The Dividend Cafe - The Changing Weather of 2018

Episode Date: January 5, 2018

This week, David looks at the year ahead..... Topics discussed: A new podcast Increased volatility The bond market Commodity price inflation Links mentioned in this episode: http://dividendcafe.com

Welcome to the Dividend Cafe, financial food for thought. Hello, welcome to this week's Dividend Cafe podcast and welcome to 2018. Happy New Year to you all. Let me give you a quick housekeeping update in terms of what we're looking to do with our podcast in 2018. I spoke a bunch at the end of last year about higher aspirations we have for this and I'm pleased to tell you, I hope you'll like it and spread the word and listen and participate, but we're going to start doing an early week or midweek special podcast every week, about 30 to 45 minutes, probably closer to 30 minutes, but we'll kind

of see how that goes, that will have totally, completely fresh content, stuff not related to our Friday Dividend Cafe, which is essentially a recitation of our written commentary that we post at DividendCafe.com every Friday. Now we're going to continue doing that as well. So subscribers to this podcast will get both the kind of midweek bonus content, 30 minutes-ish each week, sometimes featuring me talking on a special topic, sometimes me interviewing someone else on our team or another guest or another portfolio manager, something like that. But then also then on the Friday, it'll still have the routine eight to 10 minute kind of recap of our weekly divinacafe.com posting. So we think it's going to create a lot of variety, a lot of opportunity to

do some fun things and intensify how informative and useful and practical and engaging the podcast will be. So we're going to launch this new additional recording content next week where I'm going to do a special edition on the political landscape coming into 2018 and how that ought to affect investors. I'm going to be at a big conference in Washington, D.C. on Tuesday, and I plan to record a recap podcast of such first thing on Wednesday. So we look forward to getting that out to you. And then the week following, we're going to probably host a little interview with myself, interviewing Dea Pernas, who is our managing director of of strategy and analytics and and

very deeply involved with our manager due diligence and other fun things like that at the bonson group so i'll i'll dangle that carrot a bit looking forward to the political topic next week and we go from there and then for those who just want to receive the regular Fridays, the shorter version kind of recitation of our written commentary, we'll continue to do that as well. And in fact, that's what I'm going to get into right now. theme this week as I sit here in my New York office with a blizzard pouring outside, snow-covered grounds. I do think to the theme of weather and our portfolios and how 2017, there was one season and it kind of lasted all year long and that was a risk-on environment with virtually no volatility. And yet now as we enter 2018, we expect a good year. We just expect it to be a year in which there's actual volatility in the market and not the easy ride that a lot of investors had last year. And we actually see that as an overwhelmingly good thing for investors.

But let me get to a couple other topics as well. What is our moral obligation as financial advisors? And I say this in the context of the topic of contrarian duty. Consider this. The market index last year, global market, all world index was up 22%. The S&P 500 was up 22%. The Nikkei was up about 19%. Emerging markets, 36%. The VIX had 22 of its lowest readings in history last year, the measurement of fear and volatility in the

marketplace. And yet there was a net total, net of money coming into the market of $23.5 billion leaving U.S. stocks. As long as there are people prone to doing the wrong thing at the wrong time, there will be a higher calling for what we do as financial advisors. As long as human nature is what it is, there will be people prone to do the wrong thing at the wrong time. Therefore, our moral duty isn't changing anytime soon. Does a strong year, one year, guarantee a strong year the next? Well, if the subject's a stock market, the answer is no, nothing is guaranteed. There's a pretty high statistical likelihood, but what's fascinating is there's a pretty high statistical likelihood every year. Truth be told, the years following 20% plus years in the market are very similar to any other market average trend.

Roughly a 10% average and it's positive 69% of the time. So what can we predict about 2018 based on 2017? Nothing. Absolutely nothing. You have to go to DividendCafe.com to see the chart we've put about this topic this week. Human nature in the bond market. One of the great phenomena holding up the bond market and therefore holding down bond yields has been the massive flows of money from retail investors into bond funds. A phenomena now eight years old and counting. Many investors have used these bond funds as a substitute money market, which we don't think is very smart. Others use

them as a surrogate for their bond allocation in an investment portfolio. The sheer volume of bond purchases required to meet demand embedded in the inflows to the bond fund space has been a game changer and has offset much of the negative fundamentals in the bond market, unattractive risk-reward trade-offs around interest rates, etc. The Wall Street Journal ran a story this week on how this phenomena would likely continue and a declining demand for government debt will not hurt the treasury market because investors will continue to support the market with their bond fund appetites. I suspect this misses the point. Bond markets have not held up because retail investors have liked them. Retail investors have liked them because bond markets have held up. This chicken or egg of it all, as if a disruptive event occurred within the bond markets,

like a big interest rate spike or credit market turmoil, that may not happen anytime soon. But if or when it does, it is against the evidence of history to suggest that retail flows will offset such disruption as opposed to actually align with the disruption. Templeton taught us that this time it's different is not good investing. Human nature is what it is in the stock market and the bond market. is in the stock market and the bond market. Is commodity inflation back in vogue? The indication is that it may very well be. We have a chart showing you the copper prices and oil prices since late 2015, and you can see how those things have correlated with one another and played out.

correlated with one another and played out. The irony is that so many want commodity price inflation. Higher commodity prices drain liquidity from the system and represent a higher input cost, thereby serving as a profit margin compressor. Why do people want copper and oil prices to be higher? Because they indicate, in theory, healthy global demand in the overall economy. The challenge in evaluating commodity prices is that they carry mixed messages. There

can be a positive indication, but deciphering such requires a more extensive valuation of other factors, and they can create a negative result. Who wants to pay more for something? Though apparently when hearing society's approach to housing prices permanently escalating, seeing that as a good thing, maybe there are plenty who do. Regardless, the direction of copper and oil prices are monitored by our team diligently, both for what they say about the present and what they could mean to the future. Anyone remember Brexit? With the MSCI United Kingdom Stock Index up 22% in 2017, it may have been hard to remember that Britain was supposed to fall into the abyss after the

2016 passage of Brexit. I'm the first to admit that much of the reason for a benign response thus far is the relative softness of the manner in which Brexit is playing out. But I would argue that a total hard rupture with Europe was never really on the table and was actually just a part of the fear-mongering of the Brexit opponents. There remains work to be done, but the basic gist of British sovereignty is becoming reality, without the destruction to trade capacity so irrationally feared. Superstitious support for the MLP sector. Clients and readers know how much credence I put in calendar happenstance as it pertains to any investing subject. Hint, I don't put very much in at all.

So do we think the fact that MLPs have never been negative three out of four years in January, or that January has been the best month on average for the space over the last 22 years, that it means anything? No, we don't. 22 years, that it means anything? No, we don't. But flows were so low into the space in 2017 behind sentiments so poor that any fundamental pickup leading to new demand is likely to see an outsized impact on prices to the upside. I really don't know how much more emphatic I can be about the key to satisfaction with this asset class. Focus on cash flows, focus on the growth of cash flows, and what will make sure the fundamental backdrop protects the cash flow is fundamental strength from the issuers, attractive financial metrics. Those fundamental backdrops lead to

confidence in the cash flow and the growth of the cash flow, which in turn will lead to a growing price. I do believe that will happen, but the growth of outsized income is the value proposition for MLPs. That's what we want to focus on regardless of what we anticipate happening with the prices. Okay, so maybe you feel this dividend cafe was terrible. You wanted something new. No problem. Understood. We do promise to launch next week, as I said earlier, with our special kickoff podcast pertaining to the Washington, D.C. impact on markets in 2018. And I should come back from a conference I'm attending on Tuesday in D.C. with a whole lot of fresh perspective and ideas and so forth. In the meantime, do valuations matter?

How many times do I hear, why don't you buy this stock, this stock, regardless of how stratospheric its present level may be? Did you know that the NASDAQ, if you bought it right at its high in March of 2000 to right now today, even as it's been making new high after new high after new high, and technology was up 38% last year, did you know the NASDAQ over the last 18 years is up a grand total of 1.87%? Now, of course, it's up a few hundred percent for those who bought it right at the actual bottom. for those who bought it right at the actual bottom. But for anyone who's held it through this whole period of time, they've compounded their capital at 1.87%. Why is that?

I mean, the space has been on fire. A lot of these companies are making more money than you can imagine. But, of course, the entry-level valuation mattered. And so we value expected returns and basically expected returns are a byproduct. One of the inputs in determining it is the starting point. And so we would suggest that where there may be overvalued things in someone's portfolio, it behooves them to exit. But that's a tough game to play. So we don't want to do it as part of timing. We want to do it as part of the portfolio construction

we think is right. I'm going to leave it there for the week. I will really look forward to bringing you the first ever podcast next week in our kind of new and improved format. In the meantime, we do hope you had a very happy new year. Please reach out anytime. Bye-bye. Thank you for listening to the Dividend Cafe. Financial food for thought. This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance. This is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors. All data and information referenced herein are from sources believed to be reliable.

Any opinion, news, research, analyses, prices, or other information containing this research is provided as general market commentary. It does not constitute investment advice. which is provided as general market commentary, does not constitute investment advice. The team at Hightower should not be in any way liable for claims and make no express or implied representation or warranties as to the accuracy or completeness of the data and other information or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information or subjects change without notice. This document was created for informational purposes only. The opinions expressed are solely those of the team and do not represent those of Hightower Advisors LLC or any of its affiliates.