The Dividend Cafe - The Glory of Bear Markets

Episode Date: September 30, 2022

Today’s Dividend Cafe is sort of the reason the Dividend Cafe started. I didn’t call it Dividend Cafe back then, I didn’t have a website for it, I didn’t post it on social media, it wasn’t re-published on a multitude of financial websites, there was no podcast, there was no video, and it didn’t have nearly 20,000 subscribers. In fact, there couldn’t be any “subscribers” because there was no organized list – just me sending an email from Microsoft Outlook manually to clients I thought would like to hear what I had to say. And the catalyst? A bear market. The week I began doing this “weekly commentary” we were not in an “ordinary” bear market. In a ten day span Fannie and Freddie had been taken over by the government, Lehman Brothers had declared bankruptcy, AIG had gone down, Merrill Lynch ran into the arms of Bank of America, and my own firm at the time, Morgan Stanley, was in its own existential (but soon to solved) crisis. Mortgage bonds were collapsing, housing prices were utterly collapsing, and yes, the stock market was in freefall. Today I write to talk about bear markets. Not societal collapse. Not the mother of all credit implosions. Not a deep and unbearable recession (the “great” recession). But bear markets. The kind where stocks drop and investors do one of two things. We are going to talk about those two things, and I hope when you are done reading you will not merely feel better about this bear market, but even just a little bit excited (as counter-intuitive to human nature as that may be). So let’s jump on in to the Dividend Cafe, as it does what it was always created to do – present the unvarnished truth in matters of macroeconomics and investor behavior, and do so towards the greater end of the very purpose for which we at The Bahnsen Group work. 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 weekly Dividend Cafe podcast. I am your host of the Weekly Dividend Cafe, David Bonson. And I say Weekly Dividend Cafe because I've been doing it every week since September of 2008. And the topic that sort of catalyzed this weekly market commentary is the topic I'm going to talk about today. Now, it's not exactly the same. And in fact, there's some areas that are quite significantly different. But the historical context of what created this weekly communication

was the implosion of our nation's financial system that was resulting in an equity bear market in September of 2008. The equity bear market, the history of bear markets, what investors need to do about and during bear markets, that's what we're going to talk about today. September 2008 was different. We were in an equity bear market. We were at that point getting close to double one. If down 20 is bear, we were getting at that point close to down 40. But within a 10 day period, you had seen the implosion of Fannie and Freddie, the bankruptcy of Lehman Brothers, the saving from collapse of Merrill Lynch and AIG, and a lot of vulnerability that I have written about, talked about, spoken about, thought about a great deal over the years.

But back in September 2008, I started doing this weekly writing and there was no podcast, there was no subscriber list, there was no video, and the name of Dividend Cafe wasn't yet relevant. I just wrote an email in Microsoft Outlook and I sent it each week to the clients who I thought would like and need and benefit from hearing appropriate information and counsel. So we're in another bear market right now. We're not facing the implosion of the world's financial system and the violence of everything, both macroeconomically, you know, unemployment then was getting to 10%. It's right now, you know, three and a half percent. There is just simply no comparison in the Great Recession versus some of the conditions we are presently in.

And yet, bear markets are just hard. Investors totally, understandably feel an angst to see the value of underlying investments decline. And I think I take the risk sometimes of sounding callous, even though my life's mission, the entire purpose of our company exists to counsel, hold hands, provide empathy, and most importantly, actual direction, guidance, and advice through these times. But the reason I may sometimes sound a bit less empathetic than I ought is only because my conviction is so high about what people ought to do and ought not to do. And it is incumbent upon me and the advisors of the Bonson Group and the team of

the Bonson Group to never take for granted that we're dealing with humans, that human beings have emotions, have fears, have vulnerabilities. So we produce this information. We did back in 08, and here we are today with Dividend Cafe. We produce it to bridge that gap between the information that is necessary for good activity, good behavior, and the emotional starting place that is so natural and human. It's human to not like seeing the value of one's assets decline. But that humanity and that reality cannot be an excuse to do something that is totally counterproductive to one's own goals. So how do I define productive and counterproductive? What is it I'm talking about? I can't answer that without just going back to the basics as to why people invest in equities. We're talking about a bear market as a period of time when stocks drop over 20%. The S&P is now

down over 23% of the year. The NASDAQ is down 35%. And look, we're not NASDAQ investors. And I didn't put this in the written Dividend Cafe. I'll put it in DC Today on Monday. But you podcast and video listeners are getting a little bonus right now. You know what the compounded annual growth rate is? From March of 2000 to right now of the NASDAQ over 22 years, a significant portion of which were really, really, really big up years. It's 3.5%. 3.5%. Now, look, I'm totally cherry picking timing because the NASDAQ is in the middle of a 35% drawdown. And it was at a peak of a

bubble in March of 2000. So my starting and ending points are admittedly what they are. I mean, math is math, but you get my point. You then had a 70% drop before a big recovery, before another big drop, before a huge recovery. and now this drop we're in now. But my point is, we're not long-term investors in the NASDAQ. And even though I'm going to use the S&P for a lot of the points I'm going to make just to provide some historical context, we're not S&P investors either. Now look, the the three indexes I'm recording in the middle of the market day on Friday, September 30th. And so it's entirely possible things get a little bit worse. The next few hours are a little bit better.

But basically in one month, the Dow's down seven and the Nasdaq and S&P are both down more than that in one month. But my point is that the Nasdaq's buy and hold approach is not what we believe in. And even the S&P's buy and hold approach is not what we believe in as dividend growth investors. But a buy and hold approach for the S&P has been far better than it would have been for the NASDAQ based on the point I'm making. But why do, forgive the almost three minute tangent, why do investors buy stocks at all? It is to capture a risk premium. That is to say a premium in the return they'd get because of the risk they're taking. You can go into cash, which for many portions of the last 20 years was paying 0%. Over 100 years has paid about 2%.

And after inflation essentially has averaged a negative rate of return, a negative real rate for most of history. And so not only do people need more than a negative rate with inflation, but they also need a probably a higher premium just to accumulate the capital necessary for a lot of their long term financial goals. So the risk premium I talk about, what does that mean? It does not mean try to get seven, but then there's a chance you lose your money. It is a reference to volatility. The premium comes from having to suffer through volatility. And that is a two-way street. Investors won't invest in the asset class if they have to suffer through volatility,

if the return it generates isn't going to compensate them for that cost, the volatility cost, and the volatility cost is necessary to rationalize the return. That return that we talk about, let's call it 10% a year, the stocks of average for 50, 60, 70, 100 years. It isn't going to happen without a cost to it. It would get priced away and the expected rate of return would decline. The volatility is what keeps us coming back. The return side, the pain side, rinse and repeat. It cuts both ways. Now, I want to be clear, this is a byproduct of basic economics. The price of a stock is a reflection of two things,

the earnings of the companies, and the price relative to the earnings, meaning the multiple, the valuation of those earnings. And those are the two things that one is taking risk in when they buy stocks. The earnings can come down. Let's say you buy one company, not 500 companies. The company could fail. It could suffer an unexpected setback. Competition could hurt it. Consumers could not like the product or service of a company. Costs could go higher than expected. risk, but earnings are the least speculative part of what we're engaged in when we're buying public equities in a diversified and professionally managed context because,

frankly, capitalism works, free enterprise works, the profit motive works, the natural process of goods and services being produced to meet the needs of humanity, even in all the complexity and frankly, the wonder and glory of the modern market economy, this growth of earnings is the rule, not the exception. There have been very few years where aggregate earnings for diversified public equity investor were not higher than the year before. And in fact, the earnings when you go back since World War II are up thousands of percentage points relative to where they started. And yet we've had 13 bear markets, the 13th being the one we're in now since World War II. Bear markets are very

common. Profit growth is extremely common. But it is the second component that I think provides more lumpiness to that experience, that volatility of an investor. And that's the price to earnings ratio, the valuation, the multiple, there's different synonyms, and I use all of them. And I just want to make sure you know what I'm referring to. And so I've made a kind of investing career out of trying to minimize my reliance on the second one and focus more on the first one. I believe we can fundamentally analyze and understand earnings and that there can be mistakes and setbacks. But I think P.E. ratios are blowing in the wind. I have never known anybody that is able

to calculate effectively when P.E. ratios will go higher and lower. They are driven by certain degrees of fundamentals in interest rates, inflation expectations, growth expectations, currency, macroeconomic circumstances, geopolitics can all impact P-E ratios. Those are all pretty hard things to factor, but again, they are in the fundamental range. But see, all of them put together don't impact PE ratios as much as the thing that is totally unreliable and predictable and forecastable and analyzable, that is sentiment. That is public mood. There's a company called Beyond Meat, and I don't have any opinions on the company. I don't have any opinions on their product, although I guess I do, but I won't share those. But the fact of the matter is, it was a company that was trading at 940 times earnings three years ago.

Okay, something like a $16 billion market cap on a company that that year made $17 million of profits. Now, 940 times earnings, the stock price is down 94%. What am I referring to? I'm referring to public sentiment driving something very, very high and public sentiment driving something very, very low. And those are extreme examples up and down of valuation being entirely about a sentiment-driven dynamic. I don't believe that we can time, game, or forecast sentiment. But sentiment is what pushed up the stocks of March and April 2020, the COVID moment where people thought that everyone was going to behave that way and shop that way forever, that the dynamics of what you're doing when you're locked in your home were going to be the same as when you weren't locked in your home, as if somehow we were never going to recover our freedom. So there were two mistakes made. There was running it up. And then there was now, I suppose, in some of those cases, the possibility that some have been overrun down. But because the valuation is disconnected from the reality, up and down movements become impossible to calculate. And it isn't something I have to worry about getting caught in one way or the reality, up and down movements become impossible to calculate. And it isn't something I have to worry about getting caught in one way or the other because it's just not what we do and

not what we believe in doing. The difference in the bear market we're in right now as we come upon the end of the third quarter is different than where we were earlier in the year when I was obsessing over shiny objects. There was a sentiment-driven correction of stuff that was excessively and euphorically priced coming back to reality through the process of investment gravity. Right now, the bear market has impacted now everything. The Dow may not be down 20% yet, but the Dow was down four or 5%. It's now down, I think, 17, 18. S and P, which is far more than just shiny objects has come down a lot. Even some of the big tech names, there were a couple that were down a lot, but a couple that weren't now those have really gotten hit hard. So there has been a very significant

democratization of the pain in markets. And that's what a bear market does. Eventually, it starts to bring down everything, but some things less than others. And I think that's very important. But the reason I bring all this up is to say that the bear market volatility, which is generally what happens either in a valuation correction or a recession or both, is the name of the game in equity investing, that by accepting the possibility of downside volatility, one generates longer term returns. So you say, well, look, okay, but there's fundamental things. We know the Fed's raised rates. We know recession's either here or coming. Why not just get in front of it, go to the sideline, come back in? And I think that sounds like a great idea other than this little problem. Markets have never, first

of all, given you or me an instinct or information that it didn't give everybody else. So what one does in those cases is try to invest with the herd and not against it. And that has never ended well. And then the fact of the matter is that markets confound people trying to be their most intelligent, pessimistic selves by rallying far in advance of actual improvement because they price in what will end up being the corrective mechanism, the eventual Fed reversal of policy, the eventual reversal of underlying conditions, how high prices solve for high prices or low prices solve for low prices, or valuations got too high so they came down, but they also get too low so they come up. There's a number of these factors that happen in the real world, and they happen in a certain real time,

but markets are not going to respond to the real time. Markets are discounting mechanisms. And this is the painful reality that first of all, those trying to cheat the rules of the game of bear markets by being in and out, they miss the recoveries that mathematically a significant portion of which comes very quickly. And so you effectively, to try to miss 10% of a 20% downside, can miss 50, 60, 70% of a 100% upside. It happens over and over and over again. I have more stories to tell than you would even believe.

So you say, okay, well, you're just telling me I got to ride it all out then. But see, I'm not even really telling you that. I do think index investors have chosen for themselves a life of riding these things up or down and things get too expensive and they're in them and they can come way down and they got to ride it out. And that's fine. But to me, I'm saying something different when it comes to dividend growth investing is that you're benefiting from it. You're benefiting. If you're an accumulator of capital, these bear markets in which certain companies are continuing to grow their dividend, and when you're reinvesting those dividends in the accumulation of more shares, you are genuinely goosing the compounding of long-term returns it's mathematical and it's

glorious and it doesn't feel like it when it's happening other than you truly intellectualizing what is happening which is very hard for humans to do because we are more feeling creatures than we are thinking creatures and we're all uh guilty of that. And I don't even know if I should use the word guilty because it implies something bad. It's just what it is. It's how we're wired. It's human nature. But no, intellectually, what I'm saying is true, that for one who doesn't need the money in the short term, and one should not be in these assets if they do need the principal money in the short term, that long term, you are significantly increasing your expected rates of return to the reinvestment of dividends through these periods of time. Now you say, okay, but I'm not

an accumulator capital. I don't have long term. I'm withdrawing from my capital now. I need it for retirement or this or that or the other. And in that scenario, I would say your dividend withdrawals are not going down. They are going up. So you are actually not being jeopardized in your financial goals through the change in price of underlying investments. I don't know that this needs to be just a general commercial for dividend growth investing. I do that exhaustively. I make the case sometimes with a lot more granularity, sometimes more high level. But my point is, because my clients are dividend growth investors, our clients of our firm, that the bear market is actually not only something that I want all people to have a historical understanding for and appreciation

for. There have been 13 of them. The average has lasted 367 days. So last I checked, that's a year. The average has lasted a year, but the one that started March of 2000, and when I was in a younger stage of my professional investing life, it lasted almost three years. Now the COVID bear market lasted 33 days. Okay. So when I say the mean that, uh, the median, rather the average, um, that we're referring to is basically a year and they can be much longer, much shorter. And that's why the mean and the median are a little different here. Okay. I want, I want you to understand that the bear market we're in now could very well last longer and it could very well end quicker than people think because the whole thing catalyzing this bear market is riddled with

uncertainty. There is not clarity on the depth of where the economic distress will go. One does not have to say, well, if you're telling me to guess that we're going to be in recession or not, I know we're going to be in one, so no, it's bad. The problem is that's not what I'm saying. I think most everyone believes that we're going into some form of a recession if we're not in one now. The question is the depth of it, the length of it, The question is the depth of it, the length of it, and the level of pricing for it that has already taken place.

And I'm sorry, but no one knows any of those three and certainly not the last one. And therefore, the upside risk, especially when one attaches to the current bear market, the reality of the US dollar, and I put a chart in Dividend Cafe today. When you see how overstretched the dollar is and what that has meant, people generally flee to dollars when they're going to cash and they're going into treasuries and things as a safety escape. And when it has gotten overstretched, what that has meant, it has gotten overstretched, what that has meant when the dollar reverts to the mean and what kind of equity recovery you generally see very quickly, it's something else. So I just hope that the broad based understanding of bear markets, why they happen, what they mean to investors who are just playing in the rules of the game, trying to capture a risk premium in exchange for volatility.

I hope you will understand that within dividend growth, there's opportunity to benefit. Within dividend growth, there is the ability for a withdrawer to be totally insulated from an actual, functional, material, practical pain actual functional, material, practical pain that you can simply maintain your financial objectives and quality of life and cash flow needs regardless of the underlying asset. And that this too will pass. That you are dealing with markets that are up thousands of percentage points and earnings underlying those markets up thousands of percentage points, despite not one and not two, but 13 bear markets. In my professional investment career, not just merely as an adult and as an investor and as a human, but in the time that I have been paid to manage other people's money, this is now the fourth bear market I've lived through and many

other corrections and downtimes along the way. And like all of them, we will look back on this and some will say, wow, I really made a lot of money out of that bear market. And some will say, wow, I didn't make money out of the bear market, but I really did the right thing by not letting it hurt me worse. Others still listening to this or really not clients of ours may come out of it with a lot of regret. I'm asking you not to come out of this bear market with regret. It's difficult to go through while you're going through it, but I will say that the hindsight of bear markets has been overwhelmingly

positive when we put into practice these things I'm talking about, implement them, execute the right way. Thanks for listening to this message. Reach out with any questions. I hope that you will feel free, if you're a client of our firm, to take advantage of your advisor as a sounding board. Get the information you need, get the perspective, get the support, empathy, hand-holding, and whether it be on the emotional side or intellectual side, I really don't care. This is what we're here for. Thank you for listening to and watching the Bonson, excuse me, the Dividend Cafe of the Bonson Group. We're going to keep doing what we're doing. I guess I'm tired. Time to get back to work. Take care.

The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, member FINRA and SIPC, with Hightower Advisors LLC, a registered investment advisor with the SEC. Securities are offered through Hightower Securities LLC. Advisory services are offered through Hightower Advisors LLC. This is not an offer to buy or sell securities. No investment process is free of risk. There is no guarantee that the investment process or investment opportunities referenced herein

will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein Thank you. is provided as general market commentary and does not constitute investment advice. The bonds to Groupon Hightower shall not in any way be liable for claims and make no expressed 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 Bonson Group and do not represent those of Hightower Advisors LLC or any of its affiliates. Hightower Advisors do not provide tax or legal advice. This material was not intended or written to be used or presented to any entity as tax advice or tax information. Tax laws vary based on the client's individual circumstances and can change at any time without notice. Clients are urged to consult their tax or legal advisor for any related questions.