The Dividend Cafe - The DC Today - Wednesday, August 9, 2023

Episode Date: August 9, 2023

Today's Post - https://bahnsen.co/3YukmEv I think the biggest news of the day was China’s -0.3% consumer price index for the month of July, and it’s -4.4% producer price index. This was the tenth month in a row of wholesale price deflation, but it was the first month in over two years of consumer price deflation. I am dedicating next week’s Dividend Cafe to the subject of Chinafication. In keeping with the message of the last two Dividend Cafes, our “credit watch” has a couple interesting things to note. Earnings were covering interest expense on investment grade loans 9.2x over right before the Fed began hiking rates. They are now covering them 8.2x. This is called the Interest Coverage Ratio and a high one is good (more coverage of the interest expense by the earnings of the company). Now, that number will get all the way down to 6x in recessions (2020, 2008, 2002), so this move down is not dramatic, but it is a deterioration that is worth watching. With High Yield it has moved from about 5x to just over 4x. Across the levered loan world total leverage is up a tad (debt divided by earnings), and coverage of the interest expense by either earnings or free cash flow is down a bit. None of these metrics yet indicate anything broken, yet all of them are modestly worse off than they were 12-18 months ago. 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 Wednesday edition of DC Today, brought to you live from beautiful New York City. Very silly day in the market today. Let me get that out of the way first, just in terms of the market being up and then down 200 points and then up 50 and then going down 200 again in the last 20, 30 minutes of trading. Tomorrow is the day that the consumer price index, the CPI data for the month of July will be released. And I pretty much have no doubt that just sort of last minute trade positioning going into CPI day, which of course comes out before the market opens. And so that's generally my experience as to what moves

the market suddenly in the final minutes of trading. I don't say that as a good thing or a complimentary thing to the people doing it, but you're about two years now, maybe 18 months of almost every day in which it's the day before CPI or the day before the FOMC, the Federal Open Market Committee, making a Fed announcement, and then the day of CPI and the day of FOMC, where you get a lot of this kind of funky action, doesn't matter, doesn't mean anything. It's just sort of amateur hour for certain people that, you know, are getting certain positioning set up and then things kind of normalize thereafter. I actually do expect that the inflation number will move higher tomorrow just simply because of the headline number, which includes oil and food and, you know, food and energy. Natural gas has not really moved a lot, actually, but because crude oil has moved and gasoline prices were up about 6% last month, I expect

that will have an impact. But also just the base effects of where we were a year ago. You had a negative print in the month of July. And so as that kind of gets offset, even with the CPI portion of shelter, I expect should be coming down. That may kind of offset, but I just sort of feel that the headline number probably go up a little bit, but that isn't really sustainable

because the very next couple of months thereafter, the base effect from the year prior kicks the other way. So anyways, CPI data coming tomorrow, Thursday, in 24 hours, you'll get a chance to say, gosh, David was so wrong about everything he said yesterday, or say, wow, David really kind of nailed that. What you won't hear from me is any recognition whatsoever of what I said, because I say it merely anecdotally without any predictive or practical relevance to the world whatsoever. Yeah, so the Dow ended up down 191 points. That was only half a percentage point. The S&P was down three quarters of a percentage point. The NASDAQ was down almost 1.2%. Energy, though, was up 1.22% today. But then technology was down one

and a half. So high dispersion of return, a few back and forth movements in the middle of the day, the bond market barely moved, the 10-year was down one basis point. Crude oil, though, was up 1.6%, up to 84.25% on WTI crude. That's basically the story of markets today. I think the biggest news though, besides the fact that late day trade positioning may have happened around tomorrow's CPI print, I woke up this morning to the CPI number from China being down 0.3% for the month of July, and the producer price index was down 4.4%. That's the 10th month in a row that their wholesale prices, producer prices have come down. And then it's the first time in over two years, the consumer prices have dropped negatively, just out and out deflation. There's just no question in my mind that China has entered into a deflationary

period. Does it spiral into a deflationary cycle? I don't want to call that yet. I think it's increasingly likely. But I've decided to dedicate next week's Dividend Cafe to the subject of Chinification. I'll have a lot more to say about this kind of potential deflationary position and policy response that we're seeing in China, which does matter to the rest of the globe. I'll unpack that more next week's Dividend Cafe. As far as the last two weeks of Dividend Cafe, I talked about credit. I just wanted to point out that there's another metric I didn't get into in the last two Dividend Cafes called the interest coverage ratio, which is basically the percentage of earnings

divided by the cost of paying the interest on debt. And that had been about 9.2 times, over 900% earnings versus interest across the investment grade loan market about a year ago. And now it's down to 8.2 times. So 8.2 coverage is lower than it was a year ago. We're seeing that drop a little as interest expenses have gone higher. It's not rocket science. But you're nowhere near the five or six times you sometimes see when you're looking at recessionary conditions. So really, the investment coverage ratio is very similar to the other metrics we covered previously about spreads and about total debt to income and leverage ratios within firms, that it's just another metric that basically says the same two things, which is that conditions

have worsened and that conditions are not super bad. And conditions that are worsening but not super bad can get super bad. They can worsen further, obviously, but that's just kind of a little update on what we're seeing within the markets. So let's see. The Ask David today was a – I did a long answer because I just love the question. Somebody had written asking if I thought that, you know, you're seeing output is higher, that some of the, you know, economic growth has picked up from a lot of the government spending during the COVID moment and since.

And that somebody at another site had put forward the theory that maybe we're getting normalized real economic growth after 15 years of not having it. And I decided to use the Ask David section today to politely share my belief about how wrongheaded that school of thought is. And the wrongheadedness not coming from a different interpretation of economic data from which reasonable men and women can and do often disagree, but rather from first principles and the notion that when we get juice to economic output from pulling forward that which would have been spent later, this is the whole entire point of debt uh that by definition we have simply replaced resources not added and not to mention the fact that not all economic output is excuse me government use of debt to drive economic output is created equal

and so i do even if people don't agree with the policies i don't happen to fully agree with uh well i don't agree with one of them at all and i don't agree with the policies, I don't happen to fully agree with, well, I don't agree with one of them at all, and I don't agree with the other one fully. But the infrastructure bill, the CHIPS Act, those things do produce economic output to some degree. The transfer payments from the COVID moment where you're just given $2,000 of beer money to people or something like that. I don't think that did. There's a different multiplier effect, even for those who are real Keynesians, which I am not. What I just said is not controversial. But even if you believed that, hey, the CHIPS Act or the Inflation Reduction Act or some clean energy spending or the infrastructure bill, that these things involve a certain boost

to output, there's still no question that they reduce national savings as we increase indebtedness and that the reduction in national savings reduces investment and the reduction investment reduces productivity. And so one hand giveth in the short term, the other hand taketh away in the long term. So yeah, you can still read Ask David, even though I sort of just gave away the farm. But that's what the answer to the question is. I'm going to leave it there. Hopefully you've enjoyed listening to this podcast, watching this video. And I do hope you enjoy reading the DC Today. And I look forward to coming to you again tomorrow on Thursday with another update in markets. And then we have a very special Dividend Cafe on Friday unpacking some really important stuff about why companies pay dividends. Thanks for listening, watching, and of course, reading the DC Today.

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