The Dividend Cafe - The Art of a Tax Cut or a Tax Hike?

Episode Date: April 18, 2025

Today's Post - https://bahnsen.co/3S0zaIl Good Friday: Market Insights and Economic Updates In this Good Friday edition of Dividend Cafe, David discusses the state of the stock, bond, and banking markets as they close for the Easter weekend. The episode covers multiple topics including the impact of tariffs, the US bond market, and Chinese trade relations. It delves into the bond yield fluctuations, debunks the notion that foreign countries like China are manipulating the US bond market, and explains the human nature behind policy exemptions like those seen in the tech sector. David also touches on market valuations, the ongoing trade war with China, and the economic implications of potential tax policy changes. With a focus on providing clarity and perspective, the episode aims to address investor concerns amidst a volatile market environment. 00:00 Introduction and Market Overview 01:11 US Bond Market Insights 05:16 Tariffs and Trade Policies 07:07 Valuation and Market Trends 08:48 China Trade Relations 15:05 Economic Policy and Tax Objectives 18:39 Conclusion and Final Thoughts 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. Well, hello and welcome to this Good Friday Dividend Cafe. Markets are closed on Good Friday, both stock and bond and banking markets all set for the Easter weekend. I wanted to keep this dividend cafe a little shorter than it's been lately. I think it is shorter than it's been lately, but it still ended up being a little longer than I intended. But that's just because there's a lot going on out there. And rather than have a kind of single dividend cafe going

exhaustively through one topic, I'm going to jump around a little bit to cover some of the different aspects of where I think we stand right now. And it's not that it's disconnected from tariffs. All of these things are essentially tariff oriented or tariff adjacent, but where the bond market stands as a result of things, this update of where things are with China, the US dollar. I just want to kind of cover all these different things because there's a lot of talk, there's a lot of chatter in the media, and investors understandably have questions, and I want to address some of those things. Give the right perspective as we kind of come through another volatile week in markets to

get a feel for where we stand. First and foremost, I want to address this issue. I talked about it a little bit last Monday, and I think we got much more validation as to where I'm coming from on the issue related to the US bond market. A week ago, the big buzz was around this idea that the foreign countries, particularly China, were likely weaponizing their holdings of the bond market to affect their own kind of policy retaliation. And the theory was they own so much of our debt that they're using it to drive up interest rates and create all kinds of problems. I put a chart in Dividend Cafe just showing you how for several years the window of where

the 10-year bond yield has been is really quite tight. It's been a couple of times it got up near 5%. There's been a couple of times it got right below 4%, but it's really spent the lion's share of the last three years almost between 4% and 4. percent, a reasonably tight range that has a pretty good connectivity to nominal GDP expectations where inflation was and then real growth, and that's about the math as to where you'd expect the 10-year yield to be. And it can fluctuate 20 basis points here, 50 basis points there.

But what happened is that last week, the tenure jumped all the way to 4.5. Right in the range it was a few weeks ago, let alone over for most of the time over the last several years. But because it had been down a little in the immediate aftermath of the trade war, the idea that it moved higher started all this chatter. One of the things that I did is not only look at the historical bandwidth and provide all that chart for you, but my friends at Strategas Research went through and evaluated the Treasury, the long bond, and its price movements all year over the last several months. The fact of the matter is that it is up, meaning yields down prices up 3.9% in overnight market activity, and it's down, meaning yields up prices down during US market hours. So 3.9% up overnight, 2.7% down in market hours. I'm sorry, but that's not foreign actors driving bond prices

lower and bond yields higher. And then again, in fact, we had a couple of days of bond yields up last week, but since then it's moderated and in fact come lower. And as we sit here now, it's closed at 4.3%. And that's with the bond market closing a little early today on Monday, Thursday and closed all day tomorrow. So you have some traders that put certain positions on that might be unconventional going into long weekend. I would get this idea out of your minds. China owns about a trillion dollars of 36 trillion of US sovereign debt. We have a lot of issues that affect our bond yields, economic growth, inflation.

There's nobody on earth that hurts more than China by trying to weaken our bond market as the exact opposite effect of what they need for their own currency. And so the irony of Steve Moran, Secretary Besant, and other policymakers saying, we need to do something about China weakening their currency, strengthening dollar, which they're accusing them of currency manipulation, and I'm not even saying they're not doing it. What I'm saying is by them trying to weaken our bond market, it strengthens their currency, weakens US dollar. So they'd be operating in that scenario in the exact opposite of what they're being accused of. So this just, for whatever reason, this incoherence

bothers me. But what is most important to me besides my own little pet peeves about coherent narratives of economic matters is I want investors and especially clients of ours to understand what's going on. I want to talk for a moment about the human nature of tariffs and particularly the announcement over the last weekend from the Trump administration that they were going to put a waiver on the computer industry, the smartphone industry, semiconductors, as it pertains to these Chinese imports, and that maybe something would change later, but right now they're kind of carved out.

And a lot of people have said, well, this is outrageous. It's benefiting the big. Tim Cook, the CEO of Apple, had been at the White House. There was concern that there were these biases and whatnot. And look, I don't have a lot of good things to say about it, but I do want to make very clear, it's total human nature that people in a policy like this would want to receive waivers, carve-outs, exemptions. The difference is most policy, you can't do that because it's been congressionally passed. We've kind of given a carte blanche discretionary

policy to the executive branch. So the executive branch without specificity, without binding force, without clarity, there's wiggle room. So naturally people operating in their own self-interest want that wiggle room. And it just so happens that there's a lot of resources with multi-trillion dollar mega cap tech companies. But I mean, every small business I've talked to that's getting pummeled by these tariffs or the threats of tariffs or uncertainty around tariffs, they would like exemptions and carve outs too. They just lack the resources to know how to do it or to be able to do it.

They lack that reach. And that's just a byproduct of why some of us favor tax policies that are much broad-based and less discretionary. But what you can't change is human nature, and this is a policy approach that lends itself to extracting this type of response. A quick comment on valuation, which you might recall before the trade war began, was probably the biggest theme I had in markets in the first couple months of 2025, and something I talked about plenty in 2024.

And now all of the talk is tariff all the time. This week we got a little Fed talk, so that's always fun to bring that animal back around a little. But you never want to be totally monolithic, like why have one hobby horse when you can have two. But the valuation story is hardly gone either. Look, the largest cap companies, the largest valuation, they have come down in the market sell-off from 31 times forward earnings blended to 26 times. The overall S&P 500 went from 22 times forward earnings to 19 and a half times. So nothing exactly got cheap, but everything got a tiny bit cheaper. The biggest drops were on the most expensive things, which is an argument I've made forever

and same as it ever was, that the most vulnerable are the things that are most overpriced. That's not rocket science. But the only thing I want to say is when people say, well, has it gotten cheaper? We're now 26 times forward on a P to E basis, a price to earnings ratio. The problem is your E, that that is all still using the same forward expectation for earnings, and maybe those things will hold. But there is a lot of vulnerability around where those earnings will go going forward, and I'm not sure that right now we have a PE because I'm not sure we have a lot of clarity on the E. So I want

to continue making that point on valuation. We can spend the bulk of our time today talking about China. I'll make a few comments. There hasn't been a phone call yet between President Xi, President Trump. I believe a call will end up taking place. There's G7 and G20 things out there, and there's already the exceptions, the aforementioned exceptions that have been done on a lot of the export products that matter most to Americans, but there's a lot of companies that are getting hammered. China has a certain ability to reroute some of their exports through Vietnam and other

countries and try to work around the tariffs that way. It's not clear to me that the US has anywhere near an enforcement mechanism or the resources to deal with that, so that may be part of how China tries to get around it. But there's just a general lack of clarity as to where this is going to go, and I'm very, very skeptical of anyone that's telling me where it's going to go, and I want you to be skeptical of anyone telling you where it's going to go. I'm quite confident that nobody knows.

I continue to believe the most likely outcome without me putting a timeline on it is there will end up being some sort of a deal and that deal will be a little while out and that deal will be probably in substance much less than people think it will be. But when I hear people say, well, look, the stuff with China, at least now we've isolated it, I think that the 70 other countries or 90 other countries, whatever it is that's going to be a part of that other trade deals going on, I think we have to remember that it's very possible that the US weakened

its own hand by the problems with the other countries that are now allegedly in discussions and certain things are going to get announced and other deals will get worked out. But had that been done first and then the escalation with China, it would have probably created a little bit more leverage. But the issue right now is that there doesn't seem to be a straight answer, both in my own inbox from folks, but just in terms of within the administration. Is our goal to protect American workers? Is our goal to defend our own national security?

Is our goal fighting back against unfair trade practices? Is our goal human rights? I still don't really understand why a tariff would be an acceptable way to deal with human rights. Like if we get paid, then violations of human rights become okay. Or if we have critical infrastructure needs that we're reliant on China and our supply chain for, but if we get paid a tariff on the import, then it's okay. My view would be having a quick and accelerated and aggressive policy to take control of our own national security pertinent supply chain and not along

the way putting chocolate from Switzerland or coffee from South America or t-shirts from Vietnam or widgets from China in the same bucket as national security. And so I still think that we can't really speculate where things are going to go with China because it's not real clear what the actual policy objective is. My pragmatic view, meaning speaking for what I think the pragmatic objective of the administration is to get to point of a deal. But all this discussion on who has more leverage, I really suspect it's asking the wrong question. Both countries desperately need this to end.

China, we are something in the range of 13 or 14% of China's exports. That's a big number, and especially when you put a dollar on it, around $500 billion, that's a lot. It's not existential. Most companies could survive with 86% of their business. You don't want to, but it's not something China wants to happen. And certainly the US does not want to go without $500 billion of these goods or does not want the cost increases that would come about from getting them from other places or having to

go stand up new facilities, many of which just simply can't be stood up for a long, long time. So both countries are in a position of this hurting, but I don't think the question is who needs who more as who has a higher pain tolerance, and I don't really think most Americans want to hear the answer to that. I do not think the answer is America having a higher pain tolerance than China on this. So we'll see, China is a very vulnerable position. They're in a deflationary economic position.

You'll see in my chart of the week at DividingCafe.com that the property sector continues to be collapsing and that's offsetting a lot of what's happening with exports, imports, or other categories in their economy, their retail sales, their overall infrastructure. All those things are positively growing, but it's being offset by the deflationary implosion of the property sector and asset bubble bursting. No one's in a great position with all this, but as far as where I think it's going to go, I have no idea. And I think that a currency deal along with various trade protections is still probably

the administration's objective. I don't see it being able to happen very quickly. I think when you look at the uncertainty of where things stand with these other countries we're negotiating with, the upside possibility, you get some good announcements. The upside possibility, you get some announcements that sound good, but maybe aren't as good. The upside possibility of a currency arrangement that puts some curbs in place around currency manipulation from foreign countries. The downside risk of re-poking the bear on the trade war with 70 other countries.

The upside and downside risk on a lot of these economic matters, could we tip in recession, downside, could we avoid recession, upside? I don't know answers to any of those questions. And I'm studying all of it. I'm looking for hints. I'm looking for projections. I'm doing analysis.

But there's nothing that is readily available to be able to predict how those various components, all of which are somewhat important in the next six weeks, six months, are known. What I do know is that one of the lowest hanging fruits available to impact economic growth positively on the policy front would be the passage of the administration's tax objectives. And I mean more than that than just avoiding a $400 billion tax increase. Keep in mind, if you avoid it, you've done nothing stimulative. You're still in exact status quo.

These are $400 billion annually of taxes that are not being paid right now, but are set to kick up going into next year. If you just simply extend the Trump tax cuts, which has to get done, otherwise you have significant economic contraction. If nothing gets done but that, I have no reason to believe at all markets respond positively because I think that's been baked in for quite some time, at least since the election results were known. In order of priority, I'd suggest that the administration would like to supplement the

extension of the 2017 Trump tax cuts with no tax on tips, with a lifting of the salt deduction cap, with incentives for domestic production, which was not necessarily a big campaign speech, but I do believe is a high priority for the Treasury Department. Fourth, no tax on overtime. Fifth, no tax on social security. What I would say is that the fifth is just simply almost impossible to see happening from a mathematical standpoint and political, economic, legislative priority. No tax on overtime is going to be difficult. Maybe something fits in there, but I think the mathematical standpoint and political, economic, legislative priority. No tax on overtime is going to be difficult. Maybe something fits in there, but I think the incentive for domestic production and

then some higher salt cap and then no tax on tips just because of the political necessity, those are more realistic things. I believe bonus depreciation will come back 100% expensing on capital equipment. I think that will work its way in the final bill, and I think it'll be an underappreciated part. But this all assumes we get a final bill. Just continuing to move through the sausage making of this legislation and budget reconciliation process. At this point, it goes to committees, then it goes to budget committee, then it goes to final house, final Senate, and that might have to be conferenced there for ultimate reconciliation, but then if it gets passed, it goes to president's desk.

All of this could happen by Memorial Day. All of it could fall apart by Memorial Day. All of it could still be on track to happen, but not done by Memorial Day. It may take more time and push it into summer. This part I know that for all the economic damage I believe is currently being done, there is economic upside on getting this through and this is moving along. It is not a fait accompli, but I can emphasize enough that with all the uncertainty being fostered on the tariff side, if you do get some of these other things done, there is... And again, they want to try to use tariff revenue

to help fund some of it. I don't know how that's going to work. CBO can't score it. The president suspended a bunch of the dividends and then they say, well, we have 600 billion coming in from tariffs, but then most of those are waived. And also, they weren't passed by Congress, so they can go away at any time. So I don't know if it's going to give Congress the ability to try to pencil it in or not, but it can't get scored with the CBO.

So I just think that there's a lot of work to be done there, but there is still a chance that this gets done by Memorial Day. And that becomes a big boost, and I need to keep that out front and center. That's where we are right now. I encourage people to look at DivinityCafe.com for a little understanding of where our charts are this week, just seeing the things we want to highlight, and also just a deeper understanding of the dollar. The DXY is basically the US dollar

versus a basket of trade weighted currencies. It's down about 3% in the last few weeks. It was up a little bit this week. When people talk about the dollar crashing with all this, it's up 10% from where it was for most of the last decade. It's up much more than that from where it was for most of the last decade. It's up much more than that from where it was for the whole decade before that. So you just get an incredible amount of melodrama around the dollar that's factually inaccurate. This is a big story to me. The notion of the dollar losing reserve

status, it continues to require someone to tell you who is going to take it, and there's no answer to that question. Do I think there's certain sectors that are going to benefit from a relative dollar weakness? There is. It's not a secret. It's those that export, so multinationals. But trying to guess where the dollar is headed, and you're talking about very marginal movements up or down, that is not something I recommend trying to incorporate into your investment thesis right now.

So I want to leave Diven Cafe with that and let you go enjoy your Easter weekend. Happy Good Friday. Reach out with any questions at any time, questions at thebondsandgroup.com. I've enjoyed most of the correspondence I've gotten and I welcome all of it, even if you're in disagreement with me, doesn't hurt my feelings even a little bit. I appreciate the interactions and I am here to do my very best with our Divinity Cafe format to provide useful information. We are extremely engaged on behalf of our clients right now the way that we ought to

be. With that, we're going to go into Easter weekend. I will be in Dallas first part of next week and then Orange County at the end of the week and look forward to lots and lots of meetings next week. Thank you for listening. Thank you for watching. Thank you for reading The Dividing Cafe. Happy Easter.

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