The Dividend Cafe - My Heart Rate Monitor and the Economy

Episode Date: February 19, 2021

I think there is some “economic vocabulary” in today’s Dividend Cafe that might – might! – be a turn-off to some, but will be overcome easily if you bear with it. And more importantly, there is a practical takeaway through it all that I hope you will find very rewarding. I can see myself taking a more “multi-topic” approach to Dividend Cafe in the weeks ahead as opposed to the last several that have purposely “drilled down” into a particular theme that warranted special focus. That said, I find that five or six different topics seem to have a lot of overlap these days. I can think I am talking about government spending one paragraph and economic growth another, and voila, the third paragraph is talking about how government spending impacts economic growth. Economic and market commentary these days is one giant Venn diagram. Such is the case with so many things I cover today. I prefer writing where all the dots are connected by the end, and maybe you will think I pulled that off by the end. But what we have today is a lot of charts, a good amount of information, some perspective that I confidently believe will aid your understanding as an investor, and maybe, just maybe, some cohesion to it all that adds sensibility when said and done. 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 and welcome to this week's Dividend Cafe podcast and video. I'm recording from Southern California where it is 62 degrees and sunny and next week I will be back in New York where right now it is 26 degrees and sunny. And next week I will be back in New York where right now it is 26 degrees and snowing. And so, um, we will be out, uh, I will be out in New York city for the next couple of weeks. And it's been nice though, to be here in California. We got to see a lot of clients and, um, uh, it's been, it's been pretty busy and yet, um, there's some big projects I'll

be working on out in New York the next couple of weeks I'll keep you posted on. In terms of what I want to talk about this week, it is – I actually think I'm going to do a better job here in the podcast at laying it out with some clarity and simplicity versus I think the written dividend cafe. I'm a little bit worried that some people might get a little lost, not because it's written too smart or they're too dumb, nothing like that. might get a little lost, not because it's written too smart or they're too dumb, nothing like that. But I'm not sure until I reread it how good of a job I think I did at couching it in the level of simplification that I want. But it is a bit more economically theoretical. There is some more economic vocabulary that's involved in this. And I think it's really important because a lot of people pay some ancillary interest to their portfolio, but of course they watch the news a lot and not just financial news, but the news news. And from the financial news and political news,

there is this really big story right now around the size of the stimulus bill that President Biden's put forward. And all of a sudden, some folks and really kind of a both political persuasions expressing concern about inflationary pressures. And even apart from the stimulus bill, the economy is slowly but surely getting more and more reopened, the vaccines having a high degree of efficacy. is slowly but surely getting more and more reopened, the vaccines having a high degree of efficacy. And there's all these people that are worried about the economy being too good. And I don't want to merely say the kind of intuitive thing of, I find it silly to worry about good news,

because they obviously have some legitimacy in theory and where they're coming from, which is not about good news is bad, but is this good news actually risking overheating and creating some other excesses in the economy, including inflationary pressures? And I've already talked a lot about that. My belief that we're in a secular disinflation cycle, but that we'll see cyclical inflationary cycles on the way. So I'm not so much repeating that message right now. I'm talking about the concept of the economy and growth and where government spending fits into this, not just the stimulus bill, but at large, and then how that really does impact our portfolios.

So I use this term this week, which is used all the time. It's very common nomenclature in economics, but I wanted to sort of unpack it a little for you because I don't expect that all my listeners or readers necessarily are familiar with some of the terminology, and that's the concept of the output gap. And there's this school of thought that says you have economic growth, and we measure it with this thing called GDP, gross domestic product. And I think you know what that refers to. And then the output gap, when it's negative, it means that the economy is running at less than its potential. And so therefore there's slack in the economy. And they measure the potential of the economy with metrics around

at full employment and normalized productivity, what we think we'd be seeing versus where we are. And so then the delta between those two is, I think the kind of more street term is slack and the more formal term is output gap. And right now, there's this concern that because of the vaccine and economy reopening and all the stimulus we've already thrown on and stimulus we're going to throw on, and frankly, a whole lot of economic metrics that in all fairness, they're right, are very reflationary. You see a lot of things going, you know, in the right direction. But then the question is, do we overheat and what does overheat mean? Besides, I think it being an actually kind of convenient loosey-goosey term that doesn't

mean anything, if one is trying to be technical and define it, they're referring to the output gap going the other way, that it's operating above its full potential. So now we stop because I'm hoping you're going, whoa, what does that mean? How does the economy operate above its full potential. So now we stop because I'm hoping you're going, whoa, what does that mean? How does the economy operate above its full potential? So I, in my infinite wisdom of in the middle of writing, doing cafe, coming up with an exercise analogy, probably because while I'm writing, I'm sitting there thinking about all the awful, torturous things I've done to myself that week. Thought of analogy. And I will say, sometimes I think my analogies are terrible and like later on, I'm really embarrassed by them. But this one I actually like a lot, which is that concept of someone that is exercising above 100% of their maximum heart rate. And I hope you can see why that's intuitively so silly.

Because by definition, you can't operate over 100% of your maximum heart rate. It means that isn't your maximum heart rate, okay? I can say that again if you want. This concept with economic potential, if it's operating above it, it means that the potential has been miscalibrated, but in fairness to people using it, they're not using this sort of inherently contradictory term. It's just that the vocabulary is awkward. What they're referring to is that you're now getting some artificial activity pushing the numbers up that is either going to be inflationary or distortive, that you have more money and more demand out in the economy

than there are goods and services. And I think that the problem with this entire conversation is that it's always framed in the form of a dichotomy, that it is framed as a binary proposition, that either we're under capacity or we're over capacity, but there's never the needed nuance to what type of growth. Because just like the person exercising and their heart rate, someone who is continually exercising and getting up towards their maximum heart rate

and losing weight while they're doing it is in fact changing their maximum heart rate. Like they're able to function at a different level of productivity. That's the way the economy works. The potential is not a fixed number because if you have productive growth versus non-productive growth, moving GDP higher, you've moved the needle. So you have the problem with this is it's more complicated than a simple dichotomy. It's so easy for our minds to think binary, either this or this.

It's so easy for our minds to think binary, either this or this. But in reality, we are used to talking about, well, you have this output gap, you throw this government spending on it, then you're going to be over and it's bad. But the reality is there's two problems with this proposition. One is that it, in fact, may not become inflationary if, in fact, that excess government input into GDP does not generate that higher demand for goods and services, and does not, by the way, create a velocity of money in the economy, which is exactly what I believe is the case. But then people say, OK, well, that's good. That means you don't have to worry about the inflation with the government supply in. But then on the other side, you say, well, wait a second. If this is not fostering a productive growth, then you're doing something for a reason and you're not getting it. It's that sort of debate about multiplier effect

in Keynesian economics, that there's a diminishing return at certain levels of fiscal stimulus. And in this particular case, in theory, again, we're only talking economic theory here, you could say that those who want a lot of new government spending thrown at the current economic conditions, one argument against it is that it will become inflationary and excessive and too hot. And there's an argument against that. But then that does not necessarily mean the other argument, which is that, therefore, we could do it and it's all benign because, in fact, you could do it and it doesn't have that impact and, in fact, just runs up debt. So I think that this discussion about output gap, and I know some of the terms and some of the ways around it, maybe I've already lost some of you. I don't know. I really hope you look at the charts and read the dividendcafe.com.

But I think it's a really important topic because I have a very hard time when people talk about the generic concept of an economy overheating without specificity. Something is overheated when its valuation runs amok, when there's a carelessness into what's being bought, when risk-reward characteristics get dismissed, when people buy things they can't afford, when you violate laws of nature and laws of reason and laws of mathematics and laws of logic, laws of science, all that. But you can also have a productive growth that changes the conversation just as the exerciser's heart rate metrics depend on what's going on in the weight, in the timeline, in the conditioning, in the age. There's all those other factors that go in and not all heart rates in that capacity are A, static, but B, the same as other people are going to see. Right now, I look at the debt level in our economy,

and I put this chart in doing Cafe Today. I think it's really important. And I see a big focus on the fact that the United States government's running well over $25 trillion of debt, had been running over trillion dollar annual budget deficits, and is now running two, three, four trillion dollar budget deficits from last year and now this year in the COVID moment. And I also want people to understand that A, the United States is blowing out its debt and B, every debt has skyrocketed post-financial crisis by design. That was the Fed's kind of whole entire plan post-GFC was to get companies to lever up as a means of stimulating the economy, and it worked.

And there is a lot of productive debt that was put on the balance sheets of corporate America, both large corporations, middle markets, small business. There's a lot of bank loan activity and companies are borrowing at one and getting a return on capital that is higher than their cost of borrowing. And therefore, that is what you refer to as productive debt, but there's a diminishing return to it. There's a diminishing return with national country debt, and there's a diminishing return of corporate debt too. Through time, you run out of opportunities or opportunities generate less growth opportunity or take on more risk, have more failure, more capital erosion, more wealth destruction that can take place along the way. And those things ought to be factored in. So we have this situation right now where we have put on a lot of debt across the balance sheets of countries and companies. Households, by the way, are largely de-levered. Debt to assets has come way down post-financial crisis,

out of necessity. A lot of debt got deflated away. But here's the thing. When we look at the economic growth into the future and make expectations around it, both macro, big picture, and then micro, where that growth will be distributed, where it will be optimized, where it will be actualized, and then for us investors, where it can be monetized. We have to look at the overall picture and recognize where there might be excess debt, where there may be diminishing return from it, where the national debt picture does play in, what growth is pulled out of the future because it's been put into the present via the debt acceleration process. And so I think that this whole conversation, just like inflation deflation, just like risk reward and markets and valuations, it's really all kind of interconnected.

And markets and valuations, it's really all kind of interconnected. And I think that this concept about the economy, there has to be the ability to reject two views. It is not that you cannot have inflationary growth because you can, and that's a risk. And it is not that you cannot have contraction and recession because that could happen. That's a risk. It's certainly what we saw over the last year with the COVID moment and the shutdown of the country that went along with it. But there is such thing as productive growth. And so limiting our options is where you get things like the Phillips curve that pit wages or jobs and inflation against each other. And I think it's fallacious. I think that what we want to be thinking about as investors is where there can be productive growth

that is wealth creative. And from there, develop a worldview of corporate profits, develop a worldview of corporate profits, of revenue growth, of understanding competitive opportunities, and by the way, then also globalizing that in portfolio opportunities outside of the United States, so forth and so on. So the application side of it is probably a whole separate podcast that I'd love to do. But I want to leave this sort of economic theory with you today, that output gap is in fact a fair idea, attempting imperfectly to measure economic growth versus economic potential. And yet the thing that gets missed is how economic potential can expand through real productive growth in the economy. And you can always, when you're thinking about it, come back if you like my analogy to that kind of heart rate monitor exercise tracking parallel that I've come up with. There's a couple other things in Dividend Cafe today

that, and I want to do more of this going forward, kind of obsess and geek out on the stuff that I'm writing about and I care about, and then try to throw in a few other odds and ends. You may have seen in the press, there's a lot, oh, by the way, about the national debt side. I do have a chart. I've alluded to this once or twice a year, I think, in Dividend Cafe, at least for several years. But just a chart of the composition of the federal debt. We can always talk about the level of debt it is. We can always talk about the annual spending level. But when you get into the composition of it, those that believe the interest on the debt can blow us out

and they can see how just incredibly small of a percentage of outlay that actually is and and by the way that's admittedly more true because rates are at less than one percent than it would be if rates were four five or six percent but um the either why either way the the point i'm making applies and then and then also the um the discretionary spending and how low of a percentage of spending that really is. I just think there's some information there that might be interesting for you to unpack the reality of the U.S. debt profile. Then the other thing I want to go through is the stuff that's been coming up. I read a big story about it in Bloomberg.

I see it a lot in the macro research I subscribe to. I've had some people ask about it. And that's just what they used to call, or I think still do in the press, this Buffett indicator that it's measuring the total stock market capitalization divided by the overall size of the economy, GDP, and that there's percentage levels where then that stock market percentage divided by the GDP is the highest it's ever been right now. And they go, this is a big problem. And I think that it's interesting because, you know, first of all,

some people may have seen this week, Buffett doesn't seem very concerned about the Buffett indicator. If you look at all the stock securities, he has to disclose every quarter what they were buying. And we got that report this week. He has to disclose every quarter what they were buying. And we got that report this week. But my point is that in the past, you're looking at that before going into recession. And so you'd see the number high, the percentage of stock capitalization divided by the economy. And then the economy starts shrinking.

And that becomes a really big problem. Well, right now, it's the exact opposite. We're looking at that high percentage post-recession. We're about to come out of the recession we've been in and now have this recovery. And so the numbers self-correct. Now, they're going to self-correct to a number that's still high because as we already have talked about, PEs and PBs and PSs, all the ratios, price to earnings, price to sales, price to book, they're all high. But my point is that that indicator, you have to contextualize it. There's no raw data.

Data requires interpretation and elaboration, and that's what I do, and that's what I'm here to do for you. So that's sort of my perspective on it. I think it's an attempt to do an apples to orange analogy. And then our chart of the week, just a little helpful reminder, either for people that don't believe corrections happen in the market because they get complacent or people that think, oh, they do happen and I'm so afraid of them. I need to go time my way in and out of it.

I have a chart just in 10 years, one decade, six corrections of over 10%. And here we are, S&P up well more than triple since that period started, despite these six corrections along the way, some of which were much more than 10%. So check that out, read dividendcafe.com, reach out with any questions you have about output gap, about government spending. I do have a little primer in there this week

about big tech and just trying to make a caveat, a very important reminder about one big difference between the valuations we have right now, some of the FANG names versus where we were in 1999. It's not me getting bullish on it, it's just me, you know, presenting objectively all considerations. Valuation is still that concern, but I want there to be a real clear understanding of what a big difference is. That's in DividendCafe.com as well.

Thanks as always for listening to the Dividend Cafe. I thank all of you who reached out this week and different feedback on things. I've had a number of conversations with Larry Cutlow this week. I've been very, very informative.

I already have something I'll share in our call on Monday that is an insight around something I think is very actionable in policy that is a kind of perspective that came directly from Larry. I could have never, ever come up with on my own. So early stages of this, but really, really excited to have Mr. Kudlow on our team and I'll be out with him in New York next week. With that said, have a wonderful weekend and thank you for listening to the Dividend Cafe. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, member FINRA and SIPC, and with Hightower Advisors LLC, a registered investment advisor with the SEC. Securities are offered through Hightower Securities LLC. Advisory services are offered through Hightower Advisors LLC.

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