The Dividend Cafe - There’s Never Been a Recession When Profits Were Growing

Episode Date: August 31, 2018

This week, David covers the market moves Topics discussed: Yield and Phillips Curve - how do they work? The Hardest Job In the World - Fed Chair Jerome Powell Is Capex Capping? Links mentioned in this episode: http://thebahnsengroup.com http://dividendcafe This podcast is powered by ZenCast.fm

Welcome to the Dividend Cafe, financial food for thought. Hello and welcome to this week's Dividend Cafe podcast. This is David Bonson. I am the Managing Partner, Chief Investment Officer of the Bonson Group. And we are bringing you a special Dividend Cafe podcast this week as we approach the two-thirds of the year completion. We got the final trimester of the year to go. And I will simply make the observation that we are entering the final third of the year, which is the best third of the year. And I knew as soon as I said it that there'd be somebody out there that says,

well, geez, is he predicting that the final third of the year is going to be the best of the markets? And actually, that's not what I mean. What I mean is that it's football season, so that kind of automatically makes it the strongest time of year. And, of course, you get the holidays at the end of the year and so forth. We got a fun four months to go. at the end of the year and so forth. We got a fun four months to go. Real quick, anecdotally, I'm going to be celebrating, or if you prefer a better verb, memorializing the 10-year anniversary of the financial crisis, milestone day by milestone day. I'm going to do a series of short articles at marketepicarian.com throughout September into early October. We'll probably have about half a dozen articles short,

but reminiscing about the play-by-play events of what took place 10 years ago in what was by far the landmark economic event of our lifetimes and the landmark event of American history and going back to the Great Depression. And so I'm going to try to kind of personally reminisce and walk through some of what was taking place 10 years ago on those given days when Fannie and Freddie were taken over, when Lehman went bankrupt, things like that, but also try to just sort of apply a kind of catch-all lesson around what it means to investors and what we learned from those events and what we need to understand going forward. So marketepicarian.com. If you don't get that, I don't write very often on it.

So doing this kind of series for it, it isn't like you're going to inundate it in your inbox, but it is, I think, some of the better content. Let's put it this way. It's content I love writing. Subscribe, check it out. And then after the financial crisis series, you can always unsubscribe if that's all you wanted. Okay. Let's jump into the Dividend Cafe. I just did a whole dedicated podcast and advice and insights about this subject, but I'm going to lead for you with this very story. We've never had an inverted yield curve

that did not foreshadow a recession within 12 to 24 months. I believe this is basically true, and you'd really have to have financial media on mute to not hear it two to three times a day right now. But I want to add another factoid to the milieu of considerations, and that is that we've never had a recession when corporate profits were growing ever. Q2 profits were up 7.7% quarter over quarter. That's a surreal amount of profit growth on a quarterly basis. Although I guess nominal GDP was up 7.6%, real GDP was up 4.2%. So with that kind of economic growth, maybe it's not as surreal. But S&P earnings are up more than 20% year over year.

And corporate tax receipts are 34% lower than they were a year ago. At the end of the day, we don't know what the yield curve is going to mean. We don't know if it's going to invert. We don't know what the delay might be until recession comes afterwards. And in fact, as long as corporate profits are growing, that presents another fact pattern that market prognosticators will have to deal with. In terms of the Fed at Jackson Hole, I thought Chairman Powell's speech was reasonably uneventful, kind of reiterated all the same talking points the Fed's had for the last several months. What the fundamental tension is within the Fed and its critics right now is this.

What the fundamental tension is within the Fed and its critics right now is this. Look, the hand-wringing has been driven by a belief that low unemployment is fundamentally inflationary. And that is a preposterous thesis that I think has been disproven throughout certain historical periods. It's called the Phillips curve. Phillips curve. But whether I'm right or wrong about that, the very low unemployment we have had has the Phillips curve advocates on the Fed wanting to tighten monetary policy to curtail what they believe will be inevitable inflation. And on the other hand, because inflation is so low, many others see excessive tightening as playing with fire, that it's likely to tip the economy into recession and mess up the low unemployment that we've had for so many years. The fact of the matter is the premises are all wrong, making the conclusions that we're likely

to get either wrong or only accidentally right, and therefore not sustainable. The reason for the Fed to normalize monetary policy is not because low unemployment is a ghastly creator of inflation, but rather because pricing money below its natural rate creates distortions and malinvestment in the economy. The reason Chairman Powell wants to tighten in the face of low inflation is more related to finding a spot of equilibrium so as to not be caught without bullets in their monetary gun when a recession does come. I'm uncomfortable with the central bank setting any inflation target above zero percent, but even if they do believe that creating two percent inflation is a good thing,

those who see the absurdity of the Phillips curve are right to be concerned, but for the wrong reason. We believe the Fed will raise rates next month, and most likely, but not assured, again in December. And we think whatever they do or don't do, right or wrong, will likely be for the wrong reason. If nobody... Let me see here. I'm going to skip this section. It's a little tough to do on the podcast, but I will use this time to drive you to dividendcafe.com.

A few things with charts and visuals, a little easier to follow on the website. arts and visuals a little easier to follow on the website. Our taxable bond outlook, the impact interest rates have had on bond pricing this year are well known. The irony is that most investors flock to short maturity bonds to avoid the price pressure of rising rates. And yet longer dated bonds have not been impacted since February because their yields have stayed in place. And yet the short and safe maturities in the low duration spectrum have seen continued elevation of yield, therefore negative price movement.

a year we want to let bonds be bonds view the asset classes a mere volatility hedge against equities and use emerging debt asset classes as the space for possible offense and even then in real limited measure US credit has continued to perform well floating rate high yield CLOs we particularly like the CMBS-based commercial mortgage back. In no subclass of the bond world, though, would we want to take on improper or imprudent risk. Boring is better. For those hoping the Fed hits the pause button here soon, I do have good news and I have bad news. The good news is it's entirely possible the Fed will indeed pause, and that could be a boost to risk assets around the globe. The bad news is I don't believe they'll pause unless something were to break,

that is, something on a macro level were to really wear down. So in other words, the likely cause for the Fed holding back from a second rate hike between now and the end of the year, feared by many because of its impact to asset prices, is that something may happen to asset prices. So they wouldn't do it. You get the idea. CapEx is a good thing, you say. A fascinating backtest by our friends at Strategas Research of how companies' stock prices are performing based on their various primary uses of cash post-tax reform showed that the stock prices that are investing the heaviest in CapEx are outperforming the overall market and outperforming the companies that are most focused on stock buybacks. So companies whose primary use was M&A have performed the worst.

Well, why would CapEx be so favorably reflected in stock prices? The answer is it indicates an investment will go into enhanced productivity and that the fruit of productivity is profits. before tax reform. And then you go all the way down the list and where we stand now, right between Estonia and Slovakia. But just a dramatic reduction of our tax rate and adding on an absolute basis better after-tax profits to American companies, but on a relative basis, making us far more competitive with the rest of the world. The big news of the week in markets was the announcement of the progress with Mexico on a revised NAFTA agreement. No doubt the strategy to deal with the EU and Mexico, and we presume Canada, all before China is beginning to, you know,

having gone through these other processes before we get engaged with China is looking like an effective strategy. Should Canada enter the fray and the EU talks settle, it's going to produce a lot of leverage for the Trump administration with Canada. So it'll be interesting to see how that plays out. I think the chart of the week at Dividend Cafe, I would really check it out. It's fascinating to see the corporate profit growth year over year, every single year going back to 1950. And the only times that that declines year over year are when we have gone into recession. And so I just believe that the historical guide of no recession

unless there's a decline in corporate profits growth is very unlikely to be beaten up or disproven here in this part of the cycle. So a lot of good stuff there at the website. I've tried to cover a lot of ground here today. I hope you've gotten something out of it. We do encourage you to sign up, subscribe for the Dividend Cafe podcast. You can check it out at Stitcher and iTunes and Google Play and all your normal things. But we would love for you to subscribe. Other than that, reach out with any questions. We're going to head into September now. I'm going to do this series on the financial crisis at Market Epicurean. And we're

going to keep doing what we do. I think we're making good decisions on behalf of our client portfolios now and working very hard to reiterate our viewpoint and test exactly what we're committed to doing, things like that. So a lot going on, fun time of year. I'm going to leave it there. Thank you for listening to the Dividend Cafe podcast. Thank you for listening to the Dividend Cafe, financial food for thought. The Bonsai Group is registered with Hightower Securities LLC, member FINRA and SIPC, The Dividend Cafe, financial food for thought. There is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance 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 opinion, news, research, analyses, prices, or other information containing this research is provided as general market commentary.

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