The Dividend Cafe - The Elusive Pending Stock Market Crash

Episode Date: August 3, 2017

The Elusive Pending Stock Market Crash by The Bahnsen Group

Welcome to the Dividend Cafe about that old movie, Groundhog Day, where the same kind of thing was happening every single day. It was playing out just sort of verbatim. And it feels that way now in the markets to some degree, that there is this kind of conversation that just keeps happening, which is markets do well. that just keeps happening, which is markets do well. People wonder how long they can keep doing well when there is so much dysfunction in Washington, D.C., and then markets respond by doing even better. And in the meantime, other pundits, probably myself included, retort to the skepticism about market performance

in the face of political volatility and turmoil and retort by saying, well, look how well earnings are doing. And in fact, earnings continue to grab the headlines and drive markets. And then we end up repeating the whole same process again. And I do suspect that we're at some point going to see a different narrative take over. And I don't know what that is. I don't believe there's a new time period coming in which something other than earnings drive markets. Markets are intrinsically and permanently discount mechanisms around future earnings. That's what stock prices are. But I think that in terms of the news headline, it's perfectly possible that at some

point the Fed overly tightening or some kind of turmoil in Europe with the ECB or Japan, some kind of reversal of this reignited global optimism could become the next story. There's any number of things that I think would be out there. But what we kind of want to do with Dividend Cafe this week is just lay out the way things are. Yes, I've said it week after week after week and don't want this podcast to be yet another part of Groundhog Day. But quite frankly, earnings have done well. This earnings season has gone well. And so that's the reason stock prices are higher. They haven't moved significantly higher this week. Dow did pass 22,000, even closed above 22,000. And so you get a few little moves there that bring some attention, but not a huge week. We'll finish up earnings season and then start a conversation again about fiscal policy, about tax reform, about infrastructure spending, and about what the next batch of things are that could be catalytic to growth.

And so if it seems like we've had this quarter over quarter for at least three, maybe four quarters in a row, it's because we have. And maybe we're going to have it three or four more quarters. Who knows? But certainly right now, it's been a wonderful period of time for risk asset investors. That's true domestically and globally. It's true in credit markets as well as equity and stock markets. So not a lot to be complaining about, except for those who are either short or sideline cashed, neither one of which has been a very good position to be in. So with that said, let me dig into a few other things we wanted to cover this week. Yeah, here's what we know on the tax reform side.

I don't want to ignore that subject. The Trump administration has committed to comprehensive tax reform. The House and Senate leadership have stated it will get done. Here's what we don't know. Will there be more political wisdom and thoughtfulness across all of GOP leadership from the White House to the Congress than there was with the health care repeal debacle? Here's something else we don't know. How will the tax reform they bring forward deal with pass-through entities? Think of your S-corps and LLCs, expensing for corporations, and the ultimate final corporate tax rate.

We don't know some of those details yet, but we know that they're primed and ready. We obviously don't know for sure that they'll be successful. We don't know some of those details yet, but we know that they're primed and ready. We obviously don't know for sure that they'll be successful. We don't know some of those granular details, but the final thing we do know, the huge beneficiary of corporate tax reduction will be wage earners. It will be employees. It will be in the labor markets. It will be downstream into middle class and so forth. So the ability of policymakers to sell this plan is going to depend on that message getting across. I will add all indications are that they're more prepared to do this right than they were in health care, though I will, I don't think the timeline they're offering is very likely to get done. The month of July, so the first month into the second half of 2017,

we saw the stock market rally continue. The S&P was up 1.9%. Year-to-date, now up 10%. Taxable bonds were up 0.43%. Municipal bonds were up even more than that. So another big month in July. Emerging markets much higher. Oil higher. The dollar had dropped throughout the month. So a lot of other foreign currencies higher vis-a-vis dollar. To have been down in July, one really would have had to been either long volatility, because certainly volatility came in even more, or like I said before, just short risk

assets. Now, who are you calling bubble? Let's review something here that I found fascinating. The stock market's per year return from 1982 until the famous crash of October 87 was 19.7 percent annualized. The stock markets per year return from 1995 until the 2000 meltdown 26.1 percent annualized. Stock markets per year return from 2009 at the bottom of the financial crisis until present day 12.5 percent so essentially even though we've had a really big move up in the market over these last eight years the per year move up has not looked anything like what several of the past big bull runs have looked like that and and and those things obviously ended up coming into a bear market, as will always happen, but this is not the same level of elevated, excessive price appreciation

that we've seen in the past. When we zig, you zag, the stock market was not supposed to show this resilience in the face of a Federal Reserve raising interest rates, right? Three rate hikes going back to December so far, with one or two more expected this year. Draghi over in Europe is jawboning their need to reverse monetary direction. It's added to this narrative of central banks around the world tightening the belt. Though we have been careful to delineate normalizing from tightening. But let's make sure we understand the full scope of what central banks around the world are doing. There have indeed been 20 rate hikes around the world so far this year, but there have been 43 rate cuts, the vast majority of which have taken place in obscure, more emerging markets.

As you know, emerging markets have been flying this year. So the global reflation thesis is by no means dead. Much of it's being fed by the fact that while Japan, Europe, United States flirted with zero or negative interest rates these last few years, many emerging market central banks left themselves plenty of room to maneuver, and now maneuvering they are. VIX sticks. A new favorite topic of discussion in our world is how low the VIX is, the so-called fear index, and how these historically low levels of volatility bode poorly for, well, everything. The big trade has been bet on higher volatility because vol has been so low. And frankly, I do not even want to think about how badly people

have been wiped out with that trade this year. Unlike buying a stock or any other perpetually owned asset, the VIX is made up of option contracts that have an expiration date. So you can't just wait for volatility to come higher. It has to do with your timetable. Suffice it to say, it has not been working. So we know that those betting the VIX will go higher have gotten crushed, and we know that those betting on such things is outside of our worldview at the Bonson Group. Does the low VIX tell us something about the future? Should we worry about what it means for stocks? It tells us exactly one thing. Volatility has been low.

I would like to think we already knew that. It does not tell us that it will stay low or that it's about to go high. It tells us what has been. Combined with low spreads in the high-yield bond market, does it imply that investor complacency may be too high? I think it can be said that it contributes to that narrative, but it does so with less fundamental force than something like bond spreads. Look, investor respect for risk is too low,

and we don't know when sentiment will shift. Heaven forbid someone try to use any of this as a timing vehicle. But the VIX has become a sideshow and not understood by those playing around with it. That ends in pain. There's a chart at DividendCafe.com this week that addresses the difference in the United States' increase in debt since 2007 and China's increase in debt. increase in debt since 2007 and China's increase in debt, where you see the United States has actually contracted debt in the household sector as consumers deleveraged after the financial crisis. Its corporate debt has not moved higher than post-financial crisis relative to where it was before, but our government debt has skyrocketed. And then inversely, China's

household debt and government debt has barely moved or even come in, but their corporate debt has absolutely exploded. Very interesting tale of two countries. I am going to leave it there here for the podcast this week. I do want to drive some of you to the website because there's some more information about energy as a hedge against inflation and by being hedged against inflation inviting a hedge against the entire market so we think there's a great bit of information there another chart regarding copper prices making new highs and what that could mean so So please do visit us at DividendCafe.com. Reach out anytime with questions, comments, subscribe, tell your friends, do whatever you want to do. But most importantly, as you listen to this, know that the advisors at the Bonson Group

are happy to speak anytime to any of you about anything whatsoever, answer questions, give a little counsel direction, and to the extent you're a client of ours, exercise our fiduciary responsibility to always and forever put your interest above anything else. It's what we do. That's all I have this week. Look forward to talking to you next week. Thanks for listening to Dividend Cafe, financial food for thought.

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