The Dividend Cafe - Q2 Picks Up Where Q1 Left Off

Episode Date: April 5, 2019

Topics discussed: Q1 in the can Capex update The oil price conundrum China trade deal Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend 2019, and of course, we want to kind of recap a bit of the first quarter, which was one of the strongest Q1s in history in the stock market and in a whole lot of other metrics of risk assets. The markets are responding to a healthy economy, a healthy earnings environment. It does kind of make you wonder if things are so good why the Fed has to pause, but therein lies the rub of the underlying tension. Look, we're going to cover all this and more this week. The issue of CapEx, oil prices, recession talk, inflation, so much more. So let's go ahead and jump into it. But first, I do want to do a quick little plug for our Advice and Insights podcast, where we're going to be spending some time, kind of a series of podcasts going through the subject of dividend growth investing, which is the underlying ideology

of our approach to stock market investing at the Bonson Group, something I've built my career around and our team has built its entire investment policy around. And I happen to have a book coming out on the subject this coming Tuesday. So in coincidence with the release of the book, we are doing a series of podcasts around the different aspects of dividend growth investing, different arguments for that foundational approach to the stock market. And we would encourage you to check out Advice and Insights next week for some of that content. All right, let's summarize quarter one here in the Dividend Cafe.

The Dow ended up about 11.8% to the upside. S&P ended up about 13.5% to the upside. Small cap measured by an index called the Russell 2000 was up about 14.5%. Emerging markets were up 9.9%. Let's round up and call it 10. And even the bond market moved up over 3% on the quarter with, by the way, municipals outperforming taxables, and then the riskiest of credit instruments called high-yield bonds up over 7% on the quarter. So you really just don't have an example

of anything not doing well, more or less, in the first quarter. On a sector basis within the U.S. stock market, think S&P 500, technology, real estate, and industrials led the way. Energy was right behind there. I think with technology and industrials in particular, you could argue that you have kind of a China factor as there's relief from this expected China trade deal at play. And then with real estate, you have a rate-sensitive sector rallying on the news of an easier Fed.

And then the kind of laggards were health care and financials, but both of them were still up 6%, 7%, 8%. So when your worst-performing sector, health care, is up over 6%, you know you've had a pretty strong quarter. Now, I am not letting go of this theme about CapEx and the need for capital expenditures, and I put some charts at DividendCafe.com this week indicating how the drop in new manufacturing orders

and the kind of overall business sentiment captured in some of the regional Fed surveys, which indicates their kind of intent, the company's intent for capital goods orders going forward, capital expenditures has reversed back. You had this incredibly strong move up throughout 2017, early 2018, and then you see in the charts a reversal in some of those numbers. Durable goods orders have remained reasonably strong, but the fact of matter is that capital stock in the economy is as old as it's ever been, meaning we need a replacement of unfathomable amounts of goods and inventories. I don't think we're going to know until later in the year. It could even be early next year. But ample evidence exists that the long run upside for CapEx is substantial, but it's not guaranteed. What I would point out is whether it's going to happen or not, it is needed. And so a lot hinges in the economic expansion on how that plays out over the

next year. One of the factors behind the stock market's big rally in 2019 thus far, it's not gotten adequate attention. And I suppose that's probably even true here at the Dividend Cafe, has been the big move higher in oil prices and what that has meant for the energy sector. One of the reasons the topic's hard to cover is that there's a debate over the chicken versus the egg. Do oil prices reflect healthier economic conditions and growing demand? Or is the economy actually growing because oil prices are going higher? I would say the latter view is preposterous, but there is a kind of virtuous cycle or in

other cases, a vicious cycle at play that makes the chicken or egg kind of convoluted in this case. Oil prices signify demand growth or supply weakness or both. And then higher oil prices create demand weakness at some point. Rinse and repeat. Okay, this is just the supply-demand fulcrum, one of the very most fundamental components of economics. But as supply-demand forces work their way through oil markets, we do have a conundrum taking hold, and that is that the Fed went dovish a few months back as inflation expectations collapsed amidst fears of a global economic slowdown.

And this was evidenced in oil prices that utterly collapsed in the fourth quarter. And it's the argument that President Trump's National Economic Council director and my good friend Larry Kudlow has argued recently is that inflation expectations were so low, why wouldn't the Fed take a more dovish approach? But, you know, that was an easier argument to make with oil prices at $43. As they approach $70, the weak inflation thesis could find itself challenged yet again. could find itself challenged yet again. So a great chart at Diven Cafe of the correlation between oil prices and inflation expectations, particularly over the last three years,

incredibly tight correlation. My view continues to be that the Saudis have every motivation to keep prices higher if they prepare for some sort of IPO of their sovereign oil industry. The skyrocketing Permian production that we're doing here in the United States remains in a bottleneck. They cannot get all the supply out and transported quickly enough. So that keeps a lid on the supply levels that enter the market, and yet demand has remained stubbornly high.

So I would, all things being equal, hold to a higher oil price thesis for the time being. Let's talk about the China trade deal real quick. The notion we've largely held to the last few months has been that the vast majority of the eventual China trade deal is already priced into markets and therefore could lead to a fade in the market if any part of it remotely disappoints. That view has become so consensus that the contrarian in me increasingly believes that there's a chance the China deal will outperform expectations. For one thing, the very idea of a deal produces a self-fulfilling dividend.

one thing, the very idea of a deal produces a self-fulfilling dividend. The uncertainty of ongoing tension gets removed. Now, in the details, you will find the truth. If the deal transcends no new tariffs and reaches a repeal of old tariffs, there is room for a market advance. The idea that China's use of currency manipulation will be addressed, apparently it's already been agreed to, that would produce more embedded stability in the global economy. I'm not sure how much that's been priced into markets. And as I've talked about over the last several months, in certain specific sectors, agricultural and energy

purchases being increased out of this deal represents an additional opportunity. But let's ignore the benefits to the stock market and U.S. economy in getting this trade war behind us. Let's just look at China's economic health in isolation, kind of separate from all the trade talk. Nominal GDP growth there has slowed to 8%, and deflationary pressures in their overheated economy are real. And yet no significant reflationary policy tool is available,

as they have had to deal with the need to cool their own industrial and financial economy. They're not in any kind of position to double down. So, yeah, I think a more stable currency that they're not as free to manipulate, it will mute the impact of the challenges on the rest of the world. It limits their chance to export their deflation, which of course China's been doing for a couple of decades, excuse me, Japan has been doing for a couple of decades. But the fact of the matter is, regardless of the trade deal resolution, China's macroeconomic health still represents a lingering factor in global economic health,

and that outcome is always uncertain. All the talk about yield curve inversion has enabled more talk about the realities of recession. And I should say a recession is coming again at some point in the future, whether it be 2020, which I increasingly think is unlikely, maybe 2021, 2022, or who knows? The fact that a recession was coming was hardly a mystery even before the yield curve inverted. We know recessions happen. We just don't know when.

And I think one of the reasons America takes its recessions in stride historically is that the magnitude of expansion periods is so much more powerful than the damage of contraction periods, meaning the good things that happen in non-recessions are so much bigger than the bad things that happened during recessions. A couple stats that I picked apart this week in a couple of the nuggets I was reading. The average expansion period lasts six times as long as the average recession. GDP has grown 24.3% on average during expansion periods for the last 70 years, but it's contracted only 1.8% during the average recession. The S&P is up 117% on average per expansion period.

It is up 3% during recessions. And by the way, that factoid should grab your attention. How is the market up during the average recession? It's for the simple reason that markets are a discounting mechanism. Pricing in today what they believe about the future. I've been saying this now for nearly 20 years. Markets begin their upward climb before recessions officially end. Always and forever. It makes waiting for the end of a recession to be properly invested a very expensive decision. Let me pick on the gold bugs real quick

and get ready to wrap it up. The impact inflation has had on purchasing power is not something we take lightly and something that we do talk about with clients all the time. My earnest desire is to avoid the hysteria of hyperinflation forecast and yet not get numbed to the awful effect of regular inflation. A 1% to 3% annual increase in prices effectively causes the cost of things to double every 25 to 30 years. causes the cost of things to double every 25 to 30 years. And to put that more accurately,

it causes the value of your money to be cut in half every 25 to 30 years. So we agree inflation wrecks havoc on investors, but simply need to determine the best way to fight it. TV commercials are filled with the claim that gold represents the best hedge against inflation. And indeed, since 1980, gold is up 153% from $800 to $1,300 an ounce. And yet inflation is up 230% in that same period. And that actually is a huge moderation of inflation, not expansion. So put differently, we now are well over an entire generation of gold,

substantially underperforming inflation itself. Dividend growth stocks, on the other hand, have tripled the rate of inflation in income alone, not to mention the underlying increase in price. They've created income, maintained liquidity, been tax efficient, they're easy to store, meaning they're easy to own, and have offset the malignant effects of inflation time and time again. One may argue that owning dividend growth stocks carries with it the unpleasant reality of market volatility because it does. But an owner of gold is not in a very good position to claim differently. The charts about its own volatility don't lie, let alone its ineffectiveness in combating

inflation, certainly in the modern era. So what else has to go well in the present state of the economy for this expansion to continue? You know, I've talked so much about the need for this capital expenditure boom. We've exhaustively covered that. But a plethora of other issues exist as well. There's a kind of potpourri of economic factors. I think that an unforced error like shutting down our border with Mexico would be a disaster. If there were some turn for the worse with the European Union on auto tariffs, it could be very problematic. Brexit's particulars could represent a temporary disruption.

We've talked about oil price stability. Look, most of these things are going well, and they're acting how they need to right now but a global economy provides perpetual opportunity for things to get complicated uh look let me just read you one final stat then i do need to let things go for this week's podcast um those that obsess and this is just a crazy statistic i I still even like reviewing it right now, I cannot even believe what I'm about to say. People that obsess over relative market returns, you know, how they did versus the market instead of their absolute returns, are missing out on some pretty important things. If you had invested from 1960 to 1980

and beaten the market by 5% every year, you would have made less money than if you had invested from 1980 to 2000 and underperformed the market by 5% per year. I mean, think about that. You beat the market by 5% per year. I mean, think about that. You beat the market by 5% per year for 20 years and you underperform the market when you're down 5% per year

versus the market in the next 20. Well, how is that mathematically possible? Obviously, because the second 20-year period did so much better in the first 20-year period. The absolute return environment trumps relative returns any time. It does nobody any good to beat the market by 5% per year if the market itself was not doing well.

Absolute returns trump all. This is a driving force of our philosophy of asset allocation. Read the rest of DivenCafe.com. There really are some good charts and things this week. I say that every week because it's true every week. And with that, I will close out this podcast. Please do listen to our Advice and Insights podcast for a deeper dive into our dividend growth philosophy and the dividend growth book coming out next week. Send us a note.

We'll get you a copy. book coming out next week. Send us a note, we'll get you a copy. But it is definitely something we're very happy about, very proud of. To kind of be able to summarize in one book the entirety of our philosophy around dividend growth investing, why it means so much to us and our clients at the Bonson Group. And with that said, thank you for once again listening to this week's Dividend Cafe podcast. The Bonsai Group is registered with Hightower Securities LLC, a member of FINRA and SIPC, and with Hightower Advisors LLC, a registered investment advisor with the SEC. Securities are offered through Hightower Securities LLC. Advisory services are offered through Hightower Advisors LLC. This is not an offer to buy or sell securities. No investment process is free

of risk, and there's 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. All data and information referenced herein are from sources Thank you for watching.