The Dividend Cafe - Market Volatility and YOU

Episode Date: April 14, 2018

This week, David Bahnsen covers important concepts regarding investor behavior in light of recent market volatility, and more..... Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Well, hello and welcome to this week's Dividend Cafe. This is David Bonson, Chief Investment Officer and Managing Partner of the Bonson Group. And we're bringing you our weekly Dividend Cafe podcast. We hope you're subscribed to the Dividend Cafe podcast. If not, please do so. Write us a good review, all those things. I hate saying it every week, but it's just important in the way all these things kind of work mechanically, so I have to keep reminding you. And remember, if you actually like listening to podcasts, which I've become obsessed with doing so everywhere I'm walking around or in my car,

I'm listening to market podcasts and different things I've subscribed to, it's become a great way to just constantly get really high quality information. And we do an advice and insights podcast, advice and insights, which is meant to be longer form, a little longer than this Dividend Cafe podcast, and do a little more in-depth treatments of certain market subjects. So I'll leave that commercial stuff behind and move on to this week's content. You know, it's a funny week, elevated market volatility continued, but really some of the specific trade and tariff rhetoric actually seemed to stabilize a little. So you would think maybe things would have settled down

a bit, but I guess the potential for military action in Syria, the retirement of our Speaker of the House from the Congress, highly, highly publicized congressional testimony from the Facebook CEO and, you know, this little FBI raid on the president's personal attorney's office. All of these things happened in the news this week. So I guess these four stories normally would make it one of the biggest news weeks of the year in normal times, but in reality, it was probably kind of a slow or regular news week based on the lay of the land these days. But as far as what we're going to do here in Dividend Cafe today, it's primarily focused on an unbelievably important practical investor understanding and behavior. And I'm also going to delve into some stuff on interest rates, the bond market, emerging markets, MLPs, and more. It won't be too long, but let's get into it.

This really is, I think, one of the more important things that I've ever written, ever uttered, ever reflected on. But it means the world to me, and it's at the very core of what we are doing at the Bonson Group and believe at the Bonson Group on behalf of our clients and what we feel is our job to properly steer and direct them. It is our job to properly steer and direct them. I've written for nearly 20 years of the pivotally important truism that risk and volatility are not the same thing. That risk is the possibility of a failure to achieve a financial goal. Whereas volatility is the up and down movements of value in asset prices, which are inevitable in the life of any investor. With complete economic logic and empirical support, I've sought to define volatility as the key ingredient in risk premium, meaning the cost of the premium return that investors receive to be invested in an asset class like equities.

If there's anything I will never tire of repeating for the betterment of my client's understanding and well-being, it is this. I also, though, am not unaware as to why this understanding of volatility, while intellectually irrefutable, is not always emotionally adequate. During periods of volatility, one does not necessarily seek refuge in the Investopedia definition of equity risk premium. My mentor in this business, Nick Murray, defines risk as the exposure to an impairment of my standard of living and or a permanent, irachievable loss of capital. So when markets go through periods of enhanced volatility, one first has to address the substance. Is my client's quality of life actually threatened by this?

If an investor has put all of their money in a tech fund and they need to pull it all out in 30 days to pay for a wedding, I would say that they have more than just the quality of their life to worry about. But if we as financial planners, advisors, professionals have done our jobs right, understood the liquidity needs, planned for the proper access right, understood the liquidity needs, planned for the proper access to capital at the right time, the right needed times, done thoughtful matching of solutions to resources and needs, and one's bucket of accumulation capital or even dividend-creating income capital is experiencing up-and-down movements in value, in what way is one's standard of living threatened? The answer is that when planning has been done, it is not.

So the first box can be checked. We are paid to make sure that box is checked. Any failure to have that box checked is malpractice. But that doesn't end the discussion. For even where no possibility of market volatility leading to an impaired standard of living exists, fear, insecurity, uncertainty, and questions can linger. What if the market volatility we are suffering now does nothing to impede my standard of living, but one day it will.

It won't, but is that questioning normal? Of course. And what is the antidote to it? It is us. We will do the two most important things in periods of such questioning that can ever be done. A, we will listen. B, we will keep one from acting on such questioning in a manner that will guarantee the outcome that they're so desperately afraid of. Put differently, the fear one has in periods of volatility of a compromised quality of life will not come to fruition but by the fatal decision to act on such fear. So to that end, we work. I mentioned a moment ago the Advice and Insights podcast where we do deeper dive treatments into various topics. A lot of you know that new tech and the potential kind of paradigm shift or headwinds in how social and political

forces embrace the new technology sector has been a big theme of ours and we've talked about a lot. And this week's Advice and Insights podcast did about a 20-minute treatment into that specific subject. I encourage you to check that out. Something to be energized about. Longer-term listeners and even readers of Dividend Cafe will remember the heavy focus on correlation between stock prices and oil prices in the early months of 2016 and our study of how in that environment, risk assets were also heavily correlated around that one particular theme. If oil prices were folding over, it likely meant

China was, and that was bad for all commodities. And high yield bond paper was heavily invested in energy companies. No one knew how much exposure the banks had. So in other words, the contagion effect in both cause and effect, a negative feedback loop, was significant around oil prices in that era. In other eras, a declining oil price has been associated with a positive environment for stocks, not negative. Declining oil prices in the 80s indicated the defeat of the 1970s inflation, and few things have ever been celebrated by the stock market like the defeat of 1970s inflation. Well, what is going on now? Stocks are in elevated volatility.

The Trump administration is indicating a willingness to suppress economic growth in order to work on better trade deals. a willingness to suppress economic growth in order to work on better trade deals. The VIX has blown out, but yet oil prices have not budged. A $65 range is impressively stuck. Oil was, in fact, the best performing asset class of quarter one. The disconnect between this and energy stocks so far is fascinating. Feeling better about bonds, one of the amazing things taking place in capital markets right now beneath all the questioning around equity market volatility is the relative stability of bond yields since that flush out back in early February. The 10-year bond yield has settled pretty consistently

around 2.8%. Hasn't gone above 3% as some feared, but it's not back to the 2.6% where we started the year either. In fact, bonds have more or less traded in reverse correlation to stocks. As the trade and tariff-related stock market volatility has ensued over the last six weeks, the trade and tariff-related stock market volatility has ensued over the last six weeks, the reverse correlation to bonds has resurfaced, which is more in line with historical expectations. My great fear earlier in the year was not that stocks would drop, but that if they did, bonds may very well drop with them, as opposed to serving as a mitigator of portfolio volatility. At this point, I would continue to suspect a volatile ride is in order for equities,

but I do believe that if there were to be a risk-off trade in capital markets, a total defection out of risk-oriented assets, those who are holding bonds that act like bonds will be much better off. Holding bonds that act like bonds will be much better off. Deficits create higher interest rates, except most of the time when they don't. You have to read DividendCafe.com this week to understand a little what we put in there about the relationship between interest rates and deficits, why sometimes growing deficits pushes rates higher, why that's the more logical thing to expect. But then there are certain caveats that have to be understood. And ultimately, my application of this is that we basically don't know how it plays out because we don't know who the buyer of treasury

bonds will end up being that will sort of dictate where interest rates go, our anticipation is it would end up being heavily dug in and trenched reliance on foreign buyers at a very time in which the Trump administration's trying to reduce the trade deficit. And that trade deficit has actually been the source of a lot of the funding of capital back into the U.S. to purchase our own treasury bonds. So it sounds like a complicated thing, as I stated here, but read dividendcafe.com. It really isn't that complicated, but it is really that important. The emerging markets story in all this, while the U.S. equity markets play tit for tat with trade talk, China, Trump, Kudlow, and the rest, emerging markets has been

fascinating to watch. Not only has emerging withstood the equity volatility of U.S. markets, but the global growth story has created more capital flows into emerging markets, which has resulted in stronger emerging market currencies that are up about 2% to 3% on the year on average against the dollar. This then stirs more credit creation. And of course, out of more credit creation, more domestic demand. Now it's important to say that the domestic demand story on an individual company basis is what we invest for in emerging markets. But when you get macroeconomic reinforcement of it, it seems fair to point it out.

I'm going to close the podcast there for the week. I have to point you to a chart that obviously I can't illustrate for you in the podcast, but our chart of the week at DividendCafe.com demonstrating the performance of dividend growing stocks out of the S&P 500 versus those that pay dividends but don't grow them versus those that don't pay any dividend at all versus those that have cut the dividend out of periods of rising interest rates going back about 40 plus years. Unbelievable to see the benefit that dividend growing stocks go through on average out of periods of rising interest rates. We're such a big believer in that story. And it may be timely for you to look at it.

I've gone long here this week. I'm going to cut it off here. Thanks for listening to the Dividend Cafe podcast. Please reach out to your private wealth advisor at the Bonson Group anytime. If you're not a client of ours and want more information on the business, thebonsongroup.com. Reach out to us. We'd love to chat with you.

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