The Dividend Cafe - The Beached Whale of Doom vs. Reality

Episode Date: May 13, 2022

I had fun writing today’s Dividend Cafe and I think you may very well have fun hearing (and reading) it.  I also think some of you may be mad at me for it.  I hope I am wrong.  I believe there are a multitude of messages in the Dividend Cafe this week that are vital for investors in this current era, and the one that is to come.  I also feel these messages are timely.  Jump on in … 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 my first ever Dividend Cafe being recorded here in Nashville, Tennessee. I am actually flying out of Nashville here in just another hour, head back to California. But it's kind of fun to be doing it here in our conference room of the TBG offices in Nashville. We spent a whole week here, a lot of meetings, a lot of meetings, a lot of action, a lot of things going on in the portfolio. Busy times for us at the Bonson Group. And some of those busy times are what I want to talk about here today. The kind of current level of market conditions necessitates some sober conversation.

And so what I have done today is try to boil down for you a little summary of a lot of narratives that I think kind of come together and more or less turn into a negative. I turn it into a cautionary tale as to what narratives out there that I would avoid or at least understand some of the baggage that they carry. Let me just start with kind of where this current level of distress began. And it's a theme that we've had for a long time, current level of distress began. And it's a theme that we've had for a long time, which was the shiny objects that were being run into. That term I made up. And so we at the Bonser Group began some time ago referring to things that were being invested in because they were shiny, because they were popular, because they had momentum, they were speculative, they were hot,

they were new, they were what the cool kids were buying and all those things. And you got to understand now that anyone hearing me is immediately associating it with a negative because they've gotten pummeled and it's so obvious that it's been such a bad investment and all that. But when we first began using the term shiny object, it was entirely, the connotation was entirely the opposite. People were looking at it like, why wouldn't you be invested in shiny objects? They were popular, they were up and coming, the SPACs, the IPOs, the crypto,

and they just start making up these nomenclatures. The marketers of the world say things like Web 3.0 and innovation. All of a sudden, are you investing in technology? No, no, no, it's not tech, it's innovation. Okay. So my point being that it was not exactly ancient history, that all these things had a positive connotation. that it was not exactly ancient history, that all these things had a positive connotation. And yet it was divorced from investing reality, from economic reality, from financial sensibility, valuations, a revenue model, the motive in them being invested in. And so now when you look at some of these things that have blown up. That part is the easiest early innings of what took place in the current level of distress. And if there was no talk about the Fed tightening,

those things were still going to blow up. I'm perfectly willing to no longer use the expression shiny objects if we want to just go old school and look at tulip mania in the 17th century and all of the different crazes and bubbles and manias that have been documented in the last three, four, 500 years as what is the famous book that I love so much, The Popular Delusions and Madness of Crowds. We want to call it delusion and madness. And I think I use the term madness in Dividend Cafe today many times for that reason. These things are all part of the same deal. The investment particulars, the aesthetic, the kind of cultural accoutrements change, but the human nature behind it does not.

And the human nature is not going to change in the future. FOMO, fear of missing out, which in my religious tradition is what we call covetousness. In Mount Sinai, it was referred to as iniquity in human character to be wanting something and coveting it because others have it. That's an investing dynamic. And it's been true of condos in 2006. And it's been true of dot-com companies in 1999, and quite frankly, I could find many other analogies over the last 20 years and many decades before, many centuries before. This is not about another dividend cafe beating up on this evisceration of something that became a madness, that became a mania. For one thing, the evisceration seems to take place in three months,

six months, eight months, and sometimes the mania can last three years. So from the vantage point of how good you look talking about this stuff, there's a lot more months where you look bad than when you look good. I just live with it. I don't care. This is my job. This is my moral duty to tell you the truth. And these things, when they go from 300 to 500 and they're worth two at 400, I'm still right. It's just a matter of when. Unsustainable economics, a total divorce from reality, the reframing of rules of logic, math, science, and finance will always end this way. I just don't know if it takes a year, three years. That's the way this stuff goes. But see, we are not in the early innings right now of the market distress. The early innings were the evisceration of the shiny object chapter. The electric vehicle stuff,

the SPACs, that work from home things. I mean, I was looking this week at, I had a couple anecdotes about it in DC Today of companies that were worth more than the largest oil company in the world. And now they're worth what the sandwich shop down the street from me is worth. Actually, the sandwich shops here in Nashville are pretty good. So it might be a bad example. But I mean, that's the kind of wealth destruction we've seen. So what is this next inning I'm talking about? Why do we care besides again, hitting home this point about shiny object evisceration, the madness of crowds? Because in the second quarter of this year, it has gone to the next stage that companies that are not shiny objects, that are legitimately powerful enterprises of massive revenue generation, of huge brand strength, of disruptive capacity in the economy, companies that are culturally and generationally famous in streaming, in media and e-commerce have gotten killed. And that is a story of valuations having to be repriced. Did Fed modest, modest, modest tightening

and when I say tightening, you know, the Fed funds rate is at 0.75%. But did an interest rate of less than 1% break those companies? I don't think so. They had a combination of high valuations that had to become lower, and then they actually had some fallibility. They had some vulnerability. They had some competition. They had some revenue misses. Most companies do. My company has had challenges, you ebb and flow. Not everything was perfect, even for big, giant tech companies. So you've had vulnerability in that sort of sort of fang group. And then kind of the chapter beyond that is just broader market distress. That's so far been a little bit more traditional, not quite to bear market yet.

And in the S&P, Dow has really had kind of an average drawdown as far as what normal market volatility is. All those things can change, but that then becomes more forward looking around the Fed and around bond yields. That's more economic. That's more fundamental. And in this case, it's fundamental weakness instead of fundamental strength. So we're going to talk about that. But I read a piece this morning from my friend, Louis Gov, at GovCal Research. This is a really phenomenal economist, a phenomenal institutional research boutique. And he made the point that generally now when it goes from the shiny objects blowing up, that's my nomenclature, to the kind of really big, powerful, large cap growth space

blowing up. And no one's buying those dips, at least not yet. I mean, that could change, but people are not coming in to buy the dips. That's what's made this so different from some of the more recent volatility that we've had in big tech. How does it end is there usually has to be what he called a beached whale, some whale that comes up to the surface, and then you kind of get a washing out and risk takers can come back in knowing there's some pretty big carnage out there, but the worst may be behind. And he had suggested over the past

decade, several times that that carnage, that big whale that was going to kind of be the next thing, so to speak, could very likely be the Euro. But he points out, and I tend to agree with him, the European banks are kind of acting fine. I think of the distress we saw on the horizon in the European bank sector in 2010, 2011, 2012, 2015, 2018. Their credit default swap spreads have not blown out much. Their stocks are kind of in line with the American banking stocks. The euro has made a new low against the dollar, not all-time low, but in this cycle low. Credit spreads are widening in sovereign debt in Italy and some other things. But no, the euro doesn't appear to be the whale we're about to beach. And so he brought up this idea of crypto. And at first, I had thought of crypto as just part of shiny objects. But it's down 60%. And that represents one and a half trillion dollars of wealth destruction, much of which has been in the

last few weeks. So now we're not talking about those people, those poor speculators that jumped on Reddit or Twitter or some chat board or opened up a small account, put their life savings in, and they've gotten hammered. Those things are really brutal stories, but obviously it's not systemic in and of itself. The systemic fact is just how broadly democratic some of this ownership craze got. democratic some of this ownership craze got. And then what I think maybe comes next is the regulators generally don't allow people to lose a trillion and a half dollars and just sit on their hands. They usually come in and start intervening and subsidizing and regulating and all the things that they do. That probably changes the crypto narrative even more. I'm under the impression a lot of the crypto fans thought that they were going to be regulator free and government free. And so this is an interesting thesis that Louis has that maybe crypto becomes the beached whale of the cycle.

I don't have an opinion on that one way or the other. I think it's a very plausible theory. It's already been a brutal story. Maybe it bounces back. Maybe it goes much lower, another 20 to 40 percent down in crypto. And I think it becomes much more systemic and carries large cap growth and NASDAQ down even further with it. I think that's a pretty sensible conclusion. But what I guess I want to get to is this. Oh, anecdotally, because I'm going to forget if I don't say it now. This also is probably going to put people back in work. And so most of these things have a kind of like negative thing. And then there's a sort of other side of the coin.

And I think a lot of the people that have not gone back to work, they had big gains in their trading account. They had shiny objects. They had SPACs and IPOs, and they certainly had crypto. It was a much younger audience. They were putting a lot of money in. They had made money. It felt a kind of liquification that could keep them out of the job market. I don't know how marginal it is. I know it's at least marginal. It may be only marginal, but that's something. So maybe you get some folks come back in the work cycle, and that becomes a good aspect of it culturally, as I've talked about a working society is a happy society. But be that as it may, where we are right now in the cycle is a time that want us to be very

careful about listening to people who make a living saying crazy things. And because they say something that is true, does not mean that they are someone who should be listened to. And this is the hardest part. I can say all the cliches that we say in my business, a broken clock is right twice a day. These guys have predicted 20 of the last two bear markets, things like that. I think they're all cute and clever sayings and basically accurate. However, right now, you have to notice that there are people telling us to go hide in a bunker because Powell is going to be like Paul Volcker, as others telling us to go hide in a bunker because Powell is not going to be like Paul Volcker. And that we are inviting a cycle of hyperinflation or we're inviting a cycle of debt deflation or we're going to be like Japan or we're not going to be like Japan. You know, I assume you all know it can't be X and not X at the same time.

There are plenty of different theories as to what can go wrong, but to be actionable, one might have to formulate some specificity around how, what, when, why. And nobody knows those things, especially not the people who have literally been wrong about them for 40 years in a row. And now all of a sudden they're going to be right? Oh, I think there's difficulty out there. I think the Fed could very well break the economy by tightening out of this cycle. I believe that the Fed will end up chickening out and that that will end up inviting more problems later. But the notion of we know what they will do and then not do and how it'll play out is just so untrue. And that

includes me. I don't know. What I do know is what I focus on is that we hedge that risk by going into a portfolio of quality assets, that we don't make our financial and investment and portfolio outcome dependent on predicting the inherently unpredictable. I don't rely on predicting what's unpredictable, and I certainly don't invest in what is inherently unpredictable, the cryptos and things like that. So where we are right now in the cycle is one that requires humility, but requires prudence. I'm sorry, I'm not going to be listening to the doom and gloomers, especially those that can't even get their own story straight or coherent as to how it'll play out. But I do believe that the Fed vulnerabilities are very real. And what I think is going to happen is that the Fed will tighten. And I want that.

You know, the dollar is stronger. I love strong dollar. But then on the other hand, why is the dollar stronger? It's because the euro is so weak. The yen is so weak. Some emerging markets have weakened, right? There isn't always good reasons for some good things that happen. But then every single thing we're talking about has a good and a bad side to it. How do you invest around good and bad? The Fed's normalizing. That's wrecking havoc in price earnings ratios. Okay, but isn't the Fed getting off the zero bound a good thing for the vantage point of putting a sort of put back into the market for left tail risk, for severity, for really bad things that can happen? Don't you want there to be some protective

benefits? Isn't it good to have less distortion in the market? And I hate to say this, and I don't want people losing jobs, but isn't it good for the economy if some weak companies do go away so resources can be allocated into stronger parts of the economy, more opportunity? Do we really care about what the stock market does the next four weeks more than we care about job innovation for our kids and grandkids for the next 50 years? I'm sorry. There's good in Fed normalization as well. I've talked about this, written about it. So this is the point I want to make. What we're dealing with right now has good and bad in it, and it's going to have volatility and believing the very worst

outcome that is totally unknowable and could go itself all over the map. Because what if it is going to be a very, very bad thing and you know it's in four years? You still have to know what it is. And that's the problem is there's this hyperinflation argument and debt deflation argument, and they're both really bad. You treat them very differently though, right? I think that what happens is the Fed ends up blinking

and that that will not be a good thing. It will make everyone feel good. But when I say not be a good thing, it will end up stabilizing stocks. Bond yields will peak. And as bond yields go, so will go the rest of all this. And I don't have the arrogance to think I know more than the bond market. That's really what this comes down to is a class of people that have decided they know more than the bond market. That's really what this comes down to, is a class of people that have decided they know more than the bond market. Now, in fairness, some may just be saying what they think the bond market's going to say later. But thus far, to me, where bond yields go, I think it has everything to do with the dollar,

with equity premium, equity valuation, economic expectations, inflationary expectations, deflationary expectations. If bond yields peak and settle, they don't have to drop a ton, but they stabilize. Equity prices will stabilize thereafter and probably go back into a period of stagnant economic growth, a la Japan, all the things I've been talking about for years. Makes the politicians kind of happy, makes some of the masses really unhappy, makes me very unhappy because it starves us off from some of the economic vitality, dynamism, and productivity we deserve. But investors probably feel better. But you can only kick the can so long. There's a lot of uncertainty out there. But when you're talking about decades, not just

years, but decades of forecasting rates and inflation, deflation, monetary policy, what crises come up and all these things, just look back over history, the unpredictability of all the stuff that's happened. It's not going to work. It's not part of a financial plan. The part you invest in is the conviction and reliance in the human spirit and in the ability to overcome in financial markets those bad things that happen, those unknowable, inerrantly unpredictable things that come up. That's my take for this. I have to let you go here.

One, avoid shiny objects. Two, avoid excess valuations, even really good companies. Three, focus on quality, particularly at a point like this where the Fed is allowing for a kind of resurgence of volatility and uncertainty. And ignore the doom and gloomers who don't have a great track record. Instead, focus on the disciplines, behaviors, and investment beliefs that will carry you through. And if you have to look at just one thing and nothing else, just look at the dividend growth. You won't even notice anything else is happening. Thanks for watching and listening to the Dividend Cafe. Look forward to actually joining you next week from our Minneapolis office. I'll be up there a few days

and I'll be recording our first Dividend Cafe from that office. So reach out as needed. Forward, subscribe, share. I'm kind of tired of saying it. You know what to do. Thanks for listening. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, member FINRA and SIPC,

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