The Dividend Cafe - Productivity Numbers IS the story of the Week

Episode Date: May 2, 2019

Topics discussed: Earnings Watch - more come but things look good Capex Showing Signs of Life GDP - 'nuff said Reading between the Fed lines Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. what the Bonson Group is, check us out at thebonsongroup.com. Chances are, if you're listening to this podcast, it's because you do know who the Bonson Group is. And so in the course of our endeavors, managing client money and deeply engaged in not only customized discretionary portfolio management, highly active, highly focused around dividend growth, hence the name Dividend Cafe. But we, of course, do serve as a sort of multifamily office enterprise providing all sorts of peripheral services, anything engaged in our clients' financial lives. But this particular podcast we use to talk about those specific areas in the world of our investment management, specific areas in the world of our investment management, our macroeconomic overview, the portfolio perspectives that we may have. If you're interested in some of the things that we're doing along the lines of tax planning,

estate planning, various concierge or lifestyle services that are provided, cyber security, and so forth and so on, that kind of whole aura of wealth-oriented services, please do check out the financierge. Think of financial and concierge coming together. Wonderful property. It might give you a little more context about the Bonson Group. But in terms of the Dividend Cafe function for today, we are really enjoying this week. It has been quite a week to take a look at economic expansion, at productivity, at the Fed.

They had their press conference and FOMC meeting this week. And, of course, the month of April, the calendar month of April came to an end. So we kind of have more market data. So I'm going to jump into it and I'm going to give you the same caveat I basically give every single week. And that is that there are charts that I put up at DividendCafe.com and that obviously we can't have for our podcast listeners. And yet I really do think this week there are more than normal. And I joke that I say that every week, but it isn't true every week. This week it is.

And so if anything I say here today kind of gets your interest, there are one, two, three, four, five, six different charts that I think you'll find interesting if you want to go to DividendCafe.com. That is sort of the bread and butter of what we're doing is that weekly written commentary. I've written every single Friday now for coming up on 11 years. And it is just meant to sort of throughout each week encapsulate the perspective we have, the things we're watching, the things we're thinking about, and be able to deliver them on to our clients.

And in the case of Dividend Cafe, the written commentary and podcast and the video that we do are available to the world. There are some things we do that are client only. And so that's kind of the intent. This may seem like a long setup for some of you, but frankly, I don't really do this stuff enough. I need to kind of do a better job just explaining what's what and what goes with what and so forth. So I will jump into it now with that caveat about the charts at the website and let's do this. And I do want to talk about productivity. And here's the thing. I talk about productivity indirectly through all of the weekly discussions I've been promoting for over a year now around CapEx, on capital expenditures. But the CapEx itself is not the desired end. It is the means to the end. And it is a vital means. And I don't really know how

we're going to get to the end without the means of CapEx. But the end is enhanced productivity. And this week, I think that markets focus on the Fed chair's use of the word transitory and all of this ridiculous stuff with this testimony and the way the Senate Judiciary Committee treated Attorney General Barr and all this. I don't really believe that the markets have much interest in a lot of it. And I believe that markets, investors, regular people ought to have a huge interest. And this data report came out Thursday morning about the Q1 productivity rising at the fastest pace since 2014. And that labor unit cost fell dramatically. And I think it's the biggest story of the week, regardless of what kind of mention it gets. It isn't a very romantic story, you know,

in the press. You start talking about unit labor costs and numbers and GDP productivity and things that I get that it turns people off. But here's the thing. Productivity increased 3.6% in Q1, far above the 2.2% that analysts had expected. And even that 2.2% was going to be pretty good. This productivity surge absorbs growth in labor costs and it enables corporate profits to expand. It suppresses inflation. cannot say that the mere existence of higher wages is inflationary if the amount of productivity you're getting out of the additional labor is outpacing it, the cost. We call it unit labor cost.

There is no healthier way to restrain unit labor cost than with growing productivity. And if this story holds, and in frankness, it's going to take a couple quarters of validation before I forecast that it will, we will indeed be talking about a multi-ending expansion of this economic recovery and of this bull market. Now, as far as earnings go, earlier in the week, we hit the point where 50% of the companies had released and they had 50% of companies have revised their expectations to the upside throughout the month of April. And that covered on a net net basis, 10 of the 11 S&P 500 sectors on a net basis experiencing earnings revisions to the upside. Of the companies have now announced, 77% of them have announced Q1 results that have beaten profit expectations, in a lot of cases, far beaten it.

And so with a few exceptions here and there, it's thus far been an extremely positive earnings season. earning season. Back to that CapEx front, the pickup in CapEx intentions in the data does bode well for my key thesis for economic growth. Companies have not seemingly given up on their plans for additional capital expenditures. And this is one of the charts I mentioned that we have at Dividend Cafe. But the trade war delay of late 2018, you know, obviously put a pause in some of the company's action in terms of their CapEx intent. And yet CapEx orders were up 1.3% month over month in March. So there's a lot on the line there. And we're pleased with where we see things going, but we don't think we're out of the woods.

and we're pleased with where we see things going, but we don't think we're out of the woods. Now, the GDP report that came out last Friday makes my argument for me. Real GDP grew at a 3.2% clip, far higher than most were forecasting. And by the way, that's a real GDP number, meaning net of inflation. But a look under the hood shows that two-thirds of the growth was accounted for by rising inventories and declining imports. Those are what you consider to be the less growthy, less sustainable aspects of GDP growth. They matter, but they don't provide the same confidence for sustainable growth that some of the other ingredients in GDP would. in GDP would. The contribution to GDP growth from non-residential fixed investment, which is business investment, which is the category I obsess over, it continued its decline from the prior quarter. Business investment grew 2.7% in Q1, but it had been 5.4% in Q4, and it had been

about double digit level growth in the quarters before that. This continues to be the variable that I am most interested in. I'm going to switch gears to oil now, although I assure you things in the energy markets are very much connected to a lot of business investment, capital expenditures in the economy as well. Look, we're one trimester of the year down, two to go, meaning we're through the first four months of the 12-month year. And it seems silly to talk about how equity markets have done year-to-date without focusing right in on oil. The 33% year-to-date change in oil prices to the upside

is a perfect encapsulation of why equity markets are up. And yet not in any way because a higher oil price has caused markets to go higher. Rather, the higher oil price is proof of the inaccuracy of so many of the concerns that were plaguing markets coming into 2019. A recession is coming. Oil demand says, no, it isn't. Dollar strength is killing American competitiveness. The dollar hasn't dropped, but it's only up 1% on the year versus a basket of global currencies. And oil, which is denominated in dollars, has thwarted the strong dollar narrative. CapEx is collapsing. Oil says, no, it isn't. Higher oil prices push more energy infrastructure projects online.

Emerging markets instability will collapse oil and create a severe headwind on U.S. markets. EM markets have stabilized and with such enhanced the outlook for global consumption. Oil is one of the weird components in financial markets that people use to make their case no matter what is happening. If oil prices are high, bears say it is a threat to the consumer, and bulls say it demonstrates global economic momentum. If oil prices are weak, bulls say it's a boon to the consumer, while bears say it crushes industrial projects. The truth is that oil prices are perhaps the most non-forecastable thing in all of capital markets. And it takes a real outlook on why oil prices are doing what they're doing to drive an economic conclusion at all. Let me read between the lines

real quickly and kind of unpack some more of what the Fed did this week, didn't do this week, more importantly said. They did hold rates the same, which was totally expected. They alluded to the idea that recent low inflation data, they believe is transitory. They expect to see inflation get back towards their 2% target. It has to be said, they don't have any idea, nor does anybody else, when inflation will go back to 2%. I'm not convinced that any central bank really understands why inflation goes down, goes up as it does. But the notion that they can control it on a string is dramatically defied by the powerful testimony of history. They did unpack more about their so-called quantitative tightening measures, whereby they

said they have been reducing the Fed balance sheet by $50 billion a month. We knew that. That was about $30 billion in treasuries and $20 billion in mortgage-backed securities. And they plan to reduce the treasury reduction to just $15 billion a month and yet keep the mortgage back the same. So that'll bring their total reduction of their balance sheet from $50 billion a month to $35 billion a month. But then in October, they want to eliminate any reductions at all, get rid of quantitative tightening altogether. Now, actually, that's not technically true

because they will continue to let $20 billion a month of mortgage-backed securities roll off, but they'll be replacing with $20 billion of treasuries. So rather than let them both kind of be rolling off and reducing balance sheet, they're going to let one roll off, the other one get replenished, so the net net is zero. No net change, but it will alter the composition over time of their balance sheet to be less mortgage-based and higher treasury-based. They did slightly lower the interest that they're paying on excess reserves not meaningfully but

some step in that direction and trying to promote a little more activity and I will say as far as the basic fed funds rate that most people are watching I think they're very unlikely to move up or down in June as well in terms of corporate corporate credit, there's obviously a common practice in our business of people picking a conclusion. Let's say someone says, oh, corporate leverage means the world's about to end. And then they work backwards to mine the data necessary to prove their predetermined conclusion. And when one looks at borrowing in corporate America, let alone borrowing in the government sector, there's always some available data to create fear because God knows there's always a lot of borrowing in the universe. And because most things that go wrong have as a predicate excessive debt or credit issues, the mere discussion of debt and credit issues is a good way to talk about things going wrong.

going wrong. That said, and being aware of the potential for false or inconclusive data, the health of credit markets is an obsession of ours, and a couple data points I'll share with you do warrant awareness. The first is the growth of the covenant light lever loan market. This is corporate borrowings that have very few restrictions or covenants around their collateral, around required ratios, payment terms, etc. Now, before you panic, it's imperative I point out that some were waving the flag of concern about these covenant-like loan issuances as far back as 2011, and the sector has not had a single negative year since. So we talked to significant portfolio managers in the space, and they say that, yeah, there's fewer covenants on loans now, but that's because the covenants have better payback ratios. So the lenders do not need the same covenant protection they've had in the past.

And they further point out the recovery rates were really not less for covenant light borrowers in the aftermath of the financial crisis. in the aftermath of the financial crisis. However, all things being equal, and I get the idea that you're more concerned with companies that won't default than you are companies that have better protection towards if they do default. But all things being equal, it's a great example of something one does not need to worry about

until they need to worry about it. And so when we see the Covenant Light issuance, there's a chart that shows you more of it. And also when we look at middle market leverage, we see that at the very bottom of the financial crisis, when the highest amount of deleveraging had taken place, debt divided by EBITDA was at about 2.9 times throughout middle market lending. was at about 2.9 times throughout middle market lending. And it's gone up now to 5.6 times, almost doubled its ratio of debt to EBITDA in the middle market framework. That doesn't necessarily tell us when there will be problems,

but it does tell us that there's been a lot more risk that's built up. I think as far as that issue of a Fed rate cut, people say, well, who's afraid of one? And it could be a good thing. And I'm afraid of it. And let me explain why. There's no doubt that the Fed signaling more rate hikes late for the time being, at least until growth could sink in

and the long bond could increase with elevated growth expectations. I get the argument that to cut right when economic growth is so strong would represent a contradictory message and damage the credibility of the Fed, Even though I also get the argument that if the rationale for the last one or two hikes was inflation fears, the data has now changed in that regard. But at the end of the day, there's pretty much one reason

I do not want the Fed to cut rates at the moment. And that is that I'm fairly confident it would lead at some point to an asset bubble for me. And I hate, hate, hate, hate asset bubbles because asset bubbles burst. And there's no exception to that. Bubbles burst. And it's the aftermath of that that causes a lot of pain and agony. All right. I'm going to go ahead and leave it there now for the week on the political side. Stephen Moore, as of the time I'm getting ready to go to press here and do this podcast, all of a sudden the president did announce he's withdrawn his name for consideration. So both Herman Cain and Stephen Moore are now out.

And we'll see if the president comes back for his next Federal Reserve appointment. There is talk about the president trying to work with Nancy Pelosi and Chuck Schumer on an infrastructure bill. And I understand they met this week and we'll see if there's going to be another meeting. I don't believe it. I don't think that either side is going to allow the other side even the appearance of a victory. The chart of the week at Dividend Cafe is fascinating, dealing with the movement in markets, the gains that have taken place after hours, meaning that gap of when the market closes one day and where it opens the next. And you will find that that is where in fact, net, net, net, where all the gains of the market have taken place for the last couple of years. All right. I am off to the SALT Symposium in Las Vegas,

the largest hedge fund conference in our industry. It will take place next week for a couple of days. I've gone for many, many, many years. It is an absolutely intellectually stimulating event. I promise to come back with all sorts of commentary and things. I'll be recording the podcast from Las Vegas next week. And in the meantime, reach out with any questions. Thank you for your listening

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