The Dividend Cafe - The DC Today - Tuesday, April 18, 2023

Episode Date: April 18, 2023

Today's Post - https://bahnsen.co/40eo9VP I would say, at this point, the market is definitely pricing in yet another rate hike at the next FOMC meeting two weeks from today (futures are up to 87% implied odds). Markets obviously haven’t cared much. Bond yields today didn’t move a lot. Sometimes you have to report what is and not what ought to be, and sometimes what is or what will be is different than what is or what appeared to be just two weeks sooner. Nevertheless, I take it not merely as the Fed likely hiking one more quarter-point in May but the Fed likely cutting more aggressively when they swing the pendulum back the other way. I don’t like any of it, to be honest. The spread between BBB’s and BB’s (low-end investment grade and high-end junk bonds) is a mere 150 basis points – well below the 200 basis points, we have seen a few times in recent months when it looks like credit is about to weaken. Corporate credit has hung in there remarkably well throughout this cycle, for now, despite all the recession talks and doom and gloom of Fed tightening. It almost feels like the Fed can’t be satisfied until they break corporate credit, only, when they do (if they do?), they then will feel like they have to immediately put it back together again, but they can’t put it back together again if they don’t break it first, and I have the distinct impression that is frustrating them. As for what to like within markets, we like dividend growth stocks, always and forever (surprise). But it does seem to me the clear trend for extracting liquidity from the system favors value over growth and less shiny assets than those that have been shining. We shall see. 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 Tuesday edition of the DC Today. It would be very hard for me to come to you with a more boring day in the markets. You literally had a flat Dow, a flat S&P, a flat NASDAQ, flat oil prices, and a flat bond market, all give or take a couple basis points up or down. Having all of these major asset classes and components flat on the day is very rare. You get flat, boring days all the time, but there's usually something that moves. Maybe stocks aren't moving, but oil is up or down or something like that. But it really was quite a boring day and not even really a lot of intraday movement. But even apart from the bit of intraday activity that was there, it was a pretty dead day in terms of market indices.

Interestingly, the industrial sector and energy sector were each up about half a percent, and then the healthcare sector was down about a half a percent. So within the equity indices, there were a few things moving up and down, but the net sum of parts was really quite flat. The fact that bond yields were not really moving much, the 10-year was down one basis point, the three-year was up one basis point, that kind of stuff, is in the face of the Fed funds futures market now at an 83% probability of a quarter point rate hike at the next Fed meeting, which the FOMC meeting begins two weeks from today on that first Tuesday in the month of May. And then they'll announce their decision on the Wednesday, as they always do, followed by one of J-PAL's famous or infamous pressers. It seems really quite well priced into markets at this point that the Fed does intend. They've

sent four or five different Fed governors, at first, most of which were non-voting members of FOMC. But now with Waller's last talk and so forth, it looks like they're trying to do a really good job signaling to markets ahead of time. Yeah, no, we're going to give it a shot with this other quarter point hike and see what happens. The fact that it's already up to an 83% chance of this happening in terms of implied odds in the Fed funds futures, And it was 87% this morning when I first looked at it. And yet bonds and stocks are flat and actually up on the month and things like that. I do think that the market's well priced it in. But I also think the entire paradigm has shifted from not what the Fed is going to do next to what the Fed's going to do last. In other words, the end of this thing, not the beginning of it.

And the market is both pricing in another quarter point rate hike and more dramatic rate cuts out into the future. The Fed simply believes that, excuse me, the market simply believes that the Fed is determined to break something and that in so breaking, they will end up having to rush and accelerate cuts to cover up what they've done or make up for what they've done. The very interesting thing to me is how corporate credit has shrugged most of this off. And that's not just corporate credit shrugging off what the Fed is doing, but spreads not really widening a lot, despite the fact that

we're told rate hikes are the big concern. Excuse me, a recession is a big concern. I believe that what you're seeing, like the spread right now between the triple Bs and the double Bs, so you have like the lower level, but still investment grade corporate bonds. And then the spread of those yields over, excuse me, the double Bs, the junk bonds over those triple Bs, the higher quality, it's 150 basis points. I mean, it's very tight. And it had been over 200 basis points. It looked like it was widening and then it just keeps coming right back in. And the reason these spreads aren't moving is first of all, at this time anyways, defaults have not really picked up. People keep saying defaults are coming in certain

aspects of commercial real estate. They very well may, but we're not seeing it in the corporate sector. Whether it's bank loans or the bond market, the corporate credit side has behaved pretty well fundamentally, and that's kept spreads in. So my feeling is that what we're dealing with right now as it pertains to the Fed and the policymaking is the Fed being frustrated by that, that they have wanted to see corporate credit widen, and it hasn't happened. And that the Fed's view is if we break something, then we'll fix it right away. But it's not breaking, and it's sort of making them mad. And I believe that they're going to want to see something break. And I believe that's just ridiculous, just totally inexplicably ridiculous.

But nevertheless, the corporate credit markets are right now kind of fighting back. And so I don't have an opinion as to who wins this tug of war match. That's where we're at right now. And we'll see where the Fed goes past the May meeting. Other economic news real quick, and I'll leave you alone. China's Q1 economic growth was up 4.5%. Real GDP growth on an annualized basis. It's the highest it had been in over a year. So we're back to that epiphany that when an economy is open, it grows more than when it's closed.

You are free to write that down. Finally, the Ask David section in the DC Today dealt with someone saying, won't we get a surge higher in inflation if the Fed cuts rates and it causes the stock market to go higher? Aren't stocks an indication of inflation? And isn't the stock market's rise over the last 10 years the result of the Fed printing a whole bunch of money? Well, first of all, we should point out that if that were the case, there's a pretty concerning counterfactual, which is that there was no inflation throughout that period. The Fed was trying and trying and trying to get inflation above 1%, up to 2%, let alone that 5, 6, 7% was nowhere to be found. And yet through that whole period, the Fed was at 0% rates. There was tons of new money creation. There was tons of

downward pressure on interest rates really effectively around the 0% and the quantitative easing going on. The fact of the matter is that the premise in the question is one that I vehemently disagree with, which is the stock prices being higher is inflationary. Stock prices go higher because of increased corporate profits and profits go higher from the production of new goods and services. And the production of new goods and services is anti-inflationary. Inflation is too much money chasing too few goods. And if you have greater amount of goods and services, that serves as a downward pressure on inflation. The stock market was dramatically up in the 80s, 90s, and the 2010s, three of the last four decades, I mean, dramatically up, basically from about 1,000 on the Dow to 35,000 on the Dow over a 40-year period. And that was the great moderation of inflation, where we had been averaging

four, five, six in the 70s, and we ended up getting that two to three. And really, in the last 15 years, for not good reasons, getting even lower than two. So I think that a lot of the material I've written on Japanification is a more appropriate analysis of where we are here. But that generally speaking, the concern that the Fed will help stocks to go higher and that becomes inflationary is misguided. Now, can the Fed boost asset price inflation? They certainly can. Fundamentally, earnings have to be going higher for stocks to go up over a prolonged period.

But you can definitely create bubbles around kind of silly assets by manipulating the interest rate. But note, that is not by rates going lower. It's by rates going too low. There's a big difference. You create asset price inflation when the rate is below the natural rate and you incentivize people to lever up incumbent assets, boosting asset prices, as opposed to trying to get a higher return on invested capital. That is what becomes distorted than asset price inflation, whether it's housing, credit, stocks, risk assets at large. But that's categorically different than the monetary inflation in goods

and services throughout the economy. So the Fed ought to be doing what it believes is its mandate for stable money and full employment and all those things. Or we ought to re-characterize what the dual mandate of the Fed is. But no, I do not believe that stock prices should be a consideration. And that includes the Fed trying to protect them, let alone anyone who believes that they deserve to be punished. I think it should be a totally neutral scenario as it pertains to cost of capital. But there you go, me sharing what I think ought to be rather than what is. But what is is not that lower rates would be boosting stock prices unless they went to a unnatural level. And, of course, an unnatural level of rates that is too high or too low is problematic.

Thanks for listening to, thanks for watching. Thanks for reading the DC Today. We'll be back at you tomorrow, Wednesday. Thanks so much. Thank you. will be profitable. Past performance is not indicative of current or future performance and 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 opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary and does not constitute investment advice.

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