The Dividend Cafe - So Markets CAN Move Up and Down?

Episode Date: February 2, 2018

This week, David L. Bahnsen discusses Recent market volatility The most encouraging thing about the economy Hedging deflation and buying growth Links mentioned in this episode: www.DividendCafe.com

Welcome to the Dividend Cafe, financial food for thought. Hello, welcome to this week's Dividend Cafe podcast. This is David Bonson. I'm the managing partner and chief investment officer here at the Bonson Group. And we just want to bring you our weekly commentary. What a week it's been. We're kind of titling our comments this week, So Markets Can Move Up and Down, kind of on the backs of the first week where we really experienced

any even modest downside volatility in quite some time. Let's get into it. I mean, I would actually say, to me, the most encouraging thing about the week were the couple of down days. We were down about 175 on Monday and then 360 points in the Dow on Tuesday. And I think when I say encouraged, I think it's refreshing to be reminded that markets can and do go down. The percentage volatility was actually very minimal because obviously the price denominator of the market is so high. But on a point basis, a two-day drop of over 500 points has not happened in a long, long time. So I mean it when I say I

love it. This is normal market behavior. But even with this week's volatility, it did not stop January from being one of the strongest market months in history. We wouldn't consider a 1% drop much to sweat about, but we do think you can find some other things to be concerned about, and we're going to talk about that this week. So there's plenty to lift your spirits. The Super Bowl is coming here in a couple of days. But in the meantime, let's talk the economy, the dollar, all things investing. It's what we do. Most encouraging thing about the economy, if you had told me a year ago that the Q4 real GDP growth would come in at plus 2.6% and that some would be bad-mouthing it, I would have laughed.

The prior two quarters came in above 3%, and so the blended annualized GDP growth number of the last three quarters is over 3%. All of this is pre-tax reform. Once Q1 of 2018 results come in, I expect that we'll have our first trailing year of plus 3% real economic growth in forever. So what is so encouraging? The idea of 2.6% as disappointing? That is what is encouraging. Under the hood, though, there are some important comments. The single element most suppressing GDP growth for years has been a lack of business investment. While the net exports part of the GDP equation kept growth from truly exploding this last quarter, business investment grew a stunning 8% on an annualized basis. The State of the Union, say what you will about President Trump, his use of Twitter,

the controversies around temperament, the various policies one may agree with and others may disagree with, but this speech was extremely well received and provided a glimpse into a more pro-growth and unifying message. I think less protectionist maybe than people had feared. You know, look, as is often the case, one knows not what the next 48 hours will produce. But as far as State of the Union addresses go, both the general population and the market seem to particularly like this one. Early onset euphoria. The Bank of America Merrill Lynch Bull and Bear Indicator tracks 19 different signals for varying levels of market euphoria and excess, reflected 11 different market signals triggered this month,

58% of their kind of watch signals. This is not quite the 100% that were signaled in March of 2000 or October of 2007, but it is far off of the low levels of bullishness that existed in the marketplace just a year ago. And a year ago, equities were trading 30% lower. Our weighting of equities reflects this reality and captures the prudent caution we think is warranted. Further euphoria would warrant further trimming.

Let's go back to that Monday-Tuesday drop I talked about a moment ago. Obviously a 1% to 2% drop after a 7% monthly increase, which itself came off of a 20% increase year, is hardly anything to agonize over. But to the extent it was the first 1% drop in a single day in over 120 days and the worst two days in 350 market days, it was at least some reminder that markets do in fact go down too. I am not being disingenuous when I say it really was a healthy development. If there's any sign to counteract the early onset euphoria that I described a moment ago, it's things like a down 300-point day. The catalyst behind the two bad days is not completely clear, but the combination of rising bond yields and investors simply recognizing the reallocation of risk and reward,

that makes plenty of sense to me. Did someone say rising interest rates? Well, yes, indeed. The yield on a 10-year Treasury bond has hit a four-year high this week, essentially as of right now sitting at about 2.74%. Essentially a rising 10-year bond yield is what one would expect if A, we're getting economic growth, we are, and B, inflation expectations begin to tick up, and they likely will. One of the arguments against inflation ticking higher and bringing

interest rates up with it is the lack of wage growth we've endured for quite some time. Can inflation move higher without robust wage growth? In theory, yes, but it's not common. The major piece to watch, in my mind, is whether or not productivity picks up enough to absorb inflationary pressures. Inflation is too much money chasing too few goods, and productivity will increase the capacity for goods and services. So it sort of puts downward pressure on inflation. The way everyone will be watching this whole escapade is in bond yields, and so far they're moving higher. But bond yields will be so far they're moving higher. But bond yields will be telling us a lot more than the mere level of interest rates.

They'll be telling us about productive growth versus inflation in the real economy. Alexander Hamilton spinning in his grave. We made the most successful Broadway show in history about our nation's most brilliant founding father, but we have not maintained his doctrine of a strong U.S. dollar. I made a comment last week that we resonated more with the Hamiltonian teaching on our currency rather than the last 15 to 20 years, where obviously the thinking, let's just say, has been a bit different. Well, it's generated a couple questions to me. What is that contrast? What are those differences? What's that look like?

The point being made there was that Alexander Hamilton was the ultimate advocate of economic strength and competitive advantage through a strong and sound dollar. That a nation which paid its bills will attract investor confidence and that a sound currency would attract capital flows, these were highly intuitive things for Hamilton. Today, the idea is that a weaker currency will give an export advantage relative to other currencies. But of course, if that were true, it would make Zimbabwe the most prosperous country on the planet. The idea that a sound currency would actually be a magnet for other countries is believed, but it's cast aside for the expediency of short-termism. Largely, by the way, because most countries carry such a debt burden that we prefer to essentially export our deflation to other countries.

My point last week was that Hamilton would have none of it. Dollar confusion. Regardless of the policy propriety regarding the U.S. dollar, and regardless of what one believes will happen in the short term, there is a particular portfolio approach that may go a long way towards neutering the effect of either a weak dollar in the short term or a strong dollar in the short term. That is to have both emerging markets exposure and Japan exposure in one portfolio. Short term, the emerging would benefit from a weaker dollar, and Japan would benefit from a stronger dollar, as would Europe, by the way. But now this entire thinking is confused and unhelpful. No one needs to take equity positions to offset short-term currency impact, anything like that.

To the extent that one wants to avoid one-sidedness and currency exposure, then we think emerging markets in Japan play opposite sides of the discussion. Hedging deflation and buying growth. In a disinflationary environment, the performance of stocks will depend on whether or not growth is advancing. Rising growth with declining inflation is not just possible, but it's common. At a chart at DividendCafe.com this week, we show you how disinflationary booms, pretty good stock growth movement movement have coincided many years over the last 20 years. That itself represented a secular cycle shift, and we think another one is going to come. But in the meantime, there's little I want to own more to hedge against deflation than long-dated bonds, long-maturity bonds. They're cheap, they're liquid, and they're transparent. There's nothing I ever want to

own more when there is growth than stocks. So we want to own the right things based on the season that we believe we're in. And there really are a couple charts and comments at DividendCafe.com. It's a little hard to get into on the podcast without the visual aid, but I'd really encourage you to check it out. It's just fantastic. Okay, I'm going to go ahead and close it out there. There are a couple other things actually in dividendcafe.com and I'd love for you to go to the site to check those out. Appreciate you sharing this podcast and writing a review and giving us some comments and so forth.

We really want that feedback and that kind of just critique you know, critique and so forth, it helps us and certainly feel free to share it along wherever you like. Listen, for our Advice and Insights podcast that we do every week, longer form, totally fresh content, different themes and things every week, here's something we want to do. Email us

any questions you have, anything you'd like us to address. Email it to Bonson Group B-A-H-N-S-E-N, bonsongroup at hightoweradvisors.com. For the next week or two, we're going to collect all the questions that we can, and then we're going to do a whole podcast with myself and one of the other members on the team, and we're just going to go through the questions that we collected one by one and answer those different things that listeners want us to address. So send your questions to bondsongroup at hightoweradvisors.com

and we definitely will address them on the podcast and make that a little more interactive, make it a little more fun. We're going to leave it there for the week. Thank you for listening to Dividend Cafe. Thank you for listening to the Dividend Cafe, financial food for thought. opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance 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 believed to be reliable. Any opinion, news, research, analyses, prices, or other information contained in this research is provided as general market commentary

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