The Dividend Cafe - The Glass is Not Half Full

Episode Date: January 14, 2022

2022 is just two weeks underway, other people are joining me in no longer saying Happy New Year, the NFL playoffs are finally starting (a week later than ever before), and the college football champion has been declared. Coming into the new year was the time to forecast what we expected for the year – but now, we are actually in it. And speaking of those forecasts, I will keep the white paper in front of you here. But I think we are due for a little update on a few big macro issues, so update you we will. From the glorious spot of the 2022 TBG offsite where our entire team has spent the last day and a half meticulously working on improving our business (in some really significant ways, I will add), today’s Dividend Cafe covers a lot of bases. I have written ad nauseum about the fact that much of what we discuss when we discuss macroeconomic outlook is really about the state of debt in our economy. Much of what we think and ponder about the Fed comes down to debt considerations. There is much to evaluate on the periphery, but debt levels sit at the middle of a lot of these peripheral concerns, and I will tell you that I am seeing more and more people make truly faulty assumptions that I believe are headed to a bad place. This is a topic that will illuminate and inform your understanding of many things, and the only place I know to do it is in the Dividend Cafe. Links mentioned in this episode: DividendCafe.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. Well, hello and welcome to the Dividend Cafe. I'm recording our video and podcast here this morning, actually looking out at the beautiful Pacific Ocean. But instead of doing that from my office in Newport Beach, we're doing it from our team retreat, where we have been doing our off-site meetings, our kind of annual get-together for the last couple days and, you know, run downstairs here

when I'm done recording to get back to that. And it's been kind of fun because, you know, our team is 40 people now, and we have four offices around the country, and we didn't do one of these events last year. And so it's just been a very nice time of regrouping and really actually some pretty substantial changes on some things that we think are really exciting and additive for our business going forward. But nevertheless, the Dividend Cafe this week is a pretty healthy one. There's a lot that's gone into it. And I want to spend our time today talking about these kind of economic issues that we think are relevant and interesting right now. And what happens is you get, like, let's always say, offshoots of the key economic matters that become the economic matter in the

press and the way we talk about it and the way we think about our portfolios. And so you get a lot of talk about Fed activity. You get a lot of talk about bond yields, really granular. You look at like, why didn't gold prices go up last year? What's going on with inflation? There's all these different topics and they're all relevant. They're all actionable. And I want to constantly use the Dividend Cafe and my talks with you here on the podcast and the writing I do

to bring it back to the core heart of the matter, which is always, I think, in this environment, some aspect of the debt levels that exist in the global economy. And most of the things I just said, all of the things I just said, most of the things I just said, most of the things I could say stem off of that conversation in one way or the other. So this week I encountered two different things as it pertains to the deficits and what will happen in 2022 that I felt compelled to write about because both things I disagreed with and they were on opposite sides of one another. And I disagreed with both and not because I was in the squishy middle. In one case, there's those saying, God, I'm a little, and they're very hardline Keynesian, traditional Keynesian, but they're pointing out that global, excuse me, U.S. fiscal policy stimulus, the additive fiscal spending that was a certain percentage of GDP is going to be coming down. And the reason is not because all of a sudden we've grown fiscally responsible or that, you know, God forbid there's any budget cuts.

God forbid there's any budget cuts, but just simply because there was a ton of bazooka spending in 2020 and again in 2021 around various COVID measures. And those things are mostly one and done. There's a couple that had multi-year expenditure allowances. But for the most part, these big one-time transfer payments, the PPP endeavor to small businesses, a lot of the spending went to immediate vaccine distribution and so forth. You can go through the whole kind of P&L of it all, but they're all in the category of being initial expenditures that really boosted spending as a percentage of GDP and has come way down. And so I hear Keynesians going, yeah, that's really concerned about that. That's a negative thing. And it is not remotely negative. Okay.

Right sizing or bringing down that level of excess spending, that spending was not stimulative. Some, I'm totally open to the idea that some of it was justified. I don't believe all of it was, but that's not my point. I'm not going to sit here to say what I think was a good use of government expenditures and what wasn't, because I certainly recognize that reasonable people can disagree about that. But economically, it wasn't like this was our most productive use. Like in 2019, nobody was saying, you know, it'd be great for the economy in 2020 is if we go just flood a bunch of money out for this and that saying, you know, it'd be great for the economy in 2020, is if we go just flood a bunch of money out for this and that, and you know, the various COVID emergencies. That's classic

broken window fallacy thinking, for those of you who are familiar with the great Friedrich Bastiat. My argument would be that that level of fiscal stimulus as percentage of GDP coming down this year is not a negative thing. But then I totally disagree with this other school of thought that is looking at the level being much lower. And what I'm referring to is current deficit spending, that the current deficit as a percentage of GDP comes down because the add-ons to the national credit card, the rate at which we're doing it is decreasing. We're going to add a ton of money to the national credit card this year. But it's true. It'll be less than it was last year when you had those big extra spendings.

So they're seeing this. They're more fiscal hawks saying, hey, good, we're bringing that down. That's a really good thing. And I'm saying, eh, good, we're bringing that down. That's a really good thing. And I'm saying, eh, sorry, not really. You could also argue, I put a chart in Dividend Cafe, the level of global debt trading at a negative yield has gone from like $18 trillion to about $10 trillion. And so that's a good thing. There's less irrational allocation to capital out there.

But fundamentally, the reason why I want to kind of hold in the enthusiasm here is that the amount of debt we've accumulated is the fundamental issue, not the rate of growth in the current deficit. deficit. You have a debt as a percentage of GDP that 15 years ago was 36% in the United States, and it's now well over 100%. Two years ago, it was 79%, and it's now well over 100%. That is not coming down. The rate of growth to it is slowing. But what we have is a very sizable amount of debt as a percentage of GDP that has blown out. It was growing, growing, growing for years before COVID, and then it got hockey stick growth during COVID. I would argue that the key numbers are here. 154% of debt to GDP is government debt.

That includes the debt that the government owes other people, whether it's foreign countries, investors, banks, and then intergovernmental debt, what they owe to themselves, intergovernmental transfers, that has to be paid too. Whatever metric you want to use, that number has skyrocketed in the United States and is going higher still. But then you have the total amount of debt as a percentage of GDP, which includes private debt, corporation debt, households, things like that. And that's 388%. Now, Japan's well over 650. United Kingdom is over 450%. There are higher levels in European bloc and obviously Japan. But my point in bringing up the private sector debt is this, and I've written about it a lot. But my point in bringing up the private sector debt is this, and I've written about it a lot. That is debt, theoretically, that has a more productive capacity than governmental debt,

which can help drive economic growth, except for now that productive boom has happened. I always have to make a distinction. It's sort of like an eschatological comment. There's a difference between levering and being levered. The process of reflating can be very productive. Once you're there, having that debt sit there limits the ability, the law of diminishing return, a law of marginal utility that limits the ability to grow that effectiveness going forward. So right now you look at how corporate America, particularly a lot in private equity and private credit space, post-financial crisis, they've done really productive things with that debt. So that's categorically different than a lot of what you might see

in the governmental debt side of things. But those borrowers are now levered. The good borrowers and the good projects and the good activities to borrow money to go do and get productive activity out of, it has kind of run its course. I'm not saying there's no more activity or no more borrowers, but it's limited. There's downward pressure there. So when we look at the reality of debt and we see there's, by the way, just a ton of charts in DividendCafe.com all pointing to this. You see the diminishing return of debt, and then you see what it does

to GDP growth and how below trend line we are for quite some time. The real economic GDP growth has declined significantly. There's a lot of economic implication to declining economic growth by definition, but I've been writing for a long time that there's a lot of social and cultural implications. Real GDP growth exacerbates class envy. It exacerbates social divide. It creates kind of insane populist political movement. Does any of this sound familiar? Okay. insane populist political movement. Does any of this sound familiar? Okay. So to kind of simplify things and then let you go, I listed out in dividendcafe.com, and I'm going to run through it real quickly right now for you, the just kind of quick sequence of how this has played out and where we are in the timeline. Number one, a society lives above its means. You can talk about

Greece whenever they started doing it. You can talk about European Union. You can talk about Japan back in the 80s. You can talk about the United States, I would argue, mostly throughout the 2000s. Society lives above its means. Number two, that ends up creating excesses. It creates problems, economic hardship. And then number three, to remedy that economic hardship, the government throws more fiscal spending and the Fed throws more monetary accommodation of the problem. So you treat the problems of excessive spending with more spending.

And then number four, that leads to some periods of feeling pretty good and improved metrics, but they're not sustainable. Then number five, you see the things in number four start to soften. So that leads you to do more in number three. Rinse and repeat. You get this hair of the dog economic cycle. Where we are now is in phase seven. You find yourself societally with too much debt. That means less future growth, as we talked about, at a time when people are clamoring

for more growth. So you make up for what you can't give people with greater growth by giving them more fiscal and monetary accommodation, which was what put the downward pressure on growth to begin with. Rinse and repeat again. Then you get to number eight, which is where we are right now. Some of the unintended consequences of number seven have to be undone from time to time. You get excesses, you get booms, you get price escalations, you get distortions,

whatever the case may be. Then those reversals take place. And all of a sudden, you see different things that impact portfolios, impact economic activity. So I think we're coming out of phase seven, going into phase eight. And I don't have a phase nine for you. I can just safely forecast that number nine is going to look a lot like a reset of number three, where they go back to trying to remedy the challenges and economic growth that were caused by a society living outside of its means with more fiscal monetary accommodation. So bottom line implications, and then I'll let you go. In a secular and structural sense, you're not going to get bond yields back to historical levels. And people can say, well, the Fed's done tapering. And I put a chart in Dividend Cafe today showing

you, you had a 2.5% yield on the 10-year when they were done with QE3. And four years later, they hadn't bought a single bond and they had a ton of bonds run off. And four years later, where was the 10 year? Still at two and a half percent. That's a byproduct of other factors besides excessive indebtedness. I think that's the biggest factor. But I acknowledge there's a big demand for dollars. There is a global need for safety. There are inadequate solutions. Many other countries that don't want what their country has to offer, and they want what America has to offer by way of treasury safety and superiority. All of these demographic and economic and geopolitical and global realities put downward pressure bond yields on top of the successive indebtedness that suffocates growth. Then right now, number two, oil prices. 12 months ago, 18 months ago,

there was way too much supply and not nearly enough demand. Fast forward to today, there's so much demand, not enough supply. So you get move prices higher in oil while you have this secular environment of bond yields, but oil prices move bond yields higher. the secular environment of bond yields, but oil prices move bond yields higher. Bond yields can't stay at zero bound levels forever. So they naturally come up a bit, but they don't get back to the normal levels they ought to be because of the challenges we talked about. So value stocks like this first dimension, energy stocks like the second dimension. And this seems to be the investing

environment that I think we find ourselves in. Value stocks, energy sector, oil prices, bond yields that are going higher, but aren't going to go real high. This is kind of the macro and micro environment I'm leaving you with. I even put a chart in, by the way, of what this has meant in mortgage prices. You got really low yields. And then now there's a chart of what the average mortgage has been throughout this whole process and unaffordability at record highs. What's the antidote to unaffordability? It's lower prices. So the same dynamic that pushed prices higher, very low mortgage rates, has to reverse, ends up leading to lower prices. So I think you'll find thedivinacafé.com filled with charts to be a better graphical teacher and visual illustrator of a lot of things I'm saying today than what I've just very quickly gone through in the podcast. I'm saying today than what I've just very quickly gone through in the podcast. But this is the macro environment we're in right now. And all of the other conversations regarding what it's doing to

PE ratios and what the Fed's going to do and where gold prices are, bond yields, all of them are relevant, all matter, but they all come off of the greater macro progression of the time we're living in, the multi-decade time we're living in. It's going to basically encapsulate the kind of beginning of my adult life many decades ago, all the way through the end of my adult life, which I hope will be in many decades from now. And that is living through the economic reality of a period of a society living above its means. That's what I have for you today in the Dividend Cafe. I hope it's been helpful. I hope I've talked as fast as I think I have, and yet not so fast that you had to listen

to this podcast in half speed. Thank you for listening to Dividend Cafe. Thank you for watching the video. I'll be back at you next week from our studio in New York City. I will be back in the frozen streets of Manhattan next week. And we look forward to any questions you may have.

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