The Dividend Cafe - This Oily China Problem

Episode Date: November 16, 2018

Topics discussed: Credit Market Realities Brexit Bonanza Pipelines further de-correlate 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 podcast. This is David Bonson. I am the Chief Investment Officer at the Bonson Group and we are bringing you our weekly market commentary on what we call the Dividend Cafe. We will ask you to subscribe if you like listening to this. Helps us to get those numbers up with your iTunes, Google Play, Stitcher, what is it, Spotify. I can't keep it straight. If you listen to this podcast on all four different mediums, more power to you because nothing will set your week right more than listening to this podcast four different times in four different places. I think a lot of these vehicles ask you to write

a review, rate it, things like that. I know iTunes does, and it obviously helps us to have you do something like that. But let's get to the meat of this week's discussion, and that is around what is taking place in the market that we find ourselves in, market sentiment, what the catalyst to growth may be. Look at the headwinds and, of course, valuations, a lot of different topics. Markets had had a pretty mean rally off of a ridiculously mean sell-off in October. And now this week reversed off of that rally. And so just kind of that elevated volatility continuing in markets. So this is sort of what I think is the new normal. And new normal is not going to last. You know, we will end up breaking lower into a new bottom or we will end up coming out

of this and have a new rally at some point. And whether it's in a month or three months, this will change. But right now, for the time being, I believe the new normal is a directionless range bound market. And I couldn't set the low and the high of what that range may mean. If I were forced to, I would probably say about 24,000 on the Dow on the low end and 26,000 on the high end. But we went a little higher than 26 last week, and we went a little lower than 24, I believe, a few weeks ago. But right now we're sitting right around that 25,000 mark. So whether it's give or take a thousand points or give or take 1500 points as a percentage, it's not really that significant up and down. But I do think 25,000 seems to be that kind of median range at which we'll trade around for a little while. And the reason is conflicting forces. You have a tailwind

of strong U.S. economic growth, strong U.S. profits, and a headwind of global economic slowdown and global tensions caused by the trade and tariff turmoil we find ourselves in. Markets are in a funk, and I think until there's better clarity exists, particularly around U.S.-China trade relations, This is what you can expect. Also keep in mind, you have overpriced technology names that are repricing, and they've not stopped doing so. And yet at the same time, you have a cadre of stable blue chip names making new highs, experiencing double-digit gains, even as most risk assets have sold off 7% to 10% since early October. And when I say 7% to 10%, that's about average across a lot of the market indices.

You look into small cap, you look into emerging markets, you look into FANG, NASDAQ, it's substantially higher. The market may very well resume an uptrend and it may see a sell-off accelerate to the downside. But again, the most likely scenario to me is a range-bound movement, up and down volatility until these headwinds of uncertainty blow away. Let me revisit something that I've talked about a bit over the last month, elaborated on quite a bit out of our big New York due diligence trip that we had done in mid-October. And a major theme in the way we're positioning around bond portfolios, around fixed income, but also just around overall risk-reward positioning.

And that is the credit market realities we find ourselves in. And I think that some of you listening right now, your eyes may glaze over. be listening right now, your eyes may glaze over. When I use terms like credit markets and corporate debt, let alone get even real detailed like I'm about to on things like triple B rated bonds, most people don't even know what that is. But it's very important stuff. It speaks to the heart of the real tension in the economy. And in a nutshell, what I mean is that corporate America successfully re-levered post financial crisis. But along with that re-leveraging has come the inevitable, somewhat modest, deterioration of credit quality conditions. One of the examples I used this week at DividendCafe.com, I have a chart to this effect, is the percentage of

triple B rated bonds that make up the entire investment grade, the entire high quality bond universe. Okay. And triple B is the worst credit rating that is still a investment grade credit rating. And so you have basically the lowest quality of the high quality now making up 50% of that space. It was about 30% coming out of the financial crisis. This speaks to risks that are embedded in the economy at the next downturn and the challenge that the Fed has in trying to normalize monetary policy without jacking up the vulnerabilities that exist in corporate credit conditions. Again, the great chart at Diven Cafe I'd love for you to look at. the vulnerabilities that exist in corporate credit conditions.

Again, the great chart at Divin Cafe I'd love for you to look at. A lot of drama right now over across the pond in the UK. By the way, there's drama all across the pond in Germany, in Italy, a whole bunch of European noise. Don't think for a second that isn't working its way into American market action as well. But the minister who's been negotiating Britain's exit from the European Union, a gentleman by the name of Dominic Raab, resigned on Thursday, citing components that are in the deal right now. He just can't support him being a little bit harder line on Brexit than Prime Minister Theresa May is, who's really

teed up a very soft Brexit. It makes it very unlikely, frankly, that Prime Minister Theresa May is, who's really teed up a very soft Brexit. It makes it very unlikely, frankly, that Prime Minister May's plan is going to pass, or at least generate the support of Parliament. At this point, it's been a moving target. Most people have gotten this really wrong. I've kind of stayed away from projecting at all, but I will be surprised if she's still there by the end of this year. Look, it's uncertainty the market hates. It's uncertainty that continues to reign over the Brexit drama. It's not Brexit itself. It's the continued inability to kind of finalize the specificity around what Brexit will look like. I just would point out the good citizens of Britain were not so uncertain in what they wanted. Being prepared for what you cannot know is coming. The market suffered sharp drops in February and October this year, and I'm sure there's a camp of investors

who like to believe that these two drops were foreseeable. They were not. The various fundamentals, facts, and conditions that drove markets higher in January, in the third quarter of this year, in early November, just last week and week before, those conditions were all equally present in February and October when markets declined. The fact of the matter is that markets declined in those months because they declined in those months, period. The inerrant conditions of markets in short-term periods are unpredictable, temperamental, and certainly emotional. Risks and rewards, fear of missing out, and fear of downside participation, these tensions exist perpetually and are manifested in different ways without warning. So what is the solution for this permanent and errant temperamental nature of markets? The

defense for an investor against the eroticism is in number one, asset allocation. one's blend of assets in a portfolio to execute against a given risk profile, remains an advantageous way to absorb the realities of asset class volatility while maintaining the needed return aspiration. Let me say that in English. Asset allocation is the best way to play defense and offense at the same time. Now, number two is contrarianism just don't go continually with the crowd resist the temptation stick with a customized thoughtful proper plan for asset allocation and if anything invest patiently against the crowd and then number three behavioral. Avoid the mistakes that generally make the problems described in the above comments I made, the prior comments, fatal. The way you behave and the wisdom in which you enact upon a financial plan will have everything to do with your outcome. outcome. So do I think that months like February of this year or October this year enjoyable? Of course not. Do I think that an investor has multiple tools by which they can very well be insulated against the negativity of months like that, including the future months we'll inevitably face? I most certainly do.

I'm going to speed things up a little bit here. There's a few more things I really do want to cover. And, of course, you can always pick up the slack at DividendCafe.com where you actually get to see some of the charts as well. But, look, the U.S. energy production industry, I continue to take in a lot of reports on this and came across a new research boutique this week. And I spent just this morning as a matter of fact oh good 30 minutes pouring into this white paper on natural gas you know that

oil was down I think like 13 days in a row the last couple weeks and it was somewhere in the you know low 70s per barrel and now it's in the mid 50s but but we I've always believed that the energy infrastructure story has nothing to do with the price of oil has to do other than the fact that obviously the higher it is, the higher incentives exist for the producers. But my point is that we are producing 11.4 million barrels a day, more than Saudi, more than Russia, which is just absolutely stunning. And yet we are right now spending 30% less in capital expenditures and capex on supporting our energy infrastructure. The global demand is growing. We do not have the infrastructure necessary to feed the demand.

And yet our production levels are so very high. This is an untapped investable story around energy infrastructure. But let's move from crude oil, where the story is compelling enough, into natural gas, where it becomes irresistibly compelling. You have unbelievable consumption growth that is by far outpacing production growth, even rapidly growing production growth. Storage levels right now of natty gas are 17% below their five-year averages. Electric power use is not slowing. I assume everybody knows that. And yet the percentage of power generated from natural gas is just continuing to escalate. And by the way, while no one is looking and everyone's talking about stock market, the elections, oil prices falling,

natural gas is up over 20% in the last three weeks. So, look, this is not an outlook based on weather for a given month or season, the fickle nature of commodity prices. It's based on the infrastructure need that we have as a country and the infrastructure opportunity that we have. Incredible catalyst for growth right in front of us. And I will simply add that there's real low-hanging fruit there around this story, this discussion, this topic with the trade deficit and negotiations with China. The portion of exports of U.S. crude to China has collapsed in the midst of all of our fight with them in recent months represents a wonderful way to pick up the slack. Speaking of China, big fight this week with my pal Larry Kudlow out of the White House National Economic Council and Pete Navarro, the senior trade advisor, in a public fight, meaning Pete Navarro taking a hard-line stance

on what a deal with China needs to look like. Kudlow speaking for the Trump administration, coming out and saying, no, that's not the case. They're working towards a deal. And the fact that various economic actors are weighing in with input is not the president's being more favorable to the side of free trade and coming to arrangement with China, which if it were to happen, I think would be a real big bullish indicator for markets. Allow the businesses that are holding back on capital spending projects. I'm convinced that that is an innumerable amount and let the water get flowing again into the economy. Finally, chart of the week at DividendCafe.com. Look at the valuation levels of the top 50 companies in the S&P 500 right now, where the median P.E. range is 17,

versus the top 50 companies of the S&P in March of 2000, where the median PE was 31 times earnings. I don't know why I'm laughing, because it was painful to be a part of it then, and it's painful to look at it now. But I will not stop resisting the revisionism and the ignorance and the delusion that suggest that even with certain pricey components in the market now, stuff I talk about every single week, that we are in any way

in a market that's analogous to pre-March 2000, valuations are just dramatically lower than that kind of a period of insanity, which is almost now 20 years old. And now, as I say that, it makes me feel old. So it's time to end the podcast. Thanks for listening to Divin Cafe this week. We will not have a podcast next week. We want everyone to enjoy their Thanksgiving weekend.

And when I say everyone, I include myself and my family. We'll take a week off and come back at you the final week of November, going into the final month of 2018 with another Dividend Cafe podcast. Thank you for listening. And also check us out at Advice and Insights Podcast, where we have a special edition this week on the state of corporate credit. Really thrilling stuff. Thanks for listening. Thank you for listening to the D of corporate credit. Really thrilling stuff. Thanks for listening.

Thank you for listening to The Dividend Cafe. Financial food for thought. The Bonson Group is registered with Hightower Securities LLC, a member of 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.

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