The Dividend Cafe - Some Things Do Change

Episode Date: December 18, 2020

Last Friday, December 11, marked year number 25 since December 11, 1995, when my father passed away. His name was Greg Bahnsen, he was 47 years old (the age I will be next year), and he was my hero and my best friend. I have to imagine many of you have experienced things (including losses) that do not feel like they were as long ago as they actually were. I know those cliches are tired, but it just simply does not feel like it has been 25 years since my dad died. Yet it has been, and I imagine when another 25 years go by, I will be saying and feeling the same thing. Time becomes a weirder thing as we get older, I suppose (some of you will have more expertise in this than I do), and I am sure that time dynamics get even muddier when we are talking about a loss. Last weekend as I was isolated away working on a project, I spent abundant amounts of time reflecting on this and many other things. Regardless of what it feels like, 25 years has gone by since dad died, and my entire life being upended and forever changed. Over these last 25 years, not just in my own personal life, but across society, the news, the world, the culture, and yes, the economy and markets, there are a whole lot of things that have barely changed or haven’t changed at all. But, there also are certain things that reflect substantial change. Not just “evolutionary” change, but real paradigmatic change. And the biggest of those changes is the subject of this week’s Dividend Cafe … Links mentioned in this episode: 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. Hello, welcome to this week's Dividend Cafe, both the podcast, those of you watching on the video. This will be our last Dividend Cafe for 2020, which may excite some of you or may disappoint some of you, but it is kind of bittersweet in the sense that, you know, we're here to the end of the year. It's been quite an unbelievable year, but next Friday is Christmas Day and the Friday after that's New Year's Day. So I think this is kind of a special edition of the Dividend Cafe. And then I know that the first one of 2021 is going to be special as we at that point present our big recap of 2020 and our kind of special forecasting perspectives on 2021. I'll let you

look forward to that in the first week of January. But what I want to talk to you about today is going to actually cover a little bit of history. It's going to cover, I think, a significant, I mean, needle moving, you know, mind shifting subject in capital markets for in the lives and the thinking and the approach of all investors. And and a lot of it was actually in a very weird way inspired by me thinking about my late father and and his passing, which was 25 years ago last Friday. So let me pull all these things together here in the most logical way I can, and hopefully you'll find the message of this week's Dividend Cafe to be beneficial.

So last Friday, December 11th, was 25 years ago from December 11th, 1995, when my father at age 47 passed away. And I was just a young buck in my early 20s. And dad and I were very, very, very close. And so obviously, you know, you think back to this thing that was like the paradigm shifting event in your own life and forever sort of changed the trajectory of of what adult life was going to look like for for David Bonson and I spent last weekend out of our home in East Hampton and had a lot I was by myself and a lot of time of reflection and so forth and so there this whole thing with dad was on my mind and everything but then also I'm sitting there and I'm studying and reading and thinking about um you with the stuff I think about by myself which is usually

investment market oriented and I and I a particular white paper I read about the Fed caused me to think what would be different if dad were still here if dad were here today and had just sort of come back from December 1995? In other words, the 25-year period, which to me seems surreal that that much time has gone by since that significant event in my life, but when you look back over 25 years and now from an investor standpoint, which is what I'm here to talk to you all about, what has really changed? And I think that the list is incredibly short. The fact of the matter is that what drove returns in risk assets 25 years ago is absolutely what drives returns now. The susceptibility to human misbehavior is still the biggest risk for all investors. Playing into excessive levels of either euphoria or panic is still the biggest behavioral risk and impactful risk for any investor.

25 years ago, Bill Clinton was president. Newt Gingrich was speaker of the House. We're about to go into Joe Biden as president and Mitch McConnell as Senate majority leader. You have this divided government dynamic that we've had most of the time over the last 25 years. I think you could argue on the margin that the country is more politically polarized now than it was then, but the country was incredibly politically polarized then. I think the ramifications of it are more severe now. Now, social media is clearly different because it didn't exist then, And I think it represents all sorts of toxicity

that may not have existed before, but it's a magnifier of things. It isn't a disruptor of things. And I think, you know, from that investment standpoint, geopolitically, the world, I even in dividendcafe.com this week, I write about, well, is 9-11 the thing i'm missing like you know dad died before 9-11 didn't that sort of change the world because it most certainly did

in my mind but i don't think it did i don't think that investors and i don't think american society right now has a different day-to-day feeling about geopolitical terrorist, you know, radicalist risk than they did before 9-11, I think in the immediate aftermath they did. And by the way, that threat, you got to remember, in 1993, we actually had a real jihadist attack on the World Trade Center. And my dad was alive for that, even spoke about it, as a matter of fact. And so what happened in 2001 was much bigger and much more fatal and much more economically and from a human standpoint destructive, but it was still part of a similar understanding that we had about geopolitical risk.

I even gave myself a potential caveat about the euro because I do believe that the shared European Union currency is this really significant event and I would add a systemic risk that exists in global economics. But you know I think it was 1992 going into 93 that they passed the treaty that created the euro they didn't have it you know ready for for game time until 1999 but that was again already something was going on and in fact if you looked at the headlines back in 95 it would say Britain and European Union negotiating over their kind of carve out from the currency. And you fast forward today and every day there's some headline about Britain and the European Union negotiating. In this context, it's about Brexit.

So there's actually like these incredible similarities and again, sort of magnifiers of things that were very real 25 years ago. So there's an awful lot of things in the economic context, the world of investing, that I believe if you look at it this way, if someone were just literally on a 25-year nap and woke up and was watching cable news or reading the paper, I think you could come up with, and I provide a list of hypothetical bullet points in Dividend Cafe, six, seven things that you could say about today that are major takeaways, political polarization, geopolitical threats, whatnot. But then you could go back and look at that same list and say,

this was completely the case in 1995 as well. And yet the exception, I think, is what I want to talk to you about here today, which is the completely paradigmatic change in the role of monetary policy in the U.S. economy and the level of interventionism that is now status quo from the Federal Reserve. And this is not a 2020 event, although it's filled with headlines from the COVID moment in 2020. It's not a 2008 event, although it's filled with headlines from the great financial crisis. This is now, I believe, a decade, two decade, who knows how many decade forward event in which the primary actor in the U.S. economy is the Federal Reserve. Now, the Federal Reserve existed in 1995, and the Federal Reserve was at moments controversial prior to 1995, very rarely.

controversial prior to 1995, very rarely. But that to me, if one were to say what's the biggest change in the overall landscape of investors from 1995 till now, it is the role of monetary policy and the centrality of the central bank redundancy on purpose. The entire thing we're really going through right now with growth assets, with very, very high valuation technology, with a NASDAQ that's now priced at 32 times forward earnings, and the notion of investors, both institutional and retail,

that say we need the momentum now. What's working now is what will be working tomorrow. Growth oriented, momentum oriented. That is directly out of the playbook of what was taking place in the mid into the late 1990s. There is absolutely no difference other than some of the companies, not even all the companies, but some of the companies are different. Technologies have grown. Obviously, you've got to kind of contextualize where there's particular updates or replacements to nouns and verbs involved. But that whole dynamic is a replay. The Fed is not a replay. The Fed that set the price of money

well before 1995 was not the default option for dealing with crises. At this point, there is no question that when there is some economic crisis of some category, the immediate default is what is the Fed going to do? And the Fed has done something in each of those cases. So I look back historically to 1998 as a very pivotal moment with a sort of solidification of the so-called Greenspan put, where you had GDP growth at four and a half percent. Now, I don't mean nominal. I mean real GDP growth, net of inflation. You had an unemployment rate of four and a half percent, which then was as low as we

had seen in a very long time. But you had a Russian currency crisis, a default. You had a hangover from earlier year Southeast Asia currency crisis in Thailand and Singapore. You had a hedge fund in the United States, long-term capital management, that had blown up and created disruptions throughout capital markets. But really, more or or less a swimming economy. And yet the Fed cut rates three times in the fall of 1998 as a backstop to risk assets, stock market that had dropped and then ended the year up well over 20%. And I think that ever since that moment, you look to Y2K, you look to the aftermath of 9-11, you look to the recession of 2002, and of course then you get into the great financial crisis. At that point, this so-called Greenspan put and the so-called idea of the Fed being the primary actor in the economy was well entrenched into financial markets and even into policy expectations. And then out of the financial

crisis, all of that was just exponentially true. The Fed putting $4 trillion on their balance sheet, dollars on their balance sheet, compressing interest rates down to zero percent, and creating these very creative funding facilities to help intervene into commercial mortgages, syndicated loans, commercial paper, all sorts of asset-backed securities, the TALF one, and then now in the COVID moment, the second TALF. The mechanisms that were created to deal with the Bear Stearns backstop, this Maiden Lane facility. I'm getting in the weeds on it, but these special purpose vehicles were just this kind of application of the notion of the Fed becoming highly interventionist and the major player. And now the result is that the Fed is looked at as the responsible actor to monetize government debt.

They can't directly monetize government debt. When the Fed buys the bonds that the Treasury Department issues to fund their deficits, the Fed puts an asset on its balance sheet and it stays as a liability on the Treasury Department issues to fund their deficits. The Fed puts an asset on its balance sheet and it stays as a liability on the Treasury's balance sheet. And monetizing the debt would mean the liability goes away. The Fed can't buy the asset and then extinguish it like they do in some countries. And when people tell you the Fed is printing the money

to pay the government debt, they're wrong. Now, it's all a little bit gamesmanship because could the Fed sell that, excuse me, Treasury sell that debt without the Fed as the buyer? And what would the rate be to do so? And if they couldn't roll over the debt all the time with new buyers, I get all that.

But I'm saying as a matter of really important technicality, the Fed's buying an asset and the Treasury keeps the liability. The point being, the cost of that has to stay low to keep the whole thing going. And the more that the Fed has intervened, they're always intervening. Never forget this. This is a lesson for all of finance. All crises are fundamentally debt crisis. I'm not aware of what another crisis is in the world of finance than debt. And when you have a debt crisis and you address it with monetary policy, you create more debt and therefore lay the groundwork for a future crisis and you exacerbate boom and bust cycles. This is 101 stuff.

Even people that believe they ought to be doing it still acknowledge that this is the price of doing it. So as I look forward into the next 10 years of 2020s, I think that the biggest change over the last 25 years is the reality of zero interest rates that's come about from Fed policy, the incredible commitment of the central bank to prime the pump for more credit, for more liquidity, and the moral hazard that has been created around risk taking. We saw in 2018, as they started to try to tighten their balance sheet a little and credit markets

eventually kind of revolted, they couldn't deal with it. They said, no, no, no, we can't have this. You cannot tell corporate America to lever up, lever up, and then all of a sudden pull away the punch bowl. And I don't have any idea, nor does the Fed, what their exit plan to all this is going to be. And so if I want to think about the big change going forward, what the challenge for a professional investment advisor like myself is, and what the tension points are going to be inside both the investor portfolio but also the macroeconomic conditions, I think it is all about the Fed. There's plenty of other things that will happen out there, but they're not really new. Investor greed and investor panic are not new.

Tensions in the Middle East are not new. Not being able to trust Russia is not new. It's all gotten far, far, the stakes have gotten far, far higher. But even the whole issue about trade with China is not new. It's all gotten far, far, the stakes have gotten far, far higher. But even the whole issue about trade with China is not new. You know, a lot of that began in 1993, WTO and so forth. So you have a lot of things that are out there, but not necessarily new. This issue with the Fed versus 25 years ago is a theme I want everyone to understand is at the forefront of our thought process at the Bonson Group. So with that, let me just say that it has been a pleasure

to present the Dividend Cafe yet again this year. I do wish you and yours a wonderful holiday season. Next Friday, I hope you're celebrating a Christmas holiday with many, many, many friends celebrating a Christmas holiday with many, many, many friends and many, many, many family members. And not, I won't be burdening you listening to me talking about the market. I look forward to being on the other side of 2020 with you all. And yet we do still have a few DC Today's to go. So even though there's not a daily podcast of that, certainly check out thedctoday.com for a daily market digest.

In the meantime, this is maybe a little meaty of a Dividend Cafe subject. So follow up, send emails. I'm very, very happy. It's actually a joy for me to be able to interact with you about this subject and go enjoy this Christmas week ahead. Thank you, as always, for listening to and watching the Dividend Cafe. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, member FINRA and SIPC, with Hightower Advisors LLC, a registered investment advisor with the SEC.

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