The Dividend Cafe - The Lessons of Anti-Money

Episode Date: March 5, 2021

Everything is about the Fed, bond yields, and inflation right now.  Sometimes I mean that as if I am describing what really does matter, and other times I am just describing what "all the rage" is about.  "Everything is about" may mean what "everything is about," or it may mean what "everyone is talking about."  In this case, we have the weirdest of circumstances where "everyone" is talking about the right thing, but doing so in the wrong way.  Allow me to break through some of the ambiguity. On a daily basis you will find media reports expressing shock and awe about a 10-year Treasury bond at 1.5%, and it's fair enough to note the speed with which yields have moved in recent days.  But the coverage really has an implicit message in it that I believe needs to be shunned.  And as is always the case it seems, getting to my destination requires a few detours along the way. 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. Hello and welcome to this week's Dividend Cafe podcast and video. I'm David Bonson. I'm the Chief Investment Officer here at the Bonson Group, and we are doing something really very, very different this week. I think it is almost every week that I'm sitting here in the chair telling you how in the weekly dividend cafe, the written commentary that I've already done, I have this or that, and then I'm

talking to you about some part of it. In this case, I'm actually recording this podcast on Thursday afternoon, a few hours after the market is closed. And I won't complete writing the weekly Dividend Cafe commentary until Friday morning. It is substantively written. It is sort of outlined and structured in my head. But I, first of all, from a meeting schedule standpoint, I'm not sure I'm going to have time to record tomorrow morning after the written is complete. And I have done the part already that I want for your purposes, for the listeners of the podcast, the watchers of the video. I'm in the place I want to be to be able to deliver the message. And so who knows what happens between now and my finality of writing

could end up being a totally different product this week. But no, I mean, I pretty much have the track. It's just I'm doing it in a different order than I normally do, and we'll see if you notice a difference if you're used to consuming both the written and, of course, this podcast. What I'm going to talk about right now, if I haven't lost your attention already, is this thing that has become sort of a singular topic for purposes of the media.

For an awful lot of pundits and those that are making their living talking about the market, it's become a kind of singular topic and it is all the rage right now, which is the subject of what the Fed's doing or not doing about what inflation is or isn't and how it is or is not impacting bond yields. And these things are sort of thought of as this kind of singular topic that is right now the great unknown out there. You know, if bond yields stay low, then stock prices can continue doing well. But if inflation is going higher, then bond yields are going to go higher, and that could derail stocks.

And of course, at the heart of all of it, the hub of all of it, in the middle of all of it is the United States central bank, known as the Federal Reserve, that has decisions to make about which way it wants to go. So when you hear either Fed or inflation or bond yields, right now they're talking about the kind of combined subject of all of them. And it is presented as the source of equity market volatility. It is presented as the great question mark as to what's going to happen in the economy. and can the fed sort of thread this needle to keep a kind of goldilocks scenario going not too hot not too cold and everybody lives happily ever

after um there's so many problems with this thesis and so many problems with the narrative that is being portrayed uh in the media and in, a lot of other places that should know better, that I feel compelled to talk. And these are my favorite things to talk about, because if I don't feel compelled to talk and I'm talking anyways, it probably means that I'm, you know, not talking nonsense, too. For the most part, I'm only in this chair talking if I feel compelled, and this is a topic I feel very compelled to talk about. I want to start, I've printed out here from my kind of self-directed outline in Diven Cafe, a summary of what the kind of belief system is out there. I'm mostly just going to reiterate what I just said. The Fed has moved

to hyper low rates because of the extreme circumstances of the COVID moment. Fair enough, by the way. The economy still needs help and the Fed wants to give it. And bond yields are moving higher because of fear of inflation, which is leaving the Fed in the tough position of having to decide if they want to let inflation overheat while they fix the economy or taking actions to control inflation that may damage economic recovery before it's complete. So that's sort of what the message would be. Therein lies the rub. Oh, the economy does need help. That's a given to them. the rub. Oh, the economy does need help. That's a given to them. The Fed really wants to give that help and can give that help. That's a given to them. But they're in this tension point as far as where they are with a risk of overheating and what the Fed might need to do to either

accelerate or tap the brakes, etc. So there's a number of implications to believe that kind of approach to what's going on in the marketplace right now, what's going on in the economy of those three points I just gave. What's implicit in them are these eight things. I'm going to go through very quickly, and I'm going to tell you what I think about these eight things. And we're going to have some fun with this, and we'll go on from there. Number one is that the only reason for accommodative monetary policy from the Fed is the challenge of the COVID moment. That the Fed has to be abundantly accommodative through easy monetary policy because of the economic challenges from COVID. That those challenges are in the economy

and that the economy is in need of help, not just merely in March of 2020, but in March of 2021 as well. Number three, that the Fed can help the economy. I mean, you wouldn't believe the other things if you didn't believe the Fed had some power to do something about it. Number four, that bond yields are moving higher because of inflation fears

instead of natural growth expectations. Number five, that growth equals overheating. Number six, that the Fed has knobs to turn to decrease inflation. Number seven, that the Fed has knobs to turn to increase inflation. And number eight, that the knobs the Fed has to do whatever they're going to do are all a matter of human wisdom and power, namely the Fed's wisdom and power. So the reason that I want to suggest to my clients and other investors and interested parties that are listening to this podcast, the reason I want to suggest that the whole narrative about the economy and markets right now is wrong, is at least different than what is captured in those three points I already went through, is because all of the implicit beliefs that I am saying underlie them, every one of them is either wrong or incomplete or misunderstood. And this is what we have to kind of go through.

It is a matter of opinion as to whether or not the economy needs help. There is plenty of data that tells us where there are still weaknesses and contractions and vulnerabilities in the economy. One does not have to believe, though, that the economy needs help just because one acknowledges that unemployment is too high for the low deciles of income earners, one could believe that there are theoretically, they could be wrong about this, I'm just saying it's a potential explanation, one could believe that the economy itself has self-correcting mechanisms that are likely to restore wages and jobs quicker than interventions might, particularly monetary interventions in this case. In fact, one may also believe that some of the monetary interventions impede the progress of economic

restoration. Now, it's not our job right now today, it's not my job in this very moment to settle that, but I'm happy to tell you I do believe that there are likely more unintended consequences that come up from these interventions than there are quick and easy resolutions. But the point is that an assumption, a assumption like that need not be taken at face value. There are other sides to it that are acceptable in this kind of conversation. But the part that is just simply dead wrong and does matter is A, the bond yields are moving higher because of inflation fears instead of natural growth expectations. The fact of the matter is that the implied inflation expectations and tip spreads has

grown and has grown very little. It has grown something less than 100% of the amount yields have gone up. less than 100% of the amount yields have gone up. So a portion of yield expansion can be attributed since the COVID moment to inflation expectations, which were negative at one point, and a portion to growth expectations, which have expanded as you would expect the economy to do when it goes from being fully locked down to not being locked down. when it goes from being fully locked down to not being locked down. But the problem, as I've talked about in past weeks, that economists have now,

is that they are unable to distinguish between productive growth and non-productive growth. And there's too much of a school of thought that still continues to operate under the belief that all growth is inherently inflationary when it is not. So I don't believe that the assumption that bond yields are moving higher can be or should be interpreted as necessarily implying additional inflation. The fact of the matter is that one could easily believe when you're talking about a 10-year treasury at well below 2%

that it's just simply pricing in some nominal degree of growth still in a highly disinflationary environment longer term. It also does not mean that growth is overheating. does not mean that growth is overheating. Overheating and 1.5% tenure don't seem to me to be synonymous. And so I think that the idea like, well, the Fed is in a pickle. What are they going to do? Because the growth, the inflation overheating dynamic, those are not the facts on the ground. Therefore, they're not the tensions that have to be solved for.

That's what I'm trying to get to, is get back to what is actually relevant right now in markets and try to deconstruct the thesis that has got us to where we are. But if there's anything more practical than this, I don't know what it is, as far as what I want to talk to you about today. And that is the issue of the Fed having knobs that can turn up inflation if they want and turn down inflation if they want. So much of this, and this is really a lot more of the kind of deep dive stuff that's going to come in the written dividend cafe. So much of this comes down to the very nature of money. What is money? Where does it come from? And if you believe that money comes from the Fed creating more cash that can be deposited,

then the banks having more deposits that they can then go lend out, and that creates this sort of appetite for economic activity, your first mistake is in the basic premise that money comes from the Fed. Ultimately, money is only created at the point that a bank lends it out. created at the point that a bank lends it out. It is not us depositing money that then the banks can go lend that creates this potential cycle of additional inflationary pressures. Money comes when a bank lends it out and then it becomes a deposit in the other party's bank account into a household or a business and now there is new money in the system and unless that household or business pays down for their debt because when they do they've they've exterminated that money it's gone away so no there's no new money stock.

You follow me? If they then take that money and go invest it in something else, spend it in something else that gets deposited elsewhere, then you see this velocity, this activity, this economic chain of events. But notice what started all of it is loan demand. And this is the singular thing that Japan has learned for decades. And it's the singular thing that we're dealing with now. There's all kinds of buttons the Fed has to try to marginally impact, manipulate, affect, intervene. And I think their motives

on all of it are good. That's where I'm an interesting Fed critic in this sense. I don't believe they're doing it because they're awful people. There's so much Fed criticism that's irrational that treats them as if there's this sinister thing going on. I simply believe they're trying to do something with the limited tools they have that they are only limited in what they can do, where the rest of the world is treating it as if they have all these things on a string, that they have knobs that can totally control the increase of inflation or the decrease of inflation

when they have no such thing. Because before they can go circulate money in the system and have an impact on inflation, there has to be loan demand. When I want to do something in the economy so much that I borrow money, so then there is a deposit made into my account because they have given me a loan. So it's an asset from the bank and it is a liability for me, but there is cash that offsets the liability that I go then and deposit elsewhere as I'm

buying equipment or buying a home or doing the different things I'm doing. So much of this excess money that's been created has only found its way to investment assets, either real estate, stock market, really speculative things. stock market, really speculative things. But the loan demand into the economy for new projects, for new innovation, for new businesses, for the things that actually create wealth, that loan demand has been so constrained and therein lies the rub.

The Fed has no knob for creating organic demand. They can try to stimulate credit. They can certainly make credit available. They cannot really get reserves lent out. They can't control the level of reserves. They can control excess reserves and they can control the price of reserves at the banks through interest rates. You follow me? But those are marginal applications on what ultimately drives the economy, which is the supply side. It is people saying, I want to go produce something. Those incentives for production drive economic activity. Right now, we're talking about all these things as if, well, the Fed's got to look at data

and decide, do they want to do Operation Twist, or do they want to do yield curve control, or what are they going to do about a 10-year at a whopping 1.5%? All of those things are a distraction. We have to get on the other side of COVID. We have got to get the economy back to normal and then evaluate what the real productive capacity and appetite is in the economy. Because we got out of the financial crisis and we had very limited loan demand. Plenty of people delivered as they needed to. You can't have demand for new loans when you're already over-borrowed.

Therein lies the rub. What's the number one problem for getting economic activity going from loan demand? It's when there's already too many loans or too much debt, right? This is the issue that we live with, is an over-levered corporate sector and an over-levered government sector. Thank God, unlike 2008, households are not over-levered. That's a tremendous difference right now in this COVID moment. It's why there's a healthy consumer. And other than the bottom decile of wage earners who have been killed by lockdown policies, you more or less have a pretty healthy economic system that's helped get the stock market up to where it is. That's gotten consumer spending back. And then once you have services reopened, hospitality,

travel, leisure, food, beverage, you're going to get a lot, I think, of that activity going again. But in terms of what the Fed can do here, I think they're very limited. And that's not because they're unwilling to pull a trigger or they've done something bad or they're going to do something bad. It's just the limitations that they have in the economy. Now, this is not the same thing as me saying that everything they're doing is a total waste of time. I'm more making a distinction between marginal inputs and interventions and the heart of the matter. And it bothers me that we spend almost all time on these marginal inputs versus the heart of the matter, where I believe the heart of the matter is the organic economic appetite that comes from the productive capacity, the incentives to go produce, that drives economic growth and it always will. Now, is there such a thing as the Fed doing something counterproductive?

joke from, gosh, how long ago is this now? Over 25 years ago, when I was a much younger man, and me and my buddies, all of us were single. We got to Vegas for a little weekend trip or overnight trip or things, play some tables and have fun. And I made up this expression anti-money. And what I meant by it was that moment in which you don't have chips left and you don't have cash left. You've lost at blackjack or craps or whatever you're playing. And all you have left is the ATL withdrawal slips or your credit line withdrawal or credit card or whatever you've done. And that paper just sits there as the anti-money, meaning the opposite of having winnings. This is where I believe we are right now as an economy is that quantitative easing an economy is that quantitative easing and some of these really accommodative tools that the Fed has offered to help in emergency situations, in non-emergency situations, it's not just

that they're not money, and they are not, it's that they become anti-money. They rob the economy of good collateral. They rob the economy of good collateral. Treasury bills, treasury bonds that they're buying $80 billion a month of, that they already own $5 trillion of on top of another $2 trillion of Fannie and Freddie. That's the type of collateral that serves as collateral for other lenders, other credit providers. When that is being held by the Fed, it's not circulating and that's all fine when it's not needed. But when it's needed, there is a shortage of collateral that can stimulate credit activity, anti-money. The quantitative easing though is needed in the Fed's mind because they're trying to keep rates down and affect monetary policy to get to the unemployment target that they have.

So this is the problem, is that one of the things the Fed is doing is having the opposite effect for another part of their objectives. It destabilizes the economy. I believe it's all well and good right now when we're not in a crisis, but when bad times come, all of a sudden it exacerbates the issue. And I don't know what the resolution of the tension is. And even if I did, I'm not sure that's really my point to kind of use Dividend Cafe for me to coach the Fed or what David Bonson would do. I don't think you care what I think the Fed should do, and I certainly don't think the Fed cares what I think they should do. But it is to make the point that we have this view of the Fed right now having to decide which way they're going to move things as if it's that easy.

You know what I mean? Like a football coach has to decide if they're going to call a run play or a pass play and what's the Fed going to do. But the reality is sometimes there's a blitz and there's a defensive call made that totally just changes what you're able to do with the line of scrimmage. I don't know if that analogy works or not because I literally just made it up right now as I was talking, but I think I like it. It is kind of the point I'm making. The Fed is not sitting here trying to decide what they're going to do about inflationary pressures. The Fed is taking actions to solve one thing, but then those actions they take are creating another problem. And then they have to kind of solve that, go back the other way. And it's this kind of whole issue. And what does it mean for investors? And here's my conclusion.

It doesn't mean inflationary economy. It doesn't mean a disinflationary economy. It doesn't mean we're going to get growth or it doesn't mean we're not going to get growth. It means that we get put into a boom bust cycle. That they create a sort of permanent instability. There's anti-money because of the quantitative easing dilemma. There's a dependency on credit.

They can't solve the real thing that needs to be solved, which is that issue of loan demand and organic economic productive activity. And everything they do while they beat around the bush of not being able to solve the big thing invites other problems. And so the impact is felt in the fact that we end up having big boom cycles and big bust cycles, rinse and repeat. That's my view of where we are right now. And I think it's a byproduct of the Fed responding to the conditions that exist. Where does this leave investors?

Back to the thing I've been talking about week after week, is if you believe you're going to be in a boom-bust cycle, you first of all either believe you will time it all perfectly. I'm not going to even entertain that as a plausible scenario. Or you believe that you have to do something to capture the right risk level in your portfolio, that you have to capture the right level of quality in your portfolio to manage the risk, to manage the instability that is invited into your investment assets by the destabilizing

reality of monetary policy. That's a mouthful this week. I get it. I really encourage you to reach out with any other questions. I get it. I really encourage you to reach out with any other questions. To the extent that the podcast or the video has left you now with more questions or desire to have more things clarified, read DividendCafe.com because now that I've gone through this verbal exercise, maybe the final written form will hash out some of the stuff even better.

And then certainly feel free to reach out to me because I think this is the times we're living in. And I don't expect that this narrative is going to go away anytime soon that allegedly we have this huge problem of inadequate economic activity or we have this huge problem of too much economic activity. And then what's the Fed going to do? We really do need to understand the flaws in the narrative better, and then as it applies to our investment solutions, it really does come down to trying to be removed from the boom-bust reality that we're living in.

I hope that's helpful. I certainly appreciate you listening to Dividend Cafe. By the way, it's been a while since I mentioned it, but I'm very happy anyone who'd like a copy of the book Case for Dividend Growth, which is the book I wrote on this subject, just simply write us a review of our podcast. You don't have to write anything out. Just go do the stars. I don't care. Give it one star if you hate it. Give it five stars if you love it. I'm not looking for a good review, but just any kind of activity there, that's your ticket to copy the book we'll send off to you. Send us an email. Thanks very much for listening and watching the Dividend Cafe. 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.

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