The Dividend Cafe - The DC Today - Monday, February 26, 2024

Episode Date: February 26, 2024

Today's Post - https://bahnsen.co/3Iya6nH Financial markets have absorbed the $1.5 trillion (or so) of quantitative tightening thus far quite well, but reverse repos were at high levels, and bank reserves (and money market liquidity) were not challenged. Will the Fed press more QT when RRP’s hit zero? Color me skeptical. 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. Hello and welcome to another DC Today Monday edition. I'm very excited to be with you. I believe this is the second time I've been recording from our Phoenix, Arizona office. This is the second time I've been recording from our Phoenix, Arizona office. Flew out here this morning, a handful of meetings today and tomorrow, then back to Southern California tomorrow late afternoon. In the meantime, another week has begun in the markets, and it was a reasonably boring day. The Dow opened up 60 and closed down 60, give or take a couple points.

And so just kind of throughout the day, progressively going down from where it started off, but really not by very much. And the futures themselves had opened up, excuse me, had opened down, and then the market opened up. So you just kind of had a couple of weird little reversals, but they're very teeny tiny. Now, in terms of the bond market, let's see here, the 10-year closed at 4.28%, which is less than two basis points up today. So not a lot of movement in the bond market either. But the interesting thing to point out is that stocks are up so significantly since the bond yields went up 40 basis points, 35, 40 basis points. So you had a bit of a sell-off in bonds in the month of February, and yet stocks appear

to be higher. The top performing sector today was energy. It was up 0.32%, and utilities, which were down over 2%. So more downside in the down sectors than upside in the up sectors, and overall just not a particularly impressive day, but nothing to write home about. In terms of the state of the market now, I want to talk about this issue of valuation and expensive multiples, expensive PE ratios. I put a chart in DC today regarding how high the valuation is right now for the top 10 stocks in the S&P 500 and then looked at that over a bunch of past periods as well. And next to it is the valuation

of just the S&P itself. What you see is not just a higher valuation for the top 10 holdings in the S&P than we have seen before, but a monumentally higher, significantly higher. The S&P itself, its valuation is higher than it normally is, but that is marginal. The top 10 where the real concentration of this valuation is is not marginal. It's more significant. I think it's worth looking at. Now, from a contrarian standpoint, I'm the one who believes that when everything looks really good, that's not good. And when everything looks really bad, that is good.

And the only question through that contrarian belief system is timing. Right now, it's a very mixed bag because valuations are high. The VIX is low. The put-call ratio is low. Credit spreads are tight. So these are all things that as a contrarian, I'd be a little concerned about. But very candidly, as I'm looking for other euphoria indicators, I'm not seeing them. Flows into equities are not significant. You don't see a ton of IPO activity. Earnings revisions, when they come, they're not going down.

They're going higher for the most part. Breadth has improved over the last several months. So it's a mixed bag. For a contrarian, there are certain things that are going well and certain things that aren't going well. And that's just kind of the state of the economy that is also true of the state of the market. You have conflicting data at a number of different points. What else do we want to go through? This is interesting. It's not the top performing sector. The sector with the most companies in it doing better since the beginning of the year. So it

has to do a breadth within sectors. It's far and away health care. And the sector with the worst breadth since the beginning of the year. In other words, the most companies that have gone backwards is real estate. The REIT side of things is mostly related to how strong of a Q4 it was. There's been a reversal there. But healthcare has really broadened out quite a bit after a pretty flat and tepid 2023. You have a lot of companies in pharma and biotech and managed care doing quite well here in 2024 so far. On the news front, it does appear that Sweden has a path to NATO membership. A big question mark was whether or not Hungary was going to get in line

to vote for that. They did indicate so this morning. On the political side, the Republican National Committee chair, Ronna McDaniel, has announced she's stepping down, which really basically means more or less presumptive nominee Donald Trump will be naming her successor in a manner of speaking. And then as academic as it appears to be for those interested, tomorrow, which is February 27th, in the great state of Michigan, they will be having a primary,

if anyone is still paying attention. Speaking of politics, though, in the public policy side, we likely will end up with a partial shutdown of government Friday night. It's a kind of limited scope deal because they already had funded government at the top as far as what was really needed. But there's in the weeds some appropriation questions in agriculture, energy, VA, and HUD. Those components they worked on all weekend. It looks like they're a stalemate. I don't think it'll get agreed to. And if talks are broken down, you could end up getting some form of partial shutdown. You also could get another continuing resolution, which will agree to fund government out for a certain period of time, a month, two months. But again, the full year budget bill is due by April

30th. So one way or the other, there's still other lines in the sand more significant coming. Economically, not a lot of data points today. The Fed's favorite measure of inflation, the PCE, which is the personal consumption expenditures, that will come Thursday of this week. On the housing front, new home sales for January came in at 661,000 annualized. That was about 3% lower than expected. December's data was also revised downwards. And then the median home price year over year was down 2.6%. A little bit more to say on the Fed today. We're basically now finally to the 0% expectation of a rate cut in the March meeting. It's technically 2.5%. Last week, it was still holding in there at 10%. So really, 10% was equivalent to zero with just some hedgers and speculators hanging on. And now at 2.5%, it's really quite functionally near zero. But what's more important,

I think, is that the May 1 meeting is all the way down to only an 18% chance of a rate cut there. So you now have priced in, again, with over two months to go. So a lot can change as it has the last two months in Fed funds futures, an 82% chance of no cut at the May 1 meeting. And yet markets do still have 100% chance of rate cuts by the end of the year, anywhere from 50 basis points up to 125 basis points in magnitude, depending on what level we're talking about. I'm thinking more and more about what Europe is going to be doing. And I read a white paper this morning regarding their rate policy, I'm very much in line with the view that while Europe became, after years and years of more hawkish monetary policy in the Draghi regime

post the pigs crisis, Portugal, Italy, Greece, Spain, let's call it 2010, 11, 12, after that Mario Draghi bazooka moment, really Europe became more dovish even than the Fed. And I think kind of from COVID to post-COVID to where we are now post-post COVID, Europe is taking its P's and Q's from the Fed. And I think that there is very, very little chance they're going to cut rates before the Fed does. From a currency standpoint, I think they more or less have to pursue some currency stability by pegging the dollar. And I think they pegged the dollar by just kind of following what the Fed does, not trying to get out in front of it. There's a chart I want you to look at in the dctoday.com dealing with the RRP, reverse repo purchase market. I think you will find it interesting as a way of understanding why I continue to believe that the heavy amount of

activity in the reverse repo market enabled there to be more liquidity in money markets, even as the Fed was extracting liquidity from bank reserves, and that now as the repo market facility may get closer to zero in the months ahead, I think that ends up calling the Fed's bluff on QT and that they end up having to stop extracting from the banking system and quantitative tightening. So check that section out in the D.C. Today. It's my favorite part of the D.C. Today today. 1920, 28% of American teenagers were in high school.

The number today is very close to 100%, not quite, and 87% of those graduate. Oil closed today at $77.60, up 1.5% on the day. Midstream Energy had, I believe it was its fourth week in a row in positive territory, largely following the market last week, but also some good distribution growth announcements, which we love. And in the Ask David section, a very thoughtful question about how we think about PE ratios versus the PEG that factors in the rate of growth of earnings and whether or not an attractive PEG could offset a high PE. We talk about free cash flow yield, and we talk about the fact that all high PE stocks are baking in ahead of time what the PEG already is saying.

So the question is how those things get overdone or underdone. And it's a thoughtful question. Feel free to check it out in the dctoday.com. Brian will be with you tomorrow for the podcast. What's on David's mind is there at the DC today. Each and every day, I will be back with that again tomorrow. If you have any questions, reach out. We love getting your questions.

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