The Dividend Cafe - There's Reason for an Optimistic Outlook

Episode Date: November 15, 2019

Topics discussed: Greetings from New York City where I actually spent a day in Connecticut this week with clients and another day in Boston with clients and investment banks. I am en route back to California as this is being delivered to you, where I will immediately experience a 50-degree bump in weather from departure city to arrival city. Markets had no such weather volatility this week as things were reasonably tame yet again (at least as of press time). This has thus far been a very flat week in markets both from start to finish but also intra-day as well. I think the reason for that is examined in a clear and understandable way in this week's Dividend Cafe. But I strive to do a lot more in the Dividend Cafe this week than just look at the week that was in markets ... We look at the full scope of the China trade status, going into 2020, we look at the cash on the sidelines of the American economy, and we look at where growth can be expected to be for years to come (this is my favorite section of the Dividend Cafe this week!). I even offer a periodic reminder on the realities of gold investing, and of course, offer the normal mix of politics and money. Click on in, check it out, and welcome to the Dividend Cafe! Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Hello, welcome to this week's Dividend Cafe. I am sitting here in the New York office early on a Thursday morning. The market's not open yet, but I'm getting ready to run out, which is why I'm not even taking off my coat. As I have, I think, seven meetings in a row or something like that right after I get done recording this. And it has been a busy morning. I have a lot to talk about.

So we're going to get into our podcast video here for the week of November the 11th through 15th with the stunning update that markets have not moved a point, more or less have gone up 30, down 30, a little bit here and there. But at least coming into the market open on Thursday morning, we haven't really moved at all. So we've had a couple of weeks like that lately of real limited volatility. And I suppose that's a good thing for a lot of people relative to stuff that we've been used to. But the truth is, it's not really all that surprising. There have been three primary drivers of markets this year, three things that I think are two being macro and one being very, very fundamental that have been most relevant.

And all of them are in sort of a quiet period, if you will. And the first, of course, is the trade war. And right now we appear to be headed to a phase one deal. We think that will be done sometime before December 15th, even on December 15th. They're still figuring out the location of the event. And so the markets have spent the last four weeks, six weeks pricing in the expectation that the tariffs are not accelerating, that the announcement of some additional tariffs is off, and that there's some degree of pause, if not total improvement, if not actually the potential for even moving backwards from where the tariff levels were previously.

So the markets have priced in a lot of this phase one good news. And now we're kind of in a wait and see. There's not a lot going on there. And I'm just going to kind of get this part out of the way. Going into 2020, our expectation is much of the same, that phase one has about a 10% chance of going backwards, meaning getting worse, not happening, blowing up, some kind of real bad event. That's about 10% chance of getting much better than markets have expected. And what I mean by that is the idea that you get a broader, more comprehensive structure in place that allows for more concessions on the tariff front.

And I don't think that's likely, but I think it's possible. And as I've said in a couple of past podcasts, I don't think that's been priced in. So if you take the low probability of really, really positive accelerant in the trade war news and a low probability of really negative, that leaves you 70 to 80 percent likelihood that we're going to probably be on pause all the way until the election, that there won't be necessarily a real needle moving development on the trade front. And I think the way that this thing is positioned, I've been very critical of the tariffs and I still am. And I don't change a single thing that I think I've said through the whole process. I don't believe that this is as good of an outcome as we could have gotten if it had not been driven

around the trade deficit and the faulty notion that the disparity in exports versus imports for one country versus the next is in and of itself the problem. I think that had it been centered around, well, more specific, more like very, very specific intellectual property theft, but also in the broader spectrum of national security, supply chain concerns, I think that the overall technology discussion has enough tentacles to it that I think the American people would have been probably far more interested and felt to be more compelling than the way the story kind of got designed. But either way, the point I was about to make is that I do think this thing is on the verge

of potentially turning into a big positive for the president politically. And that's where I expect this story to mostly reside in the days and weeks ahead is in what its political implications look like all the way through 2020. So anyways, in terms of those three issues I was bringing up previously, the trade front on hold, as I've talked about, the Fed, I think we know to be kind of on hold. There's always this other possibility of another rate cut. And I don't think it'll happen.

I certainly don't think it should happen. And the market's now pretty well pricing in that it doesn't think it will either. But you got three rate cuts from the Fed in the last several months. The Fed has clearly been done in their quantitative tightening for some time now. And I don't expect a big move out of the Fed one way or the other again through the election. So I think that the Fed is still there as a backstop to risk investors, that if something does get real kind of ugly, the Fed has shown

that their role that they have adopted over the last 20 plus years in American capital markets as this kind of put option for risk investors, I think it's still there. But as far as an actual proactive movement, either that works against markets or works for markets, I think it's still there. But as far as an actual proactive movement, either that works against markets or works for markets, I suspect it's mostly going to be kind of on a timeout. So then that goes to the third element, which is the one that we want to spend the most of our time talking about in general. And the one that we certainly know to be the biggest mover of markets through time is earnings. And I put in Dividend Cafe this week a couple updates. You're now more or less done with earnings season. There's a few stragglers still

to report. But you had 75% of companies beat their earnings estimates this quarter. And that's above the average of how many companies normally beat their estimates. And you had pretty significant revenue tickups. Now, overall, year over year, this quarter will represent a decline in earnings from where we were a year ago. So then really where Q4 comes in will dictate how much earnings growth we got out of full calendar year 2019. got out of full calendar year 2019. The deceleration in earnings growth for the third quarter was not as severe as some had predicted it would be. So you had another quarter doing better than had been expected. It was particularly strong for dividend growth names. There were some

sectors that did better than had been expected. We're very happy at Bonson Group with how the quarter went. But then there were some big, big technology names that struggled and a couple, you know, surprises here and there. So that's not unexpected. That's generally the way it'll work. But on net, we think the earnings environment was good. So I certainly believe that earnings will prove to be the predominant driver of markets here with the Fed and the trade war kind of sidelined for the time being.

Now, aside from why market volatility has been sort of low this week, my little update for you on the trade war, there's a couple of things I'm going to go through that don't necessarily all connect to one another, but they're different topics I approached in DividendCafe.com. And I'm really happy with this week's commentary. I had a trip to Boston yesterday for a couple of meetings. And so that gave me a train ride's worth of reading and writing. And I always like the weekly Dividend Cafe better when I have that kind of focused attention. And this week, there's a few different things I got to unpack a little

that I've been wanting to get to. So I hope you'll get a chance to look at it. But I'll walk through some of it now for you, the listeners and viewers that don't go to DibbingCafe.com. First of all, let's talk about a catalyst that could really drive markets and at least a transitory sense higher outside of the three topics that we just went through. And that is the cash balances, the money market assets that exist right now in the American economy. It's stunning. $3.5 trillion sitting in money market funds around the country, pretty much the levels

that we had seen at the bottom of the financial crisis some 10 years ago. The idea that that much money is still in cash, even as the stock market is making new highs, is crazy. Now, one thing has to be said is, as a percentage of market capitalization, the number is not particularly high. 10 years ago, it was a massive percentage of cash relative to S&P valuation, indicating the screaming values that were existing in the stock market. Right now, it's not high or low. It's just kind of in a little average place. But the point is that absolute level of cash, to the extent that a significant amount of

money comes off the sideline and into productive investments, it has a chance to be yet another investment catalyst for better pricing, for moves higher in risk assets. Let's talk a little bit about the economy before I go into gold and before I go into the lovely topic of growth in the American economy for years and decades ahead. And then we're going to close up with some talk about politics and some talk about market valuation. Like I said, it was a long train ride. OK, as far as the economic update, I thought it was modestly positive news this week. The Small Business Optimism survey came for October that

it rose a little bit. It declined in September. And I was fearful that if we built a little sequence of negative months that that could get a little out of control. Now, we're still well below our summer of 2017 levels where small business optimism had peaked. And I think that going into 2018, the advent of the trade war in February is directly related to the beginning level of the levels coming down. But capital spending improved in the survey results. In October, there was a tick up in equipment, vehicles, and facilities. 40% of small business, are reporting a negative impact from the trade war, and that number was only 30% the month prior.

So we're seeing more talk on those kind of macro concerns. I'd pay attention to that. But overall, when I hear small business after small business owner and survey after survey reporting that their biggest problem is finding labor, I think that is both a very good thing for workers. They have more leverage. There's more upward pressure on wages. There's less people unemployed.

That's a good thing for the American economy. It's not nearly inflationary. Anyone who tells you that should be disciplined. But it is a challenge for businesses in that it puts compression on margins as they need to pay up to find better labor. And also, just from a productivity standpoint, it's hard to produce and grow when you can't find good talent. And so that's a push-pull element in the economy, depending on what side of the fence that you're on. I said I wanted to jump into gold real quick. And I don't have anything to say that is any different than things I've really been saying

for a significant amount of my career. But I did put a chart in DividendCafe.com this week, because I want people to be reminded of how painfully untrue it is that gold should be bought as an inflation hedge. I do make the argument that there are points in history in which gold has been an effective hyperinflation hedge. But for the run-of-the-mill inflation that actually affects consumers and actually affects workers and actually affects retirees, the kind of inflation that you care about when you go out to live your life, the fact of the matter is that gold has been an awful hedge against inflation. And gold also has not moved necessarily around the dollar. So there's a belief that people

shouldn't own gold if the dollar is going higher. And the fact of the matter is that the dollar stayed completely, totally flat from 2004 to 2014 on a trade weighted basis. And gold was up like 250, 300% in that period. There's been plenty of periods where it's done the opposite. So the reason I bring up the erraticness of what drives gold prices is because we've seen in the last six weeks, people have reached out to me and said, you know, gold is down quite a bit over $100 an ounce in the last six weeks. Is some of that related? It's about 6%, 6.5%. Is that related to the market doing better? Are people going out of gold into stocks?

And of course, the answer is, I don't know, maybe. But why does one believe there has to be a reason for why gold goes down? Because there most certainly is not a good reason for why gold goes up. There are periods where it is up and down when inflation is up or down and the dollar is up or down and stocks are up or down. It is not something that people can forecast. And the reason that they want to look for a reason is that it's difficult to come to terms with the fact that gold goes up or down for reasons that are totally unknown.

It doesn't have an intrinsic value. It doesn't have an internal that you can measure. It doesn't have an internal rate of return is a better way to put it. And so I have no opinion. Gold could go up a lot. Gold could go down. People could think that they found some trading mechanism around it.

They can think that they believe in a particular period of time it will trade relative to some other event, whether it be central banks or currencies or inflation expectations. All those things could be true in more extended periods of time. It certainly is not. And the sustainability of whatever catalyst and patterns people think they found, it's not very reliable. So I just think that this is a helpful reminder to understand the big picture on gold. I do have a pretty lengthy kind of reiteration of our thesis at the Bonson Group about emerging markets this week. And a lot of it is, I'm trying to do more work to connect it to themes I've been unpacking throughout the year. I believe that there's a structural growth challenge in the economy as a result of over

indebtedness from government spending. I don't think this is rocket science. I most certainly don't think it is controversial that we have seen downward pressure on yields as there's been more crowding out in the economy as the government spending as a percentage of GDP has increased and much of the world increased dramatically and our country increased nevertheless. And that has then decreased incentive for productive projects and boosted up the value of already existing projects, investments, opportunities, risks that exist. Those legacy risks get a better bid, but you don't see as

many growth opportunities come into the economy as the structural growth going forward is impeded. And I can unpack each premise or sub-premise that goes with what I just sort of laid out, but I think that all of it comes together to form a narrative that we don't want to be paying 25 and 30 times earnings for various growth assets right now. And we don't know that we can find a lot of new investable growth opportunities, certainly in the venture capital space, private equity, in which we are invested from an alternative standpoint. In the biotech space, private equity, in which we are invested from an alternative standpoint. In the biotech space, there's pockets where you're going to find these various opportunities,

all with a commiserate risk reward. But my point is, you cannot find a broad level of well-priced growth to buy. And we believe that where the macro environment is entirely different are in emerging markets. Those domiciles that are widely, broadly, and quickly embracing free market capitalism and developing huge amounts of their population into the middle class. and developing huge amounts of their population into the middle class. And this is a dynamic that's been going on for over 20 years. And you have seen a lot of it mature into many countries and many cities inside countries. A lot of China is still very poor, but a lot of China got rich.

A lot of Brazil is still very poor, but a lot of Brazil got very rich. That BRIC thesis, the Brazil, Russia, India, China story, was very commodity-driven as those countries developed economic apparatuses to sell a lot more things at a lot lower prices to a lot more countries around the world. It was a great investable story. And you had downward pressure on the US dollar that was making the currency risk work to the favor of EM investors. So right now, I would say that the Federal Reserve, being in the loose and accommodative position they're in, bodes well for emerging markets for a number of reasons, at least as a sort of transitory

peripheral effect. And I would say that the dollar's strong position is likely to not accelerate much further than it is at the higher end of where we expect it will be for some time. And so therefore, that takes a little bit of the pressure off the pricing some time. And so therefore, that takes a little bit of the pressure off the pricing valuation in emerging markets. And then you look at the growth rates of very high quality companies and how they're priced. You have an opportunity to buy companies that have very, very significant growth rates and growth expectations, but not paying up for the multiples that I think are for structurally challenged opportunities in the United States. So look, there's another factor, too. When Europe and America cut rates, it doesn't have a very stimulative effect anymore.

How much can you get when you cut from one and a half to one and a quarter. But when you cut from seven to four, well, that's a big deal. And I do think that you're going to see more monetary accommodation now with the Fed on hold than we had been expecting. And I think that that's going to mean more stimulative impact to much of the emerging environment. So that's where we believe growth can be found. We certainly want good growth opportunities in the United States, but we believe that the more investable opportunity is in more mature, seasoned companies where you don't have to pay higher than logic would dictate multiples, and you're buying a function of the cash flows of these companies

and the way that they're rewarding that to you. Very disciplined investing is going to make the most sense in the United States for some time. I do have a section real quickly. I'll skip over now and dividendcafe.com this week about oil and gas pipelines and some of the things that have been holding it down technically and even to some degree fundamentally, been holding it down technically and even to some degree fundamentally, but why we remain very happy to get paid 8% to 9% yields in the space while we wait for the story to continue playing out.

This is a long time thesis, and it is not one that we need to jump up 20%, 25%, 30% to say, OK, let's take a victory lap. I think that's going to happen at some point. I think it may be more than that. I think it may be quicker than expected. I don't know. I just know that along the way, the yield play and the ability to continue getting these accelerated and attractive dividend yields is why we're in the story.

You know, interesting things in the politics and money section this week, the possibility of Michael Bloomberg entering the race, the way in which the betting odds have come down for Elizabeth Warren from about close to 50% down to the 30 range, yet still far above the 20% that she was just a couple months ago. She still has a significant lead in the betting odds and is tied for the lead in New Hampshire and right up in the top in Iowa. It's tightened.

Anything goes. But again, our view is that there are four hurdles still before someone has to say, oh, look at these awful things that could happen to the economy. She has to win the nomination. That's going to be very, very tough. And then she has to win the general. That would be very tough. Then the Senate has to stay Democrat, and that'll be very tough. And then even with the Senate potentially flipping Democrat, you have to get enough of them willing to go do $52 trillion bills here and $100 trillion taxes there and things like that.

I just don't believe investors have to think about those worst elements. I think investors have to think about the rhetoric and the tone that could be undermining free enterprise, something that we definitely think is pertinent to markets. But I think that right now we're sitting here a year out from the election, and that is not the type of thing people should be looking to finally the chart of the week at divinitycafe.com i list through a whole bunch of historical valuation measures for the market and you can see where the market looks very fairly evenly priced by a lot of them a tad frothy and some not excessive a tad cheap and a couple others so that story of kind of fair value on the higher end of the range, I think is reinforced

with about a dozen data points that I provide for you. Okay, we covered a lot of ground. I've got to get running out into the 30 degree grounds of New York City. I will tell you that 30 degrees in New York feels a lot better than 22 degrees in Boston, where I was yesterday. But I'm flying back to 72 degrees Newport Beach tomorrow and look forward to rejoining my kids. My wife has been out here with me this week in the city. It's been a wonderful, productive week. Very, very meeting filled. A lot going on and more to come. Okay. Thanks for listening to Divinity Cafe podcast. Thanks for those of you watching the video. And we look forward to any questions you have and all the kind things you want to say if

you're gracious enough to review our podcast. If you do so, send us a little snapshot of it. We would love to send you a copy of the book that I've written on Elizabeth Warren and her policies. And with that said, thanks for listening and watching The Dividend Cafe. Thank you for listening to The Dividend Cafe, financial food for thought. through Hightower Advisors LLC. This is not an offer to buy or sell securities. No investment process is free of risk, and 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.

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