The Dividend Cafe - Markets Look Forward

Episode Date: April 3, 2020

As I am taping Friday morning a short while into the final market session of the week, the market is nearly flat on the week (modestly down at this point). That came with a big move up Monday, a modest move down Tuesday, a huge move down Wednesday, a decent move up Thursday, and so far, early on Friday, a “flattish” day (though off a bit – again, moving as I type). Note the theme? A “flat” week in markets, but with huge volatility day by day by day. Why did markets go up 500 points the day the worst jobless claims data in history came out? Why did markets not tank on the news of the worst unemployment data in ten years? Because markets do not go down on news they already knew was coming. Period. I am confused by media and financial professionals who do not seem to understand this, but I take seriously my obligation to help you, readers of Dividend Cafe, understand this. Because markets are “discounting mechanisms,” pricing in today what they believe about tomorrow, “good news” cannot make markets rally unless it was not already expected, and “bad news” cannot make markets drop unless it, too, was not expected. And if you know someone who has not known that in the midst of this national shutdown, that jobs data was not atrociously bad, I really don’t know what to say. The key, my friends, is where we go from here, and that itself is riddled with uncertainty. So let’s unpack as much uncertainty as we can, and jump into a fruitful and useful Dividend Cafe. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. actually dead middle, right smack at the halfway point of Friday's trading session and ready to call it a week in markets. If things were to close right now, we'd end up down on the week a little bit, not very much. You had a very big up day on Monday, a more muted down day Tuesday, but then a big down day Wednesday, and then a pretty good up day on Thursday. And then we were kind of flat down a little to start off today, Friday. As I'm talking now, we've gone down 400 points. So 400 is traditionally a lot of volatility. These days it is not. But my point being the market may end up this week.

It probably won't end up flat. It will end up down, but not violently. So take that for whatever you wish. Actually, let me address that. It is something to address as far as what the short-term expectations are, which are for us, none. We don't have an expectation. We're living in the uncertainty of the moment that week by week, we feel that our client portfolios need to be positioned for the fact that equities week, we feel that our client portfolios need to be positioned for the fact that equities could drop a lot and equities could rally a lot. And there is not a logical reason or a technical reason, a predictable reason around it being one

or the other. That's true in every single week, but some may not know that, some may not believe that, but they're wrong. On any given week, that uncertainty is why one has to have an asset allocation that fits their investment objectives, and they have to have the discipline to be able to stick to it. And that became very hard, obviously, over the last month because of the challenges that existed in markets and the ongoing uncertainty that exists around the coronavirus pandemic. And so we sit here, I suppose, a couple of weeks further into the uncertainty, therefore a couple of weeks closer to it coming to an end.

But at the same time, the uncertainty is still very real. And unfortunately, there's not a real clarity as to when exactly that will be going away. There is a lot of positive data out there. I'm sharing a lot of the health information as I get it with a lot of you. But when the national shutdown of American enterprise is going to come to an end, And that will be the point at which markets fall off. I'm assuming people know that, that whether we end up with the really best case scenario of mortality around coronavirus, which is a very low number, or some of the higher numbers that have been thrown out there, which are awful from a human standpoint. But that most certainly, either side of those things is not what the market's responding to. The market's responding to the treatment,

not the virus directly. The treatment being the shutdown of the American economy. And again, others can debate what the policy response has been and what the good or bad and all that is. My only point is that from an investment standpoint and a financial standpoint, the ultimate end run here is for the American economy to reopen for business. And most assuredly, we understand that that is juxtaposed with the health care reality. But at the end of the day, the ability for American business to get back to business is what will drive some clarity around economic recovery. And so that debate about a V-shape versus a U-shape recovery, about some third quarter improvement versus fourth quarter.

Those things remain totally open-ended. Frankly, I'm exhausted by reading some of the analysis of these things because people are making predictions based on hypotheticals that are made up out of thin air. You cannot possibly forecast with any reasonable or fundamental foundation fourth quarter economic metrics without a starting point as to when the pandemic shutdown ends and what exactly the violence of the moment kind of becomes economically. The stimulus package is right now, as I'm talking, the Paycheck Protection Program, which is the $350 billion facility to support small business with forgivable loans,

companies under 500 employees getting up to $10 million of money they will not have to pay back if they keep their payrolls intact. Two and a half times their average monthly payroll. That program has been open for a grand total of three hours now. I'm actually surprised the data, and again, this will be different by the time you're hearing this, they funded in the first few hours, 889 loans so far. Excuse me. I may have, wait, wait, wait. I think I'm giving you the wrong number. Let me do this right. You know, I've closed it out. I believe it was $889 million at 2,800 loans. So forgive me. I mixed up the two numbers. And again, that's just rapidly going higher by the minute here. Will they end up with a backlog? Will there end up being reports of bureaucratic slowdowns and processing delays? I would imagine we'll see. But the point being,

companies have all the way to the end of June to be funded on these loans to apply. And obviously, most people are trying to get cash right away. So we expect some slowdown there. But I don't know how you predict fourth quarter recovery when you don't know how you predict fourth quarter recovery when you don't know how second quarter mitigation efforts are going to go, not just health-wise, but I mean economically. Not to mention other programs around the stimulus. The Fed is still kind of getting up and running with some of their facilities. You're seeing improvement where they've begun to intervene in some aspects of capital markets. Other areas still appear dislocated.

So this is the environment we're in. My motive in very heavy amounts of communication right now is purely to serve my clients and to inform them as to our thinking, to provide adequate amounts of information for their own digestion, to share our analysis and conclusions. What the motive is not is to somehow suggest that there is kind of a secret sauce or a kind of secret code someone's going to crack in timing all of these things perfectly. There's reasonably well-known variables, And what I mean by well-known is what those variables that are not known are. We know what those things are. We just don't know what their solution will end up being, how they'll play out.

But this is the point I would make. The unpredictability of the moment is both the risk and the opportunity. And that's basically true always. But it is more true now to the degree that the downside of various bad news and the upside of various good news is higher. You know, we're now looking at one to two percent up and down days as low volatility days. So that's just insane. I've commented a lot over the last few years that in 2017, we went all year without even a 3% drop. And now we basically are having something near that happen on a daily basis.

And we've had way too many days up and down that were far more even than that in the last few weeks. When I look into DividendCafe.com, which I've opened on my screen right now, I'm still kind of completing writing it, but I needed to get the recording going first. I do think there's a lot of information there, a lot of charts that are really useful. The flows into cash out of other assets in the month of March are staggering. You can look at it as bad news, which it is in hindsight, like it describes the bad news that was. You can look at it as good news, which it is because it describes the opportunity that will be. Both those sentences I just said are accurate. Neither one of them, excuse me, the

past one comes with a timeline by definition, but the future one does not. But $658 billion went into cash in the month of March, $284 billion of it, nearly half coming out of bond funds, from $156 billion out of investment-grade, high-quality corporate bonds, $47 billion out of emerging market bonds. I commented a week or so ago when it was a hedge fund manager of ours who shared that with me that I didn't even know there was that much money in emerging market bonds, U.S. investors. So the outflows are significant in speed to the dislocations we were living through in the middle of March and into the later end of March. And yet all of that money on the sideline at some point in time becomes a coiled spring.

And of course, timing of that is not our objective. I want to provide a bit of reminder. The sort of mentality of I'd like to wait to buy stocks till things are better, it's very understandable emotionally. It's not very cogent mathematically, but that's okay. A lot of times emotions have to trump math and logic. But I put in a chart this week from Yale. Bob Schiller had a really interesting graphic of the modeling of monies that were averaged into equities over the last 10 years. And a dollar you put in in 2010 versus a dollar you

put in 2015 what those dollars are worth now and it's really not rocket science to suggest that the most profitable dollars invested 10 years ago let's say are the ones that were done at the lowest level of prices. I mean really what I'm saying here is a tautology. It's in and of itself true. The lower price you paid, the more money that was made, obviously, in the future. But the reason I bring it up, and I think it is somewhat confusing for people, is that in the moment of distress, not with the gift of hindsight, the intuition is often, I would like to invest when things are better. And so I think people have to kind of get comfortable with which side of this they want to be on to the degree there is money that within

a prudent and properly constructed asset allocation plan that needs to be invested. One has to consider if the kind of current level emotions and obsessing over the nightly news versus the intuitive math and logic of buying lower, not higher, to feed longer term investment objectives makes more sense. I don't have a dog in that fight of trying to force anybody to invest money that they're not comfortable investing. You have to sleep at night. But you have to also make decisions with the full orbit of information and perspective. And that's what we're attempting to do.

Let me kind of move around a few other categories today. I'm increasingly intrigued by how this entire escapade is affecting Europe. And I don't just mean the health data in Italy, and then Spain, and then France, which are the three kind of worst countries. I don't really know why the picture is so much better in Scandinavia and even in Germany and Holland, but it clearly is. And I'm sure that there could be either medical or demographic or geographical or climate or any kind of other issues as to why the data and the impact has been more severe in some pockets versus others. But allow me just to say that the economic aspect and cultural aspect, I think, is going to become

one of these issues that we address later on in maybe a more normalized aspect of post-COVID thinking. The fact of the matter is that the European Union right now centers on a currency that is shared. And in a moment like this, the trading cross border, the various legal differentials country to country, they all speak to a very fragmented European Union. They all speak to the individual sovereignty of the countries. And it just does kind of beg the question what the shared currency is doing for any of them. If in a global health pandemic, you're functionally completely on your own as a country anyways, then why suffer through the cost of this quasi-unionization? And I intend to really study that all the way through. I'm going to kind of skip over some of the things I talk about at dividendcafe.com this week around bond spreads,

but there are some charts and some explanations that I think are important. I have been very careful to not let up on the topic of what's happening in the fixed income markets. Because for one thing, a focus only on equity markets doesn't serve my clients well, because equities only represent about half of our total business. For some clients, it's less than half. Some, it's a bit more than half. But we're very diversified in asset-allocated investors, and so therefore I think it's important that we maintain a lot of information,

a lot of understanding around the bond market and around alternatives that feed a lot of the investor outcomes in both short- and long-term timelines. that feed a lot of the investor outcomes in both short and long-term timelines. But also, it speaks to the entire high-level apparatus that we're in when liquidity goes away, when there are dislocations in certain markets, when you see evidence of panic, not just in stocks, where it's very common, but in other arenas. And we've talked a lot about municipal bonds, for example. I also think it's important to understand these things in the context of where the Fed is intervening and where they're not. We already can see where the Fed has come in to the AAA RMBS market, residential mortgage-backed. You see dislocations almost entirely go away.

The Fed was able to become that buyer, stabilize that market. In the non-agency CMBS market, so commercial mortgage-backed securities that don't have any sort of government connectivity, those markets remain highly disconnected. And so it's important for us to be able to see where there's liquidity and efficiency versus where there isn't. see where there's liquidity and efficiency versus where there isn't. And the central bank right now is more or less the tiebreaker on those various tension points. And that both captures the description of the moment, but it also provides some forward-looking guidance as we wrap our arms around what the Fed intends to be doing into the future. There's not lengthy, but a little bit of an elaboration at Dividend Cafe around something I think is very important, particularly for those of you that are more opportunistic right

now in recognizing some of the dislocations in capital markets, especially in credit and fixed income. And we call it a toast to illiquidity. But what I mean by that is the liability that daily liquidity can represent for certain investments. When an investor has the right to redeem their assets on a daily basis, that's thought of as a benefit to an investor. But when there's leverage in the underlying asset and managers all of a sudden face required daily redemptions, that negative feedback loop of having to sell lower assets, which creates lower prices, which creates more sales and redemptions, which creates lower prices still rinse and repeat. that sort of capital risk is tremendous because you can at least avoid the self-fulfilling prophecy

of leverage spiraling of leverage finance going into negative feedback loop and and so we want to really assert illiquidity in those types of asset classes that that most require it. Where there is leverage, we want it to be smart and prudent, not risky and excessive. But then fundamentally, even apart from the technical framework we want in bonds, alternatives, you really want underwriting that matters. It's something we talked about at the beginning of the year, well before the coronavirus blow up, that the fundamental bottom-up realities, they don't matter in a given day,

like some of the days you saw in the middle of March where markets were just swooning, but they matter fundamentally that in the long run, these assets will be priced according to their actual intrinsic value. And that intrinsic value is a derivative of the quality of the asset, the cash flow, and the perpetuity of payment. That's where underwriting matters. And so I just want to reinforce that understanding as we as credit investors, whether it be opportunistic or defensive, that we take seriously the technical framework

and the fundamental strength of the underlying assets. Historically, we've already talked about this before, but a chart reinforcing the 22 days it took for the market to go from its high to down over 30% was the fastest in history. As far as daily losses, two of the worst 10 days in market history were just a few days apart from each other in the middle of March. And so that historical framework of what exactly has taken place, again, accentuated by the national margin call in the middle of March and the uncertainty of the moment. A lot of those technical pressures have been alleviated, not completely. I have no, I continue to have, I want to say this, I have no opinion as to whether or not we retest the lows that the market saw a couple weeks back in March. I don't believe that it's assured that we will. The arguments for the fact that markets always retest lows are really kind of stupid

because they presuppose what those lows necessarily were at the time. The market did not retest the lows of March 6, 2009. not retest the lows of March 6, 2009. And so again, there are low points along the way to finding a bottom that sometimes double hit, but you just simply don't know that something was a bottom until you get to look back in history. And all I can tell you is that there are scenarios where I could see the market dropping again around uncertainty and bad news and other things in the days and weeks ahead. And there are scenarios where I could see more 2,000 point, 3,000 point moves higher. has to be agnostic about the day by day and week by week. And even, you know, for the month of April, that type of timeline,

our view has to be focused on where we are on a post-COVID moment. And what I mean by post-COVID is not everything completely out of the woods, but at least that scenario by which the curve is in bent and there is a really strong national push to reignite American enterprise. At that point, we are not going back to the economy and the jobs data that we were at the beginning of January. What I do believe will happen is that we'll have a much better environment and a little more clarity as to what forward earnings can end up being, which right now no such clarity exists. So you have some level at which markets, Lord willing, will be much higher than they are now, but nowhere near back to where they were. And then you have that kind of grind of getting economic recovery going, either V-shape or U-shape. And that, to me, is the big uncertainty as to where

the end of 2020 will go. What I do believe is it'll be significantly better than it is in the heat of the moment, where we don't know what the New York shutdown will look like, what we don't know what the rest of the country shutdown will look like. And so much of America right now is not able to go to work and certainly not able to consume. So the brutal jobs numbers, the brutal unemployment claims, all those things are there. We'll have more information in a week. We'll have more information in two weeks and three weeks about the efficacy of what has been done in the stimulus program so far as cash works its way into the economy, into business owners, into employees' hands.

There's a lot of reasons I'd be optimistic about the effects of some of those things. We also are going to probably get more clarity on future ongoing programs. I don't think politically the phase four is going to be happening very easily, but I most certainly think there will end up being a phase four. But both sides probably are willing to fight out a phase four a little more than they were the phase three, which was the two trillion. And so, you know, those things have to play themselves out. that the Fed brings to the table. The size of their facilities, their willingness to go all in on supporting treasury and mortgage-backed, high-quality mortgage-backed markets

is surreal. We know they're delving into the one-to-five-year corporate bond space. We know they've already dived into the very short-term municipal bond space. But will there end up being a backstop into, let's say, some of the CLOs, the levered loan market? Will there be a backstop into the non-agency CMBS market, commercial mortgage back? I wouldn't bet against it. It isn't assured,

though. So again, it's another uncertainty. But it makes it very difficult to have a strong conviction in short-term movements because the Fed could come in with some of these aggressive ideas, supporting the mortgage servicers, which has created a lot of uncertainty in financial markets, things like that, that just really change the landscape. So that's our position right now. We wait and see around the health data, around the Fed, around the efficacy of the fiscal stimulus. And at that point, as the health data converts into something that gives us a glimpse of the future, then you get to start doing some better fundamental analysis, reweighting, re-rating, and reallocating. Right now, we are comfortable

with the positions that we have. We are actively engaged in markets every day, and we certainly welcome any questions you may have about your own particular situation as we continue trying to guide our clients through all this. We live in interesting times and I and every one of my partners, advisors, and colleagues stand ready to help anyone we can. This is our job. We do thank you for listening to the Dividend Cafe. We thank you for reading our commentary at DividendCafe.com and as we all go through this together, please stay healthy, stay well, and why don't we all abide in faith and hope. Thank you for listening to The Dividend Cafe. Thank you for listening to The Dividend Cafe.

Financial food for thought. Thank you. market commentary does not constitute investment advice. The team at Hightower should not be in any way liable for claims and make no express or implied representations or warranties as to the accuracy or completeness of the data and other information or for statements or errors contained in or omissions from the obtained data and information reference herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice. This document was created for informational purposes only. The opinions expressed are solely those of the team and do not represent those of Hightower Advisors LLC or any of its affiliates.