The Dividend Cafe - Phase One, An Election Battle, and Earnings Galore

Episode Date: January 17, 2020

As of press time Thursday it has been another strong week in markets, with the formal signing of the phase one-U.S/China trade deal, a strong start to earnings season, and the continued general feeling that this is a good market in a good economy. Of course, life is never that simple, and markets are really never that simple, so we have a lot more to say about everything. 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 here at the Bonson Group. I'm also recording a little video here as we do this. I'm recording from New York. It may be the last time I record from New York before our new studio is set up in our new office. We will, at some point here in February, be in our new office space over by

Grand Central. And we'll have a whole kind of recording set up there, enabling us to do the podcast and video whenever I'm here in New York in a little better quality and setup and ease of use for us and all that. So I'm looking forward to it. But in the meantime, the more important part is what I want to talk about today. Another big week in the markets, and I'm recording in the middle of the day on Thursday. And as of recording time, we are looking at another market rally, some of it as a result of the phase one China trade deal being signed. And the phase one China trade deal had been well announced over a month ago.

And, of course, kind of the beginning foreshadowing of it back in September. So this is really old news that we were not escalating the trade war and the kind of truce had been arranged. And the general structure of what they're looking to accomplish had largely been known as of in December. But there was some more meat on the bone that was made available this week. And to my surprise, the market light did enough to go up even higher. And you can say, well, wasn't it all kind of priced in? And I would have thought most of it would have been. I mean, the market is up a significant amount since these things were announced and so forth. And yet the market rallied quite a bit more.

And now on the margin, I think things like hearing there will be $52 billion of commitments that China is making to buy in U.S. energy, $52 billion of commitments that China's making to buy in U.S. energy, 30 plus billion more in agriculture, the idea of 200 billion over two years overall, those numbers, I think, had certain details that were pleasing to Wall Street. But the reality is that the restrictions on forced technology transfer were more tightened up than I think a lot of people expected. There's certainly plenty of things that are not firm or final. A lot of what they wanted to accomplish with the overall trade deal, there's still more to be done. And whether or not I'm of the opinion nothing will happen after the next election, there's the possibility of a phase two trade deal before the election. We'll have to see how things go with phase one. I think the reason why I say that, by the way, it's not me being pessimistic

on phase two. It's more the political reality that if you go for a phase two and don't get it, you have a political risk. If you just sit back and wait, you don't. That's kind of where I think we are. So all that to say, I'm expecting a continued benign environment of markets as far as those two factors that have been the predominant factor in markets in 2017 and 2018, and that is the Fed and the trade war. Excuse me, I said 17 and 18. I meant 18 and 19. And so now, here in 2020, I don't think it will be trade and the Fed driving markets as much. This is a big theme of ours and wrote a whole white paper around this you can find on our website, which by the way, I'll take that opportunity to say to our podcast listeners that

our brand new website is up live at thebonsongroup.com, completely, totally redone, restructured, redesigned, and we think we're very proud of it, very happy. So please feel free to check out thebonsongroup.com. But anyways, the theme I refer to is the idea that 2020 is going to have other factors that impact markets more. And of course, some just shocking surprise out of the Fed could change that. And one of our ideas is that there will be, in fact,

certain unaccounted for volatility around trade things. I suspect it could be even more possibly with Europe than with China, but not things that I consider to be secular and macro and sustainable, but more volatility, cyclical headwinds, as perhaps the possibility of jawboning and tensions enter the fray throughout the years, which I think is a reasonably politically safe thing for the president to do, but maybe market volatile. But no, I would say that you're going to see things like earnings be a bigger factor in markets this year. So now we started off earnings season this week. It's so early. I'm not really going to unpack it statistically yet. We're in single digits of the percentage of companies that have released any results.

And it's almost entirely been thus far in the banking and financial sector. Now, in that group, it's been very, very positive. The majority of companies have benefited. They've announced better revenue growth, better loan growth, better profit margins, better earnings growth, all the kind of things you want to see. But again, that's a few bank companies we need to get a little deeper in. The heart of earnings season will be over the next two full calendar weeks, and we'll have much better data when we're 70% through instead of when we're 5% through. So that type of information, earnings, the profit environment,

where we see macroeconomic indicators around business investment going, And then the second half of the year, I think the election will become a far bigger factor. So as we sit here now, we look at the trade deal and say, well, is the market overreacting in a good way? Are they giving it more credit than it's really worth? And like I pointed out, first of all, there are things that are better than we thought. The trade deal is a positive thing for markets. I agree it isn't, you know, every single thing that perhaps some people would hope for and wanted, but relative to where we were, how it backtracked the escalation of tariff issuance, and then kind of some of the peripheral things that were agreed to and now in written form, I think you have to consider it a positive. And the market has said the same. But let's just say that I was sitting there scratching my head as to why our market

was reacting the way it is. And I'm not. I kind of get it. But when you look at the way in which the dollar has moved relative to the Chinese yuan, and when you look at how the yield curve has sort of un-inverted and un-flattened, that kind of widening or steepening, which isn't by any means dramatic, but certainly more healthy throughout this period in which the phase one China trade deal has been known and revealed and over the last couple of months announced and forecasted. And then when you look at the stock market, what you have is stocks, bonds and currencies all put together saying, yeah, we actually think it is a positive. other saying, yeah, we actually think it is a positive. And so if there's a media pundit or a really bad political handicapper like me sitting around saying, ah, it kind of seems that it isn't as substantial as we thought, then we're wrong. The markets aren't wrong. Currencies, bonds, yield spreads, equity valuations, These are all things that are indicating with a particular focus in the

China trade deal that it is, in fact, quite a positive issue. There's a lot of wrong ideas out there. And I have a section at DividendCafe.com in my written commentary for the week that I walk through certain beliefs that are not crazy. They're not fringe, they're orthodoxies. They're things that almost everyone in that particular category of people seem to believe, whether it's people who borrow money, people who lend money, economists at universities, central bankers.

And I point out a belief that they either have or have had that was very, very systemic amongst their block of people and was actionable. It's something people act on, something they believe enough that they're making behavioral decisions around it. And that underlying belief is completely and totally fundamentally flawed and wrong. that underlying belief is completely and totally, fundamentally flawed and wrong. I think that we need to do a better job in the investment space, recognizing what they don't do in the economic space,

often enough, which is recognize beliefs that are wrong, that are driving decisions. People can be wrong about any number of things, but I find it to be a very interesting subject, the faith that people will have in truisms that are not truisms at all. And this subject to me, because I'm trying to really use the Dividend Cafe podcast

to not just talk on what happened in the market this week and what we believe about kind of ad hoc event, the China trade deal and stuff like that, but to drive deeper into what ultimately drives investment markets and what ultimately drives macroeconomics, which are such a big input into markets, investment markets. Well, these macroeconomic considerations are so largely driven by things that are wrong or things that we should have known were wrong. And I believe that these lessons, getting them right, adds to our investment success. that these lessons, getting them right, adds to our investment success. That doing the homework to unpack what beliefs are inaccurate. You know, I'll use one example,

which is the sort of academia, the world of academia in economics, the confidence level they have in their models. That's gotten plenty of press since the financial crisis. So they all had risk models around national housing, around contagion risk, around credit aid ratings, around what the underlying credit risk would be, defaults could be. They had these things modeled and what the macroeconomic exposures were as a result of different things, and the models clearly broke down. And I'm not right now using this opportunity to criticize economists for getting something wrong,

for a model ending up being wrong. I can't remember who coined the old joke about models are very useful. They're wrong all the time, but still useful. You know, look, the fact of the matter is that the issue I'm worried about is not a model being wrong. It's the confidence that people in elite positions of influence and power have in their fallible models. And then the practicalities that come out of that, the beliefs about investing

that come out of flawed model creation. Well, this is not like this fringe weird thing. And it wasn't a one-time thing that we all have to sort of give a hall pass to because of the financial crisis. These things happen all the time. And so you would think that there'd be a school of economists now that believe in creating models, but also want to have a kind of humility around it or want to have a stress testing on the possibility of models being wrong. But the potential for fallibility and economic modeling, that is not something that is really believed in the ivory tower. And that, to me, represents a great threat to economic stability,

but also to the way investors will operate within that threat to economic stability. And so, you know, we've been dealing this forever, my whole career and longer, the orthodoxy that risk in investing is equivalent to volatility. First of all, one of the worst things that does is tell people that low volatility means there isn't risk. And that's completely, totally false. You can have very little up and down fluctuation and still have a very earth shattering event take place that can do significant value destruction. For a bad thing to happen, you do not need up and down movement. So volatility is not necessary for there to be a risk event. So you get a false positive all the time. But then on the flip side of that, high volatility does not necessarily mean that there is value destructive

events. And so decisions for lenders to feel good about loans in low vol and bad about loans in high vol, this is a completely accepted conventional belief that is patently wrong and leads to significant malalignment of interest in the economy and in terms of best decision making optimal results. So this is something that maybe I've lost you on already. I don't think so. I kind of think it's interesting and I'm hoping I'm articulating in a way that keeps your interest, but it is something that I believe I'm going to continue to expand upon throughout the year. And it goes hand in hand with all the big picture macroeconomic things that I spend

so much of my week thinking about every week and how I can best channel it into a proper investor result. And when we talk about investor results, one of the great risk management tools ever available is process of asset allocation and then the action of rebalancing within the asset allocation. So our need to very tactically and very granularly allocate client capital around what we believe are the best trade-offs for risk and reward and managing to a liquidity objective, managing to tax efficiency, to cash flow creation, to risk tolerance, all of those things that help us drive a broad asset allocation along with more specific asset classes and sub-asset classes and so forth. Very wonderful process. But then you're going to

have things that outperform. You're going to have things that get ahead of themselves. You're going to have things that get undervalued. Behavioral finance being what it is, you very often see things that are great investments become too great in their pricing and need to be checked back a little. And you have things that maybe are in a slow period, either because they deserve it or don't, they get sold off too much. And rebalancing becomes a mathematical and operationally proficient way to realign the portfolio to take advantage of things that have run up portfolio, to take advantage of things that have run up a bit and take advantage of things that have run down too far. So rebalancing is a behavior, asset allocation is a concept, and they feed together.

And we are exercising our annual rebalancing across our entire client book of business this week. our annual rebalancing across our entire client book of business this week. And it's a real joy to see what I think we're doing there to help mitigate risk, to maintain and affirm client disciplines, and to execute this best practice, which I think is historically and empirically verified as a really important step in managing risk and maintaining investor direction towards their goals. So if you have questions about any of that, please reach out to us. China trade deal, macroeconomics,

the amount of the world that centers around wrongly held beliefs and rebalancing. Those are my main topics for you this week. I hope you've gotten something out of it. I look forward to being back in the California office next week and doing an even deeper dive and certainly on the way taking any questions you may have in our never-ending pursuit

to give you better content, better information, and a better understanding of what drives the way we think as we obsessively and diligently steward our client capital. Thank you for listening to The Dividend Cafe. Thank you for listening to The Dividend Cafe. Financial food for thought. 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. This is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.

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