people that are actually trying to make it a point to go capture it live right when it's on, that number seems less relevant at this point in time. Should we get to a point where there's an ad hoc event in markets? I'm hopeful scott would accommodate with his schedule if we need to jump on live you know for a kind of particular

event but having people meaning all of you possess the the flexibility as to when you watch and listen we thought would be easier for your schedules and probably easier for mine and Scott's and our production team and so forth. So we think the actual literal live footage kind of outlived its usefulness. But nevertheless, the content we want to keep going. And so we're still taking questions every single week that we'll cover on this dialogue questions at thebonsongroup.com. And we'll still continue getting it out at DC today on our YouTube channel, on our podcast. I have not conferred with Scott at all about what questions he has on the docket for me today. I do know a lot of things going on in the world

right now. I'm going to turn the mic over to Scott and let him grill me for the next 30 minutes. All right, David. Well, thank you so much and great to be with you as always. And David, let's start with the markets as we always do, but broader markets at or near record highs, even with the continual wall of worry that the stock market faces, inflation perhaps being most front and center. Why do you think the market is still climbing higher, even with something like that in the backdrop? Yeah, I mean, I think we have to let the premise of the question help answer the question. With the backdrop of big inflation concerns, why are neither the stock or bond markets really responding?

And I think that might help to kind of perhaps influence how we interpret what is happening in the economic data. Now, first of all, some might interrupt and go, what do you mean the bond market's not responding? The 10-year yield has moved. It was at 1.35 and now it's 1.55 or something. So the 10-year yield has moved up a tiny bit, but we have to look at this the full year. When did the price data start going higher? When did we start seeing signs of rising prices that began the debate as to whether or not it was transitory, whether or not it was inflationary, whether or not QE was causing it? Well, that was back in March of this year. So let's say about eight months ago, the 10-year then got up to 1.85%. So the fact of the matter is the 10-year is a little higher than

the last two weeks, but it's quite a bit lower in the last eight months throughout this whole debate. So I think the bond market has had its opinion all along. And then there are those who say, well, yeah, but maybe the Fed has been buying these bonds through the quantitative easing program, and that's influenced it. The Fed announced that they're tapering away their own purchases of the bonds, and yields came down. They didn't go higher, which is something I had been writing all year. I expect it would be the case because I haven't believed for quite some time that the

Fed was the reason that the long bond rates were so low. So the broader issue, though, that I think is more relevant to people listening that you get at is why is the market not responding much to it? And I don't think we have much of a choice but to say that the market believes. The market could be wrong this could all change later markets are not fixed in stone what happened in the past is not predictive of what may happen into the future but at this juncture in time markets are speculating projecting and pricing that they believe the factors creating these price escalations are solvable. That they are, as I wrote in Dividend Cafe Friday, supply related, meaning we have various extraneous circumstances that are limiting the goods and services and the production of goods and services in the economy that are serving as a hindrance to meeting the delta between the demand and the supply.

And that delta with a higher demand than supply is naturally pushing prices higher, where I think the markets would revolt as if they believe the price inflationary pressures to be monetary. And I do not believe them to be, and the market does not believe them to be. But I do believe there's a very serious supply side problem. And I think that we've talked ad nauseum about the supply chain problems, but that's not the only thing I'm referring to here. about the supply chain problems, but that's not the only thing I'm referring to here. I'm referring to the fact that people all over the globe

massively misestimated, underestimated, to be more precise, the demand resurgence that would come in a post-COVID scenario. And so now that demand has been so escalated, it comes at the same time that you have not only supply chain disruptions, but also total supply production problems, not just getting them off the ports, but actually getting the goods and services made for a whole variety of

circumstances. And one of them being the one that concerns me the most, which is the decline of labor participation. You need more workers for more supply, you need more productivity for more supply. And with more supply, you'll get price alleviation. I do think it'll happen. The market seems to be saying the same thing. And David, also, we have more infrastructure spending coming with the bill expected to be signed today. Is that more of a long-term inflationary force, or do you not see much of an impact on inflation from that? I don't see much of an impact on inflation from it. Neither, of course, do bond yields.

But I don't see much of an impact into productivity either. I want to be proven wrong there, by the way. I don't want the really minimal effect into productivity from the stimulus bill of 2009 to poison the well here. In theory, money can be allocated in such a way that it could marginally have an impact. However, a lot of this money doesn't even start beginning to be spent until 2024, 2025, and it lasts over a five to 10 year period. So there's a big price tag with the bill, but the actual impact of what things are spent on, where there may be some production is kind of more drawn out. So I don't think there's a huge impact there.

And David, when it comes to the broader markets, the Dow, nicely above 36,000, the S&P not too far from 4,700. Any reaction to those particular levels? We mentioned earlier that those are at or near record highs. But just because of this timing. My position on this is really quite consistent that I don't care much about price levels. I care about valuation levels. My friend Kevin Hazit, who was the head of the Council of Economic Advisors in the White House, is a well-known economist for many, many years and someone that I become friendly

with through my work with National Review, was kind of well known for the fact that he and a co-author wrote a book predicting a Dow 36,000, and he wrote it a long, long time ago. And so there's sort of this interesting thing about that number, 36,000, because a book had been written predicting that price at a time when that price seemed just like fantasy land. But as I think we've gone over quite a bit, the market's all-time high has been hit hundreds upon hundreds upon hundreds of times over the last 10 years.

And there's nothing about an all-time high that has anything to do with what the next price will be, because every number on a vertically escalating price system is on the way up is at one point always the all-time high. The question is whether or not valuations are reasonable. And the answer to that is they're more reasonable when contrasted to the very low interest rate prevalent in the economy. And you get a boost in valuation from that low discount rate, that low short-term cost of funds. When you compare equities to bonds, the equity risk premium is very attractive because the yield of those earnings in the S&P compared to a bond yield, it becomes more attractive when the interest rate is that low. But there are certainly by a number of metrics, some aspects of the stock market that are expensive. And I could have said the same thing a year ago, and I'm quite sure I did say it a year ago.

Some of those things in the tech side have not done well this year. A lot of them are down big. Some are just sort of flattish, including some of the biggest names in the world. And this is always a surprise to people when they find out that these numbers have been a little underwhelming in more recent times like this calendar year. Some, though, have done quite well. There's a day of reckoning coming that's sort of akin to what happened in the NASDAQ in March of 2020. I don't know. I don't think it all ends real well, but I don't know that it comes with a big bang moment like happened over 20 years ago. I just know that when you talk about valuations, that not all sectors of the marketplace are created equal.

And I think in the long term, valuations matter a great deal, but they don't always matter so much in the short term. And we do tend to see some seasonal strength at this time of the year heading into year end, right? As folks reposition, talk about a Santa Claus rally, that kind of phenomenon. Is that something you want to weigh in on? Or is that not even relevant to maybe the discussion of markets today? Yeah, I mean, in my 20 plus years of doing this, I sure feel, I think I may have said this line before, I'm open to my wife correcting me. It feels to me like around the holidays, about half the time throughout my marriage and my adult

career that markets have done pretty well. And about half the time, something seems to have gone wrong. So that doesn't seem like a very clear trend one way or the other as to what could happen. But I know that when markets go up a lot in December, we refer to it as a Santa Claus rally. I think the problem is that generally we're talking about certain revenues really escalating at the end of the year, that the market gets final indication that some concerning legislative things don't happen or some good legislative things do happen. And then that kind of just happens to get priced near the end of the year. There are event-driven particulars in more recent history that are real and relevant. In 2012, going into 2013, there was this thing that we were calling the fiscal cliff. And it was the concern that a lot of the investment tax rates and personal income tax rates from the George W. Bush administration were going to be resetting back to pre-tax cut levels. And there was a lot

of ambiguity and uncertainty in the market. And near the very end of the year, over the holidays, they kind of worked a lot of that out. It got worked out very favorably relative to what markets were concerned about. So you had a big rally. I don't think that was relevant to the fact it happened to be the month of December. If the Bush tax cuts were going to be expiring in July, it would have been summer. But my point being, it was event driven. I can assure people who remember December of 2008, that was not a Santa Claus rally. It was a very difficult time in markets. But there's been plenty of Decembers that were quite strong in markets. Last year was a pretty good one.

December 2018, by the way, well before anyone ever used the term COVID, the markets in the fourth quarter of 2018 dropped 20%, particularly on Christmas Eve. We're down, I think, 700 points in 2018. But then you got a pretty good rally in the couple of days after Christmas. So my point is, all over history and recent history, there's different periods of different events. I'm not looking to the seasonal nature of November and December

to have anything particularly relevant to happen in the markets? Could there be an event-driven response around something with China, an event-driven response around something with legislation? Certainly. But we're pretty much done with earnings season now. And we pretty much know where the Fed is. There is no groundbreaking surprise announcements I expect from the Fed. So all things being equal, I think and I hope it's going to be a boring next six weeks to end 2021. And then I think we enter 2022 with a lot of questions. And believe me, we'll be doing plenty of talking about that, writing about that as we go into the new year. But as far as Santa Claus rally, next four weeks, next six weeks, I think it's a coin flip. And David, we have an extra trading day this year,

because there's no market holiday around New Year's Day, if I'm not mistaken. We are open December 31st, which is a Friday. Yeah, I'm trying to think if that's going to be a half day or not. I believe Christmas Eve is going to be a half day of trading and New Year's Eve will be a full day. But let's just say that for those that are wondering what the New Year's Eve day will be in terms of trading, that are wondering what the New Year's Eve day will be in terms of trading, I will tell you where most Wall Street traders are going to be that day, and it is not at their desk. Yes. I think they call those days light volume days. Very much so, yes.

David, let's also talk about earning season, which is wrapping up. We've got some retail names reporting this week. We'll get a better sense of the state of the consumer or perhaps more importantly, what these CEOs have to say about supply chain issues as we head into the holiday shopping season. Any thoughts on what we've seen so far from earning seasons? And then also talk about the retail sector, if you could. Yeah, so we're not 100% of the way done. Like you said, there's a couple of retailers still reporting. But as far as the normalcy of the earnings calendar, it's effectively like 96% of the S&P 500 that's reported. So we're ready to kind of close the books on Q3 with a very close to 17% year over year revenue growth in the quarter and 41.5% earnings growth. And those numbers will be

in DC today. So the earnings growth that we've gotten from the earnings troughs of a year ago, post-COVID and post-lockdowns, have pretty much mirrored the recovery in markets, as you'd expect, and outperformed expectations. Earnings in Q2, Q3 of last year did not contract as much as has been feared. They contracted a fair amount, but it was not as much as people expected. And then the actual earnings growth in Q1, Q2, and now Q3 has been far above expectations. So that's the reason for markets recovery. And it speaks to the resilience of corporate America. But it also does beg the question as to the sustainability of earning surprises. And I'm torn on this subject because at some point you think the market loses the ability to surprise markets. Companies lose the ability to surprise markets without performance because people throw in the towel and just start overshooting on expectations. And yet the reason why I'm pulled the other way is I can say that every quarter, but you're now six quarters in a row of pretty substantial outperformance relative to expectation. And a lot of people felt this was going to be the quarter where markets finally couldn't outperform the way they had been used to doing so.

And they did it again. So margins are growing. Top line revenues are growing. And this is a big part of the inflation story about that delta between demand and supply. A lot of people underestimated demand in the economy, demand from the citizenry. And I think a lot of that demand underestimation comes down to a really tremendous misunderstanding of the human person. So what about sort of holiday spending, that kind of scenario, given all the supply chain issues we've been seeing, is that an important story for markets? Is that something you think some of the retail CEOs will shed more light on

this week when we hear more from them? Most of the stuff that's directly relevant to holiday shopping are in the consumer discretionary space where they kind of live and die off of being able to outperform expectations seasonally like holidays or sometimes back to school shopping or different events that are specific to whatever we may be talking about in terms of a brand or category or type of discretionary consumer operation. We are historically uninvested in the space or very lightly invested simply because they often tend to be very over levered companies and very cyclical and don't often meet the criteria of good consistent dividend payers and dividend growers. But of course, the only companies affected by the

Christmas shopping season, holiday shopping period, so to speak, are not just the retailers and consumer discretion names, because you do have other aspects of the economy that are relevant. You could argue that some of the shopping mall REITs, some of the manufacturers, the consumer staples might be, you know my opinion, the aftermath or the conclusion or the result of the things that really matter, meaning the production-oriented solutions in the economy. So I take for granted that when credit's not heavily constricted, which I assure everybody it is not, and the production side of the economy is rolling that the consumption side follows. I don't believe we struggle in our country from an ability to get people to consume when they want to. Everyone seems to be pretty good at doing that.

And I think that applies to retail and holiday shopping experiences and discretionary levels of dollars spent as well. So I don't want to say it doesn't matter. It matters very little, I think, in our portfolio, to be candid. But I think it matters to people who have more of a retail-oriented and consumer discretionary-oriented portfolio. David, let's end with a topic on taxes because for a good part of this year, we spent a lot of time talking about worries about higher tax rates, capital gains tax rates, corporate tax rates. Some of those worries seem to have subsided in recent weeks and months. We'd love to get your updated view on what you're hearing on the tax front and how worried investors should be about the possibility of higher taxes in 2022.

Well, it would appear that the White House's own version that still has to get scored and then worked out by the CBO and then presumably passed by the House Democrats and then go back to the Senate for more adjustment. And assuming it gets passed, resent back to the House. And based on what the Senate adjusts, the House then has to re-vote based on whether or not they approve of what the Senate did, that in this whole chain of events that still lies ahead, that there isn't even going to be an increase in marginal income tax rates on business income, on investment income, or on personal income. Now, even if there were, I don't know that this process of this bill becoming law is going to happen. I said before that I thought if the infrastructure bill didn't pass, there's no way reconciliation would,

and vice versa, that if an infrastructure bill did pass, the reconciliation would. I still think that's the best bet, but the reconciliation bill can't pass without somebody caving. And it now looks like someone will cave and it looks like that will be the progressives that they will have to agree to a lot of things they said they wouldn't can agree to, namely not raising taxes. Tons of the kind of green and climate-oriented things have been taken out. And then the spending levels, although they are quite high, are not what they had insisted

and demanded that they wanted. So I do think that it looks like part of the way they're telling the computers that they're going to raise revenue from this bill is a surtax on income over 10 million a year, an extra like 8% tax there. And I think it's a 3% tax at other levels. I mean, there's a little escalating surtaxes at very, very high levels of income. escalating surtaxes at very, very high levels of income. So a couple of those things may happen, and I'm not really happy about it, but I don't know if it's going to pass,

and I don't think it's obviously market impacting. So the question then is, well, what is market impacting from the legislation? If the tax rates aren't moving a lot, does the market mind that they are spending what could end up being one and a half to $2 trillion more? And I don't think that the equity markets see it as a huge event. I think the macro economy, if I'm right, that further deficit spending extracts from future economic growth. I think that this does speak to how we want to be positioned for the future. And the way I want to be positioned for the future

is outside of this narrative of heavy dependence on fiscal and monetary stimulus. And I believe that the policy indicators are such that they want to double down on dependence on both the fiscal and monetary side. So we have a portfolio view that's very contrary there. We want to be much more organically minded around free cash flow growth, around fundamentals, and around balance sheet strength. And I'm not pessimistic overall about the state of the market, but I am very much intensifying in my belief that selectivity is more important, both with the equity side and the alternative side. Fixed income, not as much on your boring bonds. Those are just parking lots and you're just buying,

you know, you can set your blended duration at three or at six. It really, it makes a few basis points of difference. But on the equity side and the alternative side, I think selectivity is becoming increasingly important. And David, this idea, though, that and we didn't this is not your view, but that folks should be making portfolio moves in anticipation of some sort of tax increase. Reiterate your views on that, because there was a lot of talk about that over the past couple of months. Yeah, I don't think people should be making estate planning moves, tax planning moves, or portfolio moves until they have clarity on what the bill is. Because there's no free lunch, which is the name of a book I recently wrote, meaning everything in economics is about trade-offs, it isn't like one could say, okay, well, I don't know if it's going to happen or not, but I'm going to do X to mitigate against the risk of something happening and have X be cost free.

There's some cost associated with that. So some trade off. Otherwise, one would have already done X. They haven't done X because there's a cost to it. And and it maybe helps with the risk of one thing, but it adds to the risk of another or what have you. It helps with the risk of one thing, but it adds to the risk of another, what have you. And because it appears that so much of the legislative ambition that was behind a lot of this reconciliation bill has been defeated, I don't believe people help themselves to incur unnecessary costs in the trade-offs of this non-free lunch that is planning for a reconciliation bill that requires passage in a very divided Congress, a very divided Senate. And therefore, I think people are wise to wait to see what's going to be in the bill versus trying to get out in front of it. And the only thing I want to add to that comment versus similar sentiments I've shared in the past about trying to get into capital gain management and incurring capital gain taxation based on a belief about what might happen in the future. And I'm vehemently opposed to such a thing based on the legislative uncertainty around all this. And at this point, the legislative likelihood of that not happening,

but I would apply that same principle to ones of state planning as well. People can talk with their advisors about different ideas, be prepared for what may or may not be out there. But those that are writing as if these things are fait accompli, they are wrong. And many of the things that people were months ago believing to be very likely are now not even on the table, Scott. Yeah, well said. David, I think that's a good place to leave our conversation for now, but I'll toss back to you for any closing thoughts. Thank you, as always, Scott, for the time.

I hope you guys have all gotten something out of it. The big three right now, the inflation, the reconciliation bill, and then earnings are the three things we primarily talked about today. energy around commodity prices, around economic growth assumptions. So, you know, I wouldn't be complacent on anything right now, but you know what we're doing. We're going to keep doing it. I'll go ahead and leave it there and hope that this has been a beneficial time. We welcome any of your feedback and comment, and we certainly welcome your questions to questions at thebonsongroup.com. Thank you for joining me.

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