The Dividend Cafe - The Most Political Dividend Cafe Ever

Episode Date: September 27, 2019

Topics discussed: With the trade war still front and center in the global economy, earning season three weeks away, and continued questions about the Fed’s plans floating around, why did all market conversations seem to slip into the background this week? Oh yes, the perpetual reality show that is Washington D.C. took over the news this week, and it has led to maybe the most political Dividend Café of recent memory. Now fear not, there is ample coverage of U.S. economic health, monetary policy, and the investment issues near and dear to your heart, but some extensive political-economic commentary is warranted this week. So jump on into the Dividend Café, and we’ll do our best to offend no one, or everyone. Mandatory Fed Discussion An economic reality check Summary of the economic outlook Are households vulnerable to equity prices? Small-cap warning Big word jargon to describe Fed failures Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Well, hello. Welcome to this week's Dividend Cafe. My name is David Bonson. I'm the Chief Investment Officer here at the Bonson Group, giving you our weekly market commentary. I hope you got a chance to listen to our podcast earlier in the week with myself and my investment committee talking through some really fun stuff around index investing and the role that index funds play in the overall stock market right now. But rather than go real granular into a single topic, I'm going to just sort of talk, as I do each and every week, about the overview of things in the market right now. And this week is an interesting one because the trade war is hardly resolved. Fed future

action clarity is hardly apparent. And yet neither of those things are sort of dominating conversation around markets. It's a move to an entirely political frame of mind. And so, inerrantly, the economic commentary this week, market commentary, requires a bit of political dialogue. My political commentary on things is not necessarily going to be punditry in the political side, but rather commentary on the economic and market side and where some of these political dramas play out for investors, things that we ought to be looking for, and also kind of maybe rethinking a bit. So let me just hold you in suspense there. For those who don't know, because you were kidnapped about a week ago, thrown into a closet, around a telephone call that the President of the United States, Mr. Donald J. Trump, had with the President of the Ukraine in late July,

and some controversy around what may or may not have been said or may or may not have been implied on that telephone call. And essentially where we find ourselves is that Speaker of the House Nancy Pelosi on Tuesday of this week said that they were officially opening a House impeachment inquiry. I will both state the non-news of that and the news of that. Obviously, it's newsworthy because it does seem rather clear to people that they, A, intend to bring it to an impeachment vote, and B, have gained a lot more votes on the Democratic side of the House for this than they have had all along, ever since the whole Mueller report released. The votes have just simply not been there or anywhere close to being there. And now, obviously, that impeachment movement in the House is rather significant. Now, the non-news of it is that it's an inquiry and, you know,

they've kind of bettered an inquiry for three years. I don't think that anybody was under the impression that there were not all along, not just informally, but really very formally and specifically and obviously media savvy and whatnot, various inquiries into the idea of impeaching the president. So now, is there more meat on the bone with this one and so forth? I'm not going to delve into all that. I have my own opinions. You have your own opinions. I am not really convinced that very many people's. I have my own opinions. You have your own opinions. I am not really convinced that very many people's opinions themselves have changed around anything. I think

that if one disliked the president before this week and felt he was not fit for office, that they feel that even more so now. And if one was a real significant supporter and cheerleader of the president earlier than this week. They probably are even more so now. And I do think there's a significant part of the population that's probably exhausted by the whole thing, but I don't really have a read as to whether or not their exhaustion and their fatigue is something that they blame the president for or the media for or the Democratic House for or all the above or whatnot. That, I guess, has some pretty big political implications. But what is really interesting is why the market doesn't care about it. OK, so they announced it, the inquiry Tuesday morning, and then the White

House released the complete, total, unredacted transcript from this phone conversation on Wednesday morning. It more or less showed what the president had kind of indicated it was going to show. And again, how you interpret it, I think, was largely driven by the lens through which you happen to look at the president in general. And the market was down about 150 points early on Wednesday morning. And then by the end of the day it was up 170 points. He had a 300 and let's call it 325 point swing. That doesn't sound like the type of thing that is spooking markets or creating a lot of elevated volatility.

As I'm recording here in the middle of the day Thursday, we are right now down about 80 points in the Dow. So not a real significant downside number here. The VIX, the so-called measurement of fear volatility, is still sitting in the mid-16s. And so there's a lot of stuff on my screen that's up today. There's certainly some more things down than up overall, but that's kind of where we are. Why would markets not care? Because the markets, I think, are priced on earnings. If anyone is able to connect this drama to the earnings outlook of America's top companies, I'd like to see it. But does that mean the story ends there as it pertains to investors?

There's a big political story, big political drama. We don't know how it plays out. Does this hurt President Trump? I imagine on the margins it will. Does this hurt Vice President and presidential candidate Joe Biden? I imagine it hurts him significantly. Not on the merits of the story necessarily. Perhaps though, okay, I'm not ruling that out. I'm simply saying this is a story that in theory has a lot of negative stuff attached to it for both incumbent President Trump and presidential challenger Biden. And therefore, politically, there's really no way to conclude that this is not a really good week for Elizabeth Warren, the senator from Massachusetts who has been climbing in the polls and by a number of metrics has taken a slight

lead over Joe Biden in Iowa and New Hampshire and some of the early states. The betting odds for whatever those are worth as of Wednesday end of day had skyrocketed to over a 50 percent chance that the House would indeed impeach. I actually think that seems pretty low. The Dems right now have the votes. Now, they only need a majority vote in the House for articles of impeachment, but then it goes to the Senate for conviction where you need a super majority. And that's why the betting odds have it as only a 19% chance as of last night, as of Wednesday night, that the president would actually be leaving office in the first term. So what seems to be getting priced in out

there is that, yeah, it looks like there's a much better chance now that they're going to end up impeaching at the House, but a very low chance that it's going to result in some sort of removal of office. So where does this benefit markets? Well, here's a contrarian view I'll share with you. I think it makes the president even more desperate for a China deal. Okay. I will leave it there. You can draw your own conclusions out of that. I think it makes it more likely that the president gets a China deal on the trade front. Now, it also hurts NAFTA 2.0 from passing. You'll recall that that requires congressional approval. It is a trade treaty that has to go through the Congress. The China trade deal would be an executive branch action. So it is entirely possible,

it would be really hard to get legislative compromise with a group of people in the middle of trying to convict you of high crimes and misdemeanors. And yet it's also very likely to be politically beneficial to the president to be able to say in some of those Rust Belt states that want a NAFTA 2.0, that the Democrats in the House impeded getting that done, a bill that they are mostly all supportive of, including Speaker Pelosi. So I would be watching this in the present tense around the trade ramifications, how it moves the needle with China, how it moves the needle with NAFTA 2.0. And then you've heard my comments on how it potentially helps Senator Warren. But does this give us some better indication of where we're going to be in November of 2020? It most certainly does not. I think there's a good case to be made that this hurts the president politically. There was a best case, kind of some gray area stuff that took place.

But the markets right now are well aware of a reality I'm sharing with you, which is that there is so much time and so much more drama to come, some of which could be beneficial presence, some of which could be damaging the president, that this thing is just going to have to kind of play out. And you look back to where we were when the Mueller investigation was announced and what a dud that was for the markets from day two, because day one, the market dropped and then day two rallied right back. But from day two, the announcement of that investigation, all the way till the kind of full, full, full conclusion, markets never cared, never cared, never traded around it, never,

what have you. Now, here's the thing. If you can do your very, very best to be apolitical for a second and put off whatever glasses you look at this through, the reality is that there is something in this story for everybody. There are some things that don't look good or what the president may have said, and there is a real difficult case to make that it actually is black and white, high crime misdemeanor, more than likely what this will result in is an entrenchment of both sides already held positions. And then you go to the political risk of impeachment,

where he won't end up being removed from office. And the market likely believes that the risk is against the Democrats in that the public does not like the idea of impeachment, let alone with how it would fall into a presidential election year. I think a lot of people out there might believe that maybe the president, the public ought to determine whether or not presidents fit for office into a second term. Now, that has nothing to do with my beliefs on the merits of it or lack thereof or what have you. I'm just simply saying how I see the markets interpreting all this. You know, wherever Trump kind of nets out of it, it leaves Joe Biden bruised to some degree because he's kind of stuck to it a little in the insinuations and the existence of scandal with his son and things of that nature.

And that's why I talk about Elizabeth Warren, who, again, was already climbing in the polls anyways. So I think you're going to enter 2020 with a huge unknown around the presidential election outcome. There will be betting odds that continue to say, investor surveys that continue to say they believe President Trump will be reelected. There will be a lot of polls that indicate he will not be reelected. And the best thing for anyone who's paid any attention to any of this for the last several years to do is assume it's a 50-50. If you really want Trump to be reelected, you might say, no, no, no, it's 60-40. And if you hate him, you might say it's 40-60. But, you know, you're not supposed to form your forecast on your aspiration. All right?

Like if USC was playing the Dallas Cowboys, I may really want USC, or let's say the New England Patriots, because I'm actually a real big Cowboy fan too. And I just lost some listeners and I don't even care. listeners and I don't even care. But I may very well want USC to beat the Patriots, but that would not cause me to say that they have a 51% chance of doing so. Okay. So the point I'm making is that objectively, it seems reasonable from the vantage point of how you position a portfolio and how you kind of think about the political environment to assume that we're going to enter 2020 in a sort of 50-50 situation. There's pros and cons politically for all sorts of different outcomes. It'll be easier to handicap things when the Democrats have a lower, smaller field and indeed an actual nominee. And there's the possibility that they don't get a clear-cut nominee

and that they go all the way to their convention. It's also possible that there ends up being a nominee, including one who's not going to be very friendly for markets real early on. So we deal with that as we deal with it. I'm going to cut off the politics and money section there now and move on to some other things I want to talk about. Reach out with any questions you have around that. One of the common questions will be someone saying, OK, well, David, that's fine. Let's assume, though, right now, 14 months ahead of time,

that Elizabeth Warren is going to be the president and she is advocating for a wealth tax, for free college for all, for student loan forgiveness, for slavery reparations, for significant entitlement spending, and a really belligerent stance against corporate America and against our nation's financial system? How in the world could we want to maintain a neutral investment posture around it? And the answer, of course, is that you don't make a decision in September of 2019 about what might be actuated in January of 2021. And if indeed all of the negatives are out there and you get an outcome that could be very detrimental to markets and in the presidential selection, you don't have enough information to know anything. Because a Republican majority Senate with President Warren or a House that is 50-50 or 52-48 is very different than maybe a Democrat majority Senate, a 60% majority Democrat House instead of 51% or 52% and a President Warren. So the magnitude of

where things go and the total unanimity of partisanship would matter versus the mostly divided government we've had for quite some time. The period in which we had a president that brought some concern to markets early on and had a pretty big majority in the House and had Democrat control of the Senate, almost 60 votes worth, was the 2009 and 10 period of the Obama administration. And they did indeed pass the Obamacare legislation, the Dodd-Frank legislation, regulation on the banking system, and they passed the stimulus bill. And yet bouncing off of the financial crisis bottoms and led by an extraordinary amount of Federal Reserve stimulus, both 29 and 2010 actually ended up being positive years in the market.

Then you ended up with the Republicans dramatically taking the House back going into 2011 and chipping away substantially at the Democrats' lead in the Senate and eventually taking the Senate a couple of years later. And so you ended up with real divided government for six of the eight years of the Obama administration. By the way, you could end up with a 52-48 Democratic House and still have all the stuff that President-elect Warren may want to do, never have a chance of getting passed, which is what I would suspect, even in a worst-case scenario. That representative government that has to be reelected every two years with the House is not going to vote for some of the more extreme measures in that policy agenda. There's a lot more that needs to be said

about it. Someone really ought to write a book on the subject. But what I will tell you is that here and now, it is impossible for someone to form investment policy out of something that is 15 months out and even in 15 months has a number of gray area variables to look at. Let's move on to some stuff with the Fed real quick, and then I'll kind of wrap us up here. I think that the environment with the Fed right now, where you're getting multiple expansion in the market, even though earnings growth on the year is really muted, and yet markets are still up quite a bit, is very Fed driven, right? The risk-free rate has collapsed, and therefore that makes things that are benched against the risk-free rate more valuable, and that includes risk assets like

stocks, real estate. And so you have a higher P-E ratio in the S&P 500 than you did at the beginning of the year, even though earnings, the E, are reasonably close to being the same. I'd like to see those earnings go higher. We're going to see what happens in the final two quarters of the year. We'll get Q3 results start coming through in a few weeks. And then, of course, you'll get Q4 results at the beginning of 2020. But my point is, is that this is a very good time to not be reliant upon multiple expansion. Because if you rely on a multiple expansion, then what the Fed is going to do or not do, meeting by meeting, is a huge deal for your portfolio results. And really right now, it's probably the best thing an index investor can hope for. But for dividend growth investors like us, I think the Fed has a role in what the short-term valuation of assets is going to be,

but we're not relying upon that, a repricing of risk to drive returns. We're relying on organic free cash flow growth from very well-operated companies. And then we're relying on that company's propensity to act on that free cash flow growth by returning to shareholders a higher percentage of it in the form of dividends. So the Fed impacts the whole process to some degree, no question, including cost of capital and other things that affect their profit margins. But it is far less so than with an index investor. And I think that comment on the Fed and dividend growth investing is very important right now. Now, what the Fed is going to do or not do, you would like to think, is largely

dependent on where things are with the overall economy. And I got to say, this is a very difficult time to be an economist. It's a very difficult time to be someone like me who spends so much effort macroeconomically evaluating the state of things. Because there is right now a thesis that I stand behind, that the economic expansion is largely going to depend on additional business investment, capital expenditures. And yet the trade war has dramatically declined that capital expenditure activity. And therefore, the trade war uncertainty has led to problems in the manufacturing data, CapEx, new orders, industrial production. And if it isn't outright concern that we have around the data, it's certainly increased levels of caution. But then, you know, there's some positive data you can't just ignore either.

And the fact of the matter is that people love to, you know, brag about how brilliant they are and their pessimism and doom and gloomers always have this sort of market out there, no matter how intellectually embarrassing these people consistently are. But look, the manufacturing production actually came through recently after a few months of decline is the best number in five months. You did get a full percentage increase in CapEx in August. And obviously the jobless rate, consumer confidence, they've never waned off of being a real positive data point. And even the industrial production number after declining on several months posted a really positive number. So I don't have an opinion with high clarity or

high conviction as to where the economy is right now, where it's going. We know it is good. We don't know if it's going to get better or if it's going to go from good to not as good. I do feel very comfortable saying there's not going to be any imminent recession. I do feel very comfortable saying there's not going to be any imminent recession. And frankly, the kind of index of surprise economic indicators that indicate things going better than had been expected, that generally are leading indicators, has been on a big move higher over the last couple of months after having declined through some of the worst parts of the belly of the trade war. So in summary, the trade war, trade uncertainties are definitely weighing on economic activity, primarily business investment. The pressure on those things eventually leads to a pressure on corporate profits, and corporate profits are the mother's milk of economic activity, not just stock prices, though that too, but wage growth and job growth. Therefore, a longer term

positive outlook on economic activity does require a resolution to the trade war. In the meantime, we refuse to be reckless by jumping ahead of things. In the dividendcafe.com this week, I throw in a couple little nuggets as well about how households are more vulnerable to equity prices than they've been in the past. I share the data all the time because it's accurate data and it needs to be shared. That households have actually dramatically decreased their leverage in recent times, meaning their debt divided by their total assets. However, their total assets represent a far higher percentage in public equities versus things like family-owned businesses that they represented in the past. So therefore, that improved leverage ratio is more dependent than it has been in the past on stronger stock market, which means that if you get a weaker stock market, you theoretically get a cascading effect. You could create a negative feedback loop.

Please read that elaboration in divincafe.com or rewind this little part of the podcast, listen to it again, because it's a very important point about data that has both positive and negative embedded in it, but a warning that needs to be understood. For those that have wanted me to address the old issue around the Fed liquidity story, the repo market, and what took place exactly over the last couple of weeks, I have a full section with a very helpful chart from my friends at Golf Call about this whole repo issue and where I think the Fed had an operational failure. And I'm not going to elaborate here on the podcast because it'll make you get in a car accident if you're listening to this while driving. But I think that I do a pretty good job with a chart and a somewhat concise explanation of what exactly has happened. There are a number of charts at dividendcafe.com this week, not just

the one about the Fed repo market. Our chart of the week really helps people unpack the whole narrative about active managers versus index managers and the huge change in data during quantitative easing and why the financial repression of all of that increased Fed balance sheet and 0% interest rates kind of skewed the data so much for index investors and what that means going forward. I think it's a great chart of the week. So I've unpacked a lot here today, politics, Fed, but listen, there's more things on your mind. So reach out to us with any questions. Please do review the podcast. Please subscribe to it. Send it around. Really trying to get that traffic up to help boost the ratings

so that it becomes more easier for people to access. I hate saying this every week, but it's important I do. We'll send you a copy of my dividend growth book if you'd be so kind as to post and then send us a review of the podcast. And it can be a negative review of the podcast too. I'm just looking for your honesty.

All right, that's all I got. Thanks so much for listening to Dividend Cafe. Fight on Trojans, beat the Huskies, and please have a wonderful weekend. We'll come back to you here in just a few days where it will be the month of October and the fourth quarter of 2019. 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. This 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. The team and Hightower should not be in any way liable for claims and make no express or implied representation 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 reference 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.