The Dividend Cafe - National Resilience Extends to Markets

Episode Date: January 10, 2020

Topics discussed: We have a full Dividend Cafe to bring you today. The news cycle did not slow down for the new year, and indeed, we have already opened the year with a slew of geopolitical events that add drama to capital markets. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Hello and welcome to the first Dividend Cafe podcast of just me for 2020. We did a podcast earlier in the week with my investment committee, had a great, pretty long conversation, walking through 2019, recapping the year. And we kind of walked through some of the different themes and perspectives and focuses that we have here at the Bonson Group on the year 2020, what we're looking ahead to and thinking about and so forth. So check out that podcast if you haven't yet. But I'm going to do something a little different today, kind of get back in that rhythm of our regular recurring weekly stuff. It isn't like this week didn't give us anything to

talk about besides the normal year in review and year ahead things. There's a couple of things I'm going to get into there. I want to highlight a couple of risks in 2020 that I think are noteworthy. But obviously, the week itself was mostly filled in the news cycle and to a certain degree with markets around the flare-up in the relationship between the United States and Iran. When I say relationship, it would be difficult to maybe come up with a pop culture analogy of as toxic as the relationship that the U.S. and Iran have had for decades and decades now. And last Friday, the news that the United States had taken out the longtime commander of their Iranian force, Soleimani, maybe not a household name well known for those familiar with foreign policy, but it's certainly kind of become a household name over the last week. Retaliation, the disruptive effect into the oil commodity price in the region, and then kind of the question marks around not just retaliation, but then U.S. retaliation to Iranian retaliation and so forth. do a pretty good job this week making fools of themselves in their political punditry around it,

and not to mention their lack of moral compass or moral clarity in assessing the situation. But, you know, the tribal political age we're in, that's to be expected. From a purely market standpoint, though, it's fascinating how this has all played out. It was Tuesday night, at least five, maybe four hours after the market had closed for the Tuesday trading day that we got word that the Iranians had fired, I think we heard 10 and 12 and 15, you know, somewhere. It was all different numbers. I think the number ended up being 15 or 16 missiles at U.S. presence, U.S. bases, U.S. targets in the region. And the futures dropped 400 points, implying a drop of 400 points at the open the next morning. And then slowly but surely, more and more information came in,

and the narrative changed quite a bit. came in and the narrative changed quite a bit. And essentially, because every single missile missed its target, there were no U.S. casualties, you not only had the fact that there wasn't actual damage done, which was primarily a human, you know, blessing, but then secondarily, it meant that there wasn't a particular impact that would be met more higher magnitude. Markets could be somewhat relieved by that. But then I think what happened was the narrative started to unfold of either they missed on purpose to de-escalate or by them missing on accident, it gave the U.S. the ability to de-escalate. What you believe around those two, maybe it's a hybrid of the two, maybe it's one or the other, it's somewhat irrelevant. It's de-escalation that was what the market was responding to. So instead of being down 400 points on Wednesday in the market, the market was

up 200 points. And as I'm sitting here recording halfway through the trading day on Thursday, we are up another 200 points. So the new year took place last week and we were basically up 200 the first trading day of the year, then down 200. And then we were up 50 and then kind of flattish. And then we were up 200 and up 200. Okay. So you can do the math. We're up on the year, a few hundred points with this conversation about going to war. I mean, it's just surreal. So, you know, I would be remiss. I mean, honestly, it would be like a violation of my professional duty to not take advantage of this opportunity to remind people that noise and headline events and spurts and dramas and tensions and things of that nature, they are not abnormal. They are what is normal. What is abnormal is a lack of spikes in noise and disruptive events and whatnot.

Some, of course, are going to be more noteworthy than others, and some do indeed kind of parlay into more substantive and prolonged market news stories. If indeed this issue, and I can't say for sure that it is, but if indeed this Iranian war threat hubbub is already boiled over, it's not abnormal that everyone will be talking one way and two to three days later, everything is kind of resolved and in fact actually ended up in a better position than it was. So the reality is I want people to remember that responding impulsively to a headline on CNN, and by the way, there's a double, a tundra in what I'm about to say, is perhaps the craziest thing you could ever do. Responding impulsively to any headline anywhere, responding when the headline is actually accurate,

responding when it's true is probably the craziest thing you'd do. The markets, people say, well, look, you have to admit there's a geopolitical risk. Okay, absolutely. By the way, the geopolitical risk was there a week ago, and it's going to be there in two weeks. See, markets are carrying with them every day what we are all blessed to not be thinking about every day, which is that at any given moment, Israel could attack Syria, and Iran could attack the U.S. and Saudi could be attacked by someone in the region and retaliate in the region. Middle East geopolitics is like one of the least surprising surprises out there. There are plenty of other issues that also represent

persistent source of risk premium in the market. European economic drama, it's been a long time since boiled over, and that's primarily because of the bazooka of the European Central Bank. But I mean, if all of a sudden there's a big announcement that XYZ Bank is shutting down or ABC Country is in default on their sovereign debt, it wouldn't be like we were unaware that that risk was lingering. Those things are out there back in 2010, 2011, 2012, and again, resurged in summer of 2015. These things with Europe, we got used to them for a while. And then now

they've kind of calmed down as Europe has gone through a mild recession and has had no growth. And it's not been a real investable place, but it hasn't had these kind of headline contagion risks. But those could come back anytime. And so my point being, I got on a tangent on Europe because it's one that I think deserves to be sort of always out there. Like their banking system, I think, is so deeply disturbed that there's always that problem announcement pending. But the reality is that it doesn't matter if we made a list of the top two or three we thought were most significant. There's another two or three we're not thinking of. That's, first of all, human nature. It's reality. It's the reality of a fallen world. But it also is the reality of risk premium in equity investing, in risk asset investing. And so what we got this week was an example of a spike in volatility

and in questions. There was distress and there was fear. There's fear of an unknown. Gold prices went up a little bit. But look, in addition to the fact that sometimes that responding impulsively to fear announcements being crazy. Let's also take another lesson from what took place this week, which is the total lack of drama that this actually embedded. At the end of the day, the headlines were nowhere near proportional to the reality. Bond yields dropped about 15 basis points. Gold was up a little. Oil prices were only up about 3% or 4%. And then they went down. So yeah, if you really think all of a sudden something's happened that's

bringing in Armageddon, I'm just going to tell you right now that generally oil prices are going to go up more than 3%. Gold prices more than 3%. Bond yields will go down more than 0.15%. So yes, there is always jittery people, investors with weak hands. But ultimately, I think that we have to look at this as yet another lesson, another example in a long, long list of things by which people might get ahead of themselves if they're following the media. It is very much the media's agenda, whether it's click media or watch media, read media, to have some flair. And flair is the enemy of an investor. I just made that word up right now. Half full glass, I think that in this Iranian situation, you really do have the opportunity for de-escalation and off-ramp for both sides to kind of chill. And there's a political benefit for that to President Trump. There is a war benefit to that,

to Iran. Because if it escalates, that probably hurts Trump. There is a war benefit to that, to Iran, because if it escalates, that probably hurts Trump politically, but it could devastate Iran militarily. They obviously could not keep up in an air war effort with the United States. And I'm not really quite sure that there's anyone who doesn't know that. I think that the reality is that this is maybe potentially a really good situation for the time being based on where things stood five or six days ago. Now, a half-empty glass might throw out that we don't know if Iran will be content to leave it where it is. It's very possible they want to keep poking the bear. But the severe economic sanctions and whatnot are going to take their

toll. And at some point, there will end up being another evolution to this. I point out in DividendCafe.com this week, something I want to talk to you about now, which is relevant and pertinent, related to what we've been talking about, but then kind of creates a segue. And that is, speaking of the economic sanctions and this distress with Iran, we also, of course, know that we're about to sign the phase one trade deal with China. And it calls for them to drastically increase their purchases from the United States in both agriculture and energy. But I noticed this week, and I put a chart in Dividend Cafe, that 24% of Iranian crude oil is exported to China. Their second biggest customer is India at 18%. Iranian crude exports

are dramatically down over a million barrels a day. Excuse me, I'm saying that wrong. The scale of it, let's just put it this way, it's down well over 50% in the last two years. It's a better way for me to put it rather than put an absolute number on it because I have to annualize the figure and I want to do that right now. So my point being that China could very well end up having a need here to purchase more from the United States. I'm just saying. Okay, enough on Iran. I think that you've kind of gotten my point on the reactive element to market events. A couple of economic things. I'm going to bounce around a little and then we'll call it quits for the week. I am anticipating the possibility, I think everybody who listens to Dividend Cafe knows that I, David Bonson, the Chief Investment Officer of the Bonson Group, am radically, emphatically

in the deflationist camp of the belief that the globe and the U.S. face generational, structural, and secular deflationary pressures brought about as a result of excessive debt and that the downward pressure on bond yields is self-reinforcing with the deflationary pressures that we face. is self-reinforcing with the deflationary pressures that we face. That said, I do believe that cyclical bouts of inflation cannot be ignored and are probably an underappreciated risk this year. And I believe it is worth noting that you have a central bank, a Federal Reserve of the United States, that is not concerned with asset price inflation. In fact, I would argue that many of them, if not all of them, and collectively as far as the votes go, they actually probably believe asset price inflation

is a good thing because of their ideology of the wealth effect. However, as they talk about getting to a target inflation rate and redefining what that target inflation rate is, how it is measured, allowing for averaging over years, you know, various policy endeavors to give them more leeway, not less, as far as how easy and loose they want to be in monetary policy. I believe that we would be wise to understand what they're looking at because housing, medical care, and education have had significant price inflation over the last 20 years, even over the last 10 years. But over the last 10 years, the overall consumer price index

had very muted inflation. And I believe that those of us who would argue, okay, but look at asset price inflation, you could distort valuation or risk assets. Or look at the government subsidized sectors like housing, medical care, and education. There's big inflation there. We can be right intellectually. We can be right ideologically. But I do not think that's what the Fed is concerned with when they talk about targeting inflation. Low energy prices and the effect of technology has held inflation down for a decade now. And I think the Fed views that as an offset to other areas where they may see actual inflation so they can blend together a pretty muted amount.

Overall, the price level in the economy continues to, as a result of inadequate velocity, money turning over, continues to fight deflationary forces. But I think that they would allow for some cyclical inflation, which could be problematic and needs to be monitored. Now, I don't want to go on this tangent. Is gold the way we want to respond to that? What's interesting, I throw in Diven Cafe this week that the gold miners index, it's called the Philadelphia Gold and Silver Mining Index, the XAU, been around a long time. But this is just absolutely amazing to me,

is at the same level it was at right now in 1984, 35 years ago, hasn't moved. So is that our solution to where there could be bouts of cyclical inflation? No, it is not. Ultimately, I bring it up because I think it's very important to understand what the macro perspective and operating principles are of our country's central bank, both where they could be a benefit and a threat to investors and savers and spenders and any other category of economic actor. But I also bring it up, I do want to reiterate that there are things that can help counteract growing inflation and things that have not proven to be a great counteract. And obviously, at the Bonson Group, we're pretty committed that dividend growth is the right

antidote. But empirically, it seems undeniable that a lot of the gold bug way of dealing with it has not worked out so well. So what are the risks in 2020 that we think deserve mention? I think, first of all, you have to define what we're talking about. We're talking about things that we think are not necessarily high probabilities. We're not predicting these things or forecasting them, but that they have a perhaps underappreciated consideration in the market. They're things that if stuff were to go wrong, we could see it being in one or more of these categories. The fifth one is the one I just got done talking about, which is cyclical inflation. And fourth, I talked about earlier, which is escalated Middle East tensions. I will add the comment, I'm cheating, because you could just put that on the list every year. And I think that for

future years, you could keep number three on the list too, which is European contagion risk. I don't think that anyone should be surprised if all of a sudden you get some sort of European banking situation. You may very well not get it. You did not get it last year. And yet, I think it could come at a particular time and cause some temporal disruption in markets, counterparty risk, things like that. But then the top two that I will leave you with for 2020, in our mind, is U.S. election outcomes. Certainly some outcomes are worse than others. This is highly unlikely to become a factor in the volatility of the market until later in the year, primarily because there's just so many open issues until we get maybe on the other side of the Democratic primary, things like that.

But then at the top of the list is this concept of trade war flip-flopping. I think phase one deal is done. I think it gets signed next week. And I think pretty much the broad posture will be everyone will sit still. But there could be along the way some tweets and some, you know, reversals and some backward moving, you know, some regress in the talks and in the execution or implementation. And then, of course, there's the idea of new trade tensions coming up, perhaps

with Europe. So all those, I think, are worth mentioning. Now, those risks are not what are our predominant considerations right now. We're predominantly focused on the fact that it's a healthy economy and we anticipate earnings growth this year. It's interesting in the chart of the week at Dividend Cafe, I point out the first quarter of last year, they were anticipating 4% earnings drop. We were basically about flat. Second quarter, they were anticipating 2.7% earnings contraction. It was basically about flat, contracted a little bit. They're expecting another 4% in Q3. It contracted about 2%. And now they're anticipating 1.5% in the fourth quarter. So the trend for multiple quarters in a row is for the earnings growth to have not been very good,

but to be much better than the real bad that had been expected. And I think that earnings growth in 2020 will drive markets a bit higher, but you will not get the same multiple expansion that you got in 2019, which caused markets to go much higher. Another factor I point to to just kind of give you a green shoot of optimism is the $135 billion that was withdrawn last year out of stock mutual funds and stock exchange traded funds, ETFs. I still believe that markets die on euphoria and that there has been no euphoria in this bull market. Now, there's a lot more optimism and a lot more enthusiasm and shades of euphoria here and there now than there was in previous times. But there is by no means the classic signs of a blow-off level of mindless, bullish euphoria that generally represents the end of a bull market. In fact, last year, if the sentiment can be adjudicated by the flows, the net flows of assets,

investors were still continuing to not believe in this market. So a lot for investors to be very encouraged about. Plenty of reasons to maintain allocations to the risk assets at an appropriate level, appropriate weighting in your portfolio. We're working very hard this year at that proper level of defense and proper level of exposures is what we believe could be another year in the bull market and economic recovery. And yet at the same time, maintain appropriate levels of defensiveness and caution around the understandable headwinds that are there. We also are making, and by the way, we're rebalancing our entire book of business next week, really seeking to kind of just, even though we're mostly other than some marginal adjustments, keeping our top down broad asset allocation levels very similar to where they had been.

Rebalancing within that, there's some composition changes and just modest kind of retweaking to bring people back into the balance and alignment of their portfolio that we want them to have. But I think that some of these other themes that we've written about and spoken about, I would just really encourage those of you listening who are clients to hold us accountable to make 2020 a year of redoing, revising, revisiting your financial planning. Have the conversation with your advisor about your tax services. Have the reviews and overviews done of your estate planning, converse with us about cybersecurity. It's a situation that we do not want to see ignored

and that we have increasingly grown our understanding of the risks thereabouts and why we believe it's an issue we need to converse around. And certainly if you're not engaged with our client portal, let us know so we can drive that experience for you. We think it's very valuable, the digital interaction with your financial planning and your investment portfolio that we make available on a custom basis. So we have these different themes that we really want you thinking about, that our advisors are thinking about. And then from my vantage point, as the chief investment officer, I continue to think about all the investment things I talk about very frequently, write about, and then I pretty much go to sleep obsessing over. I really feel good about how we are positioned in 2020.

Looking forward to this year for a number of reasons and encourage you to reach out to us anytime. Thank you for listening to yet another episode of The Dividend Cafe. Please write us a review, five-star us somewhere, forward around. We appreciate any of your efforts to help us as we grow our traffic to this Dividend Cafe podcast. Have a great week. Thank you for listening to The Dividend Cafe. podcast. Have a great week. Securities LLC. Advisory services are offered through Hightower Advisors LLC. This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance is not a guarantee.

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