The Dividend Cafe - One Big Week and It's Not Different

Episode Date: December 10, 2021

As I type on Friday morning well before the market will open for the day, the Dow is up ~1,200 points on the week, basically right back to where it was the day before the Omicron news and market sell-off, and the futures are pointing upwards for today as well (of course, anything can happen on that front). A week ago, I devoted the Dividend Cafe to discussing why I felt the Omicron story was a bad joke of a market mover, and we walked through a little COVID Market history. But I didn’t end on a sanguine note – I reminded you that there are vulnerabilities in the markets and that chief among them was the anti-fragilities created by excessive monetary interventions, and of course, basic valuation concerns where some euphoria may be overflowing. Today we’ll leave Omicron in the rearview mirror where it belongs and where the media has conveniently left it just 10 days or so after dramatically different assertions. But we’ll dig deeper into a couple of things that warrant our understanding – an understanding that is not the same as concern or worry. Come on into the Dividend Cafe … 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. My name is David Bonson. I am the Chief Investment Officer here at the Bonson Group. And I am excited to be sitting in my New York studio. There's been a fair amount of travel. I think, where was I last week? I think I was in San Francisco. I've been in Palm Beach.

I've been in Grand Rapids. I've been back in Newport Beach over Thanksgiving week and the week after. So, you know, kind of a lot going on the last couple weeks. And if you're watching the video, you may have seen me in a handful of different spots. And if you're watching the video, you may have seen me in a handful of different spots. But one thing that has continued is a pretty vigorous inquiry into this notion about what risks are real and what risks are exaggerated in the markets right now. So I really enjoyed last week's Dividend Cafe. I thought it was a kind of helpful 18 to 24 month history to go back over the 2020 and 2021 time period around various ebbs and flows of the coronavirus and what that's meant with markets. And at the time we were dealing with last week,

this highly volatile week coming off of a 900 point down day the day after Thanksgiving, week coming off of a 900 point down day the day after Thanksgiving as news of the Omicron variant got out. And so I had a lot to say about that last week. And then I had a little bit to say on what was ironic to me in that the certain risks that I thought were being ignored while other risks were being really overly played into it. Now, here we are. As I'm recording, the market's up about 1,250 points on the week. It has now made back the entirety of that week of volatility from the variant.

And I've written in D.C. today, every day this week, and we've discussed at length, especially last Friday's Dividend Cafe, why I didn't think that the COVID variant news was much of a market story. And really, if I'm being fully candid, because I don't ever want to hold back for people that listen to or watch or read the Dividend Cafe. And most importantly, I don't want to hold back what I say to clients. It wasn't that I thought it was overdone. I thought that it being done at all was misguided, that there was just simply no market story there at all, none. And yet a couple of things have happened that I want to talk about to further unpack what I do believe is an important market story right now.

unpack what I do believe is an important market story right now. And after I had written most of Dividend Cafe very early this morning before the market opened, as I came into my office today, there was something that happened that caused me to add this into Dividend Cafe. It's not a very big deal, but it's just I thought was, first of all, borderline hysterical. But second of all, really quite, I don't know, metaphorical to this thing I'm talking about is there was an individual who was trying to, you know, we have like, I think it's six, it might be eight, actually, eight elevators in our building. We're at the Graybar Building in New York City, next door to Grand Central at 44th Street on Lexington Avenue in Midtown Manhattan. Central at 44th Street on Lexington Avenue in Midtown Manhattan. And there's eight elevators to come up to where our floor is. So this whole kind of bank of elevators. And one of them was

coned off. The walls were scraped out. And it was a big sign up saying out of order. I mean, it couldn't have been clearer that it wasn't open and it was out of order, not safe. If you try to stop it, maybe you're going to fall 50 feet or the thing's not going to run and it's going to shake. There's nothing good can happen here. This was not rocket science. And yet the elevators weren't coming on the other one and the door was open on this one because of it being out of order. And there was an individual who I don't know, and I'm not talking about a person with a name or anything, just some person. It was a real

person that was wearing a full mask, presumably because of the COVID stuff. I mean, you got to understand like everybody I hear is vaccinated, right? But he's vaxxed. He's wearing his mask. Okay. And yet he wants to, he was like very angry. He couldn't get into a broken elevator. And so I know it's not a perfect analogy and I know some of you may not get it, but it just struck me like there was a market metaphor in here for people that are doing one protective thing that kind of doesn't make any sense to me and yet like still trying to engage in another very risky behavior. And I believe there is that exact same investment activity taking place every day where people are like, oh, I'm going to try to time the market to avoid stuff with COVID. But then on the other hand, I want to be all in on crypto and these hot tech, new tech companies and, you know, a lot of small cap growth or whatever the case may be. I could go on and on. There's a shiny object phenomena in investing right now that is like something I haven't seen since dot com.

Dot com was worse, I think. There's more dollars in this now, but that's 20 years later of a more inflated economy. But the cultural taboo back in 1999 was probably even worse. But my point, I don't know, there's metrics that make it, that would point to it being worse now and other metrics that might point to it being worse then. But one of the biggest differences is that certainly the higher caliber tech companies now are more viable and real and defensible than they were then. But when you talk about the social phenomena around what's going on, you know, both reflect a lot of craze, a lot of euphoria, a lot of disconnection from reality.

And so disconnection from reality is where I'm going now with the rest of Diven Cafe is, you know, Joe Kernan on CNBC. I've been on his show, oh, at least 15, 20 times, maybe more than that over the years. I like Joe. He was interviewing a money manager by the name of Kathy Wood, who I also know, who I think highly of, very, very smart woman. And yesterday they were talking about these high P.E. ratios, the high valuations that exist in a lot of these new, hot tech companies. And Joe uttered the statement that whenever I hear it, it perks my ears up. Maybe this time it's different. Maybe these high valuations don't contract at this time, even though they always have historically. Maybe now they just stay higher because we're in a new

world. It's a new paradigm. Interest rates are low and we're just going to have a bunch of companies that traded 100 times earnings forever or something like that. And yeah, I'll put this one to bed quickly because I think the more important comment is the one that followed from Kathy. But yeah, when you hear someone say this time it's different, you should be scared. This time it's different. Well, maybe this thing that we believe in, this timeless principle, this mathematical law of nature, this mathematical law of nature this economic law of finance maybe it's now obsolete because something has been going on for a while and I'd certainly like it to go on for longer so I'm going to just sort of reconstruct my view of reality I think that's dangerous because it does reflect someone who is probably set up for a lot of pain, but it also speaks to a complacency level

in the investing public that is dangerous. And when you start desensitizing yourself from risk, from volatility, from reality, from math, I think that what generally happens is systemically quite uncomfortable. And when people start saying that house prices can never go down and that any amount of income can justify any level of mortgage, there was this sort of suspension of math, science, logic, reason in nature during the housing bubble, the same suspension of the same things in the tech bubble, the same suspension of the same things in the Japanese asset bubble, and so forth and so on. So people can make a fundamental argument if they want for why certain things that are very high

valuation could go higher or stay the same or whatever. And every argument should be taken on its own merits. But to say my argument is that all the principles and laws are now gone and this time it just may be different is problematic, to say the least. I'm being very charitable. say that when they look at a lot of these non-fang tech names that are smaller, that are less mature, less seasoned in the business cycle, they may be big brand names, but they're very expensive and they're high valuations. And in some cases, maybe not even making money. Some cases making a little, but they're expensive. And they look out five years. She said we're discounting those valuations. We're being hyper conservative by assuming that they may come all the way down to FANG level valuations in just five years. And I just could not believe what I was hearing.

FANG as a group trades at 42 times earnings. Now, some in that group are at 70, and some are at 28, but my point is this is pretty darn expensive, okay? And so their earnings have been high, and valuations come lower as earnings grow, and that should be the case of all these other high fine tech companies. She's saying that we are not valuing them as if they're going to get to normal valuation, but we think it looks good.

And we assume that they'll come all the way down to still 42 times earnings in five years, which is not exactly like around the corner. And I would just simply suggest that that sentence can be uttered In five years, which is not exactly like around the corner. And I would just simply suggest that that sentence can be uttered. Look, a lot of those companies over five years are probably getting out of business. Some of them are going to outperform our expectations. Some will perform in line with expectations and the stock prices will get slaughtered because you don't want to end up in five years from now at 42 times earnings unless you think the growth projections in the next five years are going to result in a higher projection in the future, which is just insane.

So you have all the uncertainty of a long period of time to end up at a place that's basically high. What does 42 times earnings mean? what does 42 times earnings mean? It means that the company stopped growing but stayed the same and you got 100% of the profits to yourself. You would get your money back on that investment in 42 years. So yeah, we've lost our minds when we talk this way. Now, companies that are at these high valuations, some of them will pan out. Some will not. But my point is merely that we're talking. She used the word very conservative. We're talking as if this whole entire situation, that, by the way, is not new.

It's been going on for quite some time. You're already in the period that most of these companies have had the highest growth expansion as a percentage they're ever going to have already they're still going to grow and some of them proved to be good companies you look at those fang names those are all really really good companies but that period of like if a company is going to do ten dollars a profit and then it goes to a thousand dollars and then every year after that it does another hundred well one year it ends up at like five thousand dollars a profit but its biggest percentage growth ever was that ten to 1,000, right? Okay. These are companies that are kind of past that part of their percentage growth. And we're talking about getting to 42 times earnings in five years and that being very conservative. I just believe that there is a mispricing of risk for a lot of the shiny objects of the investing market. And whether you want to talk about crypto, which is much harder to value because of its lack of intrinsic value,

a lot of people run phases down to about 27% in the last month. It had gone down more than that a few months before that and came bouncing right back. Maybe it bounces back again. Maybe it goes down much, much further. But it's very hard to value because no one's trying to give you a projection on an earning stream like technically we're supposed to be doing when we look at individual companies. So small cap growth is now basically flat on the year. Large cap value is up 28%, but large cap growth is still up 20 something percent. 10 companies in the S&P make up 30% of the, over, I think it's 31% of the S&P 500 are 10 companies, and there's 500

companies there. Five companies in the S&P 500, so 1% of the index makes up about 24% of the index. So that's an all-time high for concentration, top 5, top 10. So my point is, I actually think you could argue that it is logical that FANG has held up the way it has so far because at least there you have massive balance sheets, massive cash generation, big, big brand names. There's a lot of problems. You know, they definitely have passed their peak years of growth percentage, but they still have great growth. They still have great earnings. They still have a lot of assets.

They still have impenetrable brand names. But they do face, you know, government investigation. There's a mixed case, okay? I'm not even referring to the FANG stuff there. That is far more defensible to me than what I'm talking about. And when we are in an environment where people want to go get in a broken elevator that may not even have walls, you know, to hold them from falling down a shaft, and yet they still talk about how they want to wear a

mask. Something's just off. And I prefer we approach investing with a more logical, rational, reasonable, sensible calibration of risk and reward. That's my lesson in this week's Dividend Cafe. We find that calibration calibration risk and reward more logical and rational in cash flow generation that comes from high quality companies of good balance sheets. But we do not believe in a utopian outcome here that we can do all this devoid of risk. There's still risk. We just would prefer to avoid the risk of trying to get to a 42 times multiple in five years. We prefer the risk of execution, of business interruption, of cyclical circumstances.

We diversify away that risk. But we want strong balance sheets that provide a lot of defense, high-quality management. You get my point. So risk-reward is the ongoing subject of an investor. I would suggest that the great investors of all time have focused on the risk part. And that is the world in which we live right now. I hope it's been helpful, maybe even some parts a little humorous. But at the end of the day, these are

serious subjects. And I hope you're getting something out of the way we treat them here in the Dividend Cafe. Thank you for listening to the podcast, watching the video. Please go read the commentary for some great charts. And as always, rate us, forward us, tell a friend, especially a friend that's about to fall down an elevator shaft even while they're wearing a mask. Thanks so much.

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