The Dividend Cafe - Politics Played A Role in Portfolios

Episode Date: January 24, 2020

Topics discussed: Markets re-opened Tuesday this week after the MLK holiday on Monday, and experienced some modest moves to the downside on the week as of Thursday's press time ... But in a shortened market week where the big political news (impeachment hearings) are completely ignored by markets, and where there is no notable macroeconomic news or Federal Reserve announcements to process, it gives us a great opportunity to catch up on other topics not given enough attention in the Dividend Cafe. We'll talk shale this week, viral fears in China, why a high bond supply does the opposite to interest rates that most people expect, and we spend a lot of time in Politics & Money ... So jump on into the Dividend Cafe. It's a good one. 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 the Managing Partner here at the Bonson Group, bringing you our weekly market commentary. We're going to have a kind of heavily political theme this week, although not so much oriented around all the impeachment stuff, barely even at all in that regard, because I want to talk about things that actually matter economically and in investment markets. And there is a handful

of political activity, discussion, news updates that I'm going to hit on that I think are pertinent to the lives of us investors. But we're going to jump around a bit, a few different conversation topics. So bear with me. We'll go through things and then hopefully we'll spur you on to further reflection. And of course, if you have any questions, you can reach out to us. I'm going to start off at the very top by making an offer. If anybody would like to write a review of our podcast at your player of choice and post some kind of rating and review situation, regardless of what you say and how you feel about us, you will earn yourself a free copy of my brand new book on Elizabeth Warren. and that kind of traffic and sharing around our podcast helps build up our traffic and play better in the algorithms of the different iTunes and Stitchers of the world. So we appreciate any help you want to offer us in that regard for the Dividend Cafe podcast. Let me tell you a little interesting thing that I went through this week. I have written quite a bit in the past on the correlation between the president, a candidate for president, an incumbent, either candidate or party that wins, but generally speaking, I find the correlation to be extremely high.

Incumbent party or candidate wins when there is a general positivity in the stock market and incumbent candidate or party loses when not. And there's a couple of exceptions over the last hundred years, one that's real clear, one out of a hundred years, and maybe one or two that some people could consider gray areas. So I've always found an interesting study and I've done a lot of work in that regard over the last several years. But I read a little thing this week from one of my research partners that talks about, and in fact, they go through, let's see here, it's something like 15 of the past election cycles that 14 out of 15 were predicted, again, either the incumbent party winning or losing based on how the S&P 500 had done in the three months prior to the election. And I said, okay, well, that's a very interesting correlation. And then that's even more tighter

mathematically, because my study was more based on a broad performance and impression of the market. And, you know, you could have a term where, like, for example, Bill Clinton's second term, the market was up huge in 97, huge in 98, huge in 99. And the NASDAQ crashed in 2000. The Dow actually was up in 2000. But with the broad ownership of technology stocks that crashed in 2000, when people were voting in November of 2000, the broad impression, the most recent event, the kind of most logical association mentally was with a market that had tanked, not a four-year broad improvement in markets. So you could argue on the margin that could have been a factor when Al Gore lost the presidency.

That's a gray area to some degree, but again, it's not a hard and fast mathematical rule, where this report I read this week is. It's pure 90 days prior. But there's a problem with the study, and it is this. It is susceptible to getting the chicken or egg backwards. There's a cause and effect situation. Is the performance of the stock market in the 90 days going up to the election the cause of a candidate winning or losing? those years where the election was not necessarily going to be very close, that the market itself was going up in the 90 days because of the election. So the election was not determined by the market, but the market was determined by the future election result because the market was pricing in from August to November of 1980 that Ronald Reagan was going to beat Jimmy Carter. That's a good example. Certainly in 1984, there wasn't a lot of ambiguity about the fact that Ronald Reagan was meaningfully higher in the polls than Walter

Mondale and the market liked that. Now, of course, there's some years that that can't apply because the 2004, for example, the market was up a little bit in the 90 days before the election, but the market really didn't know if Bush or Kerry was going to win. It ended up being very close. Bush ended up prevailing, and the market rallied a lot after the election but wasn't able to price that in ahead of time. And so all things considered, there's a bunch of different indicators like this out there, and I've tried to reference some of them in the last couple of podcasts. Some of them I think are more pertinent than others. They're all interesting. They're all useful. But would anyone want to hang their hat on my general stock market feeling or excuse me, the three month S&P test or even other things about

disposable income or recession? You know, generally speaking, we know that there are some really good indicators that have like an 80 to 99% track record. That's pretty darn good. It's pretty helpful. And you get all four of them lined up together and that can be even more helpful. I still believe that we're living in a time where I would not be betting on the 85% probability. I would not be betting on the 85% probability. I would bet on it more than the 15% probability because of, you know, math. But I do think that 15% probability events right now should not be discounted in America's political culture. All that to say on the political side, that there's some interesting data points out there that give us more of a feeling as to where things will go. We are right now in the very first time seeing President Trump in the higher position with most of the betting odds.

The betting odds had had Trump beating several of the Democratic candidates, but losing to some of the others. And now the betting odds have moved more in President Trump's favor, although a lot of the polling has not necessarily moved in his favor. But again, we know the reliability of national polling at any time, let alone 11, 10 months for an election. So I think that there's going to be a lot of ups and downs along the way, and that the market is going to have a very difficult time pricing and what to expect, at least with all the data points being what they are now. Now, what else happened this week that might be of interest from a political standpoint? Well, Larry Kudlow, the White House Economic Director, has been tasked with designing a tax cut 2.0.

They want to aim it at the middle class, make it different than the corporate tax reform bill that already passed. Clearly, no one really believes that this could get through Congress right now, the Democratic majority in the House. So more becomes campaign fodder in this election year, but then perhaps gives us a glimpse of what a second Trump term, if there were to be one, might pose for the economic agenda. And I think that it's worth considering that if President Trump is reelected and the House stays Democratic and uncooperative, there are a couple of things he can get done on tax policy without Congress. And one of the ironically most low-hanging fruits is in tariffs because he raised them without Congress, so he can lower them without Congress. And that could potentially be stimulative. He might actually have control over his own tax cuts in an election year. That's not something I'd rule out entirely,

by the way. Of course, there's other policy agendas at play, but I do think it's certainly possible to consider. Another aspect we've talked about in the past is the indexing of capital gains to inflation. And the president has said he's not intending to do it. He's kind of ruled that out. But again, that is something he would have the discretion to do at an executive branch level with Treasury Department cooperation. But what I would expect that they would put forward, which would put the Democrats in the House in a difficult position to resist, are an expansion of earned income tax credits, something very targeted towards lower income households, and then potentially a payroll tax cut, which is something that is very

popular with middle class households. It's certainly geared at middle class earners. I question its stimulative benefit. I don't think on the supply side it is as effective as marginal income rate reduction, but it certainly would be popular politically. And so those are the types of things I think you'll see on the table. I think from a spending standpoint, you're going to hear a lot more talk on infrastructure, highways, things like that. And so we will see what they both present in the election year, primarily as campaign talking points, more than likely. And then if indeed there is a reelection, what could potentially be on the table in 2021 that the market might respond to.

And by the way, if the House were to flip from Democrat to Republican, I wouldn't be expecting that. But if that were to happen, then obviously there's a lot more leeway they'd have for things that they might want to do with a tax cut 2.0. A couple of the political things, and I want to get to some just raw economics. The president has sent up Judy Shelton's name to the Senate for approval as the governor in the Federal Reserve Board. It may not be huge, dramatic, market-moving news, but Judy is a very respected economist and someone I am very fond of in terms of her advocacy of sound money. And I don't believe at this point

that the president will have trouble getting her through, and that will make for an improved Federal Reserve Board in some capacity, at least through the eyes of David Bonson. In terms of what's happening in the Democratic primary, Elizabeth Warren this week wrote some letters to the CEOs of the eight largest banks demanding to know what they plan to do about climate change. change. And then Wharton Business School released a very highly regarded anticipated study of the wealth tax proposal from Bernie Sanders, Elizabeth Warren came back and reported that they think it would woefully underperform in terms of revenue generated. They expect it to be about a trillion and a half dollars less than the candidates have projected. So a lot happening in the political sphere. The reason I say I'm skipping over the impeachment side is because it is true. I'm a little bored of it and tired of it. But it's also true that I'm here to talk about the economy and markets and I don't

see the impeachment and markets having any impact whatsoever. A couple of the things that are in the Dividend Cafe this week that I think are really important. I want to reiterate week after week after week the importance of emphasizing quality in one's equity portfolio this year. The quality of balance sheet, quality of business model, meaning perhaps the less cyclical one, repeatable cash flows. Obviously, we measure all quality through the prism of dividend growth. all quality through the prism of dividend growth, but even just a kind of raw operating earnings, high margins. There are businesses that just have better risk characteristics. They're a bit more, shall we say, defensive than others. And it is my opinion that 2020 will end up being a year where quality in equities will be valued. Ironically, the first couple of weeks of the year, that's not true.

The highly cyclical, lower quality names, higher PEs, more indebted, they've performed better. And some of the real high quality names have performed a little less. There's nothing about our theme that has any opinion at all what the market might do in a week or a month. But I think that that broader perspective is right now very timely. week or a month. But I think that that broader perspective is right now very timely. I'm asked to comment a lot on the kind of viral fears of this so-called coronavirus out of China. Obviously, these numbers are in motion, although we would hope that these numbers would represent

a ceiling, not a floor. But as of right now, the report is that there are 17 fatalities, a total of 500 infections in China. And I make the comment, look, I think it's a really awful story. I hope no one else gets sick and let alone, God forbid, has a fatality event around it. It's awful. To the extent that this is being portrayed as a market story, it's rather disingenuous. So to the extent that this is being portrayed as a market story, it's rather disingenuous. Interesting to note that when we had the avian flu outbreak 20 years ago, SARS outbreak in 2003, swine flu a few years later, and Ebola, in all four of those periods, the market was higher, in some cases meaningfully higher. So I think it's going to get a lot of media coverage. There's a certain degree of wanting to panic around things.

And I just think, first of all, even versus SARS, this is a categorically different situation. The transparency and the preparedness of the Chinese government appears to be very different than it was 17 years ago. But even then, I think it was largely overdone. I have a wonderful chart in DividendCafe.com showing you the annual dividends of the S&P 500 for the last 20 plus years. And how those dividend amounts have moved up year over year over year. Except for in 2008 to 2009, it dropped quite a bit. And then it's gone up every year since then. And the S&P 500 was paying $197 billion in dividends, not per share, in 2009, and it's paying $483 billion now. And I think that you have a growth of dividend per year that is right in line with the growth of price per year. And then you get this kind of miniature illustration of exactly what we believe, that prices catch up to cash flows.

Cash flows don't catch up to prices. Investing around pursuit of price is impossible to do, makes you a momentum investor or a speculator. a speculator, but that because you believe value technically is always driven off of the earnings and cash flows that a company is generating, by tracking the fact that dividends went up this much year by year by year in the S&P, it really helps put into context how much the prices moved up and how rational indeed that move was. Now, I will note that the S&P had very low dividend growth in 2000, 2001, 2008, 2010, and obviously in 2009 had negative dividend growth. And I think this is why dividend growth investors cannot be S&P index investors.

The good business model of maybe 25 to 50 companies in the S&P is disrupted by the more cyclical models of hundreds of other companies, 200, 300 others, that may have a far more cyclical orientation and therefore make the overall index subject to more muted dividend growth results, even if within that index, 25 to 50 companies might be growing their dividend quite nicely. We want to focus on those 25 to 50 and eliminate the others. And in fact, we want to open up the entire universe beyond S&P names, but even some small cap, mid cap, international, a whole equity universe that enables us to go find the best opportunity where there is good valuation and expected robust dividend growth, even in

troubling market period. As I get ready to wrap it up, I do think that the economics lesson for the week in Dividend Cafe, reiterating kind of the mystery around why quantitative easing is added to, I should say, the bond inventory. We put so many more bonds in circulation as they were buying more of them without paying for them. And yet it pushed yields so far down. And people would normally think that a higher supply and lower demand would push prices lower. In this case, it's pushed prices way higher, which, of course, is the inverse of the lower yields. And the answer for it is the downward pressure is a direct result of the fact that the marketplace, the global economy knows that there's a lot of debt biting into future growth and it puts downward pressure

on bond yields. That does make stocks and real estate and risk assets more valuable. As bond yields go lower, it puts a valuation variable on that results in a higher valuation for risk assets than they would have if the comparable rate was a higher one. But just because you have a lower discount rate that is valuing your risk assets higher, it doesn't necessarily mean that the underlying value is really going up if you believe that ultimately fundamentals will prevail. So I think that all at once we have two things going on, a very compelling reason to be invested in risk assets and a risking up of the American economy where it makes itself more subject to macroeconomic risk if something were to reverse. As people feel more and more incented to buy risk assets they may not otherwise buy. So read that paragraph in DividendCafe.com or reach out to me if you have any questions on anything I just said. But I do thank you for listening to this week's Dividend Cafe. I hope

you got a lot out of it. I tried to cover a handful of things, both politically and especially economically. And I'm going to have a better update on earnings season next week than I did today, just because I still think we're too early in the season. Clearly, some mixed bags right now, some companies that have just crushed it and other companies that have failed. But for the most part, we're feeling good about what earnings season is, but we want to give that a little bit more time. So thank you again for listening to the Dividend Cafe. We look forward to reading your reviews, answering your questions, and coming back to you next week with yet again another Dividend Cafe. Thank you for listening to the Dividend Cafe, financial food for thought.

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