The Dividend Cafe - TBG Investment Committee - A Year Ahead, A Year Behind

Episode Date: January 7, 2022

CIO and Managing Partner - David L. Bahnsen Deputy Managing Partner - Brian Szytel Deputy CIO and COO - Deiya Pernas 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 the very first Dividend Cafe of 2022. Those watching on video can see that we have quite an elaborate setup because we have our partner in crime and investment committee member, Brian Seitel, joining us remotely. I'm sitting here in the studio with our deputy CIO, Dea Pernas, and I, of course, am here in the studio in Newport Beach as well. So we are bringing our first Dividend Cafe of the Year with the whole investment committee and something we intend to do a lot more

of this year. And to prove that commitment, we are starting the very first podcast and video of the year off this way. And the subject is no less than our 2021 review and our 2022 perspectives. And I'm not going to lead my colleagues through our entire white paper, lead you as listeners and viewers through it, but we're going to kind of hit some of the highlights of our key points and themes and perspectives of the year behind and the year ahead. But I wouldn't be doing my job if I didn't say that there is just absolutely no way that I can tolerate any of you watching this video as a substitute for reading the white paper. Listening to the podcast as a substitute for reading the white paper. We do that work and put a lot of charts and a lot of information and summary type info because we think it's very valuable.

And we really do believe if you go to dividendcafe.com, print the whole white paper, there's a very well designed and laid out kind of summary of the Bonson Group's collective work on the year behind and year ahead. And so please do pay some attention to that. You're welcome to share that PDF far and wide. And in the meantime for your video and podcast purposes today i'm going to bring in uh dea and brian so guys i i start off in the paper talking about the 2021 in review and i say a sequential trip down memory lane and rather than us go through the whole what how many pages that was it about a 20 minute read or so?

Well, it depends on how fast someone reads. So there are people that might take them like an hour. And then there's some people that could read it in four minutes. Yeah. That's what I would say. The average. Yeah.

About a 20 minute for the average straight through human being straight through. Yeah. Not too bad. It's a little longer for that. Okay. If they're like, you know,

really absorbing. Yeah. Yeah. With the charts and looking over all the info. It's good, though, like I said. What do you think, though, in terms of the sequential trip down memory lane, rather than go through the whole two pages of all the market went through last year, the January stuff and April or whatever,

what for you, Brian, would be kind of the major event of 21, not thematically like what we're about to go through, but just kind of something from the calendar, like an event that happened in markets last year that sticks out as one of the major, not even highlights or lowlights, just things that really stuck out for you in the way you remember last year. Well, I mean, you know, I remember actually a year ago when we did the 2020 white paper heading into 2021. I think the things that stuck out to me were, first off, I think risk assets performed better than I thought they would have. So pretty much across the board, you know, stocks, bonds, alternatives. So there was an outperformance there.

I think the supply chain issues were more, were a little longer lasting and more substantial than I would have assumed. But we also haven't really dealt with a lot of these sort of global shutdowns before. So, you know, I think, you know, it makes sense that it would be, you know, something to surprise us. You know, and then inflation, I think. Dave and I were talking about it a little bit. But inflation being something that was sort of topic du jour, where for most of my adult life, at least, it really hasn't been a couple of times here and there.

So, I mean, as far as market impacts and things, things i mean those were some of the topics and things i thought were most relevant for 2021 um and then i mean all the variants that seemed to kept coming out of this thing uh the different night names of them and the different sort of uh you know issues they caused and all that so you know it was definitely a year and all in all i mean it ended up being a pretty good year for risk assets for markets uh so day what about you um not so much thematically but just something from the actual kind of like flow of the year from the calendar like an event or whatnot is there anything that you think was particularly memorable so as far as not really thematically just an event uh i it's hard for me to think of something event-wise it was particularly uh what if i give you some options surprising yeah you know we had the meme stock uh escapades early in the year

yeah yeah uh we we we had the vaccine uh uptake throughout the spring and really at one point it looked like total eradication to covid you had delta which brian brought up that uh cyber attack on the uh and the pipeline and the hackers taking over the colonial pipeline um the afghanistan withdrawal you you had uh obviously by end of the year the omicron events um there's one I'm going to say that, but, but I, you know, just from out in 2021, since it's January six, as we're recording, I'm hoping you haven't forgotten last year yet. No, no. I, I, I hope not. It's a great year. I hope,

I hope it stays in my memory forever, you know, performance wise. But as far as those events go i don't i mean even if you when you when you uh tell them to me i i i don't remember them sticking out that much i mean the meme stock i just remember thinking it was ridiculous yeah i cannot believe what some of those stocks are still trading at i i i was i was dead wrong in my prediction that they would sink back down to reasonable levels. But as far as anything stuck out event-wise, I don't know. Nothing really just comes to my mind that's that strong. Maybe market reaction around a lot of that stuff is, you know, the market continued to grind higher and higher and higher despite whatever event seemed to happen.

And, you know, my focus is more on, you know, the asset prices, really. But I'll throw it back to you. What do you think? What stuck out the most in your mind? But before I answer, I guess I'll say maybe one of the reasons is that nothing is sticking out in a meaningful way is something we allude to in our key takeaways from the year. Number two is that if this is market volatility, sign me up. I point out it's basically tied, you know, for third as like the least volatile year in history. The total drawdowns were never at any point. There were six of them, but they were really all kind of three or 4%. And I think that

lends itself when you look at the year before, when we had a 35% drawdown in a month, those are kind of events that go into the history books. And 2019 was this year of the Fed reversing course and assets rallying so hard. 2018 had a 20% drop in the fourth quarter. It had a trade war. It had Fed tightening. 2017 was this massive rally all year long, plus the first year of all the roller coaster of trump so we kind of had all this stuff and then all of a sudden 21 it seems like it would be a newsworthy year but nothing is really grabbing any of us is like it was this huge thing i mean the the meme

story does it to me belongs in the in the comic books not in the white paper and yet it it might've been one of the bigger stories of the year. And I think maybe that's one of the reasons that we just got through kind of such a low volatility year. Did it feel like a low volatility year to you, Brian? Absolutely. It's funny because in the white paper, you talk about 17. And I remember distinctly that year, how there was really not any volatility at all. I felt it was the same.

I know technically on paper, it was, I think we had a 5% drawdown or something. For one day. Yeah, for one day versus the three. The last day. Although we did put money to work, if you remember back then, quite a bit, if I recall correctly. So we got that right. But no, I think that you hit it on the head, which is the three of us. Look, I'm affected by a lot of things, but I probably get most affected by how much markets are moving in different periods of time, depending on which different reasons, because we have a lot of clients who care about. And the fact that they didn't move all that much with all this sort of some of it nonsense, some of it, I guess, meaningful is probably why it doesn't really didn't like, you know, engrave itself in my mind or anything like that. But, um, you know, so, yeah. Well, well, David asked me like what mine

was and, and I think I'm even reinforcing the point of the non-eventfulness of the year by my answer being something, the biggest thing that happened in 2021 for me is something that didn't happen, which was these long awaited tax and spending bills. Right. And I think it is one of the most profound stories. And I'm now wearing my CIO hat that as an investment professional, the amount of things that some people either did or wanted to do or thought about doing around an event that, A, never happened, and B, was never anywhere as close to happening as they believed it was, is staggering. And yet, if you think about how many times, just even in the D.C. today, we were writing about Joe Manchin and reconciliation bill and infrastructure and Build Back Better and

the words White House and Biden and Congress and Manchin and Sinema and infrastructure and build back better. And, and the words white house and Biden and Congress and mansion and cinema and this and that they were, it was there all the time and it was the media story for months and months. And then, and then you just buy the holidays. They go, yeah, it's done. We're not going to do it. Yeah. I mean, I think that's incredible. I think it's absolutely incredible. It's very, very telling. And even late into last year too, I think it was consensus that at least on the investor side of things, there were going to be some changes tax-wise.

And as you alluded to in your white paper, maybe the market didn't think so, but it certainly seemed that in all the conversations you were having with Politicos and whatnot, that that was going to be the case and nothing ended up happening. I think it's something that's really worth remembering when people try to make any sort of predictions when it comes to what's going to happen legislatively speaking. Yeah, I think you're right. And we dealt with a lot throughout the year. And I'm insensitive with this comment because I know that there are people that did do some estate planning strategy changes based on some things that could come down the pike that may or may not. I'd actually think those are still sound just because of the cliff that's going to happen with a lot of the estate tax stuff in 2026. But aside from that, all that stuff was

shocking that it just came out to be a nothing burger, really. And to the positive. And I think markets actually, the latter half of the year were moving up part of the reason i think there was a little tailwind because i was taken off the table yeah it was kind of a it was kind of a weird symmetry because they didn't go down when those things were more likely supposedly and then they did go up when they became less likely and uh it doesn't really work that way, right? My argument, I remember saying this on Cutler's show a couple times early in 21. The market didn't ever seem to think it. And in a way, the market, very similar to COVID, the market was a better understander of Joe Manchin than all these political

analysts were. And the market has most certainly been a better understander of COVID than Fauci, right? I mean, I guess it's just interesting that markets are not always great indicators when you get a lot of excess and markets are susceptible to black swan events as anything is when it's unseeable and unforeseeable. And yet in a couple of these things that involve the ability to discount probabilistic outcomes, the market did a pretty good job.

Yeah. And I remember your predictions around that. And you, even though you were on the minority by saying that little to nothing is going to happen, even the, you predicted there was going to be some slight changes. Absolutely. And you were part of that minority on the other side of the spectrum. Yeah, and that's right. I always believed that the biggest things people were freaking out about

were not going to happen, but I certainly thought something would end up getting done. If nothing else, to kind of save face a little. And there's kind of political reasons why that didn't happen. I think there was a lot of misunderstanding. But where I really did change to even open up the idea that nothing would happen was after the Virginia election and the way some things went in November. And we talked about this politically. President Biden's approval ratings really started going down a lot in August.

down a lot in August. And look, if he had not wildly popular ratings, like some of the ratings that President Obama had at certain points in time, or the President Bush had after 9-11, if he just had kind of normal approval ratings, the political pressure to get something done would have been much stronger. And perhaps a Joe Manchin or a Kyrsten Sinema would have given in. But I think that everything kind of came together in a way that just there was no reason to force anything to get done. Got it. Oh, so your prediction as far as those tax rate changes towards the latter half of the year kind of fell off. By the fourth quarter. By the fourth quarter.

You were going with that. Yeah. Yeah. Wow. It's hard for any sitting Republican to go against a popular Republican president. And it's hard for any sitting Democrat to go against a popular Democrat president. But apparently it wasn't so hard for a popular sitting moderate to go against a reasonably unpopular president of the same party. And so, you know, we'll see where those things go. So, Brian, you brought up the supply chain issues

and that being a surprise to you that it lasted as long as it did. So let me ask you this. I'm going to start doing more with you and Daya either or questions. What's a bigger surprise? Either that prices did inflate the way they did or that bond yields didn't inflate the way they didn't. Good question. So what is more of a surprise? Look, I mean, so as far as inflation goes and in prices moving up partially because supply chain I guess that's intuitive. That makes sense to me. We hadn't sort of been through that

for, in my knowledge in a long time. So I guess there was some surprise there just because it was something kind of new to digest. But like you said earlier, like, you know, markets got it right. Markets do get it right. Most of the time, there's black swans that throw them off. But as far as the bond market saying that 10 years at 150 and rates are going to start to say low like that, even with inflation numbers being so high, I think speaks to the market not really believing that the inflation number is, number one, going to be lasting, and number two, is it anything more than just a snapback from it going negative or down a whole lot the year before in 2020, and then sort of a recovery? And you sort of spoke about that, we have that in the white paper, which I thought was fascinating as well. I guess a long answer to

a short question is, I was more surprised on the supply chain guess a long answer to a short question is I was more surprised on the supply chain side because it was a little bit more unknowable to me personally with my 20-year existence in this business, whereas the bond market I've been analyzing for quite some time. And what I see from that is that it isn't trusting those inflation numbers to be lasting. And I wrote about it a ton in DC Today. Yeah, yeah, absolutely. So, Dave, pretend we're not doing a look back on 2021 and pretend you haven't read the white paper already. I'm sitting with you and it's January of 21.

And I tell you, CPI is going to be up over 6% on the year. And that the only financial story that is going to be getting covered on left-wing media, right-wing media, financial media is just really shocking levels of price inflation. And the 10-year is at 1.5%. What is the 10-year going to end the year at, in your opinion? Um, I, so, and I, and I'm glad you asked that because, uh, and I think as, you know, uh, portfolio managers and, uh, you know, investment professionals and make decisions around where to allocate capital, uh, you know, when it comes to markets, it's important to keep in mind what you're thinking was in stages of time. I think a lot of people may have trouble as reality kind of transpires and they lose sight of previous memories.

But I remember very clearly not thinking that there was going to be too much movement when it came to – and as far as the bond market, I'm just going to say the 10-year. Primarily given the amount of Fed manipulation. primarily given the amount of Fed manipulation. I mean, even if there were market forces that were going to cause it to rise, which I didn't think they were given just the amount of debt in our system in general and how difficult it is for a long-term growth. But I just thought the Fed was going to do whatever it could

to keep that part of the curve down. But as far as the demand side, uh, as far as the demand side of things, as far as the CPI numbers, uh, and I know, you know, we're for some of those months, we're coming off, uh, maybe a lowish base in 2020. I am, I am shocked to see some of the, just how, just the surge in demand and how sustained it was really. I mean, just inventory levels across the board on everything were just absolutely compressed. You got wages, the market for used cars, the market for luxury. I mean, any sort of market you look at, inventory dried up. And a lot of people, obviously, there's some supply concerns there are supply shocks but really is uh you know is the fact that there's a huge

demand story and uh that kind of demand surge to me there's no way i would have been able to predict that level but uh but you know maybe somebody else has a different opinion um so brian let me ask you if i tell you the same thing it it's January 21 and I say CPI is going to be up over six. Um, and the fed is going to have to start talking about tapering and there's all this political pressure on inflation. Um, and, uh, I tell you that gold is at, um, $1,900 an ounce, $1,850 an ounce. What do you tell me gold is going to end the year at? Well, as far as gold goes, I mean, we have it in the white paper too. It didn't do what most people think it does, which is an inflation hedge. But I'm asking, what would you have predicted a year ago in those circumstances? If I told you those set of variables were going to

play out, what would you have thought gold would have done? If inflation was going to be higher than we expected, was your question? Or way higher than expected, way higher than- I would have expected gold to be a little bit higher. I mean, I would have expected that it would have gone up a little bit if we were expecting a higher inflationary period of time, but not meaningfully and not necessarily directly correlated, you know, which is what my career has taught me with the price of gold, which is that it isn't necessarily an inflation correlation hedge. And so the idea that gold was down 5% on the year, that the dollar was up 5% on the year, and that the 10-year bond yield didn't move at all in the

year, these things become very complicated circumstances for a lot of people to have to process, I think. They're always moving targets. And if you're trying to predict a one-year move in interest rates based on the facts that you know at the beginning of the year, or one move a year in something like a precious metal, or one year move in something like that based on everything that you know on January 1, markets are too fluid and things change. Correlations are there, but they're not perfectly correlated. Those things can change as time goes on as well, which, you know, it's what makes what we do so fun and fascinating, right? We get to learn something new every day.

You know, but the reality is that the way we mitigate it, like some of that risk and phenomena going on is through the asset allocation that we build and the portfolios that we manage. And so we can sort of, you know, zig when other things zag, I guess, along the year. Well, I want to move us out of 2021. And so just real quickly for listeners, the five key takeaways we had from the historical year that we've been sort of discussing was the price inflation and the bond market. We talked about it. This is market volatility. Sign me up. An incredibly friendly year in terms of downside volatility. The third theme is that not everything came out unscathed. It's something we've already seen in the very early days of 2022. A lot of the very shiny object

things, hot tech companies, smaller cap growth companies. Certain areas of the market came way off of their mid-year highs. And that I think is a really underappreciated fact of the year. We talked about the national tax policy story ending up very different than people expected. And then the fifth theme that we won't get into right now in the podcast, but that we wrote about in the white paper is a nation changing its mind on work. I think both Dan and Brian made comments on the supply chain that really have to also incorporate intersection with labor shortages, that it became very connected to a declining labor participation force. And there's a lot that remains important in both the culture and the economy around labor conditions.

So let me move us into 2022. One thing that the white paper does is give the themes that we had a year ago in 2021 and provide a little report card. If I said one of the themes was don't fight the Fed, how did that theme play out? If I said the M&A train is coming, how did that theme play out? And I'll let you read that in the white paper because I don't want to take all the time. There were eight different themes. I do think it was one of the better years of macro forecast that we there were some that we got uh almost creepily and profoundly right i completely agree it's one

yeah one of the best yes you know that as far as forecasting goes is there's usually really there's usually one where it's really really wrong and there weren't really any i thought were really wrong there were some that were kind of quasi right. You know, it's all that people read it on their own and interpret how they would get, how they would score us if they were our teacher. But now we're going to put ourselves out there again. And in a year from now, we'll be having to face another report card, but our themes for 2022, I'm just going to say it.

I'll let you guys kind of add to it or push back or play around with the theme. Number one is just that equity returns are highly unlikely to be what they've been. And when you're coming off of a year that our dividend portfolio is up nearly 30% and the S&P is up 27%, and the Dow is up 18%. This is a pretty, and not to mention really strong returns in 2020, 2019 in equities. It's not that hard of a forecast, but I think we're saying a little more than just instead of 20%, you're going to get 10%. I think I am suggesting that there's real vulnerability for certain parts of the market. And the only reason why I'm content to let people say, hey, you're not being that specific, how much will it go down or what will go down?

I'm not doing that because I say all the time that I can't do it. So why would I pretend to do something I can't do? But I do believe what we can do and where there is some legitimacy in the application of this theme is that investor expectations ought to be different. And by the way, there's a really big risk if we were wrong here. Like what if you had another 25% year in the S&P? What does that mean the market multiple would be going into next year? I mean, to me, that would mean you're talking about blow off top. And then right now, my view is there's a lot of things that are going to get the heck beat out of them. I think if you have a 25% S&P again, then you're going to have everything get clobbered, everything.

And I'm not convinced of that right now. I think right now we're in a period that it's still Darwinian and there's still the possibility of rotations as opposed to risk off. But if you have another year like this year, then you just simply have a market multiple across the board that's insane and very dangerous. So you guys kind of offer your own commentary around that theme, equity returns, unlikely to be at the same level they've been. I'll start with you, Brian, and then go to Dan. Yeah. No, I absolutely share the sentiment and the thesis, which is that intuitively it makes sense. Last year was a great year and we had great earnings growth last year, huge,

coming off of a very low of 2020. And I don't want to jump themes because I know what the other ones are. But as far as the S&P being up another 25%, look, I would agree. It's not what I want. It's not what I want with no volatility. It's not what I want because it basically means that the prices are fully distorted at that point. So if earnings come in in the 2023 level, the S&P 500 and the markets are up 25%, you're going to have a multiple. David's better at math than me, but something like what, 25 or 30 times earnings, something like that. So no, I don't want that. So I think it is more realistic to assume a lower level of return. Do I think there'll be negative? Look, it's hard to predict a one-year period of time precisely. What I can say though, and I'll add to this from the white paper a little bit or add to the white paper, is the idea of there is no alternative, right? I mean, so we have, yeah,

equities are a little stretched. They're at 21.5 times earnings, but that's including a lot of tech names that are at much higher multiples. When you look at some other sectors that I think will drive those sort of positive returns in the S&P, so I think you'll get a little bit more of tail wagging the dog where the big part was all these huge tech companies. I think those will underperform. And then I think you'll get some of the more value, some of the more cyclical names that are trading at 15, 16 times earnings, maybe moving those valuations up a little bit. And as those earnings come in, that's where I

think you'll get positive performance. But I wouldn't throw the market out for 2022 just because let's look around the globe for a second and think about where opportunity lies. There's still opportunity in markets. You just have to be very selective, very actively managed and so on and so forth. So those would be some of the things I would build on upon that theme. Yeah. Yeah. I mean, I think Brian's answer is pretty comprehensive and I agree with everything he said. It's hard to add to that. All I would really say as far as I mean, hard to add to that. All I would really say as far, I mean, I don't see a scenario where we do get the same earnings growth as we did in 2021. 45%? I'm sure that's a very high level prognostication ability there. Okay. But obviously we're not going to get that. So

will we get higher than expected earnings growth? But just real quick, I would say if we did get 45% earnings growth, then I would be perfectly happy with another 25% move up in the S&P. Well, yeah, if you got 45% earnings growth again, your multiple would be back to par. You'd be at about a 16X. But the key is not obviously the same earnings growth. On your point there, right now consensus is about 8% or 9% earnings growth,

and that's at a 22 times. So to get 8% earnings growth to move the markets, you're going to have to get multiple expansion. So basically, to get kind of mid-single digits, maybe high single digits, you're going to have to get some outperformance of earnings expectation. Do you think you could get 11%, 12%, 13% earnings growth? earnings would outperform expectations, I would take that bet simply because I think the surge in demand that we're seeing, I think, continues. I mean, but it's not something I have a huge degree of confidence in. It's like, you know, that's what I think may happen.

But it's difficult to say for certain. Obviously, there's the cost side of the equation as well. There's significant wage pressures. There's commodity pressures. I don't know how all this will translate as far as net income growth, but it'll be fun to see. Can you guys just yes or no, because I want to move on, but yes or no, can you see a scenario where earnings growth outperformed, but the market is down sure yes that's the thing i think is out there that um it's baked in you get eight or nine and if you get 10 or 11 it may not be enough because of where multiples are so then then you have to kind of get like 13 14 and then you're going to need margin expansion and you're going to need this pent-up demand to persist, and you're going to need top-line revenue growth. All of those things are possible.

It's just that you need all of them. You really are lined up where nothing can go wrong in order to get that index-like return. And I think from a risk-reward trade-off, it's the most unattractive it's been for a long time for me. The other things that have hurt markets over a year were never in this projectable, analyzable, discernible framework. They were black swans. It was COVID, and it was financial crisis, and it was 9-11, and it was Greece, and it was Europe, and it was geopolitical, it was China. I'm not talking about anything event-driven here. I'm just saying, let's assume a normal world. That's supposed

to be a great investing environment, a little bit of peace, a little bit of prosperity. If you get 9% earnings growth, you can have markets down 5% because you're at 22 times already. So I think that's the issue where I'm going to skip for a moment to number six, which was another theme about, excuse me, to number five, that this is values year. I think that even if all those things did line up, it ends up being a decent year for index investors. I think that's the very best case scenario is it ends up being a decent year for index investors, I think that's the very best case scenario is it ends up being decent. What about any sort of events that could be a catalyst to the upside for equities? Well, see, we know various potential downside catalysts. So what are upside catalyst equities? Like what if they come up with a vaccine? Okay,

done that. What if Omicron rips through and then there's even more herd immunity okay well that's happened what if they don't end up passing big tax cuts or tax increases people worried about that's happened yeah you can say what if the republicans are more tax and regulation friendly and they take back the house tell me one market actor that doesn't already believe that's going to happen so i don't know any upside catalysts that are not priced in. I mean, the Fed cuts the Fed funds rate from zero to zero. Maybe a little bit longer. Yeah.

I mean, the Fed doing something unforeseen like that, going the other way, more dovish, I think would move valuations. Wouldn't you argue that that could also be more unexpected dovishness, Brian? Could be bearish because then people have to say, what the hell is wrong in our economy? Don't make them do this. I agree. I mean, these are sort of just hypothetical. It would only be in a vacuum of not that much bearish reason for them and them acting in a perceived way from markets. They didn't have to be so dovish, but they decided to anyways, type of a thing.

I mean, maybe we fill the 10 million job openings. Maybe people want to go back to work. Maybe baby boomers stop retiring and they come back to work. I mean, all of these things, most likely none of them will happen. But I guess those could be some positive catalysts for stocks. And in that case, would that push PE or would it push E? I think it would push E, but E would be, it'd be future E. But again, though, it's what you alluded to. And again, not to jump themes, but when we say the market's having some tailwind here because of valuation,

that's completely true. And we're on the same page. But then we're really telling you is that don't own the whole market. I don't think you should at this point. If you did in 2021, it worked out just fine. It did in 2020, frankly. But I really do think now more than ever that it's going to be an important time to be selective in this market because there are parts of it that not only are overvalued, some of it grossly overvalued, but there's just not a lot of unforeseen tailwinds that we can even think of right now to keep the valuations moving the way they are. And so being selective, I think, and what part of the market that you own is going to be more important in 2022 than it has been. And I have said that I'll speak my book. I've said that before. And and I'll say it again, that's okay. But,

but I do think that's an important thing for 22. But I think us having said it before has to be contextualized just because index investing did well in the year that we point out a kind of concern in the risk reward trade-off. All I'm doing right now, same thing you're saying, is giving the updated math. If you think you're going to get earnings growth of 5% in a given year, and that's consensus expectation, and you're trading at 18 times, you can point out and be right, hey, this looks like it's a better year to be selective

because earnings growth is not looking like it's going to be very big and you're already above market multiple. Now all I'm doing is saying, look, they're already baking in 8% to 9% earnings growth. And you can say, well, maybe there's going to be a lot more, but we already just got 45% earnings growth. So how much more do you really think it'll be? And 22 times starting point. So just to do the math of what it takes to get to a 5,300 S&P, which first of all, if we got it, that's still only a low 10% return.

It's good. That's real good. return. It's good. That's real good. But just to get half of what you got this year, you have to have another multiple expansion and outperformance on earnings. I'm not saying it can't happen. I'm just saying that your point in the past, Brian, it's even more true now than it's been that the risk reward trade-off is unattractive. Yeah. And I'll end it with, or at least in my section on with this, they was, I like what they said on the demand side. Cause I, when I, when I do think about what, what could happen to the positive side that that that could change the earnings

picture, it is demand. It's, it's that, that we're still in this lull and the demand ends up being, you know, twice as much or far more than we would have, you know, that we would have thought. And that flows into the E in the earnings equation. So there's that that could drive it a little higher too. But either way, I still don't think it's... We're not getting a 2021 year, I don't think.

It's going to be something positive, but something pretty benign. And so I guess let's transition that to our fifth theme of this year is this is values year. And this is where I think one can have some market bullishness and still be consistent and compatible with what we all have just been saying. This is very much a kind of 2000 and 2001, and I should be careful, a 2001 pre-9-11 thesis where you can have an index kind of blow up and you can have certain parts of the market kind of blow up and you can have some entire major segments of market still do real well. And that's actually a more common thing, what we call rotation. Generally, rotation is a more common outcome out of a great market than just plain sell-off. But we're so used to event-driven sell-offs around the last 20 years of investing with

financial crisis and European and geopolitical and COVID and other things. I feel like this is a very logical possibility that we get a compression of the delta, a reversion on evidence-based assumptions and probabilistic investing, I see value doing well and growth not doing well as more likely than growth doing very, very well. Your thoughts? Yeah. No, it's funny because you and Brian were just talking about it. It's funny because you and Brian were just talking about it. I felt that for quite some time. I do think now I'm more convicted in that than ever. I feel the same way.

I thought the part you said, it was interesting as far as we're so used to event driven sell-offs and really when there's more of a garden variety end of cycle type of rotation, you know, this is something we should see. And now it's time to kind of, you know, try to load up on some of these names that have attractive valuations. By the way, if today were December 31, 2022, then we saw it. Yeah. In the first four days of this year, then that's what we've sort of seen. But of course. Let's annualize that. Yeah, exactly.

It's been a great year for energy. It's up a trillion percent. Yeah. The beginning of 2021 where you started to see that rotation pretty sizably and, you know, and then, and that, and that's, and that's something we talk about in the white paper. It did look like it was going to happen, but I candidly admit it didn't, but see the differences, large value was up 25 last year. Large growth was just up 28.

However, I want to ask you this, Daya. Large, excuse me, small cap value was up 28 and small cap growth was barely even on the year. It was actually down going into late December. It had a little rally the last couple of weeks. down going into late december it had a little rally the last couple weeks is this small cap distinction where value hugely outperformed growth is that foreshadowing for large cap value growth i i mean it's i i don't think so i think i think the large cap growth names that have captured the hearts and minds of the American public are, are special in the sense that they're completely in their own kind of

class, you know, and valuations on that side of things, I don't think matter to a lot of those investors, but we, but we know they don't matter now. I'm asking, will they matter in a month or in a year?

I, I think so. I think they will. I think they will. I think they will. You know, but you know, I've thought, I've thought that before,

but I do believe that as, as more time goes on, it makes it more and more likely that we'll happen to be right on this particular topic. And, and by the way, for listeners and viewers, I actually make a joke about what day is.

There's point is that we, Brian's in the same boat. I'm most definitely in the same boat. Like Daya, we thought this was going to happen before and it hasn't. I've always been very humble about the fact that I am never certain when something is going to happen, but that's why I use the word probabilistic a lot is that we have to allow for risk reward trade-offs, not making hard and fast timing predictions. But the analogy I use in the white paper is joking about playing basketball with friends and saying, oh, I'll bet you 20 bucks I make this shot. And then you miss it and you go double or nothing, double or nothing. And you keep doing it. Eventually you make one, you're not

going to have to pay out. And that's sort of the joke I feel like with this is if you say it long enough, eventually value outperforms growth. But I don't think we're merely saying, Brian, hey, value is going to be growth this year. I'm saying that there is going to be a secular period where there is a mean reversion, that value and growth's long-term investment record comes back to a historical relationship. With that, we will require a very sizable and extended length of time of value outperforming growth. Do you believe I'm right? I do believe that you're right, very much so. Getting a secular shift in markets, a secular shift in change like that is not easy to do because secular is inherently meaning this is a secular period of time.

It's a longer period of time. When we're talking about the two things of rotation from growth to value, you know, that can most often is relatable to a business cycle. You know, you get growth outperforming in the beginning and value outperforming in the end of it. I don't consider us being necessarily at the end of a business cycle here, but I do think we're no longer in the first inning since they're going to start hiking rates next year. And that technically usually starts the middle of the end of the business cycle. So you'd have some wind in your backs from a rotation perspective, from a business cycle perspective. Then you would also have wind at your back just from a secular perspective that growth hasn't outperformed value this much basically ever since the year 2000. And we sort of remember how that all played out.

The last thing I'll say before I dig up all the time real quick is is when you said the small cap growth and small cap value, is that an indicator of what can happen with the large side? I would say this. It could be in the sense that, remember, small cap growth valuations were probably double that of large cap growth valuations. And I think the relative outperformance on the other side, on the value type, on the small cap side, is showing you that valuations do matter.

And I think you're starting to see that in 2022 already. I mean, it's only been a week, but that you're getting that outperformance in lower relative value names than higher relative value names. So those would be kind of a couple of things on that. Well, we have a few themes that I'll do all at once or kind of bring together because there's a relationship in the topics between the Fed and inflation and housing and bond yields. But let me ask you, because you're on that theme, Brian, do you believe that the Fed, our second theme is that a lot of people are worried about something they shouldn't be with the Fed, and they're not worried about something they should be. And what I mean by that is I couldn't care less if they raise rates three times, and I certainly couldn't care less if they taper their ridiculous QE. And so there's all this hand-wringing over a little bit of tightening in this excessive, excessive, excessive, accommodated, easy environment. I pointed out in the DC Today what, by now, people listening to it was yesterday.

But the market has been up basically every time that they've raised rates six months later at an average six-month return of over 8%. I don't care about that. It needs to happen. However, what I do think people aren't worried about is the sustained malinvestment and lack of price discovery and distortion in the markets, the excessive liquidity and mispricing that has taken place around heavy monetary accommodation. I guess I'm wondering, do you think I'm being too sanguine about tightening? And do you think I'm overreacting to Fed distortion? I'd say no to both of those questions.

Fed distortion? I'd say no to both of those questions. It's hard. As far as being too sanguine, we'll have to see. But I share the sentiment, which is going from zero over the period of a year and a half to one and a half or maybe 2% on Fed funds before that's terminal on Fed funds rate. Do I think that is something that is going to overturn the markets? I don't. I think you'll have some Edwin and maybe some bond markets on the shorter end as they do that. And we speak about it in the white paper, but they also have a $9 trillion balance sheet where I really do think they're going to take their time with raising rates and just do a combination of a rate hike. By the way, I'm saying this all after QE ends. So QE ends in April.

Then they can do a combination of a rate hike in July and September. Then maybe you get some balance sheet reduction or just stop reinvestment in interest and dividends. Then you get another rate hike. And so I don't think it's in the Fed's best interest to get to terminal Fed funds rate, in other words, in like 18 months. I think what they want to try to do is do it over the course of a couple of years. And so in that environment, does that make me lose sleep on equities or fixed income or alternatives or even real estate in some ways? It doesn't.

And I'll start with this. To your other point on what's the real story with the Fed, it's that they've become the buyer of everything of last resort. And so this isn't in the white paper. But what I would say is if there is something that keeps me up at night, it's since markets are now dependent on that, let's just hope they can keep being the buyer big enough to be that buyer of last resort, because that's what the position that they've put themselves in. So. Okay. So Dave, to Brian's point there, do you believe that he's saying, look, getting to terminal Fed funds rate over a couple of years and still talking about being at zero or negative 50 basis points in real rate. And to Brian's point, that taking a couple of years. So I guess I'm wondering, what is your expectation from the Fed? Our entire adult lives, I'm older than you, so it's not just yours, but mine as well.

The Fed has been an accommodator, a cuddler, an enabler of risk-taking. To me, the thing that has to really, maybe Brian brought this up by alluding to the idea of them not being a buyer of last resort. The thing that has to paradigmatically scare investors is if all of a sudden the Fed changes uniform. We are no longer there to really be an enabler of risk assets. Do you think that's actually on the table? I do not. But if that were to happen, I mean, the repricing that you would see in risk assets would be one for the ages. It's hard for me to consider a case, especially

in an environment where the Fed and the Treasury are so closely linked, and even more so than they have in the past, where the Fed can act completely independent of just the broader society and the nannying and coddling that's been going on, as David mentioned. I don't see that ever happening. So I do think that everything that Brian and David mentioned, as far as the terminal rate being low and has been in the past and that taking over a couple of years, the cost of money will go up a little bit, but not as much as it should, not as much as market forces would dictate. And I still think it's going to be fine for risk assets. If anything, it might help our rotation thesis.

How many would the cost of money go up a little bit? Maybe that'll be the trigger. It would. I mean, if you can actually get the long end of the curve higher, that's one of the problems is people say, oh, well, the Fed has been holding the long end of the curve down. But the problem is then the Fed leaves the market and the long end of the curve doesn't go higher. Right. But if you were to get a wider spread in the yield curve, I think it would be advantageous to our value rotation thesis. There's a great chart, by the way, I'd love all you to check out in the

white paper, page 16. Going back to me leaving high school, okay, so we're talking about 30 years ago, the amount of predictions from analysts about bond yields, and then the actual line of the bond yield itself. And you see that time and time and time and time again, that there is the propensity to expect bond yields to go higher than they do. And that the actual versus the forecast is a 30-year-long story of the actual being different than the forecast, meaning the forecast being for higher and the actual being lower. But since we're talking about inflation expectations and we're talking about the Fed, the eighth theme that we have for 2022 is that bond yields will be higher, just not that much higher. And I wonder, Brian, if you think that I'm onto something, will we see a 10-year higher by the end of the year, but not that high? I completely agree with that. And I'll explain. First off, the chart that you have in the white

paper is really neat to look at. I think there's a lot of reasons why, but not to get off topic on that. But as far as bond yields being a little, but being higher, because they're going to raise rates a little bit and maybe they're not purchasing assets and that causes rates to move a little bit. Okay, fine. But just think about this. So they're raising rates and they're not purchasing assets. Is that stimulative for growth or is it constrictive for growth? It's constrictive. Do long-term yields technically go up when there's less growth or down? They go down.

So I think sometimes it's counterintuitive when people think about rates. And you think about what they're doing is to try to help the economy get off of life support and be able to function on its own, in which case they're going to raise rates along the way to do that. So yeah, that will cause rates to go up a little bit. But then there's sort of the tug of war between that and also as they do that, they are taking maybe a little steam out of the market while they do that. And so rates tend to be a little subdued to that. And then also the simple just demographic and structural phenomenon

of a globe that is over indebted. All of those things causing low rates to happen. So yes, I think you're spot on with it. Absolutely. Daya, your comments on 2022 expectations, not just bond yields. Brian kind of covered that. But inflation, Fed, do you think 2022 has anything to surprise people with these categories we're talking about that are all sort of related to one another? You know, it's funny, and I changed my mind on this after reading your white paper, actually, given that I did think that inflation was going to continue to be a story.

But I didn't think the headline numbers are going to read as high as they did in 2021. And because there was going to be that disinflation, I think that the Fed could very easily just couch it in a way that, look, we have inflation, but it's less than last year. And so we don't need, everything's fine, guys. You can all go back to work. So I don't see the inflation thing being a big story for that particular reason, because it is- Which is different than you saying there would be a good thing you're just saying you're agreeing on my thesis that it will get couched that way right right exactly exactly it's a well look well let's take it to the other other side of things so if inflation was somehow higher than it was in 2021 then it might become a problem and it might cause the Fed to take some sort of hawkish stance,

which could really spook markets. But because the headline numbers were so high last year, it's likely that those inflation numbers come in significantly lower, even though they're still high relative to historical standards. But it's couched in a way that where the FED can continue to be very dovish. So, yeah, I thought that was a very insightful point. But as far as, and it was the other part of your question, anything else is going to happen in 2022? Yeah, just any surprises you're expecting. Because it wouldn't be a surprise if you were expecting it, but maybe it would be a surprise to somebody else.

Maybe, you know, maybe it would, we didn't talk about U.S.-China relations at all. Maybe it would be a great surprise if somehow the U.S. and China had some sort of reconciliation. I think that could be really helpful for markets. I would love to see. Or, I mean, some sort of improvement in their relationship. Just communists and Democrats getting together and hugging it out. Well, I mean, you know, like maybe how U.S. and China were pre-Trump. We go back to that type of dynamic.

Yeah, I know what you mean. And frankly, that was a pretty civil relationship. Right, exactly. But you would admit that's a really unlikely tale event i i i would think it would be very very unlikely given uh just the current zeitgeist uh u.s and china for that matter uh when when brian and i were at morgan stanley uh their chief economist at morgan was a guy named david darst It was really, really funny guy, smart guy. I remember him saying one year in like 2011,

that his most bullish upside surprise catalyst would be a picture getting out of Nancy Pelosi and John Boehner in a bathtub together, drinking champagne. And, and so, you know, because the Democrats and Republicans were fighting so viciously at the time and the, uh, the partisanship, and it was hurting the ability to get certain things done. And he was saying, what if it, you know, there was this Kumbaya, he's been funny about it. And, and so that's day is a 2022 upside.

Surprise is, uh, president G and the powers that be in the beltway, uh, uh, coming back around. Brian, any upside surprise you want to throw out there before I take us home? Sure. I'll give you three quick ones. How about one quick one? A first upside.

Well, I was going to make a joke with who would be in the Super Bowl, but I'll put that aside then for a second. Upside surprise. Chargers was the answer. Are they going to make the playoffs? This Sunday's game will determine that. And I think it's a several Sunday games, right? They need to help.

I think they beat the Raiders and I'm pretty sure they're in. But now look upside would be on the demand side for me. So 2022 upside surprise could be that the demand picture, while it was robust in 21, is continuing and maybe even builds upon that into 2022 with pent up demand, with things reopening and those types of things. The last thing I would say an upside surprise is if we don't have to wear masks on plane anymore because this variant and everything tends to kind of run its full course and we can kind of move on with life so i like that one yeah uh i'm with you on that uh much more likely that by the end of the year we're not wearing a mask on a plane that the chargers win the super bowl um i'm gonna take us home i'm'm going to land this plane to play off of our theme there. Just by reading from the very last paragraph of this year's white paper, it has not been a good period of investing for the pathological pessimist. I have the rare burden of believing there are structural concerns of significance in our world,

in our economy, central bank distortions, cultural shifts around work, governmental size, geopolitical apathy about the international order, all kinds of things that Brian Day and I have talked about here today, and yet also being an unrelenting optimist. Betting against humanity has been a losing bet for a long time, and regardless of what 2022 produces, I remain optimistic about the future for investors who are exposed to the ingenuity of mankind. The greatest investors of the last few decades, and I believe the next few decades, will be able to hold these two realities in tension with wisdom and humility, that there are concerning things in the world, even as there is investable opportunity in human action. So as for anything that Brian Day and I got wrong in this discussion, anything that is

wrong in the white paper, Lawrence Peters' quote is applicable. An economist is an expert who will know tomorrow why the things he predicted yesterday didn't happen today. Thank you for listening to and watching the dividend cafe. Thank you to Brian and Daya for joining me. All three of us are excited to be doing this quite frequently with you all throughout 2022. We like these group discussions and hope they bring you a fuller perspective.

And of course, thanks to our communications department for putting all this together. And let's go get it in 2022. Please reach out, any questions, any time. Thank you for being a part of the Dividend Cafe. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC,

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