The Dividend Cafe - The New Normal Looks Like The Old Normal

Episode Date: May 18, 2018

This week, David covers some of his favorite topics ..... Topics discussed: Capex Alternatives Emerging Markets Oil Japan The Fed Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Hello and welcome to this week's Dividend Cafe podcast. This is David Bonson, your managing partner and chief investment officer here at the Bonson Group. And it has been actually kind of interestingly boring week. By boring, I mean not nearly the same crazy levels of volatility that certain weeks have created in recent memory. Interesting little factoid, we right now here today are at the exact same place we are in the market that we were a month ago. And yet the market is up 1,200 points in the last couple of weeks. The market is down 1,200 points in the two weeks before that. So we've just done

this little round trip and yet in between had two different over 1,000 point moves, each one going in a different direction. I would say that's a real interesting kind of encapsulation of what is happening in the market. The overall trend and broader kind of summary of market conditions is very directionless right now. And yet, around that directionlessness, you are seeing a pretty significant amount of volatility, up and down movements, fluctuation, etc. So anyways, let me get into it this week.

A couple of different topics we want to cover. By way of weekly redux, I'm sitting here recording on Thursday. We're down a little bit on the week. We were down a couple hundred points one day. We came back one day and kind of been flat a couple days, that type of a deal. The will they, won't they issue in North Korea hasn't moved markets. The Israel, Gaza, the Jerusalem embassy stuff has not moved markets. I don't believe Michael Cohen, Stormy Daniels, James Comey, Robert Mueller, all that stuff is moving markets.

Robert Mueller, all that stuff is moving markets. What we're doing is we're wrapping up a quarter in which earnings grew in the S&P 500 year over year over 20%. And yet we're digesting a 10-year bond yield that has been now comfortably sitting over 3% in what is a move we would call normalization. And we're waiting to see, frankly, what the real business investment ramifications of all this will be in the quarter ahead. And so there's going to be lots of coverage in the next few minutes on business investment, capital expenditures, those types of issues, which I think are pivotally intertwined with the need for the market to continue this rally. But I want to cover a few other topics that I think, because we are kind of in a little bit of a lull in the state of U.S. equities, it gives us an opportunity to reach out, cover some other ground as well. Let me talk about Japan, because Q1 GDP in Japan shrunk by 0.6 percent this last quarter. That is the first economic contraction on a quarterly basis in eight quarters. And so the source of the weakness, of course, you know, is always household consumption.

They have a kind of secular demographic story that has definitely put a lot of downward pressure on anything household-related and consumer-related. Look, you should note that this economic contraction coincides with the Nikkei, their stock market, hitting its highest point in over 20 years. So, in other words, the constant truth that GDP growth and stock market performance do not correlate is being reiterated in spades. Stock prices reflect profits, and Japan is experiencing a renaissance in corporate profits and profit margins. I expect a, shall we say, significant divergence between profits and GDP growth. As valuation levels are actually at their

lowest since 2009, there exists a potential for substantive movement up in stock prices, even as their economy continues to work through its demographic-driven malaise. In terms of this contrarian belief system, which I won't kind of reiterate right now, I should do an advice and insights podcast sometime on the whole subject of contrarianism. If you don't subscribe to advice and insights, by the way, please do so. This podcast you're listening to now that we call Dividend Cafe is our weekly kind of 10 to 15 minute sound bites covering a number of topics in the market. Advice and Insights is meant to be a weekly podcast, generally longer, where we do a deeper dive into a whole lot of issues. find that the way in which we cover things in Advice and Insights for those that are looking to kind of really get a better understanding of certain investment topics is a great way to go

about doing it. So all that to say, I really should do a full Advice and Insights podcast on contrarianism. But one thing I want to say right now is you can look at a chart of the S&P 500 and kind of see its movement over the last year, been positive, and then you had the volatility last couple months, it's kind of flatlined. That would all be reflected. But one of the things you saw throughout the rally that was taking place last year, there's an index that kind of measures the activity of small investors, that measures the activity of folks at the online brokerage type firms, things like that. And obviously, there's some very smart people investing there.

There's some very not smart people. But when you index it all together, you get a pretty good representation of what I think is often, shall we just say, the retail sentiment, the smaller investor mood that would represent a type of thing that generally a contrarian would probably want to bet against. And you see that what had been a real kind of anti-equity bias quickly changed last year. And you saw the index of that activity quickly kind of get very heavily correlated with the S&P 500. And yet now, since the volatility commotion in February, you see on the chart, and we have the chart printed, by the way,

at DividendCafe.com, you see it look like a cliff, like a straight line down. And that kind of optimism run amok, meaning, you know, collapsing levels of optimism and sentiment is exactly what a contrarian would want to see. And it has not happened very frequently in investing history that that particular demographic of investors is buying heavily into what will end up being a great market and you have not seen them generally sell heavily into what ends up being a down market hence the contrarian opportunity speaking of contrarian let's talk alternatives for a second. The golden

era of hedge funds in a lot of ways was 2000 to 2002. The S&P was down over 40 percent, the NASDAQ down 80 percent, but many hedge funds were even or even up in that period. So that led to what? Well, massive flows into hedge funds, of course, from 2003 to 2007. During that period, the stock market increased 100%. Many hedge funds lagged the stock market. The next period, the financial crisis and the immediate aftermath of the crisis, is a little harder to pin down. A few hedge funds did even worse in the market, those that were, you know, like leveraged bundles of psychopathic recklessness. And many blew the market away, like you think of the famed hedge funds that were shorting subprime, for example. Broadly, though, most hedge funds were down in the 2008 period, but not down nearly as much as the market.

Okay, fair enough. But then you have this real high-octane bull market of, let's call it, 2012 to 2017. In this period, hedge funds primarily generated positive returns, but much less than that of the market itself. And they underwent a very interesting scrutiny from the media around performance and from investors around their fees and so forth. performance and from investors around their fees and so forth. Fund flows were decidedly negative. Now here we are. We're contrarians across all asset classes because ours is a conviction about what? Behavioral realities. Will the next five years bode worse for hedge funds or better? Has the cycle of hedge funds most useful years being followed by great inflows been set up for the inverse? Is that setting up for the inverse? Great outflows that are followed

by very useful years. That's what I believe is consistent with the testimony of both history and human nature and therefore our optimism about the very individual alternative investments that we are pursuing. Interesting update this week in the Emerging Markets Index. 30% of the index now, over 30%, is in China countries, companies based in China. Over 10% in South Korea, over 10% in Taiwan. So with three countries, perhaps the three biggest exporters in the world, you have 55% of the index covered. Essentially, a major play on exporting from a few countries,

all a rock throw from each other, to the developed world. In short, the index is becoming less and less of a solid play on actual emerging markets. And we think you're better off buying active approach to the emerging world where there is that great domestic growth that we want to participate in. Keep getting asked, what is the Fed going to do? They've raised rates twice already this year. No one I'm aware of doubts that they'll raise one more time, meaning at least one more time. The question, though, is whether or not they'll raise two more times, which would be a fourth increase on the year, that fourth coming if it were to happen likely in December. The Fed funds futures market is now pricing in a 54% chance of a fourth rate hike.

And this is the first time all year that the futures market has gone over 50 percent. I believe that this accurately captures the lay of the land. At this point, there's a long way to go. It's a coin flip. Some really interesting stuff, by the way, at DividendCafe.com this week on the silliness of those who buy into sell in may and go away and we went and did the empirical research on how the months following the month of may have actually done in the stock market over the last 20 years uh really interesting uh reinforcement for those that believe we are under infrastructure in uh the energy department here in our country. And kind of interesting sort of caveat about what's going on with oil prices in the Permian Basin right now.

And then our big theme this week, and will be for quite some time, regarding CapEx, why the tax reform leading to capital expenditures out of business is so important. So if you go to DividendCafe.com, there's a link there to an article I wrote on it this week that we think you'll find very interesting. So the beat goes on. I'm going to go ahead and leave it there. I really do encourage you to look at DividendCafe.com. We love the fact you're listening to the Dividend Cafe podcast, DividendCafe.com. We love the fact you're listening to the Dividend Cafe podcast, and we hope you will consider subscribing to it and writing a review for us. And it helps us with some of

those other podcast applications, particular iTunes and Google Play, things like that. But I'll avoid pitching you on all that any further. I hope it's been a beneficial listen. And if you have any questions at all, what's going on in the market and what we're doing, please feel free to reach out. Next week, we're excited to, at our Advice and Insights podcast, feature a special guest, the famed small cap growth manager, Ron Barron of Barron Funds is scheduled to be interviewed by yours truly next week. We'll have a fun conversation about that. In the meantime, have a wonderful weekend. Thank you for listening to Dividend Cafe.

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