The Dividend Cafe - Q1, The Fed, The Roaring 20's, and the Future

Episode Date: March 29, 2024

Today's Post - https://bahnsen.co/4cDi2Sq The first quarter of 2024 is in the history books (both because it is done, so therefore now history – and because it was a big quarter with a lot of surprises for market pundits). As you go into your Easter Weekend and enjoy the market holiday that is Good Friday, take a trip around the horn as we look at history, market valuations, passive investing, credit, money supply, financial conditions, and more. Jump on in to the Dividend Cafe … Links mentioned in this episode: TheDCToday.com 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. Well, hello and welcome to a special episode of the Dividend Cafe. It is special because we're recording on Thursday. You're getting it on Friday and it is a very rare market holiday on a Friday as we celebrate Good Friday and the beginning of the Easter weekend. We also come to the end of Q1, calendar year 2024. First quarter is done. We'll hit up Q2 next year. And it has been a fascinating first quarter to say the least this year. I'm recording from Austin, Texas. We were set to record in our Austin office,

but it's been kind of a whirlwind crazy morning of things moving around. So I'm recording here from the hotel in Austin, heading back to New York City, and I'm going to be providing clients next week a much deeper summary of what took place in Q1 with markets, particularly with various elements of our portfolio. But my focus today is on a handful of different things that have been on my mind around the markets, macroeconomic, and we did kind of one of these multi-topic dividend cafes. multi-topic dividend cafes. First, I'm just going to jump into it in the interest of time, not just my time recording, but your time listening, because I got to think you have some March Madness games to watch and Easter weekend to enjoy. Passive investing, it's all

the craze. It has seen trillions of dollars go into it. It's benefited over the last 15 years from a bull market where virtually every year markets have increased. There's really only been one bad down year and one barely down year. And that happens at the same time there's been a lot of innovation in the product manufacturing of passive indices. So it's not a big surprise. Cap weighted indexes have drawn a lot of capital. Some of the biggest companies have become even bigger. But there's a couple of things I want to share. I share all the time how passive indices clearly rely upon multiple expansion and multiples, which is what we call price earnings ratio, are already very, very stretched. But I also want to point out that right now we have an average median stock across the whole US public stock market of only 17 and a half times. It's a little

bit higher than normal, but it's not brutal. And yet at the same time, we have a pretty high number. It's not an all-time high, but it's a very high range of things of 23% of companies trading above 30 times earnings. And we have, obviously, as I've talked about a lot, the highest weighting of the top two, top five, top seven, top 10 companies we've ever had. So it's a very top heavy index. And if you basically have 17 and a half times average median, but you have a high level of those companies that are above 30 times earnings, it stands to reason that it's a small amount of companies that are extra super duper sized that are bringing that higher valuation. At the same time, you see a really declining correlation among stocks, a big dispersion of returns. So my friend and frequent Dividend

Cafe reader, Michael Polos, himself a wonderful analyst and intellect in his own right, mentioned to me this week in the email correspondence that this appeared to be an indication of a weakening environment for passive, a better way to say it than as the way he put it, opportunity for active managers. I could not possibly agree more. I think that when correlations are dropping, you're going to see a breakdown, a higher dispersion of returns. And a lot of this is driven by, first of all, right now, the easiest trade in the world. You could be wrong in it and lose money. You could be right and make money.

But one way or the other, you're going to be different than the market. It's just to simply own a lot less of the super duper big things and own more of the smaller things. But see, right now, when you say that, you're also saying own less of the expensive things and more of the not as expensive things. Those two things are synonymous based on where valuations lie. I think it's worth pointing out that that is probably something that bodes very well for active management. And I also think that's an inverse way of saying something that doesn't bode well for passive index management. Just for those wondering, high interest rates, tightening credit, spreads had widened, Fed's been tight for a while. Where are we on the default cycle? High yield bonds, they were financial crisis, I believe, at 14 or 15% defaults. The dot-com crash, the total high yield world was over 10% defaults. During COVID, we got to 8% or 9% defaults. We've averaged 5% to 6% for 25 years. We had been at about 2% as the Feds tightened. We've come up to about 4%. So we're still below averages and that's with it

increasing from Fed tightening, but well below those periods of actual distress in credit markets. This continues to be one of the major stories of this Fed tightening period, of those things that often have happened that haven't. The Fed will end up being the big story of Q1, but it will be the big story for the reasons I said it would be at the beginning of the year, not the reasons many others said. And the simple reason is at the beginning of the year, we were pricing in six Fed rate hikes for the year. They're now pricing in three, maybe four.

We were pricing in that they're going to start in March. We're now pricing and they're going to start June, maybe July. And yet markets are up significantly in Q1. The markets have said time and time again, other than on the day of or day after, other than the noise surrounding a Fed announcement, they're not buying the noise. The markets are responding to liquidity.

They're responding certainly to valuation, expansion. They're responding to sentiment. They're responding to animal spirits. They're also responding to earnings. But whatever the different factors are, the noise of the Fed is not the primary driver. And that narrative desperately needs to change. A couple other random things I'm going to let you go early today. The Fed is well aware that their headline inflation rate remains higher than the 2%. They're well aware it's come down significantly.

They're well aware that the shelter number, if it were properly measured, probably does have a two handle in inflation. If not two, somewhere around two and a half, 2.6. And the Fed is not interested in there being a resurgence of inflation. So why would the Fed be talking down rates, talking about rate cuts if they believe the inflation issue is still lingering? The Fed is well aware that deflationary spirals are why they exist, that when they happen, they lose control of the ability to put it out. They have policy tools that can do a lot of harm and damage that people don't like, but do put down inflation.

They don't have policy tools to put down deflation once it spreads. That's been the story of some of the great contractions and cyclical periods of pain and distress throughout world economic history. So at a high level and long term, I don't care what anyone says. The central bankers of the world exist to put on an anti-deflation uniform. They still care about price stability. I don't think they're very good at creating it. They are somewhat political animals, but at the end of the day, they are well aware that there's been massive disinflation. They take somewhat political animals, but at the end of the day, they are well aware that there's been massive disinflation. They take a lot of confidence, as they probably should, in seeing how core goods have basically come down to 0% inflation and that the shelter number is

not really reflecting reality. So then it looks at the higher services number, tries to get its arms around where the difference in core and headline is. So at the end of the day, I really believe that the Fed is going to prove to not care as much about this optic, this narrative, this conversation, that they will be cutting rates later in the year and that they're not as worried that there will be upside surprise to inflation. I don't happen to agree with what the Fed's been asked to do. I don't happen to agree with the way they always do it. But that's why the inflation narrative is not one lingering around Fed policy.

Read DividendCafe.com for the rest of this week. I do have to run right now to my next meeting, but I do want everyone to have a very happy Easter weekend. There are three or four other topics addressed to Dividend Cafe. Unfortunately, the video and podcast is getting the short end of the stick this week. I'll make it up to you next week as we enter Q2 and go into the month of April. Thank you for listening. Thank you for watching. And thank you for reading the Dividend Cafe. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC,

member FINRA and SIPC, and with Hightower Advisors LLC, a registered investment advisor with the SEC. Thank you. The data and information are provided as of the date referenced. Such data and information are subject to change without notice. This document was created for informational purposes only. The opinions expressed are solely those of the Bonson Group and do not represent those of Hightower Advisors LLC or any of its affiliates. Hightower Advisors do not provide tax or legal advice. This material was not intended or written to be used or presented to any entity as tax advice or tax information. Tax laws vary based on the client's individual circumstances and can change at any time without notice. Clients are urged to consult their tax or legal advisor for any related questions.