The Dividend Cafe - The Trump Era Begins

Episode Date: January 19, 2017

The Trump Era Begins by The Bahnsen Group

Hello and welcome to this week's Dividend Cafe. By the time you're hearing this, Donald Trump is the new President of the United States. And regardless of one's political views on the President who's just left office, the President entering the office, or any issue involved therewith, the peaceful transition of power in the United States is a hallmark of our country and its remarkable system of government designed by the founders. From an investor's standpoint, it would not be possible to even comprehend the disruption to markets and risk premiums if such a reality did not exist. Would you want to invest in a market where the national leadership change was subject to military coercion every several years, you get my point. Our republic stands and stand it will. And with the new president, this new year to come, a whole variety of impact on financial markets can be expected. Just as a new regime and monetary policy, a new quarter of earnings results,

and a constantly changing global economic paradigm take shape. Digesting all of these things, translating them into an outcome-oriented investment approach is the end to which we work. So with that said, let's get into it. Five areas that the now not President-elect Trump, but President Trump, five areas that we see investable or investment-related deeper policy expectations from around the new president. More important to us than trying to trade around his tweets or offhand comments, five areas we'd want you to consider. A tax reform package we expect will take much of 2017 to get done, but that we expect will be retroactive to the beginning of 2017. Two, a nearly immediate

removal of the blockage of key energy infrastructure projects. Three, the repeal of Obamacare with some ambiguity around what the replacement will look like. Four, a multi-year ramp up of defense and military spending. Five, the potential for real trade impediments that create ambiguity in global markets, if not worse. Emerging sentiment on emerging markets. It is a truism of investing life that investors generally love most what just got done going up and hate most what just got done going down. It behooves investors seeking premium returns to not fall for such emotionally understandable but economically counterproductive thinking. We're free to agree or disagree with fundamental-based arguments for or against the

asset class known as emerging markets, equity, and debt investments in country domiciles known as more third world or underdeveloped areas. But what we do not give much ear to are arguments that are only based on the prevalent sentiment. The reality is the most negative sentiment we hear in the space causes us to be more long-term bullish. The reasons one may feel trepidation in EM right now include fear of a rising dollar, growing anti-globalization sentiment, and overall Fed activity.

Their tightening would make return premiums in emerging markets less attractive. Our perspective, which is anything but emerging and in fact is quite consistent, is that to the extent credit spreads, commodity prices, currency exchange rates, and sovereign bond yields affect emerging market prices, well, join the club. Those things have transitory impact in every aspect of capital markets all the time. But fundamentally, at a deeper level, we are buying a current claim on a future earning stream of real operating companies when we invest in emerging markets. If we merely want a tool to take on the risk and reward of commodity prices and sovereign bond yields, we have much, much, much safer ways to play those areas than emerging

market stocks. This space is about growth of value through growing earnings and opportunities in areas of geopolitical volatility, period. Well, enough back of the book. What do the chapters say? And I guess it's a funny way of saying we get the overall framework, we get the point you're trying to make, but with some meat on the bone, what is the investable side of the emerging markets? We've made a case for bottom-up approach, but how does it really look right now? And we don't want to ignore the reality of expected volatility from global macro events in this space. But we see tax reform in India that's creating certain company opportunities as those paradigms change. You see e-commerce opportunities in parts of China where the services the companies create are critical to government policy objectives and not as prone to intervention from the kind of interventionist government.

Banks in various countries that are just now reaching the point of scale in a modern economy. Areas with highly unlevered companies that stand to grow as more operating and financial leverage takes hold. As an example, by the way, consumer loans are 80% of the U.S. GDP. They're just 10% of GDP in India. There are consumer staples companies around the globe, not domiciled in the U.S. or China or Japan, that produce most of the world's beer or tobacco or other household products. The financial metrics have to drive expected returns, but we will keep talking about emerging markets as a legitimate growth vehicle in client portfolios. Government spending doesn't impact the S&P 500, or does it? The politics of national debt, deficits, size of government are not the focus of the dividend cafe.

The investor impact of such things certainly is our focus. And to that extent that we believe the private sector and its intrinsic profit motive represents a better allocation of capital than government spending, we believe that higher government spending means lower stock valuations. Why? An optimal allocation of capital boosts valuations, so therefore the inverse must be true. A less optimal allocation of capital compresses valuation. Yield curve is too fancy a term for me to care about. A steep yield curve references lower short-term rates versus higher long-term rates. The greater the delta between the two, the steeper the curve is said to be. An example of such is provided in

dividendcafe.com in a chart this week. When that line from short to long is flatter, it means there is less space between the short-term rates and longer-term rates. And in fact, when upside down, meaning the cost of short-term rates is higher than longer-term rates, then we call that inverted. The reason I bring this up is to illustrate for you why a buzz has come back into the financial sector. Yeah, all interest rates have come up, but the yield curve has steepened and banks are in the business of borrowing short term and lending long term, collecting the spread in between. The steeper yield curve has put a buzz back in financials and for good reason. We ask a lot about if stocks are too expensive and we talk about it a lot. And a lot of times

when clients ask about it, they're wondering if the price level of stocks is too high as opposed to the valuation level. Generally speaking, we find a broad passive market index like the S&P 500 right now to be pretty fully priced, not excessively so, but in the range of full value to slightly over full value. We're sensitive to this metric provided that it's comparing the entire stock market to total GDP. What I mean here is that there are just moments in history in which the market, the aggregate value of corporate stocks, has been significantly higher than the total size of the economy. And we're at a pretty high level there now, not as high as we were in some of the past bubbles,

but just nowhere near an attractive spot. And so we have to watch that, yet all the while realize that sometimes valuations can stay stretched longer than we expect. There's a big section in the divinacafe.com writing this week about MLPs and some of the attractiveness of the oil and gas sector right now with a few specific points that we'd really want to point you to. And then a number of areas about China, including a fascinating chart about what China's doing in selling United States Treasury bonds. So please do check out the written dividendcafe.com if you can. But we will go ahead and close up the podcast here. I want to close with a quote from my friend and mentor and partner, Lowell Miller.

Investing is not divorced from the real world of businesses and how they succeed or fail. So we love this time of year. We hope you're enjoying your January and we'll have a great weekend. Reach out to us anytime. We really enjoy client interaction right now and are looking to meet with as many clients as we can. Talk about your financial affairs and investment management needs, our portfolio outlook. In the meantime, thanks so much for listening to Dividend Cafe Podcast.