The Dividend Cafe - The Fed Delivers as Promised

Episode Date: November 1, 2019

Topics discussed: And just like that, we find ourselves in the month of November, a stunningly quick completion of the first ten months of the year. This means that we are now officially in the holiday season, that the Presidential election is only one year away, and that end of the year portfolio re-positionings are on the top of everyone's mind (okay, not everyone's, but at least ours). This week's market produced all-time highs in the S&P 500, and this week's Dividend Cafe looks at why that is, how painfully unintelligent it is to think that "an all-time high" is something to be afraid of, and why the Fed did what they did this week. There is plenty to chew on, so please do grab a coffee, and jump on into the Dividend Cafe ... Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. California in our Newport Beach headquarters where our real life podcast recording studio actually resides. I think you may have noticed that there have been a couple of weeks in a row where I'd been elsewhere and it affects the audio quality. And of course the video doesn't look the same and all that stuff. So let's see here. I can't remember. Are we three weeks in a row I've been gone? I know there was one week where I'd flown in and went straight to the Blackstone Alternative Investment Symposium in New York and recorded after being on the plane all night. And then we had our whole week of New York money manager meetings and the investment committee, just Brian Saitel and Daya Pernas from that

committee and myself are going to record a special podcast this coming Monday, which I believe is November the 4th. We're going to record a podcast just kind of summarizing a lot of our big takeaways from that whole week. And so that's not really the subject of Dividend Cafe here today. And then I had more business in New York and then was down in Palm Beach, Florida for a couple of days with my wife as part of a gala for a big organization called National Review that I'm on the board of. And then I flew back yesterday and here we are. So the reason I bring up that this is a little unique here, recording is not back in California. I record most of them in California. It's just been a lot of New York time in October. The recording on Friday is rare because normally we have to record on Thursday to get it all teed up on time, get through the editing and let the production people do what

they do and all those good things. And now we're just going to kind of force it out here on Friday and we're going to expedite our process internally. And so what it's doing is it's enabling me to have a little more updated market week for you, because as turns out the market's up about 250 points here as I'm recording on Friday morning and of course we'll see what the rest of trading does on on Friday because the market's only been open for a couple hours but it's been a very positive week in markets and I'm going to suggest about three reasons and I'm going to do it in order and And the first one is what came out this morning, which is really a positive employment report. They were expecting because of the impact of the GM strike, which had been affecting quite a few auto workers over the last month, that it would be a bad number and even adjusted for the impact of that GM strike, 120,000 new

jobs created. There just isn't a lot of signs right now other than those select categories, which remain a concern in business investment and manufacturing. But when you look at jobs, when you look at wages, when you look at the GDP number from a couple days ago, I'm going to talk about in a moment. Look, you have a strong economy and it is tiring that there is controversy around this. I talk about the concerns for slowing the economy. And it is tiring that there is controversy around this. I talk about the concerns for slowing the economy. I talk about the policy measures that could get in the way of expanding the economic growth period that we've been living through. Certainly, there are plenty of things to focus on in global economic weakness. But I don't think that there are very

many economic minds that are of the mindset to downplay where the U.S. economy is that are not just somewhat politically motivated. I think that that is fine. I get, you know, look, if you want President Trump to lose and a bad economy will help him lose, it makes sense to kind of talk about how we have a bad economy or we're going to have a bad economy. I mean, I get that. And I'm sure it could work on the other foot as well from a partisan standpoint. But in terms of just a sort of empirical and objective analysis, and it impacts the way we view the future, it impacts the way we view the present. A lot of positive things happening in the market. Excuse me, in the economy.

But of course, that trickles into the market as well. You have an S&P at an all-time high. It crossed 3,050 this morning. And you have a Dow that's getting very close back to its all-time high, only about 100 points off at this point in the 27,300 range. So quite a bit of positivity to go around. Now, I said three things. And so one was the strong employment number. Number two was the Fed. And yeah, the Fed cut rates this week. Everyone knew that wasn't going to happen. The futures market had priced in a 99% chance.

But in their comments after, the Fed did not do much to kind of downplay where they were. They made clear that these cuts are probably going to stay on for a while. They didn't talk about any new cuts. I don't think the market was expecting that. Right now, the futures are pricing in an implied probability of a 25% chance for another cut in December. So that's gone down. It's been sitting between 20 20 and 25% this week,

but it had been about 40% a couple of weeks ago. I really do not want them to cut again. I certainly do not think they need to. I certainly, certainly do not think it will do anything positive if they do. I think it will have no stimulative effect at all. But the concept of an insurance cut was acceptable a couple of months ago in the face of the trade war, in the face of negative yields worldwide, in the face of an inverted yield curve. An insurance cut for the fourth time? At some point, you can't really call it an insurance cut anymore. The first two that they did were taking back the two that they did in the fourth quarter of last year. I can pretty much guarantee you Truth Serum injected into any Fed governor would get them to say, yeah, we kind of regret having done those two. They unwound those. Those were the two that really led to the inverted

yield curve. They've solved for that. The two tens are now positive. What I mean by that is that the two-year treasury is at a lower yield than the 10-year treasury, which is what should happen in an orderly universe. And as a matter of fact, it's actually about 17 basis points wide. So that's still considered pretty flat. But it's not like five basis points or three basis points wide. You have the un-inversion now back to 17 basis points. Highest has been in a few months. So the Fed policy or undoing a prior

policy has had that impact. And then now there's extra cut this week. I guess they call that insurance. I don't know what you'd call the next one. But they said a few things that I want to elaborate on. One is that he specifically, I say he meaning Chairman Powell of the Federal Reserve, specifically said that if and when the trade tensions are resolved, it will not necessarily mean that these rate cuts will be reversed. In other words, he's not really hiding behind the idea that, oh, we have to do this because of the trade war. Because many have thought like, oh, well, there's positive movement in the trade war. Is that going to offset the issues with the monetary easing? Is it going to take away their need to do it? The Fed is not merely trying to

get to their 2% inflation target. They're trying to overshoot it. And that's part of this new thinking that says you set a inflation target for a period of time and you average that, which gives them the policy tools or leeway to go over it to make up for the periods where it was under it. And it's just an extraordinarily reckless and nonsensical idea. But it's gaining weight, and he paid lip service to it this week, and gaining momentum, I should say. So they're not only are able to still justify overly accommodative monetary policy when they're so close to their 2% inflation target, a target that itself, I believe, is counter to the very principles of sound money. But they're even now able to justify within a 2% inflation target going over a 2% inflation target

so they can average a 2% inflation target, which is moving the goalpost to say the least. He did refer to the fact that this whole period may last for a while. There was some idea that they may be in a hurry to normalize. He certainly does continue to talk about CapEx, capital expenditures, business investment. You know how important that is to us, what we believe it represents for the economic cycle. He believes the resurgence in business investment will come from trade war resolution. And I certainly hope that's true. I believe it's true. And I certainly hope that's true. I believe it's true.

And I believe we're getting closer to that happening. But at the end of the day, we definitely have an economy that is moving far faster than one would think would justify a 1.5% federal funds rate. percent federal funds rate. And even the big decline in business fixed investment all started around the trade war, not necessarily a result of monetary policy. So I don't think that anything the Fed's doing is going to ease in that effort. But it is what it is. And I say that every week, that we're here to talk about what we believe their Fed is done and is going to do and why they're doing it and will do, not what I think they ought to do. And if at any point they call me to be Federal Reserve Governor, I still won't be able to talk about what it is that ought to be done because I will turn down the job opportunity. So there you go. Not waiting by the phone in case you're wondering. Now, as far as the GDP number,

this is important. It came in at 1.9% for the third quarter. And this is very important because many were expecting 1.2, 1.3%. There was a consensus view of 1.6. Now, of course, the spin that comes out politically is, oh, this is below the White House's 2% to 2.5% target. That was for the full year. The White House always said they thought it'd be lower this quarter around some of the trade issues from a few months ago. Will they end up averaging on the year their full target? Maybe they will, maybe they won't. And I think that if they don't, which is what I expect, if they're a little short of it, it will entirely be related to the trade war. I think they could have reached three to three and a half percent, not just two to two and a half if it were not for the trade war. But be that as it may, 1.9 led by stronger government expenditures and stronger consumer activity still reflected economic growth above

expectation and maintaining a trend line higher than we have seen. And yet, the business fixed investment number really dropped this quarter. And so you now saw the business investment number had been up about 4%. And then it was down 1%, now down 3%. And that is a drag on GDP growth. And that was the key ingredient that was driving economic growth in 2017 and most of 2018. So really a lot still up in the air around if and when we get substantive relief in the trade war and potential de-escalation of present legacy tariffs, does that really reignite capital expenditures in the business economy? I think that that will be the big mystery going into 2020, along, of course, with the political issues. On the China front, I do

think that there's a lot of indications that this is well on its way to getting phase one deal signed. Chinese have indicated that. President indicated that. They have to find a new location now because they were going to be at the event in Chile, and that's been canceled, and now they're pretty sure they can find a venue for it. The president didn't respond to my tweet suggesting they do it at one of the Trump hotels, but be that as it may, I think you're going to find a phase one deal and that what is not priced into markets is the possibility of phase two coming that allows for a repeal of some of the current tariffs. Markets have been plenty happy with not seeing

tariffs go forward, seeing the currency side of this settle down, seeing the overall trade thing settle down. Markets have enjoyed all that as they should. We potentially appear to have dodged what looked in August like a nasty bullet. But that does not mean we've gotten the full best case outcome yet. And to the extent that it still exists as a possibility, I believe it would carry with it a melt up in equity markets. It's a low probability event. But I am convinced that markets do not believe it's possible at all. And I think it is possible.

You can call it 5, 10 to 20 percent. but that's something that people need to be aware of. Now, in terms of the other possibility that you get a full reversal, that's probably 5%, 10%, 15%, 20% as well. That all of a sudden something breaks down and we're back to that cycle of the president saying China broke their word and we're doing this and we're going to get them here. But, you know, at this point, politically, something like that, obviously, would be very, very unlikely going into this election cycle. Speaking of which, we're one year away. I'm sure it'll be a lovely, positive, dynamic, wonderful year of lesson in American civics and bipartisanship. That was my sarcasm for the week. Earnings season, we're 55% of the way through. We're actually a little more than that after this morning. A lot of companies came this morning,

and it was one of the things that was near and dear to my heart today was digesting some of the companies that we own, their results, and it's been an absolutely splendid earning season for dividend growth. As far as across the whole stock market, 74% of reported companies have beaten their earnings expectations. Generally, it's about 65% to 68% of companies that do, so it's above the average. 68% of companies that do, so it's above the average. But more impressively, 64%, far above about 50% average, have beaten revenue forecasts. Earnings expectations are tracking about 2% better than consensus forecasts were indicating. But there's still, like I said, nearly half of companies to report. They were anticipating about a 4% decline in earnings just a couple weeks ago. It's now tracking towards more closer to 3%, but that number could move around.

So we'll hold off on the report card. $500 billion overseas still that U.S. public corporations are repatriating from foreign markets. So we've gotten over a trillion dollars repatriated. That's been extraordinarily stimulative. By the way, the vast majority of that money, over 60% has gone into CapEx, M&A, higher wages, reducing debt. It's been roughly 40% that has gone into stock buybacks and dividend increases, which I also consider stimulative and also consider an efficient use of capital. But to the extent that the political play is always, oh, yeah, this money was not put to productive use, it was. And as I said, it has $500 billion to go, something we shouldn't lose track of. So when I look at an assessment of the overall

stock market right now, there's a few things that I want to be able to focus on from a top-down macroeconomic standpoint in the short term. The Federal Reserve is absolutely suggesting full-blown pedal-to-the-metal acceleration of risk. A year ago, they were an impediment to risk on. They were quantitatively tightening on balance sheet and they were not only continuing to raise rates, but indicating more rate raises, more rate hikes were coming. Now, because of the fact that lower risk-free rate justifies a higher valuation of risk assets, and you have an abundance of liquidity in the market, and most importantly, just that kind of backstop, what you could call the Powell put, if you want, what we used to call the Greenspan put,

the Bernanke put, that the Fed is there to help bail out the stock market, or at least some form of risk assets. I would argue real estate belongs in that list as well. I see nothing that is suggested that's changed, and I see everything that is suggested it's very much still in effect. But of course, beyond the Fed, we have the China trade war, and it's not done, but it's moved in the right direction, and perhaps really in the right direction, with all the political sides suggesting it's going to continue to. You have bond yields, cash yields so low right now, and of course, many international markets that investors are afraid of. You get that TINA trade, that there's no alternative. All these things suggesting a better place to put capital is in risk assets and not just risk assets, but U.S.-based risk assets. So the earnings story is good, if not great, because it isn't great.

Earnings growth has definitely slowed, but it's slowed off of a huge number and it's still been outperforming quarter by quarter. Fed is a bullish sign, trade is a bullish sign, and relative investment opportunity is a bullish sign. There just isn't a whole lot more that people could do. I don't want to get carried away because I'm still aware of some of the tail risk things that are out there, even if they're not Fed and trade right now. I recognize global economic weakness. I recognize the possibility of a blow up in the trade war. I recognize 2020 election, recognize that, you know, business investment is slow. And so we have to factor all these things in. But ultimately, the shorter term outlook, I think right now suggests that investors by no means get ahead of themselves

with taking risk off. I would keep it in a balanced median allocation, something we've been doing all year at the Bonson Group. Longer term, of course, trillion dollar deficits during a really, really good economy is a simply stunning development. The possibility of socialism in the Oval Office is something people have to be aware of. The world that's awash in negative yielding debt, which is distorting markets, it's creating a malinvestment of capital, it's suppressing healthy financial institutions. We can't predict how this will end. It's a science experiment that we've never seen before. So no, I don't think it's a time to get lazy. I do believe the profit motive still works. I do think that there are intervening forces from the government and the Fed, or not just our Fed, but central banks around the world, that are making things more complicated than they need to be.

And yet the economy continues to grow. Look, on that election front, I'm going to be talking about it for the next year. I don't know what to say on the poll side. You know, you get a poll saying a national Democratic poll, a credible one saying that Biden is up over Warren 15 percent, the CNN poll. And then you get one, Quinnipiac, another respected poll saying Warren's up seven percent. I mean, you can't have a 22 percent gap between two leading polls allegedly polling for the same thing. So it's not that I am buying into the fake poll or biased polls or any of that stuff. I don't do that.

Generally, by the way, people that say they don't believe the polls are the people whose candidates are going to lose. And people will say, well, in 2016, that wasn't true. But that's not totally accurate. The popular vote Hillary Clinton won by about what the national polls said. And then on an individual poll basis, it was within the margin of error in Florida, Pennsylvania. Trump outperformed in Ohio. They never really polled Wisconsin.

So it kind of just, he ran that perfect inside straight. He got exactly what he needed in the states to deliver the electoral college. That's different than saying that the polls were all wrong. The polls just had it tight, but with a slight bend to Hillary. And the polls ended up being tight with a slight bend to Trump. All margin of error stuff. That's math. That's science.

That's, excuse me, statistics. So anyways, I don't think that if the polls were really unanimous right now about a particular outcome, it would mean much because there's so much time to go. So we can't really focus a lot in terms of current allocation of capital about some of the outcomes that could happen for next year. But what we can do is look at NAFTA 2.0, which could be getting done within a few weeks. I'm not really concerned from a market standpoint on the impeachment thing. I still expect it will happen in the House.

But I don't think the markets have cared. I think it's pretty obvious they haven't. I expect that to continue. It doesn't seem like a market event. I think the market believes probably the House will vote to impeach. They might not. And then the Senate almost certainly will not vote to do anything from there, and we go back to our lives.

That's for those who left their lives to begin with, which hopefully are none of you. It certainly is not any of us. So check out divincafe.com to look at the chart of the week. I want you to see the financials in the S&P 500, their total debt to assets. Because one of the big things I'm going to be talking about with my partners on Monday from the New York trip, from our money manager due diligence, is a lot of opinions and convictions we're forming around credit markets, around what is a risk and is not a risk, but a lot of factoids that linger out there about credit and what that means for the overall economy, what that means for risk assets and for

valuation and for corporate health. But when we talk about a buildup of leverage and a modest deterioration of credit standards, credit quality in the corporate sector, it's imperative that you understand that we're talking about non-financial companies. You have had a reverse effect on the other side. Non-financial companies have levered higher. Financial companies have way, way, way levered lower. And in fact, the chart of the week will show you the debt to assets pre-crisis reached about 40% and debt to assets in the financial sector now is well below 20% in between 15% and 18% depending on the company, but as a broad sector, somewhere in that range. So you have a de-levered financial sector that is where the systemic risk generally would come from. All I have to say, there's other

systemic risks. There are other things I want to talk about, but I want people to understand the right risk. And when you hear people say, oh, it's like financial crisis again. Well, and the key ingredient that actually was at the heart of financial crisis, it's nowhere near the same in terms of that debt to asset leverage buildup in America's financial system. So this is a pretty positive Diven Cafe, I gotta say. It'd be more positive if USC can somehow beat Oregon tomorrow. Oregon looks very good. I don't know what to expect. I do get to spend a weekend with my boys. Been doing a lot of business travel lately. Can't wait to spend a little time with Mitchell and Graham. The Bonson Group's

entire firm, our New York folks in Connecticut, and all of us here in the California office. We'll be out in Palm Desert, California next week for our annual team retreat near the end of the week. So we will be bringing Dividend Cafe to you next week from the little paradise that is Coachella Valley, talking markets, talking earnings, talking the economy, and all that good stuff. Please reach out with any questions you might have. Please email us if you'd like a copy of the book, The Case for Dividend Growth, or a pre-order of my book on Elizabeth Warren. All we ask in exchange for a copy of the book is that you put a review up of the podcast at wherever your chosen venue for

listening to podcast is. We'd like you to do that even if you don't want a copy of the book. Some reviews, some five stars, some kind of thumbs up, whatever the word is. As we spread the word about the Dividend Cafe podcast, thanks if you're watching the video. Enjoy your weekend and we'll come back to you next week. Thank you for listening to the Dividend Cafe. Financial food for thought. This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance 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 opinion, news, research, analyses, prices, or other information contained in this research is provided as general market commentary. It does not constitute investment advice. Thank you.