The Dividend Cafe - Sowing the Seeds of Human Flourishing

Episode Date: May 8, 2020

This week’s Dividend Cafe will do all it generally sets out to do.  We will look at the overall economy, and I even close with something I don’t often do: A summary of our short term, medium term, and long term outlooks.  There is quite a deep dive into the jobs data, the economic picture, the state of the U.S. energy industry, some post-COVID economic realities, and much, much more.  But there also is a sober assessment of something else – the human toll of non-productivity – the impact to joy and fulfillment when people are cut off from productive activity.  It is the heart of our tragic moment. 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 and welcome to this week's Dividend Cafe, where I am recording right now on a Friday afternoon, literally to the second as the market is closing for the week. And I actually didn't even time it that way. It just has been one of those days where I couldn't record earlier. And now we need to get it kind of done so that we can get this podcast out for you, as well as distribute our whole Dividend Cafe commentary so that everyone can go into their weekend with my latest market updates. What a crazy week here in the market. Today, Friday, we are closing up over 450 points on the Dow, closing at our

highest point that we've been in the market since the COVID crisis began. And yet yet today was the day that we got the April jobs numbers and saw 21 million jobs lost in our country in the month of April, and an unemployment rate in the high 14% range, representing the highest unemployment rate that we've had since the Great Depression. So I'm going to get, actually, I already got probably, I don't know, 10 texts and emails today of people wondering why could the market be higher when these bad things have happened. And I do feel like I'm answering that every week and perhaps even more often than that. And the answer is not going to really change very much. But I also understand where the question comes from. It does seem so counterintuitive. So I don't want to spend a lot of time on this, but let me briefly just reiterate the reality that markets are discounting mechanisms that are looking forward

and the jobs data reflects the really bad news that was from the month of April. Does not mean the jobs data is going to be great in the month of May. It won't be. But there is a certain expectation in markets that a real high percentage of the economic pain and distress we're going through right now as a country is going to prove to be transitory. 78% of the 21 million people that are unemployed identify themselves as on a temporary layoff. Now, of course, it is very true that that's their own self-identification as employees. It is not the employer saying that. And employers may very well end up determining that a lot of the people that they want right now to be temporarily laid off will end up being permanently laid off. And that a lot of the people that they want right now to be

temporarily laid off will end up being permanently laid off. And that would make things worse in that regard. We fully expect that there will be some of that. But it's certainly something over 50% that are going to be rehired in pretty short order when the economy reopens or when more of the economy is reopened than it is now. All the data points thus far where there's been very minimal economic reengagement are outperforming expectations. I even think to a certain massive amusement park in Shanghai that's opening up on Monday. It's been closed for four months and it completely, totally sold out and pre-sale tickets within like a couple minutes. There is a pent up appetite for living and working that I think is going to really outperform expectations where it's allowed to,

where it can be. There's wild cards around that, variables around the health data, around governmental policies and controls. But I think that the market took the bad unemployment data today in stride because it knew it was coming and that theme of reengagement, of a transitory, violent interruption to economic progress being followed by some degree of improvement. Not V-shaped quick improvement, but light at the end of the tunnel, combined with stimulus, monetary interventions, all these other things we've been talking about week after week. So I'm going to more or less try to go through here in the next 20 minutes for those listening

to the podcast, watching the video, walk through a lot of things that I walked through in the Dividend Cafe, written commentary. I still always wish that listeners and viewers would also read the Dividend Cafe, not only because writing it is one of the great joys of my life, but also because the charts and so forth that are part of it, I think really color in a lot of the experience and the information and perspective we're trying to offer. So when I look to a 14.7% unemployment rate, first of all, just in the weeds of these numbers, over 5 million of the, let's call it 20 million, 21 million unemployed folks from the April data are in the restaurant and bars industry, some form of food and beverage

hospitality, over 2 million in retail, a much smaller number of government workers, smaller number of business service professionals. So, you know, here's the thing. Hourly wages went up in the month of April, which might seem counterintuitive until you realize why. And it's an awful reason why. But the reason is because the lower end of the wage spectrum is where the vast majority of the layoffs are taking place. And so the folks that are remaining in the labor force are of a slightly higher wage pool than the ones who have been laid off. So it's pushing hourly earnings higher. I hope that makes sense. My view is that we are wise to do our best to analyze this economic damage and to understand any econometrics that we can as far as what's going on and what it points to from our vantage

point as investors in terms of future corporate profits and in terms of just the GDP that serves as kind of the economic fodder of our society. But I will tell you that what I think is a far more profound issue right now is the purposelessness and the emptiness that it represents for so many people having a day-to-day objective and a day-to-day endeavor and opportunity for productivity being stripped away from them. I truly believe that men and women were made to be productive, made to be busy, made to be engaged, and that there is a real existential tragedy playing out. I know a lot of this unemployment will not prove to be structural, but because someone like myself and my objectives and my passion around investing

and around successful achievement of financial objectives, these are means to an end. And the means of successful investing and wise stewardship of capital, those means are towards the end of human flourishing. And I believe human flourishing is evaporated when we take away from people productive endeavors. And I earnestly hope that out of the unemployment saga we're dealing with right now and economic contraction we're dealing with right now and economic contraction we're dealing with right now, what we will find is as quick as possible and as much as possible in a total context of safety and public health, people being able to re-engage with their day-to-day

productive behaviors. There's no economic metric that could possibly capture how important that is. economic metric that could possibly capture how important that is. One of the most common questions we're getting asked right now is what we would do in event of a market leg down. And I always like to sort of preemptively help with this. I just presume one will happen. I don't get into it. Well, could we go back and retest those bottoms? You know, we're now over 6,000 points higher in the Dow than we were on the intraday bottom of the market back on March 23rd. I don't know if we will go that low again. A lot of the technical indicators would suggest very much not, but see, those things can change too.

I don't know when we go to new highs again. There's just a lot of uncertainty in the technicals of the marketplace and the fundamentals. But I do know this, it's a 50-50 chance always, pre-COVID, during COVID, post-COVID, as to what the next move of the market will be, up or down. It's 50-50, it could be down. And yet I truly think it's important that we remember the futility of trying to time that. And anything that is done when it is futile is inherently foolish. And so therefore the foolishness of even trying. I can't stop saying it. It is not cliche other than the fact that the wisdom of it may force it to seem

cliche. People with longer term goals should be less concerned about the next two weeks or two months of the market. People with shorter term goals should not have money in the market. So to the extent that you need capital in a period of time where we would worry about short-term movement of market and you'd be withdrawing principal, it should not be in the market to begin with. To the extent then that we want to optimize the return on capital and all things being equal, it would rather not suffer a drawdown before going forward, then we have to make risk-reward calculations. There are stocks I think seem very overpriced. There are market indices that may seem to be a bit stretched.

And there are stocks and companies and sectors that may be in a different position. And we try to have a more data-based and evidence-based and fundamental-based way to adjudicate these things. And for us that's in cash flow, it's very difficult to get a read on companies' free cash flow right now, but we can look to the company's payment of cash flow to us as investors in the form of a dividend. And so if I address this too often, I apologize, but it comes up so much I need to not stop addressing it. If markets go lower and you're an accumulator, you're going to be reinvesting dividends at lower prices. And if markets go

lower and you're a withdrawer, you will be withdrawing from a steady flow of growing dividends, not from depreciating stock prices. That's my answer. I do think by the way that markets exist primarily to humble people humble investors so the folks that are just so incredibly adamant that markets must go down again um it's entirely possible that there's just a divine lesson in humility that is at play here just as when people get over exuberant in markets, they often get humbled. I've been on both sides of that experience, and I'd like to think I've learned from it. I certainly want my clients to learn from it. So that's our answer around what would happen if there were indeed another leg down. Let me talk a bit about some post-COVID changes. We're going to see so many things that are being talked about as though the new normal

and on the other side of COVID, Americans are never going to do this again and they're going to start doing this now and so forth. And I don't know what of those things will prove to be accurate, what won't. But one of the things I put a chart here in Dividend Cafe that I suspect will be somewhat paradigmatic in its shift is America's, and I don't mean right now just the politicians, I'm talking about the American people's sentiment towards the country of China and the government of China. And this has implications in trade.

It has implications in geopolitics. Let's see, the stat here is that 66% of people now claim to have an unfavorable view of China, where that number was at 43% just a few months ago. So I don't think it's rocket science to figure out what may have changed that. But what I would say, the second chart I put up here in Diving Cafe is that that number is 72% on that unfavorable side with Republicans and 62% with Democrats. So it's not even really a I think that that is going to have currency in the trade relationship and also in on-shoring arguments for moving manufacturing of certain key national defense items, certain pharmaceutical items, things like that. pharmaceutical items, things like that. So I bring it up to say that if people want to look at the idea like, oh, maybe everyone's going to have to sit two seats apart at a Broadway show in a post COVID life. I don't think that's going to be true at some point in time. But do I think that there's

a paradigm shift in America's relationship with China? I do think that's very possible. By the way, I also put a chart up. I love looking at this. It brings back some memories as I sort of translate what I look at on the chart to what was happening at this time now, nearly 20 years ago, post 9-11. But you had a pretty significant drop in the 12-month average of passengers on US Airlines post 9-11. And it started to pick back up a little bit over a year later. And it got back to its pre 9-11 levels a couple of years later. And then it just kind of took off from there. There was a decrease in travel through the financial crisis, obviously, as there was less disposable income and so forth. And then the number from the pre

9-11, excuse me, the kind of bottom post 9-11 number to where it peaked out at here a couple months ago, it almost doubled, not quite, but almost doubled as far as the millions of passengers in America flying on airlines. That number is going to drop and it's going to drop big and it will take time until it picks back up. But I'm evaluating post-COVID thoughts with the same humility and skepticism that the gift of hindsight has given me to the way we handicapped post 9-11 American life as well. Now, here's an interesting thing for those worried about the risk level right now in the economy and capital markets. I look at high yield bond spreads that had blown out quite a bit after in the peak of the panic in March, and they've come back down. Those spreads have

tightened a bit. A lot of that tightening is admittedly because of the Fed announcing they're going to be there to help credit markets. A lot of it is the other fundamental backdrop that the health pandemic did not go the direction that many were fearful of in the middle of March. That's good. But I put the chart of the high yield spread spiking higher March up against where they went in the financial crisis and how spreads really never even got half as high as they did post financial crisis. And a spread, a credit spread is an incredibly telling data point. In a credit spread is more than just what a buyer of a bond might be thinking at one point in time. It's capturing an entire sentiment over a pretty extended period of time about risk in the economy.

And I've studied, I don't know, a dozen different risk indicators in my career. I took this very seriously post-financial crisis, and I have not found one that's been as consistently useful as high-yield bond spreads. And so the high-yield spreads pushing up higher in March were fundamentally defensible and obvious. But the fact that it did not go to the same way as the financial crisis or anything close is very telling. But here's the thing. It basically is not even where it was in 2016 right now. Now, it did go higher than 16 for a brief period in March.

But as spreads have come back in right now, our high yield bond spreads are less than they were in 2016 when we were worried about the Fed raising rates. No one's worried about that right now. We were worried about China perhaps tipping the global economy into recession. And we're not worried about that now because we already know what's happening globally, where things are in the state of world economics. Now, there was also the energy sector in 2016, and a lot of those high-yield spreads had really blown out. But of course, that's happening now as well, and with even bigger reason. Oil prices are lower. There's even more demand erosion than there was then. Back then, there frankly wasn't very much demand erosion. So I really think it's interesting that the Fed's intervention is as powerful as it is,

and the perception of an economic repair is as strong and powerful as it is. I'm going to spend a little time on the energy sector here. I have some good news and bad news. You know, myself being a big fan of American shale and the American energy story, the renaissance has taken place over the last decade and the geopolitical advantages to American energy independence. And of course, the investable story, which has been so important to job creation, manufacturing, capital expenditures, industrial production, high wage manufacturing jobs. It's a big story. And more or less, the good news right now, I guess, is that oil prices have

picked up quite a bit. If they closed here today, let me check exactly where they closed. Somewhere around $25 a barrel on the WTI, just shy of 25. And they were, after the kind of hiccups and things from a few weeks ago, as things sort of settled, they were sitting in between 10 and 15. So, you know, more or less, they've kind of doubled oil prices from those insane lows after the May delivery dates. from those insane lows after the May delivery dates. Well, the problem is that the reason oil prices have solidified so much is that U.S. production, not OPEC, not Russia,

U.S. production has come in so much. And I have a chart at Dividend Cafe of the rig count in the Permian Basin kind of being cut in half right now, right over 400 to right over 200 in just a couple of months. 1.7 million barrels per day of production that have come offline in American energy production. And so you have a good news and bad news story there. The good news is oil prices have solidified. The bad news is why. Now, of course, the supply-demand crux that we face going forward is that I believe demand will come back and will be ready quicker than supply can then go keep up. quicker than supply can then go keep up. Because by taking these rigs down and other wells that don't get tapped, you end up with a lag before you can pick it back up. And so when demand

inevitably resurges, I don't know that we'll have the supply capacity to deal with it. And that'll probably push prices much higher, but we shall see. But a little bit more technical and cerebral point I want to make, and I'll try to go easy on you here on the podcast, but I really unpack it more at DividendCafe.com, is the financial structure of a lot of our shale companies. The debt profile they have has a lot of their bonds maturing in 2022, 23, 24, starting in 2022 and going for about four or five years from there. Very little debt due in 2020 and very little debt due in 2021. And I think it's one of the reasons that argues for them having a liquidity issue through this tough time, but not having to sell a lot of assets

at such a distressed part of the cycle. Because I think if they can get liquidity management through 2021, and then the cycle naturally picks up, I believe that then they'll have a healthier balance sheet, healthier collateral, healthier business conditions, healthier commodity price environment as they face the debt maturities of 2022 through 2025. And so it incentivizes the Fed, Department of Treasury, when they look at it to say there may be solvency here, but there's some liquidity challenges that perhaps can be bridged with public policy, let's say that Main Street lending facility. The big irony is that one of the criticisms of American Shale was that all the jobs it was creating and all the things it was doing,

it was still largely because of the massive investment necessary into infrastructure was not generating positive free cash flow. The producers were having to take a lot of the monies that were being generated and put them back into new wells, new services, new field activity. It's expensive. Well, all of a sudden, I put the chart here of the free cash flow negatives in 2012, 13, 14. We had the really distressed period in 15. Then a lot of the companies kind of refinanced debt, tightened the belt. The technology improved so much that profits were really much more attractive at a lower oil price. So free cash flow kind of improved out of 2017, 18. And then 2019, going into 20, was going to become a free cashflow positive sector

throughout shale industry. And yet now the whole COVID crisis, demand erosion, the supply war with Russia and Saudi all hit at once. So where that story goes, we shall see in the midstream sector, the pipelines that we're were invested in the month of April is the biggest month that the sector has ever had. I put a chart dividend cafe showing the top 10 months the sector has ever had and what its next month return and next 12 month return has been in all 10 of those periods. I'll let you look to see. Suffice it to say, we find the data very compelling.

Another example of good news, bad news is in midstream, where the EBITDA projections for the year, the earnings are now all that have been lowered, as there will be less supply and volumes running through the pipelines, and very likely renegotiated contracts because of the producer's distressed financial condition. And then because of lower earnings expectations, companies lower their capital expenditure plans. And because they lower capital expenditure plans, their free cash flow increases. And because most of these MLPs and midstream pipelines are priced off of their dividend distributions, you end up with more dividend coverage than you had before because the CapEx expenditures are so much lower. Free cash flow expectations for the year have actually been increased in the last month, not decreased. So it's ironic, and yet I think it's important. Okay, let me close this up with

our short, mid, and long-term projections, and then we'll call it a day. In the short term, we continue to expect high volatility. High volatility is not bad or good. It is both up and down movements, day by day, week by week, sometimes hour by hour. We had a lot of that this week. The market did not sell off today in the final hour of trading, but it rapidly reversed direction most every day this week until Friday. So high volatility short term, just around the uncertainty of structural economic damage and what post-COVID life will look like. Medium term, we're moderately bullish as post-COVID resilience proves higher than expected and post-COVID normalcy proves more normal than expected. That's my outlook midterm. Additionally, I do think it's the medium range where the purest

marination of fiscal and monetary stimulus is likely to take place. That's where you'll get the most enhanced risk asset valuations and the most elevation of cash flows. Longer term, we're economically concerned about the deflationary effects of excessive government spending and monetary interventions. Obviously very bullish on select assets and producers that are capable managers, capable operators, but we are concerned about the lack of risk-free asset possibilities in the economy with treasuries likely to yield something near 0%. That Japanification problem for our economy looking out 10, 20, and 30 years would be a long-term concern. Okay, there's a little politics and money and obviously a chart of the week.

The quote of the week from Leo Tolstoy, and I'll close this up. The two most powerful warriors are patience and time. I do commend all of you who have the patience and are willing to give it the time for us to get through this difficult period. We're working very hard to make the best decisions we can at the Bonson Group. On your behalf, we're very grateful for your partnership. We're very grateful for your trust and confidence. And we do wish you and yours a wonderful weekend. We solicit your feedback. And if you're so inclined, your positive reviews and likes and things like that on your podcast players and

social media, whatever it is. In the meantime, reach out anytime with any questions. And thank you again for listening to this week's Dividend Cafe. Thank you. All data and information referenced herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary. It does not constitute investment advice. The team in Hightower shall not be in any way liable for claims and make no express or implied representations or warranties as the accuracy or completeness of the data and other information or for statements or errors contained in or omissions from the obtained data and information reference herein. The data and information are provided as of the date reference.

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 team and do not represent those of Hightower Advisors LLC or any of its affiliates.