The Dividend Cafe - The DC Today - Wednesday, October 12, 2022

Episode Date: October 12, 2022

The market zigged and zagged all day and was down -100 and up +200 before closing down a tad in the final minutes of trading. Lots to say about the Bank of England in today’s podcast … MARKET ACTION Dow: -28 points (-0.10%) S&P: -0.33% Nasdaq: 0.09% 10-Year Treasury Yield: 3.89% (- 4 basis points) Top-performing sector: Energy (+0.75%) Bottom-performing sector: Utilities (-3.42%) – the collapse in this sector in the last month is absolutely unprecedented WTI Crude Oil: $87.09/barrel (-2.53%) Key Economic Point of the Day: Core PPI (ex-food and energy) came in exactly in line at +0.3%. August’s PPI was revised downwards. September’s PPI headline read (w/ food and energy) was +0.4%. The year-over-year headline PPI is +8.5% vs. +8.7% last month. Processed goods prices fell for the third month in a row. Prices for transportation and storage fell -0.2%. Goods down, services up. Links mentioned in this episode: TheDCToday.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Hello and welcome to the Wednesday edition of the DC Today. I actually am clearly not in my studio for those of you watching on the video. But I just left the office about an hour ago and I have a conference down in South Orange County this afternoon. And so I'm recording just as the market is closed and we'll head downstairs to the conference in just a few moments. Let me just briefly give the market synopsis and then walk through a few things related to what I consider the biggest story in financial markets right now, which has to do with the Bank of England. And when I say financial markets, I include American markets, global markets, not merely for those rare non-British souls who might actually

be invested in British sovereign debt. I don't think there's a ton of that going on. There's obviously some, it's not the types of people likely watching or listening to DC Today right now, but it's a big financial market story for other reasons I really want to go into. Just to give you a little idea of the kind of intraday reality of market volatility right now, futures were up about 200 points this morning, and then the PPI number came, the producer price index. Let me just quickly tell you what the number was so you can see why in the real world it's a nothing burger. Their estimates were that core PPI would come in at 0.3%, and it did come in at 0.3%. The August headline PPI, which includes food and energy, was revised downwards a bit. The September PPI headline, which includes food and energy, were up 0.4% and a little bit less than that had been expected. The year-over-year producer price index inflation was 8.5%.

Last month, it had been 8.7%, so it came down a little bit. So there's like a little bit of things going higher and a little bit of things going lower, and it was very much in line where things were expected to be. The processed goods prices fell, meaning actually negative price movement, not merely disinflation, but actual deflation of those numbers for the third month in a row. Prices for transportation and storage, remember this is all wholesale now, this is the producer price index, not consumer, fell for the first time last month, about 0.2%. So there's a theme here of goods being down and services being up. And we'll get

the CPI number tomorrow. And I expect that you won't likely get a big surprise to the downside in CPI, because I think the cost of housing and rents is still being reflected on where things may have been four or five months ago, far distorted from what the reality is of what we're actually measuring. And I don't know how anybody could disagree with that, but maybe somebody could. So the PPI number comes and the headline is 0.4 versus 0.1. And that plus 200 futures dropped to negative 80 in about three seconds. Okay. And then within about five minutes, it was back up 90. And so then the Dow was down a hundred. You just had really very quick volatility. It's only explainable by algorithms.

quick volatility. It's only explainable by algorithms and basically those trying to jump in front mathematically computerized on a keyword, a buzzword. It's just so stupid. I don't know what else to say. So then the future, excuse me, we're in the cash market all day long, markets trading, and things were kind of up and then down. But basically, the market at one point was down 100, and it got up 200 and stayed up over 100, around 150, 130, all the way to the very, very end. And in the last five minutes, it dropped down 28. So the market basically closed on the Dow flat on the day. The NASDAQ was pretty much flat on the day. And the S&P was down 0.33%.

So that very final few minutes of trading continues to create an anomaly. And I will leave it there. The 10-year Treasury yield dropped four basis points, closed at 389. The energy sector was up 75 basis points today. That was the top performing sector. The energy sector was up 75 basis points today. That was the top performing sector. But a bloodbath in the utility sector, down 3.5%. The collapse of the utility sector over the last month is unprecedented.

I suppose that during the financial crisis, utilities could have dropped the same amount. And I probably should look this up. But I got to think this has been the worst four or five weeks for utilities ever. It's just been a bloodbath. And so that's probably worth revisiting. A couple of market comments I want to make. And then I want to move on to the Bank of England. The Dividend Aristocrats Index is, so that's just the index only from names in the S&P 500, is, so that's just the index only from names in the S&P 500, only that have like 25 years of precedent of growing their dividend. It's a very stringent historical look to be in this passively constructed index, is beating the S&P by over 10% this year. Of course, as a lot of you know, various active dividend growth strategies are beating the S&P by 15% this year. But I think it's worth pointing out that on a relative basis, there's no question that it's within the dividend growth realm.

you whether there's some value attribution there or there's energy attribution. People debate about factors that drive performance, but you'll be hard pressed to find a more consistent theme than dividend growth. At the beginning of the year, 19% of the companies in the Russell 3000, which is a very large, large cap index, 19% were trading over 10 times revenue, 10 times sales. Right now, that number is down to 10%, which is still too high. But that number has been cut in half as far as how many companies were trading at that revenue multiple per version. The growth to value PE ratio, meaning the relationship in the multiple or the valuation by price to earnings from growth to value, is still higher growth multiple versus values by almost a whole standard deviation, a little less than one now,

but basically higher than it's been throughout its 25-year average. And this is after what 2022 has done, which has basically been the worst year for growth so far compared to value since 2001. So you not only have had a bloodbath in that ratio, growth getting pummeled by value, relatively speaking, but even at the end of the pummeling, the valuation of growth relative to value is still highly distorted historically. Okay, that's the market synopsis for the day. I gave you the kind of key economic factoid on PPI, and then we'll briefly just talk about the Bank of England having told pension

funds, you have a few days to get your house in order. A bunch of pension funds dealing with the reality of low bond yields over the last few years went, and I won't get into the details, but they utilized a derivative product called an LDI. It's a way of margining up via leverage, the leverage coming through a derivative product to juice the return of their long-dated bonds that had a very subpar yield. Now those bonds have been hammered with price depreciation as yields have risen. And the Bank of England has come and said, okay, we've been coming in to help. We were buying long-dated bonds to kind of bring some order back to the market, but you have to end of the week to kind of get things resolved.

So they're kind of jawboning of leaving their support. At one point when I was typing this morning, the 30-year bond yield in England went up to 5.1%. It was up about 20 base points on the day. It's up 60 basis points from where it was a week ago. Okay. This is, this is a bond implosion. Then things did settle throughout the second half of the day. And let me see exactly where we closed here. It closed down nine basis points. So it came 30 basis points off its high. It closed at about 4.8. Nevertheless, it was still in the low fours a week ago. I bring it up. It might have believed that there are American investors saying, I don't feel comfortable unless I know what's going on with the British 30-year. Of course not. It's that it's indicative of, first of all, I do suspect, by the way,

that it corrected second half of the day that the pension funds who were over-levered and caught with their pants down on this use of margin have largely de-levered over the last couple of weeks. That's a big part of what's exacerbated. And I'd like to think that the bulk of that is over, which has brought back a bit of stability. But the lesson here is not about central banks or yields, bond market rates, currency. I mean, all those things matter. They're all factored in. But I got to tell you, anytime there's forced selling, the forced selling is a steamroller. And there's nothing you can do.

And it is violent. And it is disruptive. And it has a contagion effect to other asset prices. And that's what's happened. But I would add a second point. There is no free lunch. People thought there would be a benefit to very artificially low rates. Pension funds didn't like the low rates.

They thought there would be a benefit to leveraging them up. But when I say there's no free lunch, when I wrote a book called There's No Free Lunch, there's an economic law called trade-offs. And the trade-offs are not merely something the Bank of England has to deal with, let alone pensioners in the British financial system. The use of quantitative easing in America, the use of yield curve control in Japan, the low rates and violent amounts of quantitative easing with the European Central Bank. Okay, the Italian 10-year close today at 4.73%. So say what you want about inflation. say what you want about inflation. The sovereign countries of this earth, their bond markets, excuse me, their governments that utilize the bond market for funding cannot afford their debt with these higher rate levels. It invites manipulation and manipulation by definition

tautologically invites distortion. But Italian bond yields can't go that much higher. The Japanese can't stop doing yield curve control to protect the yen. The countries can't afford it. So I don't know what this means in specifics and timing to what the Fed does or does not do a quantitative tightening. I do know that the notion that there was ever going to be no trade-offs to the use of leverage and the use of rate manipulation to factor in, to account for excessive indebtedness was a silly notion. That's what's playing out right now. That's all I have to say today on the DC Today. I'm heading down to my meetings. I'll be back at you back in the studio tomorrow on Thursday.

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