The Dividend Cafe - The Next Move in this Market

Episode Date: January 19, 2018

This week, David Bahnsen recaps the week in markets and reviews the ket takeaways from our 2018 whitepaper. Topics discussed: The excesses of markets and human behavior Sector outlooks for 2018 Why asset allocation matters Links mentioned in this episode: https://www.hightoweradvisors.com/team/~/media/hightower/team/bahnsen/documents/tbg%202018%20whitepaper%20pdf_v1.ashx?mkt_tok=eyJpIjoiT0RrMlkyWm1aRFUxTVdOaSIsInQiOiJkbnhKcWUzbVFqaFpRXC82SW9nRitoZ2s4MzY4cHlWSmNqc2ppY3NKeHFtUlJJd284UitIbHNDU2N3eTg3NHBGcks5amdqU2FiVXZYbmdNekIySkZRakR6cVF1c2hvZmp2NjF0SSt0aTNpUXY0NTdoWXZabVRvODlXYjRXK2RqdUgifQ%3D%3D

Welcome to the DividendCafe.com to check out. But for all of you listening right now, we're going to cover a lot of topics this week and kind of get it going. If you're interested, by the way, in a pretty long form version of our 2018 outlook, pretty significant analysis as to what we see going on right now and how we want to be positioned around it. We'd encourage you to get our white paper that we've written on the subject. It's on our website at thebondsongroup.com, but also we did about a, oh, I don't know, 40-minute podcast or so, and kind of walk through all of it. So if you're listening to this, you must be somewhat interested in listening to podcasts,

and we tell you to go there and check it out. So that's our Advice and Insights podcast, and we walk through a whole review of 2017, a pretty long-form analysis of 2018. So check that out if you get a chance. Markets did continue a ferocious start to 2018 this week. And we'd like to give you a little substantive perspective on how we're navigating the market, what principles and behaviors we think ought to guide what we do from here. Let me jump into it with this. One of the most difficult things I could possibly message right now for my clients in the present

and the future is the seemingly contradictory realities around valuations and timing. I insist on presenting the truth 24 hours a day, doing so as part of a vow of trustworthiness that we have all at the Bonson Group taken for our clients. Well, these sentences I'm about to utter here are all emphatically true, and that's why I'm sharing them. Yet they require additional explanation by way of how they get applied to investor behavior. So number one, try this on for size. Number one, try this on for size. Valuation is an extremely important metric in evaluating risk and reward in investments and their expected long-term returns.

Number two, valuation is a nearly worthless timing tool. As markets spend significant amounts of time overshooting average valuations and significant amounts of time beneath average valuations. Number three, we expect markets to get expensive to get more expensive and markets to get cheap to get cheaper still. And we believe this to be a worthless maxim in actual application. So all of these things are true, but what does it all mean in the implementation of portfolio management here and now? It means that stating markets are richly valued or markets may get overvalued is neither a mandate to sell or buy more. It does mean there is no mandate to sell. Markets are likely to get overvalued historically,

but it surely does not mean we want to play for that excess. Essentially, the disciplined approach and the one we're confident will play best, outside of lucky timing, is to maintain strategic allocation on with equities, as is appropriate for one's timeline and risk tolerance, yet to maintain vigilant rebalancing and trimming along the way. All of those predicting the end of this bull market are right about one thing, it will end. But they have no idea how wrong they are about the timing of such. Looking for corroboration, part one. If one was prone to believe that equities were in a state of bubblicious excess, they would likely have corroborative evidence to go along with the high prices in the stock market. For example, we find the tightness of bond spreads

in the high yield bond market to be a far worse indicator of present risk apathy than market valuations. But what else supports this narrative? IPO activity is very restrained. Flows of capital into equities are modest, if that. Margin buying has not skyrocketed. Bullishness in surveys has only recently even gotten back to median levels. Corroborative evidence may come for equity market excess. It's just not readily visible yet. Looking for corroboration part two. But is there corroborative evidence for the other side? That the bull market is set for an even newer stage of growth? Besides rising bond yields, increasing GDP growth, and accelerating profits, which we talk about every week, there also is rising business confidence, commitments of new capital expenditures, and high cash levels on corporate balance sheets ready for deployment.

balance sheets ready for deployment. There's deregulation in the financial industry and there's the pending benefits from tax reform. So yes, there is corroboration on the other side. Is it conclusive? Is it timing helpful? No. But my point is that the narratives are not nearly as one-sided in the way one may think. Sometimes, in fact, the opposite could be true. So it's easy. The bulls win, right? No, no, no. As I just said, the corroboration of the bullish thesis may be far more supported by empirical evidence than the bearish thesis, but that ignores a really cruel reality of markets. And that is that sentiment often flips in advance of the detectable evidence that would have forecasted it. We prefer to stand behind our major theme,

the recognition that advancing stock prices should not be laughed at or thought impossible, but with a healthy respect for volatility and, frankly, normalcy. Is there any other choice? So we see the 10-year bond yield moving higher. The Fed is shrinking its balance sheet even so slowly. The Bank of Japan is announcing it will back off from some parts of its aggressive federal purchases, meaning the federal treasury purchases of U.S. debt. The European Central Bank is slowly tapering its bond purchases.

Inflation expectations are moving higher ever so slowly. And then now China announces a potential slowing of their U.S. Treasury purchases. Is there anything out there calling for a decrease in bond yields? No, not really. Perhaps rates will get ahead of themselves, but all things considered, fundamentals appear to be calling for this slow move higher in bond yields to continue. The caveat is just that there's a limit to how high they can really go as long as global accommodation remains so high. Hey let's quickly walk you through our sector outlook in 2018. We cover a lot of the different individual companies in our weekly report we send for clients only but just from a top-down standpoint in

terms of sector allocation hopefully this will be somewhat useful to you. Technology front, the bullish case is that new business capital spending has to find its way into technology. The bearish case is that already high valuations and a limited benefit from tax reform, given they're already low rates for many tech companies. Our conclusion, we like old tech over cool tech. The REIT sector, well, our bullish case is that they're undervalued. They've underperformed. The bearish case is that rising interest rates may hurt their values as they're largely priced around their dividend payment to shareholders. But our conclusion is that when rates rise because of economic cyclical growth, the impact to REITs is highly transitory and the economic growth will actually push rates higher and become a positive to REITs, not a negative.

Energy sector or bullish case is the broad sector's lack of participation in this broad bull market move of the last year or so. The bearish case is kind of hard to find, frankly. The easiest risk to quantify is obviously commodity price risk, but our conclusion is that from upstream to midstream to downstream, we can see certain companies with compelling value right now. Financials. Well, the bullish case is the deregulation movement taking place at an executive branch level and at the Federal Reserve. The increased

margins for banks that higher interest rates create. The bearish case would be that a lot of this already priced in, it's fair enough. Our conclusion is that we want to keep diversified exposure in financials. So yes, big banks, regional banks, but also asset managers and insurance companies. On the consumer side, the bullish case is that the consumer may spend more in a growing economy. The bearish case is that the e-com effect on many retailers. So many of these names have significant financial leverage on their balance sheets, and e-commerce represents a sort of existential threat. Our conclusion is we want to limit

exposure in the consumer areas to those with balance sheet strength, not excessive debt to equity and things of that nature. But also where we're talking about specific retail, you most definitely want to see a viable e-commerce strategy. Finally, I'll close with telecom. The bullish case is that tax reform should be very beneficial to those names with high capital expenditures, like a lot in the telecom sector. The bearish case is that there is a market saturation throughout the industry,

particularly of wireless services. Dividend payouts are already high. That limits some of the growth of dividend possibilities. Our conclusion is we don't want to be overweight or underweight. We want to stay the course, but we mostly want to look to the dividend sustainability of selective companies to drive decisions. lead the market since the election. No one would complain with a 44% return last seen in technology over the last 14 months. But the first place performer has actually been our beloved bank sector. Banks are at 48% since President Trump was elected. A fact that's slightly less surprising when you consider the deregulation out of Dodd-Frank's onerous requirements,

corporate tax reform. The former president of Goldman Sachs is the head of the National Economic Council. And of course, the financial sector really quite substantially underperformed coming into this. So there's a pretty good explanation for a lot of this superior performance. I will point you to DividendCafe.com for an incredible chart. I like posting it every year. It really reinforces the theme as to why asset allocation matters. Not all China fears are created equal. August 2015, China announces they want to let their yuan float against the dollar. Markets go into convulsions as fears hit hard that China is seeing a massive depletion of their excess reserves and capital is running to get out of the country.

January 2018, China announces a quasi-similar initiative as the one they announced in August 15. And yet global markets have one of their best weeks and years. Stabilized credit conditions and particularly improved foreign exchange reserves. Paint a wildly different picture than that of 2015. The bottom line is that fundamentals color a macroeconomic event. They matter. And our basic approach is that the currency that you see, the currency behavior in China, tells you so much more about global macro conditions and the impact that China has on investors of all shapes and sizes, whether they're invested directly in China or not. Inflation or not inflation, that is the question.

Basically, they are reporting a CPI number 2017 at 2.1%. But they have apparel inflation down 2%, meaning what people are spending, price of clothing, airfare down 4%, wireless down 10%, but you have rent costs up over 3%, energy up over 6%. So you get kind of a tug of war netting out at 2.1. I don't know. I mean, who calls it inflation when your auto payments, phone bills, clothing bills, and travel bills are all going negative? More measurements and metrics will come in the week ahead, but at the end of the day, our takeaway? They really don't know how to measure inflation. The most concerning economic metric for young adults.

No question about it. No hesitation at all in my answer. It is the exorbitant and absurdly high prices in housing, whether in the rental or purchase market. There are now and will be worse in the future ghastly economic consequences for the millennial demographic out of this policy-created mess. I think it is shameful. Many point to the $1.1 trillion of student loan debt as the culprit and the 5 million people already in default on said debt. Forgive me for being unable to see the student debt fiasco as something other than a directly correlated byproduct of the aforementioned housing price

monstrosity. 2018 prediction check. Normally it's good to wait more than 10 or 15 days to check on a prediction one made for a full calendar year, but in light of our belief that 2018 will be an interesting year for much of big tech as it pertains to their political and social reputations. I couldn't help but notice the headline in the Wall Street Journal Wednesday this week, the antitrust case against Facebook, Google, and Amazon. We don't expect this rhetoric or vibe, if you will, to die off anytime soon. A big lesson I just kind of want to share real quick.

A thought occurred to me this week about the conviction with which some very smart people told us the dollar would rally last year up. And of course it didn't. In fact, a lot of things reinforce this thought. The insistence market skeptics have had for years and years that stocks were about to drop. Seeing Bitcoin down over 40% in just a couple weeks.

Bond yields stubborn refusal to do what bond experts have said they would do. Frankly, any other number of forecasts that lacked the necessary humility in making an economic or investment forecast. And that is this. This is my thought. Investing capital is the job of the humble and ought to be done by no one else. Arrogance and unbridled confidence in a certain prediction or forecast can do unthinkable harm to one's financial well-being. Humility is a good characteristic to have in all walks of life, but in the field of investing, it can be provided to you by mr

Market if you do not enter the game already equipped The need for diversification and asset allocation is the necessary application of investment humility period Our chart of the week at dividend cafe comm has to do with the exchange rate between the Chinese yuan and the U.S. dollar. Can't really imagine a higher correlation right now than how global equities and risk assets do when the dollar is dropping and more specifically, the yuan is rising. Very interesting to study that. Check it out at DividendCafe.com. very interesting to study that check it out dividendcafe.com hey beware those who are sure what the market's about to do for good or for bad

i believe in living one's life by a set of foundational principles and i believe investing money by principles as well sentiment shifts market psychology and other investors behavior those things are all going to move around, but they do not alter timeless and true principles. Stay focused in a tremendously positive bull market on a disciplined plan, just as you should stay focused through adversity in a bear market. And above all else, love your friends and family this week

and seize the day. God is good. Thank you for listening to the Dividend Cafe podcast. Reach out anytime with questions, comments. Write a positive review for us. Subscribe. Make your friends subscribe. Have your spouse subscribe when she doesn't know you're holding her phone.

Thanks for listening to Dividend Cafe, financial food for thought. The Bonson Group is registered with Hightower Securities LLC, member FINRA and SIPC, and 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, and there's no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Thank you. Opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary. It does not constitute investment advice.

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