The Dividend Cafe - Much Ado About Much

Episode Date: August 30, 2019

Topics discussed: The bulk of the first half of this week's Dividend Cafe is dedicated to that which is most relevant to the markets right here and right now - the latest, the greatest, and all that is fit to print. Trade war, interest rates, the yield curve - I promise you will get sick of all these terms by the time this little era comes to an end. But the second half has a prolonged section that I believe you will find far more compelling and relevant to your investment strategy. These economic matters are pivotally important to developing the right framework for investing, and I am completely obsessed with studying it, communicating about it, and ultimately, properly positioning client capital in the midst of it. I expect it to be the great duty of the next twenty years of my adult life and calling. So if this sounds dramatic, click on through and see what the fuss is all about. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com Subscribe to the Dividend Cafe Podcast

Welcome to the Dividend Cafe, financial food for thought. Hello and welcome to this week's Dividend Cafe. This is David Bonson. I am Managing Partner, Chief Investment Officer at the Bonson Group, and we are bringing you the weekly market commentary, hopefully representing something up to date by the time you're listening to this and where we go in the markets. And I think it's something in the range of about 80% of the time we record on Thursday. And by Friday, things are still reasonably close to kind of where we were talking. And there's nothing that even if I were recording 24 hours later, I would necessarily feel the need to record.

But then you get into a period of enhanced market volatility, like we've been in this month, and we've had maybe two other months in that same kind of environment over the last year and a half, two years. And it's almost like assured that whatever I'm saying right now, a day later becomes somewhat obsolete. Maybe that won't be the case tomorrow. Well, by the time you're listening to it today. See what I did there? I don't know. It's possible that the Friday going into Labor Day weekend will not be as crazy as some individual days have been ought to be throughout the month of August, just because you would expect there'd be a lot less traders on their trading desks, a lot of people leaving early, a lot less focus on capital markets, perhaps less drama and attention out of policymakers of the West Wing or the Beltway

at large or out of Beijing. Who knows? I know for you and I, it will be a Labor Day weekend and whether or not it will kind of be one in capital markets remains to be seen. However, what I do want to focus on today is two different kind of elements of Dividend Cafe. And I'm going to do this for those of you listening and viewing right now, because all of this content is very important to me. And I think that the shorter term aspect, we're going to call it part A of the podcast, is important to a lot of you. I think a lot of you listen for that reason. You like that kind of what's going on right now. What do we expect right now? What's moving markets? What do we think could happen

next week? All that stuff. I get it. It's fine. I'm not going to ever stop doing it. I have plenty to say on all of it. Okay. But if I do all of that and provide those perspectives at the expense of the longer term and more substantive issues that I think are superior in importance to our clients and to all investors, then I think I'm doing a disservice. And so not only does the written dividendcafe.com this week offer that kind of bifurcated, you know, both the shorter term considerations and something that is a bit more long-term or secular in its focus. But I'm going to do that here right now as well. Okay. Let me just get right into kind of, let's call it part A. Latest in the market,

latest in the trade war, latest in the rate war, the interest rate environment, and the yield curve. Those things, I suspect, we're going to keep on the menu for, oh, I don't know, another two months, four months. I can't tell you. I think that those are going to represent the major categories that drive investor interest and therefore probably a lot of our conversation for some time. On the market front, let's just walk through the last week or so. I could do this, by the way, by memory, all the way back to July 31, day by day by day. But I've been doing it week by week. And so I think you're up to speed.

Starting Friday of last week, the market dropped 600 points. But basically, I really do believe that there was a specific market reaction to fundamentals that was worth about 300 points. I'm making that up, but I'm estimating. a erratic nature of wondering if Jerome Powell is a bigger enemy of the United States than President Xi of communist China. Okay. Or ordering American companies to start making provisions to, well, to do anything, ordering a company, but in this case to pull manufacturing out of China. So you had just a really big volatility down day out of a lot of

uncertainty and a little, you know, just kind of craziness. And then now this week, the markets were up 300 points on Monday. And that was on a report. President Trump had said that China had reached out by phone saying they wanted to make a deal. And now there's some question as to whether or not the phone call happened or who made it or when or whatever. So markets moved up Monday. Also, I think we were oversold from Friday on a technical basis. And then Tuesday, we did go down about 100 points. Wednesday, we jumped up another 250. And as I'm sitting here talking right now, we're in the middle of the market day on Thursday, and we are up 350 points. So here's a couple of things I want to share with you, which is just incredible to me.

Yeah, the market on this week is up 650 or 700 points. So it's fully offset the 600 from last Friday. And prior to that, the market had gone up about 800 points, making up for the 800 points that had been down a couple of Wednesdays ago, if you remember that, that glorious day. So when all said and done, again, I don't know what's going to happen to the market on Friday. It looks like for the whole month of August, the Dow is going to close out somewhere around down 500 points, about 1.82%, something like that, after averaging close to 350 points of movement per day. And when all is said and done, you're going to get about one or one and a half days worth of total net movement in the market. I don't know if that is as important

to you or not, but I think it does kind of powerfully symbolize the theme right now, which is not directional bearishness. It is not directional bullishness on either front yet, but it is extremely enhanced volatility that stems from uncertainty, stems from all the stuff we talk about all the time. In the trade war front, China announced last week after the market closed that they were going to impose 5% to 10% tariffs on $75 billion of American goods and that they were reinstating previously suspended or previously threatened 25% tariffs on auto products. After the market closed Friday, President Trump announced that 25% tariffs on $250 billion of Chinese imports were going to

be raised to 30%. Those are tariffs that are already on that we were going to kick up a notch in retaliation to their tariffs, which were being kicked up a notch in retaliation to our new tariffs that we're going to call Tariff 4.0, the round four of tariffs out of the U.S. And by the way, there were some 10 percent level tariffs that were announced for this 4.0 that President Trump said he's going to actually do at 15 percent instead of 10 percent. So, you know, I don't know what's going to end up getting tariffed, when, at what level. I know what both sides threaten and peel back and all those things. But I will say this. peel back and all those things. But I will say this. I think it's important to understand that this is the tit for tat nature of a trade war. That's all one side can do is one side puts on

additional tariffs and then you retaliate with more. And your retaliation fosters a counter retaliation and so forth and so on. So that's kind of what a trade war is. I think thus far, a lot of other countries, we've been able to avoid having one country implement tariffs and retaliation for the trickle-down effect from other tariffs that one country's done. But this is kind of where things stand in the trade war is there's a lot of uncertainty around it. And when China says, you know, look, we want a calm resolution, and that's why markets end up rallying, you know, today, allegedly, of course, people want calm resolution. But I think if you do a deeper dive on what's going on, it's very unclear to anyone who's analyzing this what a catalyst will be at this point in time to getting any resolution that you could call with a straight face structural or substantive or comprehensive. that the disconnect between the political realities of America and the economic realities

of China are creating a lot of ambiguity as to leverage, as to who holds leverage, as to who holds negotiating superiority. But there is a part of me that really believes that they may be working towards a suspension again, a delay again of the escalation where there's no real substantive progress, but both sides say, okay, we're kind of both bleeding a little here. Neither one of us know exactly where we want to go. They're preparing to really blow this thing out.

And of course, both sides are buying time to get a lay of the land for the 2020 election and the American presidential race and things like that. And you could very well end up with yet another delay or pause button, which probably markets would like, probably would decrease volatility and yet would still leave lingering the uncertainty as to where this is actually going to go. And in fact, I'm more and more convinced would serve the purpose of helping both sides get a little more entrenched into their own position, you know, preparing for some of the things that

they're not really prepared for right now from a currency standpoint, from a supply chain standpoint, from strategic partnerships, from foreign counterparts. The pieces are not all there for either side to really prosecute their case in the negotiation. Delays and pauses give each side the potential to do that a bit more effectively and probably satisfy or soothe market pressures. So again, a reinforcement of this idea as to why jumping to a bearish conclusion is probably not any better of an idea than jumping to an overly bullish conclusion. I don't see an end in sight to this trade war. I don't know how it gets rectified in a satisfactory way on this side of the election. And yet I also do recognize there's plenty of continued little gyrations that could take place that an investor may not want to be unexposed during.

want to be unexposed during. Moving past the trade war, let's talk interest rates. The Fed did not fully telegraph exactly what they're going to do with the September meeting in Jackson Hole, Wyoming. I'm not sure if they have to. I mean, the Fed funds futures now are at 100% for a quarter point cut in September. So if it's 100% at a quarter point cut, the Fed funds futures are telling you there's 0% of two quarter point hikes, a half point, and there's 0% of no, I keep saying hikes, I mean cuts. Excuse me. There's 100% chance of one quarter point cut. That means there's a 0% chance of a half point cut and 0% chance of no cut. So we're expecting another quarter point. But then where you have

some ambiguity, I'll update you a little, is in terms of how we finish off the year in December, that we're talking right now about the futures market indicating an implied probability of a 35% chance of two more cuts at the December meeting, a 48, let's call it 50% chance of one more cut, and then only a 16% chance of no cuts. So bottom line, you're somewhere between 25, probably 50, maybe 75 basis points lower than where we are now by the end of the year. It's a lot of stimulus that the Fed would put into the market. And as I would be talking about in a moment, a lot of ambiguity to me as to whether or not that stimulus would be economically efficacious, but I think it's hard to argue it would not be effective in stimulating asset prices, which may be what investors care about even more.

Let's talk latest in the yield curve, and then we're going to get down and dirty economic for a minute, which I'm sure is keeping you listening. You're afraid to hit your pause button, your stop button, because I've dangled the carrot of macroeconomic talk to come. But actually, I think you're going to find it interesting. But first, the yield curve. Yeah, it inverted last Friday again for a couple of minutes. It inverted the Wednesday before. And it's actually been in and out of inversion quite a number of times this week. And yet, you know, you're talking about like a half a basis point as I talk right now, one basis point a couple of days ago.

So the inversion is A, going in and out, and B, when it is on, it's just very, very small. And I did a podcast with my partners on the investment committee here yesterday where we talked at great length about the fact that there is very legitimate argument to be made that the just incredible amount of global buying pressure for long dated U.S. bonds right now is just so heavily distorting markets, distorting yields, distorting market conditions, that it is not necessarily giving us clear signals into underlying fundamental economic health. A very good point, by the way, should be made when we talk about the frequency of yield curve inversions preceding United States recessions, especially over the last 25 years or 30 years. And I've already talked to you over the

last several weeks a couple of times about how those numbers are not 100%. So correlation causation is alone difficult to work out. But then when you factor in the imperfections of the frequency, it gets even more challenging. But an economist I follow religiously wrote a paper last weekend about how the yield curve inversion preceding recessions is a reasonably high indicator, though not perfect in the United States. It's no indicator at all in many non-American countries, the United Kingdom being one of them, where you had just extended periods of time where the UK had yield curve inversions and then actually went through multiple years of economic expansion following that. And the question would be, why would a yield curve inversion be some rock solid dependable indicator in the United States, but a total

non-indicator in certain other countries, especially because they are like-minded and fellow developed economies? It's a good question, one I don't know the answer to. All right, let me close out today. Oh, but real quick, anecdotally, corporate bonds, this is stunning. You know, corporate bonds is an index, the investment grade bond index on the year, just for the first eight calendar months of 2019, on the year, just for the first eight calendar months of 2019, are up a record level over the past decade, 13% year to date. I cannot comprehend who could have predicted at the beginning of this year that A, you'd get an amount of downward pressure on bond yields to push bond prices up this much, combined with spread tightening between the

corporate bond sector and the treasury bond sector, that would have led to this type of performance. It's worth looking at in one's taxable bond allocation, where their opportunity set and risk-reward trade-offs may have moved around based on this really robust performance from the high-grade corporate bond sector. When I say that this next topic is the economic matter I most care about, that's been true for many, many years, and it's going to stay true for many years. And it is not just totally disconnected, like, oh, I just talked to you about a bunch of short-term things that don't matter, but now I'm going to talk to you about a long-term thing that does matter. This long-term subject is very much connected to the short-term things going on right now with the

trade war to some degree, but primarily with interest rates, with the low level of interest rates in the United States, with the negative level of interest rates around the globe in a lot of countries, and with the concept of an inverted yield curve. So I think that when we look at the macro asset allocation, the top-down blending of assets that investors are going to want to have for years and years to come, that a lot of things that are affecting weekly perspective on the markets right now are going to be long gone, long removed from our new cycle and current kind of mental space. And yet we're going to have to have serious, yet we're still

going to be having serious conversations about investing in a world of an aggressive monetary regime and one in which global indebtedness has changed the landscape of the bond market, of the yield curve, of interest rates, of economic growth in a very secular, structural, sustainable, and in an entirely negative way. structural, sustainable, and in an entirely negative way. Inflationary expectations have always driven bond yields when things are normal, along with the realities of the business cycle. So you have cyclical expansions, you have cyclical recessions, and the bond yields will move accordingly, plus or minus what they're pricing in for what they expect around inflation. And it's normal. It's healthy. Get too much inflation expectation and it's not healthy because, but the bond yields reaction to it is healthy or expected. All rules go out when you have a glut of excessive indebtedness.

And that's the world we're now living in. And not just the country, but the world. You see it in the United States. You see it in Japan even worse. You see it in Europe even worse. And so the issue that I'm having to deal with is macro asset allocation decisions that have to be informed by the impact that this debt I refer

to will have on growth and on yields. Both those things matter. Interest rates matter to the extent that they price risk assets. And the level of debt impacts those yields, how those interest rates affect prices, and then they affect growth. And the problem is that these two things work in concert with one another. Overindebtedness, both nationally and globally, has changed the landscape such that debt as a percentage of economic activity has forced bond yields dramatically lower. About a month ago, I put charts in Dividend Cafe just saying, how clear can this be? Looking at 40 years of debt skyrocketing higher in the US, Japan, UK, and European Union, and bond yields dropping like a rock in those same four

for geographical domiciles. There's a negative feedback loop at play because debt as a percentage of economic activity forces bond yields lower, but then this forces a depressed return on capital, lower yields, which means less capital investment. There's less incentive to invest capital into projects when yields are so low. And then that means less productivity because there's less investment into projects that would themselves be productive. So then you're getting less growth, which means what? Lower bond yields still. So these things are feeding on each other, creating that kind of vicious cycle. And at DividendCafe.com this week, I put a chart up of real GDP growth and real yields for 200 years and then over the last 20 years. And you can look at the correlation

between how higher real GDP growth has led to higher bond yields, higher expected returns on capital investment, and then you have lower GDP growth leading to lower yields. And the problem is that what you need to drive growth is higher capital returns, but it's excessive debt that forces yields down, which depresses capital return, which then undermines the prospects for growth. So this negative feedback loop that has played out so dangerously in Japan and Europe that we're watching right now in the United States, it's not just that it's like a bearish indicator for risk assets, because this is the tension that I think we face right now as asset allocators at the Bonson Group. It's that it's a quasi-bullish conclusion when you realize, well, what is the Fed to do about it? There's very little the Fed

can do in using monetary policy to stimulate economic growth. So they decide, let's do the next best thing. Use monetary policy to stimulate asset prices. If you can't stave off economic deflation, then try your best to stave off asset price deflation. So that might cause one to believe the right place to be is in the risk assets, that the monetary framework of our world is set to try to enhance and stimulate. And yet, of course, the quasi bearish aspect of what I'm getting at is that we are going to have a very hard time creating the productive growth that society needs to deal with the debt. When the low bond market, excuse me, low yields in the bond market are not just indicating the problem, but then feeding the problem as they lack the incentive for capital productive investment. The monetary imagination of central bankers is experimental. It's unprecedented,

and I would argue it's dangerous. You have a very low velocity of money right now. Central bank interventions are less effective when velocity is this low. So can the long-term compression of growth actually be long-term compatible with a long-term stimulus to asset prices? That is not a rhetorical question. It's one that I don't know the answer to. It's one that we have to sort through that likely will take different shapes and sizes and different periods along the way. But I do think it properly identifies what the tension point is going to be in capital markets for many years to come. And around that answer and that framework

is how we have to set our stock allocations, bond allocations, alternatives. And the one conclusion I'm able to very concretely draw is that durable, dividend-paying, non-cyclical companies that are in the market of things people must have, that these are the components of equity risk that make sense. And that fundamental boringness of high quality dividend growing companies is perhaps going to have re-rating issues in the future, re-pricing, but is the likely best candidate to be in the environment

we're going to be for a long time to come. So it's a lot to give you in a podcast like this. It fits in to the present reasoning as to why we're dealing with low interest rates or negative interest rates all over the world. I can't stop talking about it because I cannot tell you how profound it is that there are 15, 16 trillion dollars that are trading at a negative yield and that it's all on purpose and that it's all done so that a central bank can help facilitate a government that is spending excessive amounts of money and has already spent excessive amounts of money. They have a balance

sheet problem, too much debt, and they have an income statement problem, too much spending relative to revenue. Negative interest rates are an enabler of that paradigm. And the problem with that paradigm is that it is also suffocating the possibility of productive economic growth, which is what you need to pay off the debt. And so if that kind of summary makes sense to you, then good, feel free to leave it alone. But if it's left you with more questions or more desire for clarification, don't hesitate to reach out to us. Hit the little reply button, reach out your question, and it'll get to me and I'll answer it. And maybe our investment committee will discuss it in next week's podcast, because I think this is complicated stuff, but I think it's important for you to understand and understand why cash can be so dangerous in

an environment like this and where deflationary pressures rule the day. And yet high risk, high growth, high beta, high valuation stock investing can be potentially fatal. And so we want to continue framing these things in the right way for you that you understand it. And hopefully you've gotten something out of this week's podcast. I think I've gone on long enough. So I'm going to say goodbye to you. I'm going to ask you if you would please be so kind as to rate us, give us a little good review there. You could write something up if you're so inclined. It helps a lot. You can give us some stars or thumbs up or likes or all that and help spread the word on the Dividend Cafe podcast. Thank you very much for watching and

listening. And we look forward to come back to you next week. Have a wonderful Labor Day weekend and go Trojans. you next week. Have a wonderful Labor Day weekend and go Trojans. Thank you. All data and information referenced herein are from sources believed to be reliable. Any opinion, news, research, analyses, prices, or other information contained in this research is provided as general market commentary. It does not constitute investment advice. The team and 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 referenced 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.