The Dividend Cafe - The Ups and Downs of the Market This Week

Episode Date: December 6, 2019

Topics discussed: Welcome to the final month of 2019! I. Love. December. I love it no matter what the market does. I love it no matter what the news cycle is doing. It is just a wonderful time of year, and I have done my best to bring in this special month with a special Dividend Cafe - covering all the ups and downs in the market this week, really meaty stuff on the trade war, the most important thing I could ever say about "perma-bears," the timely reality under-pinning dividend growth, and a really crucial economic lesson. I think this is the best Dividend Cafe of the year (okay, maybe I say that too much), but jump on in and let's get in the December spirit ... 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. This is David Bonson. I am the Chief Investment Officer here at the Bonson Group. We're bringing you our weekly thoughts and commentary, reflections on the market, the economy. I am fresh off of a plane from New York City where I had three days of meetings at our New York office with some very fun announcements we'll be making soon around that.

But then now back in California, recording the podcast here this morning, absorbing, really had a wonderful opportunity last night on a long plane flight home to pour deep into several of the topics I want to address with you all today. So hopefully you'll find this to be a worthwhile podcast, delving into certain things happening in the market this week, happening in the economy overall. And I really think the political environment is getting more and more interesting. And then I have two other little topics I want to address with you this week that are near and dear to my heart. You guys know that I've been spending

more and more time this year trying to carve out a space in the podcast for various economic truisms and foundational realities that impact the way we understand the overall economic picture in the times in which we live. And I want to address something in those lines as well. But let me start with just this week, because a little bit of

volatility to come back into the market. Some might consider it quite volatile, but they'd be wrong in terms of it's all relative, I suppose. And on a relative basis, it's nothing to write home about. I'm recording here in the middle of the day on Thursday and the market's basically flat on the day. And we were up a couple hundred points yesterday, but we were down several hundred, more than several hundred points on Monday and Tuesday, about, I think, 200 Monday and over 200 Tuesday. And then we're up 200 Wednesday and we're flat Thursday. So net-net down on the week. But again, the point I'm making is that there's been a little volatility in the up and

down-ness of this direction the week we're going through. And that volatility is entirely related to China and the trade war. And one of the points that I've been trying to make lately that's important is that's the big, that's it. That's the one factor out there right now. Earnings season from third quarter results is done. The Fed, there's not really a lot of ambiguity right now around what they're doing. They became extremely friendly to markets and we've gotten over 20% move higher in stock since that became clear. At this point, the chances that the Fed is all of a sudden going to turn on risk assets are slim to none. And the ability of the Fed to do much more to help risk assets is slim to none.

So you kind of sideline the Fed. There's not a lot of other macro news at this point in time. We're far, far, far too away, far away from the election, too far away from the election to have that being a major impact into where market expectations might be. And so it's the trade war. And the ISA manufacturing numbers came out on Monday for the month of November. They contracted yet again and, in fact, contracted worse than had been expected. You had a pretty precipitous decline in new orders, and again, a reinforcement of declining business conditions, declining business activity, and that is most being felt in the industrial

part of the economy. And so as long as we sit here with some degree of incompletion in the phase one of the China trade deal, I think you can expect the possibility of a bit more ongoing volatility. Now, one thing worth pointing out is it was a couple of press conference comments and Trump saying, oh, maybe we'll wait until after the election and him just kind of pontificating the way he does. Why would the market move down over something that then on the other hand you hear leaks that, oh, they're much closer to the official closing of the deal than previously thought? So what's going on out there? Well, obviously no one really, really knows. And if you've learned anything you've learned, the president could very well change his mind

at any time. There's a certain unpredictability to all of it. But here's the very serious reality, OK? The market rationally expects that a deal will get done. I believe that the political dynamics for China changed quite a bit a few months ago, that the political dynamics for China changed quite a bit a few months ago, that they now do not necessarily view their ability to try to play a role in damaging the U.S. economy to a point where it would damage the re-election efforts of President Trump and therefore damage his possibility of hammering them in a trade deal.

I don't think they view that kind of sequence of events as working to their favor based on the fact that there is such a high possibility of a Democratic candidate not necessarily being a great friend to China themselves. So the political gamesmanship was altered and now we're sitting here more or less. I'm really overly simplifying here, but the paradigm is basically that China is willing to commit to higher trade volume with

the United States, meaning purchases, yet there is still not the same commitment around the alteration of China's role in the United States technology sector, in our supply chain, and most importantly, in what enforcement mechanisms would exist in the theft of intellectual property of American intellectual property, intellectual technology, in terms of our technology sector. And so I think that the two-headed monster from 2018 of the Fed and the trade war has now become a one-headed monster. And it is more or less the primary impactor to, one, the stock market, two, the economy itself via its impact on manufacturing, capital expenditures, and business investment, and number three, the election. In a year out, if you go into Q1 and from Q1 into Q2 of 2020, and a sizable trade deal has been arranged that gives Trump a political victory and the

economy a little tailwind, that that probably will have a huge impact in what the outcome of the 2020 election ends up being. So that's been the source of volatility in the market this week. And I maintain my view that it's fundamental. It's not just noise. It's not just sentiment, that there is a real fundamental reality at play, that where the threat of the trade war lingers, it has impacted the confidence of business to make the necessary investments in capital expenditures to drive productive growth. And therefore, although it's a leading indicator, we don't see it immediately. When you see that kind of decline in productive investment, it inevitably catches up up in the job market, in wages, in overall economic growth, and ultimately would probably be the catalyst to another recession down the line. So the inverse of that is that resolution of the trade war opens up the possibility of that resurgence of business confidence we were experiencing earlier and out of that business confidence a rational human action into business investment

that would perhaps create the productive projects necessary to continue growing the economy. Now, a lot of people out there, and I'm going to do my first kind of interjection into something that is so important to me, has been for 20 years, how we want to think about and deal with as investors, but also as human beings, this sort of a cottage industry out there that exists of what I will call perma bears, those constantly selling doom and gloom that have their own belief or theory as to why everything is awful and everything will collapse and it's all fake and it's going to blow up and it's this and it's that and we're always around the corner from a 50 or 70 or 80% drop or something like that.

And that one of the things that is most interesting, I say it's ironic, but it's actually kind of disgusting. But regardless of how descriptive one wants to be about it, a perma bear cannot develop a business model very easily around actually managing money. And actually, because the you know, the nature of markets that are up, you know, thousands of percentage points over decades is that maintaining a belief in a fantasy gets exposed and you spend most of the time losing money and you have little pockets of time where you get to brag about how right you were about a financial crisis that you were never really right about either. But other than those periods of time in which markets are troubled, markets certainly go through trouble all the time, but they're intermittent

and they are less frequent than good times. And ultimately, this is a self-attesting reality because if it wasn't true, people wouldn't be invested in markets and you wouldn't have so much money get made and what drives US economic growth and investment in public risk assets. And so it's a pretty bad business model to try to get paid to be a perma bear managing money. And yet what they figured out is, well, it's a short-lived career doing that, but it's an absolutely recession-proof dependable career to do it by just selling the concepts of doom and gloom in print, in the web, newsletters and websites and articles and books and things like that. And so you have a pretty high-profile group of people out there.

They can get interviewed on TV and they can write their different things. there. They can get interviewed on TV and they can write their different things. And every now and then I get a link. Clients, it's a lot less than it used to be, but clients will email and say, what do you think about this guy? And are you worried about this? And oh my God, there's a headline here and some financial pornography site. And they're saying that such and such is going to go wrong or what have you. And I am critical, of course, of their worldview. There are some of them who really believe it, by the way, but there are a lot of them who don't. But I'm not going to get into that stuff. The disingenuity of them is not my problem.

It is the idea that the markets might drop 4% and they've been up 400% for the prior 10 years and they'll go, oh, look, we told you. And it happens all the time and it's going to happen again and it's irritating in advance to know that there's some idiot who has cost people hundreds of percent of return who at the first drop of two and a half percent is going to try to take credit for something. So there's obviously an arrogance but also a fundamental dishonesty there. But let me get to my real point for you. Human negativity bias is never going away. The fact that some people have found a way to monetize it is not a surprise. It is part of human nature. And I want to make sure that for the assets that I am the fiduciary steward of, that our business is responsible morally and legally and economically for certain outcomes

and endeavors, I want to make sure that we do not touch these types of people with a 10-foot pole. We are fully aware that there will be periods of very substantial pain in the life of a risk asset investor. That's why it is risk asset investing. There will be more recessions and bear markets. They're part of the journey. And we want to mitigate. We want to dampen the impact of volatility as is appropriate. We want to utilize risk management. But the notion that we can insulate someone entirely from pain in the market is absurd.

And tail risks, while they certainly exist, are not hedgeable or foreseeable or predictable. And we just want to make very sure that we continue to remind people that the perma bears have done extraordinary harm to otherwise well-intentioned people. And that to the extent one has fear because they're a human being, suffers from human negativity bias because they're a human being, there is a remedy for it that will do far better than buying the next charlatan's book. And speaking of those various mechanisms that we think are a more effective way to access risk assets and access a return on one's capital that will help them achieve financial goals, I'm fascinated right now at the short-term outlook on dividend growth. And what I mean by outlook is not necessarily the performance outlook, but the universe of possibilities. At the bottom of the financial crisis, we had 65% of stocks paying a dividend higher than the 10-year bond. than the 10-year bond. A year ago now, it was only 27% because you'd had 10 years of stock prices going higher and 10 years of the bond yield going lower. And as stock prices go higher,

the yield as a function of math, of course, goes lower. And so there were just many, there was a significantly lower amount of stocks in that universe by which one could achieve that higher dividend yield at purchase. And yet right now, here we are a year later, and we are back to 65% of companies in the Russell 1000 Index offering a dividend yield higher than the 10-year treasury. Except for that's not because we're in a financial crisis. That's not because all stock prices have dropped and therefore dividend yields gone higher. not because we're in a financial crisis. That's not because all stock prices have dropped and therefore dividend yields gone higher. The stock market's up over 20%. And somehow we went from 27% offering a higher dividend to 65%. How is that? It's because there's been such robust dividend

growth for a lot of companies out of the corporate tax reform and because the treasury yields themselves have dropped so much. We were at two and a half roughly a year ago, and we're at one and a half to 1.7 roughly now. And so the conflation of those two factors has made for a significantly more attractive universe in dividend growth. And that's very useful for diversified investors looking for those right opportunities. U.S. economy is doing well. The business economy is slowing. I've spoken about the trade impact from that. But a really, really important series of charts at DividendCafe.com this week about real disposable income growth, meaning net of taxes, net of inflation,

and how it had been advancing quite nicely throughout the bulk of the Trump administration and just recently has dropped down to about 1.18% percentage change. And then the second chart is showing the averages of real per capita disposable income growth going back about 50 years. And you see that it has been over 1% growth a year out from the election for Clinton, for Obama, barely, well over 3% for Reagan, Johnson, Nixon. And that the only two presidents that had sub 1% income growth year over year, real per capita disposable income growth were Bush 1, who was not reelected and Jimmy Carter who was not reelected. So obviously there's all kinds of other factors and you can never assume one particular thing is a foolproof indicator and six, seven different incidents is not statistically enough for us to

say that this is authoritative, but it is very anecdotally interesting. I think the need to see that real disposable income growth growing at a higher rate like it was through most of the Trump administration is a very good idea. It is something that I think has come down a bit in light of the trade war. But previously, when you look at the low inflation, tax cuts, low unemployment, healthy economic growth we had until some of the trade war stuff disrupted things, that explains why these data points were so much better two and three years ago than they are now. Finally, I'm gonna close with a kind of economic refresher of the week. There are, by the way, four or five charts at DividendCafe.com

that I really will recommend you look to. But let me say this about artificially low interest rates, and I've spoken throughout the year about why I do not believe that they stimulate economic growth. And in fact, I believe that they hamper economic growth. They hamper economic growth of the sustainable variety. The kind of persistence of interest rates that are below their natural rate incentivizes people to leverage up the purchase of pre-existing assets. Whether that be real estate or whether it be stocks, there are assets already in the economy, already in the society that one can buy more of now and achieve a higher return on capital because they use the below natural rate to leverage

up that purchase. But then it disincentivizes the productive investment into new assets that the economy needs, which means whether it takes a month, a year, or a decade, you, through time, are hampering productivity, let alone the fact you're also distorting markets and driving money into what we call malinvestment, just otherwise bad investment ideas that get distorted by the low cost of funds. Now, of course, if low interest rates were actually a cause for economic growth, then the logic would indicate that negative interest rates would really, really accelerate growth. If low is good, then zero is even better. And yet, what are the weakest economies in the world right now?

The ones with negative interest rates. The confusion comes from people mistaking the need for a return on invested capital versus the mere satisfaction that comes from a below market interest rate. Below market interest rate can work very well when it incentivizes the leveraged purchasing of good productive pre-existing assets. But it does nothing for the creation of future productive assets, which is needed to drive sustainable productive growth. And that is, of course, the objective we have in our economy is sustained economic growth higher than where we've been. So this refresher I offer you because I really want us as investors to maintain our understanding that where low interest rates right now provide a higher bid to pre-existing assets, they do not

satisfy the need for new assets, for new technologies, for new development, for new R&D, for new intellectual property, for the various activities and endeavors that will drive decades of economic living and thriving. History is clear on this. Economic reality is clear. And the notion that we will ask monetary policy to do all the heavy lifting is simply inadequate. The politics and money section, by the way, I provide a pretty long quote from both Stephen Moore and Larry Kudlow, one an unofficial council or the president won the official head of economic council in the White House, Larry Kudlow. I encourage you to read the quotes, get an idea as to how strongly they feel about a trade war getting done. And with that said, allow me to

conclude this week's Dividend Cafe. I really believe that we are going to finish the year in a very different environment than we did last year. There is optimism of a phase one China trade deal getting done, but that is by no means a foregone conclusion, although I think the odds are on the side of it coming to fruition in the weeks ahead. And meanwhile, we are going to enter 2020 with an awful lot of thoughts as to what is most important to markets next year. It'll really be one of the first times in a while that we'll have less of a focus and concern around where the central bank is and more of a concern around real fundamentals. And we're going to unpack so much of that in the weeks ahead. Reach out with any questions. As always, thank you for listening to and viewing The Dividend Cafe.

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