The Dividend Cafe - “Oh no! We’re at an all-time high!”

Episode Date: June 28, 2019

Topics discussed: Markets in the first six months of 2019 Fear of Market Highs Where we are in the trade war with China Dividend Cafe Podcast will be merged with Advice & Insights Podcast going forward. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Hello and welcome to this week's Dividend Cafe podcast. This is David Bonson. I am the Chief Investment Officer and Managing Partner of the Bonson Group and I am bringing to you what I believe will be our last podcast of the month of June, and therefore the last podcast of the first half of 2019. And I'm going to quickly just give you a little update on some things we're going to be changing with the Dividend Cafe podcast. We are going to make this our sole podcast property.

We've been trying to divide it up where we used Dividend Cafe as the kind of weekly podcast with sort of the run-of-the-mill commentary, kind of using the podcast to reflect what was primarily written about at our DividendCafe.com written commentary each week. And then we would use our Advice and Insights podcast for sort of special podcast, you know, ad hoc event driven type things. And we've decided that from a lot of feedback we've gotten from a lot of listeners, that'd be easier to just simply streamline it into one podcast brand, one podcast property. And there will be the weekly recurrings that come and then there will be special ones in the middle of the week from time to time. I like to start doing some

interviews and group session podcast with some of my partners and other advisors, our investment committee, just kind of doing some different type things, but doing all of it under this moniker Herdivine Cafe. And of course, you as a listener will choose to listen to what you want and not listen to what you don't and hopefully give us a lot of feedback along the way. So look for a more frequency of podcasts from the Dividend Cafe in the second half of the year and hopefully new and improved and really impressive type content. Well, impressive is a subjective word, so we'll see how it goes. But speaking of impressive, let's get into this week's because it's certainly been an impressive month in the markets. And this will conclude the month of June with meaning we've had five out of

six months to start the year in positive territory and risk assets, particularly the equity market, and May being the big exception. But then June, not only making back what had gone down in May, but then some, and doing so for a couple of things we're going to talk about this week. I'm going to give a little announcement I give kind of every week, but it's because it's just something I really believe. The dividendcafe.com will always have certain charts and certain visual reinforcements that I think you'll find valuable. And so even if you really like getting this by audio format, check out dividendcafe.com. This week, there is a chart showing how trade war sensitive equities have not outperformed the broad equity market since the trade war optimism of the last couple of weeks kind of came back,

leading us to believe something I'm going to talk about here in a moment, which is that the Fed is more at the center of the kind of renewed improvement in markets than the trade optimism is. There's a chart showing just this total collapse in business confidence that took place over the month of May and what that might bode for other indicators we care about. And I can just tell you the data and I can share it with you, the point I'm making, but there's something about the visual illustration of the charts that I think really sometimes powerfully reinforces the message. We have a chart about the energy sector and why, from a valuation standpoint, this sector represents something that is so incredibly inexpensive relative to a wide array of historical measures and how that stands in contrast to

virtually every other sector in the S&P 500. There's a chart showing the Fed funds rate in the futures market and what the probabilities or the kind of pricing that is being put into the futures market is for rate cuts, whether it's one cut, two cuts, or three cuts into the future. A chart indicating all kinds of indicators about the sustainability of the bull market and the different measures that have gone soft in the past, the last couple of bear markets we've had, and what those measures look like now. And then as is always the case, we have a chart of the week. So if nothing else, even if there aren't five or six like there are this week, there's always at least one chart that we call chart of the week at dividendcafe.com. And this week, it is showing over the last decade,

the increase in U.S. crude oil production, and then the decrease in U.S. crude oil imports. And obviously, you can imagine those things are inversely correlated. And I think that seeing that visual of how our own production is skyrocketing up and how our imports of foreign oil is collapsing, and to see it visually gives you reinforcement of the point we want to make, which is, of course, a very optimistic one. So let's talk about the tale of two trade wars. It was pointed out to me in a research paper I read this week. It was last spring, 2018, when let's call it trade war 1.0 kind of was launched by President Trump. And you had the U.S.

dollar rallying higher then. Emerging markets rolled over quite badly. Gold tanked. Bond yields stayed flat. The Fed at that point was extremely hawkish. And it was U.S. tech stocks that were leading the market. And now we get into this year's spring, and you sort of have the next iteration of trade war, largely launched over Twitter by the president. And let's look at all those different areas for how the response has not just been different, but virtually categorically different. Fed now is extremely dovish. U.S. bond yields have collapsed. Emerging markets have done very well, particularly ex-China. The dollar has dropped. Gold has gone higher. And then tech stocks are lagging, not leading the market as of late. So I think that there is something really interesting

about all of this. And ultimately, it's the Fed's change of posture that I think is more of a cause of the other changes than the effect from these changes. I think emerging markets were more logical to sell off a year ago on a valuation basis than they are now. But as far as gold goes, I've long given up on speculating why it does what it does. I recommend you give up as well. Essentially, I think the various complexities around the trade war are more developed than they were a year ago, and the entire environment around monetary policy is categorically different, for good or for bad. So was the latest market rally Fed-driven or trade-driven? Well, I think both factors are

at play throughout all aspects of markets right now. So the answer is not mutually exclusive of the other option. But that said, it does appear that market sentiment has been more impacted in recent weeks by the signaling of monetary accommodation than the idea of an imminent trade deal. Stocks with more direct exposure to the trade war. Semiconductors, emerging markets are all up in this market rally, but they're not up as much as the broad market itself, which indicates more Fed causation than trade wars. Like I said, we have a chart to that effect, the German Cafe. So what do we expect here out of this kind of China saga? We know that the president will be meeting with President Xi of China this Friday and Saturday in Japan at the G20 meeting. By Wednesday morning of this week, Secretary Mnuchin was telling us that the trade deal with China is 90 percent complete.

It isn't clear in that declaration whether or not that 10 percent gap is fixable or at a stalemate or somewhere in between. On Thursday morning, word was out that China's President Xi was bringing with him the list of final kind of needs that were necessary to finish this deal. And there was different speculations about what those things were, but there's not a lot of clarity as to if this bridge is fixable or not. So we're going to know more in a few days. China's leverage has largely been considered to be, A, their dominant market share in rare earth exports, a leverage point that I think is far more bark than bite.

It can be changed in a moment if it needed to be. B, their heavy ownership of U.S. Treasury debt, which I consider to be a non-leverage point, as I talked about several weeks ago, because I don't believe China wants to tank their own economy. C, they want to play hardball with U.S. tech companies doing business in China. That's a pretty legitimate leverage point. And then D, they want to devalue their currency. And this is obviously the go-to move. And it does work to offset the pain of a trade war for them, but it only works to a point. At press time, the latest news on this front is that there is still no news to be had. There is no update until the two meet and they go stand in front of microphones themselves, we know nothing. And so all the speculation that I could give you right now as to what will come in the next 48, 72 hours,

I think is not worth the paper it's printed on. We'll know more in the days ahead. So why do we care about the trade war? Where do we see the trade war most impacting the real economy? It's in business confidence, which is the precursor to business investment, which is the precursor to productivity growth, which is the lifeblood of needed economic growth. And the drop in the business confidence index last month, I think, tells the story. And as mentioned earlier, there's a chart to that effect at dividendcafe.com. The whole concept of the market being at an all-time high, it's one of

the most interesting things about my job is hearing people say when things are distressed in the equity market, well, shouldn't we lay off of stocks? I mean, things seem kind of weak. And then when things make highs, the same voices say, hey, shouldn't we lay off of stocks? Things seem kind of strong. And I'm actually not criticizing such a contradictory message because as I write every week in the Divin Cafe, an intimate understanding of human nature is paramount for the competent financial advisor. And it's perfectly within the logic of human nature that one would find a different, if not contradictory, rationale for their human fear in different circumstances. I'll write and speak and talk and message till I'm blue in the face

this simple fact. An all-time high in price is a meaningless data point, as every price ever achieved was at one point the all-time high. Rather, it is valuations that matter, interest rates, comparative returns, sentiment, and all sorts of things. And even evaluation is an awful timing indicator as assets spend the vast majority of their time being either overvalued or undervalued. They spend very little of their time being perfectly valued. Thank God for our focus on dividend growth. That keeps one's eye on the ball of investing and not the kind of peripheral side issues that are not nearly as important. Well, where are valuations? The S&P closed last week trading at 17.3 times the expected earnings of full year 2019, which is just slightly above

historical PE ratio averages. It's trading at 16.5 times the expected earnings of 2020, but that's a worthless measure, and I mean worthless, because those earnings face inevitable revisions as circumstances play out in the 6 to 18 months ahead. Price to sales is about 2.1 times, and price to book value is about 3.4 times, and both are above past averages for a variety of reasons. Now, these valuations apply to the broad S&P 500, and of course, they have to be measured against a 2% treasury yield on the 10-year bond. In other words, the relative valuation measures that matter all reflect cheaper valuations, since for most of history, the multiple paid for earnings was against a comparable safe

rate that was more than double what it is now. But speaking of all-time highs, guess what isn't at an all-time high, as I mentioned earlier? Energy sector. And so if one's process for investing capital is to deploy capital when something was cheap and lay off when it's not cheap, then I would think energy would be seeing a significant amount of inflows right now. And again, on an aggregate of valuation measures, energy is trading below its historical average. We talked in the Dividend Cafe this week a bit about Iran and how it does represent a particular tail risk, a very unlikely problem that could have outsized impact, that right now we see it more as a geopolitical issue and we don't anticipate escalating military conflict.

But to the degree something were to light up out there, it would be certainly likely to have a big impact on oil markets that elevate volatility for equities. A lot of it depending on the nature of the conflict and how it were to play out. But for the time being, there's little investors can do to prepare for the tail risk of Iran that doesn't represent a larger cost than the undesirable outcome they're concerned about to begin with. I'm going to leave it there for now. I do believe that the Fed is going to cut at least one time in July.

And the Fed funds futures are telling you it's very likely going to be two times. So we'll follow suit. Ultimately, the jury is out as to what the effectiveness of all of it's going to be. A lot happening in the political front. Last night was night number one of this big Democrat candidate debate. Tonight will be night number two. By the time you're listening to this, both nights have happened. And what I'm going to do is wait for the second night and then over the weekend, do a big special podcast that we'll get out to you next week, kind of recapping the economic platform of a lot of the Democratic candidates and what it may mean to investors. So in the meantime, I will let you go.

We'll leave it there. Please reach out with any questions and please especially with our new enhanced kind of commitment to the dividend cafe podcast and our efforts to consolidate there we would love for you to subscribe if you haven't already get it in your feed and send it to others that you think may do the same write the review whatever you feel called to and we appreciate your help in boosting that traffic and audience of this, the Dividend Cafe podcast. Thank you for listening to the Dividend Cafe, financial food for thought. 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

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