The Dividend Cafe - The FED did What??

Episode Date: September 20, 2019

Topics discussed: Some weeks are filled with little news but lots of market volatility, and then there are weeks like this one, where there actually was very little market volatility, but a lot of news. In this week's Dividend Cafe, we dive into what will be some of the biggest news events of the year, and question why there wasn't a bigger market impact from it all. Investors wanting to understand better what the Fed did this week, what they didn't do, why they did it, and what it means to them, will be well-served to jump into the Dividend Cafe! We won't just leave you with a little Fed discussion and some thoughts on Oil and the Saudi attack ... The dollar, the trade war, negative yields, and even fracking get a little attention as well. This is a "do not miss" visit to the Dividend Cafe. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. kind of a short week, but definitely very action-packed. And not just action-packed in my schedule and meetings and so forth, and I'm not going to say in the markets either. It's really been a remarkably subdued week in terms of market volatility, but it's been a very action-packed week in terms of market events, things that theoretically could have caused a lot of price volatility, but were certainly headline interesting events. And you start with the Saudi attack, Iranian drones taking down half of Saudi's production capacity in oil over the weekend, leading to a 14% drop, excuse me, 14% increase in

the price of oil on Monday alone of this week. Then you had the Federal Reserve and their long-awaited Federal Open Market Committee meeting announcing on Wednesday that they were cutting rates another quarter of a point. And then you, there's all the kind of economic aftermath and repercussions and forward-looking projections and questions around that. So either one of those stories would have made this one of the bigger event weeks of the year, and you had both packed into a couple of days. I'm recording middle of the day on Thursday.

Dow was right now up about 100 points. Yesterday, when the Fed came out with their announcement, it was late in the market day as it normally is. I was sitting on set at Fox Business getting ready to discuss the aftermath of the Fed announcement live on air. The market was maybe up 30, 40 points at the time it came out. The market at one point dropped as much as 200. It kind of bounced around in that range

and it closed up 30 or 40 points on the day. So in that final hour of trading as the Fed made their announcement and Chairman Powell had his press conference, the market did move around a bit. I don't consider 100 to 200 points much even intraday, but from start to finish, it didn't move at all. Basically kind of a flat reaction. That's uncommon. We haven't had a lot of that in recent times. And then now, as I said, we're sitting here Thursday, market's up about 100 points. So, flattish week, you know, maybe perhaps down a couple points, not much. We still have a little more time here

on Thursday. We'll have all day Friday. So, you really have had, from start to finish thus far, very low market volatility and even intraday and day-by-day movement, considering the magnitude of some of the events, not much. Well, I'm going to start with the Fed, and then we're going to unpack the oil-related issues. The fact of the matter is that you really had to be out of consensus to expect anything different than the Fed cutting a quarter point. There was one Federal Reserve governor who had a vote, who voted to cut two quarter points, 50 basis points. There were two Federal Reserve governors who voted to not cut at all. The rest voted with the one

cut. So this is what the Fed funds futures market and pricing close to 100% for several weeks. In the days leading up to it, it came down a little bit in what those odds were, which is, you know, bound to happen every now and then. But I really do believe that the bigger issue right now is what they do going forward. And I have a very hard time believing in anything like the dot plots, anything like the Federal Reserve's press release indicating, you know, we expect the next move will be a rate hike into next year the dot plots in june were anticipating no uh action they've cut rates twice since then i bring up all the time they're going into 2016 the dot plots were for four rate hikes

and they ended up not hiking at all so i think that they are mostly right now stuck in the position of having to give the market no more than it wants, but not everything it wants, so as to leave themselves some optionality into the future. I think that the uncertainties around the trade war, their inability to create this inflation target that they want, most significantly being grounded to where international bond yields are in a lot of cases in negative territory, has forced them to take an overly dovish position. And one of the things I write about in dividendcafe.com this week

is that this is a very bizarre position to be in because the way they're messaging it leaves you either unsatisfied one way or the other. So in other words, there's two messages they're giving. One is that these kind of last two rate cuts are not really necessary, but a form of what they are. This is their term, not mine.

Risk management, kind of an insurance cut. And then the other line is, well, you know, we maintain that we are data dependent. But see, risk management by definition is not data dependent. They're talking about concerns around global growth slowing down. That's not a data point. It's a sort of abstract kind of broad fear. It may be a legitimate one, it may not be. But my point is, into the hard data that has always driven the discussions on monetary policy, the unemployment rate, wage growth, GDP growth. You could argue for staying still. Some may argue for raising rates. You certainly wouldn't be arguing for cutting rates.

Now, not all events are created equal. So the point for me right now is not to critique what they ought to be doing or what they're doing, but it's to get a gauge as to what's driving them and what we have to expect going forward. And I don't see the conditions that led them to cut these last two times changing much. Now, look, the Fed funds futures market as of my very, very early wake up this morning, were suggesting greater than 50% that they would not cut again this year. Previously, the number had been 40% chance of cutting one quarter point and a 40% chance of cutting two. So basically an 80% chance of some rate cut. That number is now dropped to below 50%. But it's still close enough that there's just this sort of uncertainty around

it. What do we expect this to do for markets? Well, markets haven't moved a whole lot, but they had already moved up a couple thousand points from that August bottom. So it's been a very robust number for markets and robust activity in the month of September. Very similar to June. Last time you had a month, and it's only two months of the year that we're down, we're May and August, both driven by extreme bad news around the trade war front. Then the market started to get the feeling things were looking better. They rallied hard in June. In September, things looked like maybe it weren't escalating further with China. So off of the August bottom, markets rallied hard here in September.

My own take is that the Fed itself cutting rates another quarter of a point is not necessary for market action. Why do we feel that it is not very important? Well, I'm going to turn to my actual writing in DividendCafe.com. Okay, the point, you have to be able to wrap your arms around here. If you're listening to the podcast, watching the video, I want you to appreciate how different it is in the stimulative effect it provides to the economy

to be cutting rates when you're practically already at zero versus cutting rates when you're at five, four percent, a larger number. The impact is magnified when you're starting from a higher rate. When you're already low and you're just going a little lower than already low, it doesn't have the same impact into the economy. What it does do is re-rate assets, meaning it reprices the risk-free rate from which all other assets, risk assets, are themselves valued. So this is something I've talked about so much over the last few months, and I'm telling you, I'm going to be talking about it for years to come. When you go down the path of using manipulation of risk asset valuation to achieve a broader economic end, it opens you up to certain distortions. Can this be a benefit to markets?

Perhaps. Can it be a big benefit to the real economy? I don't think so. Long term, the true causes of disinflation is not understood. If it is, it's not appreciated. And I don't just say that about the Fed. I say that about the media, about the investing public at large. So that's why this subject that I've been harping on for the last several months is so important to me as to what the negative pressure on growth is by excessive spending sovereign wealth funds government indebtedness puts downward pressure on growth and therefore downward pressure on bond yields and creates

this pressure you see it in the european central bank you've seen in japan for decades and you see it right now in the united states. Pressure on central bankers to try to make up the difference or overcompensate for another macro effect that they can't really deal with, that they don't have a play to run. And that's where I think we're at now. Okay, now let's talk about interest rates. So Fed funds rates a little lower.

Yield curve is not steepening. You would you had seen the 10 year 30 year go a bit higher 30 years up about 25 basis points over where it was at the bottom level in September. But with a 10 year still, you know, well below 2%. The fact of matter is you not going to get steepening in the yield curve unless you see the 10-year come up higher above 2%, or they even come cut the federal funds rate another, not just 25, but probably 50 basis points. It's going to be very hard for them to do that. So you already had a lot of movement in treasury yields and and that's perhaps why they had seen some move higher in the last couple weeks just because they were perhaps overdone a bit

it's part of the normal zig and zag of markets and we're not trying to trade our client bond portfolios around it you want to have a more stable macroeconomic outlook that you make bond decisions on and i think right now being a bit more defensive and also recognizing that credit has behaved very well. So that's why we've gotten really good price action in the corporate bond sector, especially investment grade, because people have not been worried about this as a corporate credit economic event. It's been far more driven just simply around interest rates, therefore having a bigger impact positively to the pricing of duration-sensitive bonds. So let me kind of

dig in a little bit to an outlook right now. I do think that a balanced, moderate, median exposure type approach to markets makes a lot of sense. And I love some of the stuff I wrote this week in the commentary. I hate reading myself, but I guess you're here to listen to me, so you may as well listen to me reading me. Look, monetary policy is loose. It's accommodative. People would think that's a potential benefit to have a higher weighting of risk assets.

But the trade war is still lingering. It's certainly uncertain. It's certainly problematic. So again, you have that push-pull. Fiscal policy is very pro-market. You've had big corporate tax reductions, incentives for businesses to invest. But fiscal health, very weak. Excessive deficits, national debt, etc. The U.S., relatively strong.

There's an absolutely insatiable global desire for U.S. assets. But on the other hand, the strong dollar that comes out of that is a real factor. It's impacting earnings for multinational companies. Push-pull. Liquidity is certainly abundant. Credit flowing. Demand is high. cost of capital is low, but earnings projections are themselves questionable, perhaps slowing around what

had been earlier previous momentum. So as you go into what will be our next earnings season in another month, you'll get a better indicator. But could it be a disappointing quarter? It very much could. Could it be an outperforming quarter? Of course, both factors play at once. Hopefully, you get the idea. A number of factors where there's a very strong argument to be made and a counter argument. What is the prescription here? Humility, sober-mindedness, balance. That's what we're doing, not only in our own thinking about this, but in the way we're executing the client portfolios. Probably wrap it up here. As far as the issues out of Saudi Arabia,

some great charts at DividendCafe.com for you to take a look at how significant it was to have 5.7% of the world's oil production go offline, and yet the reason why it didn't have a bigger impact and a chart there showing the increase in U.S. production, real life production, not just capacity, that has provided a buffer. The rest of the world could look at this and say geopolitically we're not at risk the way we would have been in the past pre-U.S. fracking revolution. By the way, I titled that part of Dividend Cafe

A Note for Elizabeth Warren. I'll let you read into that. So, oil, big story this week. The Saudi Arabia attack, the situation with the Fed. Now, what do markets look to next? You're getting more and more kind of calming in energy markets and normalcy returning there. Oil is sitting above $58 a barrel. It had been above $60. It just simply

hasn't moved out that much. It's been good for the energy stocks this week. We have a very healthy weighting ourselves, but it hasn't caused any kind of global impact for the reasons I've already discussed as far as the Fed next I will be utterly shocked if you get a rate cut in October but maybe we end up teetering around here with a 50% chance of another rate cut in December perhaps it ends up being higher than that if I'm a betting man, I probably would try not to take this bet, but I would bet that they will end up cutting one more time. Certainly going into 2020,

I think you have to assume that they want to be in as neutral position as possible in election year where the market is not looking to them to be cutting or hiking. I suspect that's where they get. And other than if we go into recession, then I think you're going to see full-blown quantitative easing. I'm going to write an article next week at Market Epicurean, a little deeper dive on some of the things that happened in the repo market this week. I don't imagine a lot of you

know what I'm talking about. It's a subject that's important. Chairman Powell yesterday made a comment about looking to organically increase our balance sheet. And some people said, wait a second, is he talking about a QE4? Is this another round of quantitative easing? He's not, but I want to be able to unpack what that means. I think the best place for me to do that is in a little higher end article I'll write that some of you may find interesting. So with all that said, please do reach out with any questions or comments. But I really am just as a constant bottom-up, you know, company-oriented,

profits-oriented investment mind, much more excited for earnings season to get started again. Geopolitical events like the drone attack in Saudi Arabia is a big deal. It matters in our world. The Fed, I think, matters less and less at this point when you're getting so close to the risk-free rate being back to zero.

But we have to pay attention to it. It has a pricing impact. It has a valuation or rating impact. But really, ultimately, what can really go right for markets is a strong earning season. It could really go wrong for markets is a very disappointing one. Either outcome is possible. And, of course, a middle-of-the-road thing could happen as well. So that doesn't kick off for another month, by the way.

All right. That's that. Like I said, I have a plane to catch. I'm going to leave New York. The next time I'm back will be our annual trip. Daya and Brian from my team, partners and members of our investment committee, will be joining me and we'll be meeting with, you know, well over a dozen of our primary portfolio manager, relationships, asset managers, hedge funds,

primary portfolio manager relationships asset managers hedge funds strategist analyst various people that I find this week that every year utterly stimulating and I hope you'll get a lot out of it as well but that's that's a few weeks away so in the meantime going back to California and look forward to come back to you next week with more thoughts here in the Dividend Cafe. Thank you. 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. The team at Hightower should not be in any way liable for claims and make no express or implied representations or warranties as to the accuracy or completeness of the data and other information or for statements or errors contained in or omissions from the obtained data and information referenced herein.

The data and information are provided as of the date referenced. Such data and information are subject to change without notice. This document was created for informational purposes only. The opinions expressed are solely those of the team and do not represent those of Hightower Advisors LLC or any of its affiliates.