The Dividend Cafe - The DC Today - Monday, December 4, 2023

Episode Date: December 4, 2023

Today's Post - https://bahnsen.co/3uFMLMZ Ask David “If you are an investor in a passive index fund, exactly what happens to your equity when that fund/index removes a poor performer, and replaces it with a stock that has recently performed much better? While I suspect that your equity may stay the same upon replacement, it seems intuitively like an example of buying high while selling low. Is there any documented study of index fund performance over time due to the survival bias? Do you have any thoughts on the topic?” ~ Dom I think I understand what you are saying but actually in this case the survival bias of the index methodology helps its performance over time, not hurts. What you are suggesting makes sense prima facie – that they are adding companies at high prices and removing others at low prices – but the fact of the matter is that the companies removed from the index is very rare, and almost always only happens after the company is broken. A significant amount of companies that have been removed from market indices over the years no longer exist at all, meaning that path from “a low price” to “zero” was never experienced by the index investor. Of course, there are cases when a company is removed from an index and subsequently rallies from a low valuation, but that is much less frequent than the opposite. And all of it is very rare and inconsequential … Links mentioned in this episode: TheDCToday.com DividendCafe.com TheBahnsenGroup.com

Welcome to the DC Today, your daily market synopsis of the Dividend Cafe, brought to you every Monday through Thursday to bring you up-to-date information and perspective on financial markets. Well, hello and welcome to the special Monday edition of the DC Today. We are back at it for the month of December. We're going to try to finish out 2023 strong. the month of December. We're going to try to finish out 2023 strong. I'm here in the Newport Beach office this whole week, and I am pretty happy with the way this Monday, D.C. Today came together. A lot of info on the Fed, a few things on energy, I think are real important, especially in light of the OPEC Plus meeting, and just a few nuggets on policy and the economic data and housing. But I want to start with the markets. Let's get today's action out of the way. First, you know, it's funny, a day like today, where the market opens down 200 points, and then like, five minutes later is back to flat.

And then an hour later is down to 50, then comes all the way back and gets kind of even and more or less ends the day even. I think we ended up down 0.11%, 0.11%, 40 points on the day. That would seem kind of exciting a little bit in the grand scheme of things, but not really compared to the month, about five, six weeks we've had now, just really a pretty significant market rally and a really significant bond rally. And so days like today seem kind of boring. Now, the S&P was down half a percent today. NASDAQ was down 84 basis points. But again, this is coming off of just what's been quite a move.

Higher markets. I don't really know what to tell you as to why the market went way up and then way down and then back up. But again, even though I say way up, way down, in the context of 200, 250 points, it's actually, those are not modifiers I would normally use on a day like that. It's just maybe comparatively because we haven't had much up and down movement. Now, what's the story here? What's going on? Why have the markets been moving so much higher? I want you to understand I have been talking quite a bit earlier in the year, mid-year, last several months,

about this just almost unbreakable, right now that is, unbreakable correlation between the dollar and bond yields and then inversely stock prices. And so in other words, bond yields and bond prices are definitionally reversed and stock prices and the dollar became cyclically inversed and bonds and stocks became very positively correlated. So I just gave you kind of a mouthful, but the bottom line is when the dollar goes up, stocks have been coming down and bonds have been coming down. And when the dollar And when the dollar goes lower, then bonds have been going higher and stocks have been going higher. OK, well, in the month of October, you had a major reversal. What's been going October, the dollar was up against pretty much, not literally every international currency, but almost every international currency.

The dollar had been higher. And then, of course, as you know, in that period of time, Treasury bond yields were up and stock prices were down. And the U.S. dollar since November 1st, so let's just call it basically the last month, four or five weeks, has pretty much been down against every currency on the planet. And in that dollar reversal, you saw bonds go higher, bond yields come lower, and stocks go higher, meaningfully higher, a few thousand points in the Dow. So the question becomes, is the dollar pulling bond yields up and down or are bond yields pulling the dollar up and down? You know, the sort of classic chicken or egg question. And the answer, in my view, is that a feedback loop gets created. And the answer, in my view, is that a feedback loop gets created.

So higher rates attract buyers to the dollar. And then central banks of other countries, they have to sell treasuries they may be holding to limit the weakening of their own currency. And this tension is basically between yield aspirational buyers and yield agnostic sellers. And I always talk about the Fed with quantitative tightening becoming a yield agnostic seller. But you have other central banks internationally that become, they're not buying or selling around anything to do with yield. It has to do with their currency. selling around anything to do with yield. It has to do with their currency. And in this case,

now it become buyers, excuse me, sellers relative to protecting their currency. So market expectations that were priced into the bond market, what the bond market believed about what the Fed would do and what growth and inflation expectations were, then drove the dollar lower. That's my belief about the sort of sequence of events here. But it must be reiterated that we have until we're not because these correlations are absolutely breakable. They are not a constant, but right now they're holding and they will hold until they don't. And it's been a little while. You know, it's not been a month. That's not a constant, but right now they're holding and they will hold until they don't. And it's been a little while. You know, it's not been a month.

That's not a correlation. It's not been a quarter. It's been a good year plus change. So lower yields, lower dollar, higher stocks or higher yields, higher dollar, lower stocks. That's pretty much where the two options lie right now. That said, the 10-year bond yield today closed at four and a quarter. That was up three basis points on the day, but that's how much the 10-year has closed lower over the last, let's call it, six weeks, about 75 basis points. Today, top performing sector was real estate. It was up over half a percent. But communication and technology were each down over 1.3 percent. Bank lending has officially

gone negative on the year. We have a decline year over year in the amount of bank lending. And then breadth in this market rally, we've had three of our rally days recently representing the highest advance to decline ratio that we've had in about six months. There was another day in June that was a little higher, and then you have to go back to January. So the advance decline level, which kind of helps us capture the breadth of the market, has very much picked up in this rally. The public policy side, the Congress is fighting over some form of a compromise, potentially give some Republicans what they want on different treatment at the border, funding protection and whatnot, overall policy at the border in exchange for Republicans agreeing to vote for, and this is House Republicans, by the way, agreeing to vote for Ukraine funding. I don't have a prediction of where that will go, but that's the tug of war right now is between the border funding and Ukraine. On the economic data, it's a ton of stuff coming in this week. So tomorrow we'll get the JOLTS data, which is the job openings.

We'll also get ISM services. Wednesday, we'll get the ADP private payroll report. And on Friday, we'll get the big one, the BLS jobs report for the month of November. But today, it was just the ISM manufacturing, which actually came on Friday, stayed at the exact same level as last month, 46.7. So still in contraction, but no worse and no better than the month before. And this is 15 consecutive months of manufacturing contraction now. Very interesting statistical fact I want to read. I read a big article in The Atlantic on Sunday. In December of 2008, there were 2.2 million, 2.2 million vacant housing units, single family residents that were available for people to buy.

There are right now 732,000. Yet the population is also 25 million people larger. It's actually a little more than that. So you have a pretty meaningfully higher population size. more than that. So you have a pretty meaningfully higher population size and a granted, by the way, in December 2008, we were in a complete you know what, you know what of available inventory. So I'm by no means suggesting that amount of available inventory in the midst of what was beginning onslaught of foreclosures and defaults and evictions and abandonments. But nevertheless, the market then, which was the textbook definition of a buyer's market, was at 2.2 million vacant.

Now you have a million and a half less available homes with 25 million more people in the population. So as I mentioned, Treasury yields had sunk Friday. That was when they had 4.22%. I did notice Chairman Powell in his speech tried to sound a bit hawkish. Bond markets weren't really buying it. I think the only question right now, I mean, we can see 100% chance in the futures market of no rate hikes in December, no rate change in December. But then there's a 16% chance of a rate cut in January. And that goes all the way up to a 71% chance of a rate cut in March and 86% chance of a rate cut in May. So the whole debate now has gone to when they will cut, not whether or not

they'll hike again. And then the whole thing has gone to where the cuts will be, like how severe. Are we going to see them cut a quarter point in the first half of next year? Are we going to see them cut a whole point somewhere in between? That's where the debate is. And the futures market isn't providing a lot of clarity there. Oil closed 73.30. It was down 1% today. Last week, when OPEC Plus did have their kind of delayed meeting,

Saudi agreed to extend their current production cuts that are already in place. And the other member firms of OPEC Plus, other member countries, agreed to cut an additional 1 million barrels per day. So they're very much trying to put in place a backstop in prices and also, frankly, trying to punish the U.S. for not doing their part to clear the oil market and refill the Strategic Petroleum Reserve. A surprise to many that OPEC Plus announced that Brazil would be joining them and not only joining them but doing so quite soon. Midstream, by the way, the midstream energy sector, there's a couple of different indexes out there. So there's different ones you could use, but was up between 16 and 20 percent year to date, up basically about 7 percent in the month of November. It was the second best November ever for the sector. Don't forget, it was up 24 percent in November 2020. MLPs, which is not the whole midstream sector, back in 2012, 13, 14, it was a lot of the

midstream sector. And it's less of a midstream sector now because so many MLPs have converted to C-corp. But MLPs as an asset class were up in 2012, 13, and 14. And they haven't been up three years in a row since. But they were up 2021 and 2022, and they're up over 16% year-to-date going into December for 2023. But of course, who knows what happens in December? I won't predict anything here because I don't believe in jinxing these things.

Are you against doomsdayism? I am. 1995, 30 of the world's 109 developing countries have seen their economic growth rates move to a place that doubled income every 18 years. Another 40 countries have growth rates that would double income every 35 years. That's basically where the United States has been historically. Massive increase of the growth rates of the developing world. The Ask David today dealt with whether or not I thought indexes that have what's called a survivorship bias, because the index marches on, but they can take out certain companies and put new companies in, that whether or not that was maybe hurting

the index investors' performance because they were taking out things at a low price and putting in other things at a high price. And I actually make the point that I don't agree in the sense that historically, so many of the companies have been removed from indexes have gone on to extinction. And so if you were to play all of that out, it's actually helped the index for those changes that they've made more often than not. There are cases where a company gets removed from an index and ends up soaring later. But for the most part, the indexes have a greater propensity for the opposite when they're at when constituencies are removed. That's the whole scoop today. A long one today, but wanted to cover all this. I love your questions at thebonsongroup.com. And in the meantime, thank

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