The Dividend Cafe - Taking a Stand On Interest Rates

Episode Date: May 11, 2018

This week, David tackles a variety of topics ..... Topics discussed: Interest rates Monetary policy Capex The bond market Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Hello and welcome to this week's Dividend Cafe. For those watching on video, forgive the casual outfit, getting ready to head out on a weekend vacation and annual trip with my wife. For those listening to the podcast, you don't have to worry about what you can't see, now do you? Listen, interesting week in the markets, and I say that every week, of course, but based on where we are right now, it appears that we may end up, again, it's not done yet, but we may close up on the week, And things seem to have leveled off a little bit.

That flatline trajectory has most definitely not changed. And what I mean by that is the lack of any real direction as to whether or not the market wants to sell off further. Every time it's sort of done that in the last month or so, it's been followed up by a rally higher. And then every time it looks like it's wanting to kind of make a new move back towards our all-time highs of January, the market is then kind of sold off. So we've been in this sort of range between, let's call it 23,500 on the Dow on the low end and 25,000 down the high end. And that's a sort of little middle level running in place that is below where we were at the highs in late January in the 26,500

range. Keep in mind, if you just simply go a few weeks earlier than that, back in December, we were in the 24,000s. So the Dow moved up so much in January, it only was there for a few weeks. And then it's really this February through the end of the first quarter and now here into the middle of the second quarter of 2018 that things are just in this little spot. I think maybe people want stocks to make a meaningful move higher. People would like to feel that stocks are not going to make a meaningful move lower, understand all that. But I do have to say, just for one who is so religiously dedicated to our philosophy, that these little flat trading ranges do absolutely no harm because we're sitting here reinvesting dividends, which we love.

And then to the extent that earnings season has created far more dividend growth than I would have anticipated. And I was anticipating very robust dividend growth. So we're really happy in that angle. But I think it's fair to kind of wonder, is the market due for some sort of particular sell-off next? And the problem is that's just not a question that can be answered. And I write about in the weekly written dividend cafe that one of the things that is difficult for me in week by week, coming and saying, oh, the market on Tuesday did this, and you notice Wednesday, Thursday we had this. And so I'm writing about it sometimes, commenting on it, and yet at the same time reiterating rightly and passionately the complete irrelevance of it. So there's something almost contradictory about the fact that we're talking about weekly and daily market moves and also reinforcing the fact that they should have no material

substantive impact on clients at all. I understand that there are certain outliers to that. There are weeks in which a political event, a geopolitical event, a market disruption be significant that warrants a real clear commentary and perspective in the here and now. But I do believe that this constant talking about we were up 200 a day, we were flat yesterday, it's unhelpful. And I would like to do less of it.

But that's really primarily to stay consistent on the bigger picture things we're focused on. So when you look at the written dividend cafe this week, one of the things I do that I think is very important is actually take a stand on interest rates. But that may not mean what people think it to mean. I'm not going to sit here and tell you, the 10-year is at 3%, and we are ready to make a call that it will end the year at 3.2%. Nobody gets those calls right. They can't be made, and they're totally unhelpful and unnecessary. The issue right now that is substantive to markets and the way we would asset allocate and position our client portfolios is the secular movement of interest rates.

giant portfolios, is the secular movement of interest rates. Is there some reason to believe that this major downward trend in rates that then is bottom and start to inch higher, that all of a sudden we face a secular rising rate cycle? I don't buy it. I don't know if in the short term, the Fed raises two more times or one more time on the short term. The Fed raises two more times or one more time on the short end. I don't know if the 10-year drops down to 2.8 or goes up to 3.4. But do I see us continuing to go in the 10-year Treasury yield from 3% where we're at now that it's going to go to 5% and 6% and 7% over the

next 3, 5, 10 years? I don't. I think that there are secular, disinflationary forces, demographics, technology, globalization, that no one has convinced me have all of a sudden, after nine years of the impact of this deflationary forces, both globally and domestically, been cast aside. I'm perfectly content to say we have adequate enough economic growth and hopefully improving economic growth. That would say those one and a half percent 10 year yields are not coming back. I hope they don't come back. I think they're ridiculous. I don't want artificial valuations in the economy set by the natural interest rate that indicate that the only thing that can move higher is asset prices and there's no organic growth in the economy. But do I think that the growth we are going to get calls for a

3%, 3.25% 10-year bond yield? That sounds about right. And then maybe an inch is higher if we continue to get more GDP expansion. I hope that is the case. But from a secular standpoint of, oh, finally, everyone's never lived through a bond market. We've lived through bond choppiness. We've seen rates zig and zag. But do I think we're going through this decade-long process of rising rates year over year? I do not. And that would force a repricing of equities. And that is not our call. Along the way in the short term, we don't have a call. And if someone forced me to make one up, I'd say I think we're kind of around the range we're going to be, give or take maybe 20 basis points on the 10-year. So that's kind of our

perspective on interest rates. And we've been talking the last several weeks on why that's having such a big impact on the market. You know, the jobs report came out last week. I don't even know how I'm doing time-wise. Let me make a couple more points and we'll wrap up. The job market report was a little lower than expected, but the unemployment rate dropped again because the labor participation force had decreased, so that brings the denominator down, which made the percentage drop. So you have the lowest unemployment rate percentage, 3.9 percent since 2000. OK, basically in this millennium. But there was it was one of those reports where everyone gets excited. They

go, oh, it's back to the Goldilocks. It was a good report, but it wasn't so good. The Fed's going to tighten. And I just can't stand this thinking like we want a little growth, but we don't want too much growth because then inflation and the Fed. And this is the kind of thinking that enters the fray when there's been too much intervention from monetary authorities. Economic growth looks to me to be very good. Economic growth does not look to me to be inflationary. Economic growth, by the way, is not inflationary. Inflation is a monetary phenomena. The Fed can control if we have excess money supply or not. Right now, I don't think we do because I don't think there's a high velocity of money in the economy. Money is not turning over.

So to the extent that I believe we're going to get better growth and that pushes natural rates a little higher, causes some degree of volatility, I think that's all healthy and normal. But do I think a lot of that's already priced in? I do. I just think investors need to be focused on investing where there is growth and where there is profit-making, and those are the things that provide a return to shareholders, and that's what we're doing.

So the not-too-hot, not-too-cold type deal I don't think makes a lot of sense. And to the extent that people are saying, well, the jobs numbers weren't huge, the GDP number is pretty good. As I keep pointing out, it's the CapEx we're looking at. The Institute of Supply Management this week, I have a chart on this in Dividend Cafe, recalculated their 2018 projections for manufacturing growth and non-manufacturing growth basically more than doubled their forecast of growth year over year. And in the manufacturing side, more than tripled their expectation. The CapEx stuff is happening.

It takes a little time to work its way through the economy. I would not lose track of that particular optimistic projection. There are shorter term and I think kind of more pedestrian metrics that the media will follow, things like that. But fundamentally, the reason why we still believe that perhaps, just perhaps, this great bull market the last nine years has an entire new sizable leg to go, will come out of a multi-year process of business investment expansion. In the shorter term fray, we're fully content and, by the way, just resigned to the reality

of a higher volatility paradigm. And I've talked about it all year long. But I believe that perhaps into 2019, 2020, the growth of the earnings has to slow down because the earnings growth right now is so heavy. And markets discounting may at that point decide to kind of take some air out. But right now, I really think that there's a lot of very positive things happening. To the extent that we want to put a little more risk on, we're doing it in emerging out. But right now, I really think that there's a lot of very positive things happening to the extent that we want to put a little more risk on. We're doing it in emerging markets. But the defensiveness and caution we want is embedded in our asset allocation. We're not overweighted to equities. So it isn't like we're saying, oh, yeah, we recognize the risk factors. It's time to sell

back. We've sold back. We've rebalanced and lowered targets. We have that nice moderate and prudent spot in which we want to be. On the oil and energy price side, we've made new highs. I have a whole section in Dividend Cafe this week, really critical of the media's portrayal of this Iran story with the Trump administration this week. It's fundamentally false. The oil right now is bouncing or moving or whatnot on anything to

do with their expectation of the Iran deal. If they were, it could be traders and speculators for an hour, an hour and a half. But there's absolutely no way to measure the impact as to what could happen if all of Iran's production came off of world supply. That would have a big impact, of course. But they don't know what's going to happen. We don't know what's bark and what's bite and what the specifics end up being. To me, we know short term, there's a whole lot of things that impact the noise of oil prices. And we know long term, it comes down to supply and demand. The story in oil prices is that it's been moving higher because of robust global demand. And we have this painfully inadequate infrastructure to

feed it. We're investing in that infrastructure. Those stocks are performing well. The energy sector is performing well, but still deeply undervalued from the way we're valuing it. And that's an opportunity we keep talking about. The bond market side, let me tell you, I do think municipals look the most underpriced. There's spreads relative to treasury yields. We're still very skittish around the high yield side. We just think spreads are too tight and there isn't a lot of risk priced in relative to the risk you're actually taking. Treasuries are more attractive now than they were beginning of the year. Rates have moved higher.

That's a safer and I mean, it has interest rate risk, but it's a bond that will act like a bond. Merging market debt, again, the growth trajectories and the underlying economic fundamentals are very good. So we have small allocation in emerging markets bonds, but there's currency risk and other factors that play in. And on the floating rate bank load side, we're still allocated and the fundamentals look strong, but there's so much supply out there that we just have some sort of technical concerns. So we've de-risked a lot of that bond side. I'll close up with this. I read a report this week, and actually it's from an analyst I like. He's with a firm I really, really like,

a big macroeconomic research firm. He was talking about the, from a contrarian standpoint, being concerned that there's just not enough fear. People really seem to, they shrug off a lot of bad news and, oh, the Fed won't do this. And, oh, Trump won't do that. And everything is fine. And he's saying that's a big concern. But the interesting thing is I kind of don't see what he's referring to. I don't believe that there is this excess amount of complacency or risk appetite. I see the opposite. I see people very skeptical of this bull market. I see retail individual mom and pop investors very underweighted to equity, very overweight cash, very low end of the risk spectrum. So I think that level of distrust for this bull market is really quite heavy. So there may be some pundits and institutional perspective that seems like it's getting a

little overly euphoric. I don't really see much of that either, but I could understand if there's some pockets of it. But broadly speaking, from a contrarian, I take the opposite view. But broadly speaking, from a contrarian, I take the opposite view. As a contrarian, I don't think you've had that kind of retail buy-in to this market. And I maintain my belief, rooted in history, that the bull market will end when that takes place. And in the meantime, we keep plugging along. So that's our perspective of the week.

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