The Dividend Cafe - The Week that Wasn't Sure of Itself

Episode Date: April 8, 2018

This week, Chief Investment Officer David L. Bahnsen discusses the wild swings in markets this week. Links mentioned in this episode: www.DividendCafe.com

Welcome to the Dividend Cafe as quickly as I can. Please ignore my voice. I am struggling with a little cold type deal, but I'll live. No big deal. In the meantime, just want to go through. It's been an amazing week in the markets and give you our scoop on things. There are a few charts, as always, at DividendCafe.com if you want to get the full-orbed experience by reading there. If you want to get the full experience by reading there.

And, of course, we encourage you to make advice and insights podcast a part of your regular feed where we do long form, much, much more elaborate kind of discussions and so forth. But look, it's been a while where the time delta between what I'm talking about now on, let's call it a Thursday morning. And by the time you're actually listening to this, let's assume it's after the markets closed on a Friday, where that actually matters. That day-by-day volatility from a Thursday to Friday hasn't necessarily made a big difference for quite some time. But now, 700-point moves from one day to the next, or as we saw this week, within one day, an 800-point move is not at all uncommon. So yeah, we did see markets go down 700 points on Monday, but then they came back 250 points in the final hour, so still down 450 to start off the month

and the quarter and the week. But then we saw an entire day of seesaw action on Tuesday, but then the market ended up over 300 points. On Wednesday, we saw markets down over 600 in early morning hours, but then they ended the day up over 225 points. You had an 800-point intraday swing. As I talk right now, we're up 200 points in the Dow on Thursday morning. And so who knows? Who knows what it will be by the time you're listening to this. But my point is, these crazy intraday moves need to be unpacked. And that's what we're going to do this week in Dividend Cafe. So trade wars are easy to win, eh? Well, as I said, markets dropped 700 points Monday before settling down 450.

And I'll admit, a lot of that may have been to do with the carnage in the new technology space, even the trade and tariff conversation that's dominated a lot of market skittishness lately. But they ended up nicely Tuesday after a cease on day. But that Wednesday morning drop is what I want to focus on here, that 700-point move overnight. In response to the news that China was launching its second round of retaliatory tariffs, they were against or in response to our second round of the same. This time targeting soybeans, cars, whiskey, chemicals. So, you know, their first strike was only $2 billion to $3 billion. The market's tanked on that, knowing that China had a lot of room to go.

It's about a $180 billion import market, and they were only tariffing on $2 billion to $3 billion, so they were leaving themselves plenty of wiggle room. Well, now this time they targeted $50 billion of U.S. products annually. It's 106 products in total included in the tariff announcement. Well, does this mean a trade war? Maybe not, but I certainly think you could call it a trade battle that is surfacing up. But you have to remember that all these tariffs so far are proposed.

None of them have been imposed. And so the reality is just from the kind of conversation and threats and jockeying, we've seen enough market volatility. We're still well over 2,000 points below where we were. I don't think the market wants to even comprehend what a full-blown trade war would look like. But what reversed markets Wednesday, when the threats of China retaliation had already pushed us down so violently was the new National Economic Council chair, Larry Kudlow, announcing that the tariffs were in fact not final, that they are negotiating tactics that all parties hope to never see them imposed

because they hope some form of deal-making will take place. So this is the lay of the land. It's a highly skittish and volatile market that one day wonders how serious the administration is, and the next day realizes it may all be bluster. Reversing this market decline, what would be a catalyst to reversing the present stock market distress? There are two possibilities as I see it. One is a robust earning season that launches late next week, and by robust, I mean more so than markets already expect.

Two would be an effective, face-saving exit from this trade tariff debacle the president's gotten us into. The combination of the two would be particularly bullish. Will one or both of these happen? It's impossible to predict. But those are, as I see it, the lowest hanging fruits in the short term for markets. Forget Q2, let's talk about Q1. Before we begin funeral processions, let's put some things into context here, okay? The S&P 500 and the Dow did both end Q1 in negative territory, despite the melt-up they both enjoyed in January. But this was the first negative quarter in two and a half years. Ten quarters without a negative quarter.

It's an insanely long time. As the red circle below, and now I'm reading here from a chart, but you've got to go to differentcafe.com to see a chart where I circled how low the volatility has been over the last several quarters. You will understand that the, and then you see it just absolutely spike to extraordinarily high levels, not seen since 2011, which is the last time the market had been down almost 20%. So in almost seven years since we've seen volatility like this, it blew higher, but it's coming off of just historically low, sustained, very low volatility. So we had kind of a too low, too long volatility environment. And now I suspect

have been overreaching on the other end. But this is an important thing for me to share about the first quarter of this year. 23 days, 23 days, the markets have moved up or down more than 1%. up or down more than 1%. Last year, it did that eight days the entire year. So you have three times the number of days of that sort of intraday volatility in the first quarter that we had all year last year. This tells you the change of environment that has come on. By the way, does this heightened volatility mean the market's about to go way up or does it mean there's more trouble around the corner? Does it mean we should sit on our hands? Does it mean we should be actively trading? You know, what's a person who's sitting there hitting refresh on their online activity every day supposed to do in this

environment? The very simple truth is that a properly built portfolio does not pretend to know what various market stimuli will mean in the short term. How many people said accurately the rates were going higher in Q1 and that higher rates were bad for bonds? Actually, how many have been saying that for about seven years? But what has the market return been though since the volatility and mayhem began positive? Getting premises right in one week or one month periods of time is very difficult. But then applying those premises to accurate and profitable short-term conclusions is even more difficult. Why? Because markets often exist to humiliate you, to punish you for the sin of violating real investment disciplines and behaviors. But also because nothing is as easy as it seems, and if it were, everyone would do it, and then it wouldn't be easy anymore, as the pricing would take away whatever easy opportunity was supposedly there.

How do we respond to present levels of volatility? supposedly, there. How do we respond to present levels of volatility? By being asset allocators, grateful that our alternatives and fixed income were such an effective hedge against equity distress last month. By building a portfolio for each client designed to withstand the volatility they can tolerate and not push them into the intolerable zone. And by being a behavior-minded advisor, recognizing that the equity premium we seek to receive through time comes at the cost of volatility headaches along the way. This is the playbook, my friends. If there were a shortcut, I would tell you.

Or would I, actually? Perhaps you think, as I do, that these short-lived gyrations and zigs and zags around trade threats and so forth are not the real fear, but the possibility of an actual bear market is, a 20% or more decline in stocks that actually lasts for a while, maybe gets even worse than 20% down. After all, this bull market has been on for quite some time, and panic attacks notwithstanding, let alone the couple corrections, we may just be due for a bear market. The reason we do not see it that way is that there is just no economic catalyst

we see for such at this time. Recession is not on the horizon, and in fact, economic activity is picking up. On the inflation front, there's been a pickup in conversation. There hasn't been a pickup in real inflation, certainly not to the level that would remotely create bear market worries. On the Federal Reserve front, there are no indicators that they plan to shock markets or take excessive monetary actions that would force us into contraction. Finally, the euphoria one generally sees when a bull market is ready to switch to bear has been noticeably absent, as it has been throughout the last nine years. I respect bear markets, and markets in general, too much to say that something can't happen. Yet far more money has been lost preparing for a bear market than from a bear market. One has to invest off of sensible frameworks, probabilities, and risk-reward tradeoffs.

So to those ends we work. I'm going to have to call it quits there, not only just for time constraints but for vocal constraints. But if you do go to DividendCafe.com, you'll also see another section on the way central banks are playing in this market, what we view their impact, positive and negative, being Japanese deflation and what's going on out there, the state of CapEx in corporate America, and a little refresher on our philosophy around alternatives, which those of you who are clients know have been a great offset to our equity volatility of benefit in our portfolios. And we expect that to continue. Thank you very much for listening. I apologize that the kind of somewhat scratchy voice is bothering you. I assure you it's bothering me more than you. But I'm going to leave it there. Thank you for listening to Dividend Cafe.

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