The Dividend Cafe - Theory Into Practice

Episode Date: October 29, 2021

I wrote last week about a small amount of rather large economic principles that are too often forgotten in contemporary thought, and in many cases were never learned in today’s financial advisory community. I promised a part II this week where we focused more on the application of these principles, and there is no way I would disappoint you after that powerful cliffhanger. I will point out before we dive into the Dividend Cafe that I hosted a fireside chat with Bahnsen Group economic and policy advisor, Larry Kudlow, this week. You can find that whole video replay on our website if you are so inclined. Today’s Dividend Cafe is short and sweet but does focus entirely on the promised mission – putting into practice for investors what the theories of economic wisdom look like. Off we go … Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Well, hello and welcome to another Dividend Cafe. I am very pleased to be back in New York City. I've been back for just minutes. As a matter of fact, I flew on a red eye last night from Southern California. But let's see where I think I recorded last Friday in a hotel in Dallas, Texas. And then I flew. So I had flown from New York to Dallas, recorded there last Friday. Then I've been in California all week and and then now just came back to New York. And so I hope I don't look as tired as I feel. And I certainly hope I don't look as tired as I feel. And I certainly hope I

don't sound as tired as I feel, but I do feel kind of tired, but that's all in a good way. It's been an incredibly productive week and, and there's just a lot of projects and things going on. Obviously a lot happening in the market. We have a lot of searches and due diligence around some of our investment projects going on. And then in the meantime, you know, we had a big fireside chat event this week with Larry Kudlow, who had come out to Southern California and we had a lovely time with him. That replay of that event is available also on our YouTube channel. But now we get ready to close out the month of October. Obviously, it'll be Halloween here over the weekend,

and then we'll go into a fresh week, a fresh new month that is next week in November. And I think back to this weekend a year ago, it was the weekend before the election. And even though markets had recovered just in a massive way since the COVID drop of March, September and October were both down months in the market, modestly so. But there was, you know, a bit of anxiety. There's a bit of kind of skittishness and uncertainty going in the election. Now, there are a lot of people on the right that

were not just skittish, but they were petrified, like, if the election goes the way we don't like, markets are going to tank. And I had a very different view than that. And it had nothing to do with what my beliefs were on election outcome, but it had to do with what I know about markets, which is markets' real sincere hatred of uncertainty and markets ability to price in rather quickly known news, whether that news is subjectively bad or good. And what ended up happening a year ago this weekend is markets hit their low point after the COVID low point. So the lowest they got after any kind of recovery period post COVID was this very weekend. And then and that same exact thing had happened in the weekend going into the election in 2016 and 2012. 2008 doesn't count for a whole lot of reasons if you recall

what was happening in the world then. And 2004, it happened. And so I just happen to know that there is this historical precedent for volatility. And it's not necessarily markets being nervous about what happens. It's people believing the markets will be nervous about what happens. And so it's self-fulfilling prophecy of a human activity response that bids up vol. It bids up vol because of uncertainty. And then what happened in last year's election was that the outcome was reasonably known pretty soon thereafter. And one of the aspects of the outcome was the Senate race didn't go in a way that some thought it could that I think would have been more severe.

And we're actually seeing that right now in the struggle to get this massive tax and spending bill done. It is proving to be very, very elusive for the very reason that there isn't this clear majority, clear mandate. And so it's forcing the democracy to work, you know, in a very different way than if there was a really overwhelming single party control. But all that to say, you know, here we are a year later and it's been quite a year. If you look at the year, not just as 2021, but kind of starting in early November, where markets started flying and energy started flying and financial started flying. And we're doing so in the aftermath of the election results not turning into some of the things that they could have. And a few weeks later,

the vaccine approval that came. And of course, we've been kind of living in the aftermath of a lot of that. I promised last week after sharing some principles and I talked a little bit, some economic principles last week, I promised that I would talk this week about investment application and some of that. price discovery or the price mechanism as a key aspect of driving free enterprise, of having signals in the market that help inform free decision making and that leading to a better outcome. And there is a overall view of economics that I hold to that views economics very anthropologically, that there as a study of the human person. And that leads to not only a different approach to some of the political economy policy application, but my argument is it also leads to some investment application that I consider to be particularly unique. And I promised I'd share some of that this week.

And so I don't know if the written Dividend Cafe was my best work or not. I know that I mean every word I said. I probably could have gone on much longer, but it was a little more time constrained in writing it than it often is. And it was heavily sleep deprived. But all that to say, if you read Dividend Cafe or you listen to what I'm about to say now, I'm hoping that you get the connection, that the dots get appropriately connected between certain principles about human action and the investment application that we recommend. I start with the premise in my beliefs about economics that the human person was created with certain rationality, with certain order, with certain

design, with certain capacities and included in those capacities are the capacity for creativity, for productivity, for innovation. And none of these things are buzzwords. These are all definitional words. Like it's existential to who mankind is. And I believe that in my particular case, out of an overarching faith worldview, but I don't know anyone who could hold to a different faith worldview than mine who would, could, or should

say any different, that the economic events that allocate resources in society are the outflow of humans acting and acting very organically and very orderly, very rationally, and acting very organically and very orderly, very rationally, strikes me as completely indisputable. And so I look to the testimony of history, what I believe about the nature of the human person, and I say, I want more of that. I see really bad behavior sometimes. I see abuse and excess sometimes. Sometimes I see abuse and excess sometimes, but also see this created capacity for problem solving, for innovation and for extracting value out of things that can be really quite rewarding and quite profitable. And I don't believe in investing in equities as an example, something that's going to have risk of failure.

It's going to have the assured risk of volatility, of up and down movement. I don't want to take on those risks without the reward. And for me, the reward is connected to the enterprise and endeavor of the human person. And this applies to the way we view small capitalization equity. Publicly traded companies are smaller in size. Private equity, it applies to how we view dividend growth equity. And I would make the argument it applies to how we view emerging markets, particularly in third world countries, the belief in the capacity of humanity, even in third world countries, to generate outcomes that can be profitable. And the appropriate diligence, the appropriate research has to be put around that process.

And I think a lot of people could say, yeah, that's fine. We want stocks to go up. And so we're going to have a spreadsheet that helps us track price momentum we have charts we have algorithm but we're we're buying uh low and selling high and so the math of buying something at seven you sell at 10 and the math of buying something at seven that you sell at 10 for a different reason may be the same thing. But that different reason is, I think, extremely important. The repeatability, sustainability, and many times the perpetuity. Why would you want to sell something at 10

if you believe in the continued function of the enterprise, the continued capacity for innovation, for cash generation. But it all flows from that belief that economics fundamentally is not econometric, it is not algorithmic, it is not spreadsheetable. Those are all backward-looking captures and encapsulations of what is actually happening in wealth creation, which is humans acting. And of course, when you get to very large hundred billion, 300 billion, 500 billion dollar companies, dividend growers or not, they're still pretty bureaucratic.

So for you to go into a company of that size, we think you want to have this incredibly defensive business model and probably a brand around the company that provides a lot of the premium value. Because the knowledge problem that I wrote about last week, that knowledge is widely dispersed throughout the economy and so no central figure is able to have the specific knowledge necessary to make perfect decisions, to allocate correctly. That, you could argue, applies to a much lesser degree than government or central planners, but it could argue to very large behemoth companies too. So it puts a bigger burden on us when we start buying those very large companies

because we think they're subject to some of the knowledge problem. Ultimately, when you go downstream, we're so big on subsidiarity, this notion of the optics being strongest when you're right in front of something. And yet those businesses don't necessarily always scale. They don't necessarily always have the dependability, reliability, balance sheets necessary to become investable for clients, especially when we want a long-term preservation of capital. So you have to balance these things. But my argument is that you have to think about them as well. What are your objectives or your caveats when you buy very large companies or small?

But whether that asset class is large cap, small cap, or emerging market, or private equity, it's driven by our pursuit of human activity, which is why we're not momentum people or chart people or algorithm people. We believe we are real fundamentalist. We are real bottom up human action investors. And the other piece to that I want to share is we are production investors. We want to invest in companies that are creating new things that are producing new things. When a company's value proposition is people love to consume what we make,

I think, well, people love to consume. And if my macroeconomic assumptions that drive how I want to invest are all based on finding some environment where people want to consume. And you hear the line all the time like, oh, well, you can't ignore consumption. It's 70% of the economy. But that's an incidental reality. I'm surprised it's not 100% of the economy in the sense that, of course, people want to consume. Nobody has to be told to enjoy good food. They just enjoy good food. No one has to be told to go enjoy a fun

vacation and we inherently enjoy good vacations. But when you find businesses that have the incentives in place for production, because I think humans act and respond to incentives, production, because I think humans act and respond to incentives, I think production is not something that is inerrant and yet there's a high capacity for. So when you find policies that are feeding an incentive for production, when you find companies that have tapped into that incentive, those become very investable opportunities. So this shapes both our macro and our micro outlook. Having a production-oriented focus, what is commonly referred to as the supply-side mentality, versus a consumption-oriented focus. The final economic principle that I alluded to last week that I'll touch on this week from an investment standpoint is that issue of price discovery and the way in which altered price of capital leads to an altered price of potentially everything, certainly many things, and that the present monetary regime is unapologetically in need and in desire of altering the price of capital

for the purpose of affecting other policy objectives. for the purpose of affecting other policy objectives. And I believe that, first and foremost, we have to be aware of it, we have to know it, we have to share it, we have to say so, lest people believe that there's some free lunch, that there are monetary objectives out there that can be met that solve a problem and that there's no offsetting trade-off somewhere else. And there most certainly is. In our opinion, the trade-off is largely in the form of distortion. And so we want to avoid things that are more susceptible to that reality. Zombie companies that are getting by and maybe

their stock prices go up, maybe they've gone down. But people can feel positive about it because the companies are alive. And yet, the truth be told, they would be dead. They cannot really reduce their debt. They cannot really build new value. But they can live to fight another day because the cost of capital is held down so that the debt leaves them in this zombie-like state. And we don't find that very promising, to say the least. We don't want to reach for yield. We don't want to go take 10% more risk to try to get 50 to 100 basis points more potential

reward. Okay, this is a byproduct of our worldview around what monetary policy does when the cost of capital is distorted. view around what monetary policy does when the cost of capital is distorted. And so avoiding very high valuation, avoiding yield reaches, avoiding zombies, it comes from our respect for the fact that the cost of capital is distorted. But the caveat I give is even the things we honor are potentially impacted by that. The question is whether or not they're how direct the exposure is. But no investor in risk assets is not in some way exposed to that reality. But we want to be conscientious of it. And then we want to be intentional on how we position. So this is a few of my favorite things.

And I hope that sharing those applications, some of our favorite applications and investment markets that come out of economic beliefs is useful to you we most certainly remain steadfastly bottom up in our equity orientation and now you know a little bit more about why we want to buy the profit motive we want to buy self-interest we want to buy humanity and we want to do that in the way we think about real estate, the way we think about alternatives, and most certainly the way we think about equity operations, because that's who we are. We are investors in the human action of which I speak. I hope this has been helpful. I would like to tell you you're off the hook with much more of my economic pontificating but as the book is actually coming out now in the next week and ahead I can see myself talking about this stuff even more just because with it in the book it's on my mind but actually next week I have another topic I'm thinking heavily about going to so maybe I'll spare you we'll see how

it goes thanks as always for listening to and watching the Dividend Cafe. We appreciate you subscribing and sharing and doing whatever you can do to help us build up our appropriate rankings because after all, humans act and that includes us. Thank you for listening to the Dividend Cafe. Swanson Group is a group of investment professionals 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. There is no guarantee that the investment process or investment opportunities referenced herein will be profitable.

Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors. All data and information referenced herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary and does not constitute investment advice. Thank you. and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice. This document was created for informational purposes only. The opinions expressed are solely those of the Bonson Group and do not represent those of Hightower Advisors LLC or any of its affiliates. Hightower Advisors do not provide tax or legal advice.

This material was not intended or written to be used or presented to any entity as tax advice or tax information. Tax laws vary based on the client's individual circumstances and can change at any time without notice. Clients are urged to consult their tax or legal advisor for any related questions.