The Dividend Cafe - Trade Wars Not So Easy to Win for Investors

Episode Date: August 5, 2019

Topics discussed: The market suffered its worst week of the year last week and the downside accelerated today in response to China’s currency depreciation and the general market realization that this trade war ending is nowhere in sight. We sat down as an Investment Committee this morning and recorded our best thoughts and ideas around all of this to inform and edify your understanding as it pertains to your portfolio and overall economic expectations. We particularly hope you will at least listen to the ending conclusions we offer. Please listen to this special Dividend Café podcast! Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. doing a kind of extensive unpacking of the newest escalation in this seemingly unending trade war between the United States and China. So we're going to dig deep into all things trade war, currency, tariffs, and even where that might impact Fed and earnings and some other kind of collateral conversations from that. But the other reason special podcast, it's the first of what we hope will be many with our investment committee kind of doing this together. And so you obviously are used to me doing a weekly different cafe podcast. That's not going to stop. I, on certain occasions, enjoy doing kind of special topical ones. I, you know, like every time there's a trade war escalation, it seems we've done this and we have one in the works right now around the election and a number of different things.

So we want to do more and more of this. But it's important that you get the full arsenal of Bonson Group Intellectual Capital. And we are sitting here today, our 80% of our investment committee, Robert Graham is out of town in client meetings, and so he's not joining us today. Robert is one of the CFAs in our group, and will certainly be joining here one of our future podcasts. Let me quickly just tee up who's with me here, and then we'll start talking amongst ourselves. Sitting on my left is our newest member of the investment committee and one of the newest members here at the Bonson Group. He joined as our director of equity research just recently here. I guess

been about a couple months now, Julian. So welcome to the Dividend Cafe podcast. Thank you very much. Thanks for having me here. Yeah, it should be kind of fun. I'm hoping to spring some surprises on these guys, but we talk about this stuff so much, I don't think anything will shock them, but perhaps their answers will shock me and therefore shock you, the listeners. Over across from me, Brian Seitel, longtime partner at the Bonson Group. Brian, how are you doing? Good, good.

Thank you. And then, Daya Parnasu has been our managing director in the investment solutions group for quite some time. Daya, how are you? I'm just ready to do this. Now, we did a podcast together, I think by remote once, right? About a year and a half ago. I think I interviewed you from New York, or we just sort of chatted a little bit. Yeah, just sort of chatted.

It started off, I didn't really get my footing at first. I thought it was going to be like an interview kind of thing. No, you were pretty bad. It was pretty bad. And then it morphed into a bit of discussion, which we're hoping to do here today. Yeah. No, it was good. It was good.

I think all of the 17 listeners really got a lot out of it. And then not counting your family, even the other 10. It was good. And there's 20 that work here at the Bonson Group. Which three didn't listen to it? Okay, so listen. This is kind of interesting. It's disappointing.

As you guys know, we were going to talk about earnings season today. And we're 80% plus into earnings season. For us, I think our only three remaining companies still to report last quarter's results are Cisco, Walmart, and Steelcase in that order. So we've mostly gone through all of ours and we're all kind of pumped up to sit and talk about the highlights and lowlights of earnings season, what we got out of it, what it looks like for the whole market and our own portfolio positioning. But really, it seems somewhat disingenuous to go into some of that stuff based on the events of the last, let's call it, 96 hours.

So by recap, the Fed met Wednesday. They cut rates. Quarter point is expected. His press conference was normal. Fed, World Reserve, incoherence in one ear, out the other. One side of the mouth, all the cliches you could think of. Just stuff, I don't know, the market knew how to digest it. But more or less what they said was, yeah, we're data dependent.

We think we might do another quarter point, but we might not. And the market didn't really like it. It went way down. Then it kind of went a little down. But then by Thursday, that was sort of moot. We actually rallied back 300 points on Thursday. So we're down 300 Wednesday at the end of the day. Rallied back all 300 on Thursday. So we're down 300 Wednesday at the end of the day. Rallied back all 300 of it.

And then this guy at 1600 Pennsylvania Avenue starts tweeting. And President Trump's tweet was something to the effect of, we're going to go ahead now and implement a 10% additional tariff on $300 billion of Chinese goods. China exports about $500 billion to us now. We already have tariffs on about $200 billion. So essentially, he was saying this is the rest, like we're going forward. Some tariff on everything. We'll start at 10%, see how things go and so forth. Market fell a lot, went from up 300 to down 300, fell a lot Friday. And as we're

sitting here talking right now, market's down 550 points. So, from high level, Dow was, when did it hit? 27,400? Sounds right. So, we're 25,900-ish right now. So, you're either down 1,400 points from the high, or 1,000 points plus change from where we were on Thursday, depending on how you look at it. Either way, it's a pretty significant move. So that's a little recap of what's happened since Wednesday that I kind of wanted to drive.

I don't know, Julian, what do you think? What's the pattern here? What are you taking out of this recent chain of events? Well, I think what's quite interesting is looking at all the earnings. I think the companies we own, they're quite a good reflection of the overall S&P 500. And if you look at the earnings, most of the companies have done very well, actually. They beat earnings. They beat on revenue.

And then I guess you see quite a lot of difference between the ones that are quite exposed to international markets and the ones that are more U.S.-centric. exposed to international markets and they were now more U.S. centric. So I think this, actually if you get some stats that were done by Faxet, you see that basically earnings are down year over year about 1%, but for the companies that have 50% of revenue outside of the U.S., the blended earnings decline is 11%. While for the S&P, the one that have majority of the revenue in the U.S., the blended earnings growth was 4.5%. So basically the U.S. is doing fine.

The U.S. consumer is doing fine. But do you think that has anything to do with the trade war? Well, yes, I think so. I think it's trade and currencies. Clearly they're all talking about that. So you see the companies are more exposed to international markets, about that. So you see the companies are more exposed to international markets, like the semis or the agriculture industry that are impacted by what's happening with China. On the calls, they talk about currencies, they talk about trade. And the ones that are not

like McDonald's, they're not so exposed, or PG, they're fine, they're doing okay. So I think clearly you see trade war impacting international companies. But see, I guess what's kind of frustrating is that the earnings results we just got aren't going to be obviously impacted at all by the most recent iteration here, this brand new escalation. So they reflect kind of the last quarter's tensions that we're in, and now you've got this sort of new round of it. And I wonder, Brian, if you could talk a little about this pattern.

Julian had sent this illustration last week, and I'm going to put it in Dividend Cafe this week. But it really, it's somewhat comical, and yet it actually really isn't because it's pretty much precise, I think, economically, that the pattern of, okay, we announce a big bluster around trade, market drops, then we say thingsuster around trade, market drops, then we say things are looking better, market rallies, nothing changes at all. And we've gone through this cycle a little bit.

My concern is that that's been the pattern in the market, and PE ratios have dropped when there's an escalation in trade war. Then they come back around when stuff doesn't really happen or it looks like the world's not ending yet. But I'm not sure that the underlying fundamentals of these companies are not actually taking on real deterioration. I think they eventually will. Julian kind of recapped the earnings season. It went well, I think, in the light of some pretty robust dollar strength. And a lot of these companies, 50%, 60% of revenues come from overseas. I think it was

actually impressive to see earnings do as well as they did in light of that. And I would suspect that that continues. I think the last time China had a $7 to $1 ratio with the yuan was 11 years ago. So this is going to be new, and it'll come out in the next earnings report. We did have something similar in 2015. I was looking at that this morning and just trying to correlate what went on then with China manipulating currency, devaluing currency at that point, and then dealing with capital outflows out of the country. That was the... O' When?

I think it was August of 2015, if I remember. O' Yeah, you're right. We had about a 10% correction in markets, maybe a little less, something like that. We're at five already. We're down 5%, I mean, the last week or so. So I just think it's going to be a process and we'll work through it. But it's yet to be seen how it affects earnings and companies and how they deal with it. I suspect that they'll be okay. I think fundamentals are pretty sound at this point. The one thing I would say too is that I think the sell-off today, I mean, it's just a day, and it's a down day, obviously, because of the news. But I think it has to do a little bit more with just the rate of change of the yuan versus the dollar.

It's actually the second largest decrease in the currency ever. The last time was 2015. So I think that just kind of spooks markets. Anytime you get a big change like that, that fast, overnight, basically, you get markets that kind of react accordingly. Dave, are you up for a geopolitical angle on this? Can I throw something? Sure, sure. What about Hong Kong?

I mean, does Hong Kong fit into this? I heard this morning some analysts making a comment real early. Julia, no offense. They say they're really used to this in France. You can have protests in France frequently. It's part of the social fabric of the country.

Italy, Hong Kong, they don't do this. And this thing looks to me like it's going somewhere worse than people maybe thought. And so I just wonder, is part of it, the combination of events, this sort of revolt taking place in Hong Kong, they don't know how China's going to respond. U.S. is kind of ambiguous about their play into it, combined with China's deteriorating efforts in currency, combined with trade war.

I think it acts as a bit of a corroborative signal to a bit of distrust with China in the geopolitical landscape. I think China has not really played ball in a lot of different areas. And it's one of the reasons why this trade war is happening. I think it's all correlated. As far as how things affect earnings, yeah, I agree with what you said that that a lot of this manifested after Q2. When I went through the earnings reports, one of the things that surprised me is that I didn't hear many companies talk about China's big risk. I think I heard maybe Jamie Dimon and a couple of other financial CEOs say that, look, this is a big short-term risk.

But other than that, we don't see many short-term risks. So I think that if this thing drags on, any sort of companies that have supply chains that run through China or have a large exposure to the Chinese consumer will be substantially affected. I'm actually, as far as portfolio decisions and where to add and what to buy and maybe what to sell, I think it's going to be interesting going forward. Ideally, I think we would like to add to companies where they don't have that kind of exposure that we talked about to different tariffs or tsunami tariffs or on the supply side of things, were companies that if this thing goes nuclear, and maybe this tips the U.S. into a recession, companies that we wouldn't mind holding through a recession, who don't have that kind of exposure.

And I'm looking across all our companies, like Julian said, this is a pretty good reflection of the S&P, and most of these companies do have that exposure. Some of them are more U.S.-centric. It's difficult to pinpoint. But what do you guys think about where to add if this really sells off? I have kind of a different angle than just looking at the direct hit. You talk about companies with exposure to Chinese consumer and companies that are directly involved in the supply chain. Those would be like the most obviously connected to the trade war.

But my whole thesis and what we've talked about for so long is a little longer term than where – so if the whole market is down 2.5%, you're looking at companies that are only down 2% versus companies that are down 3.5% and it blends to 2.5%. I mean that's kind of interesting in the shorter term period. But I guess what I'm going to is the industrial production. So the consumer in the U.S. is somewhat insulated for now. Chinese consumer is getting whacked. Okay, but is this really going to happen without deteriorating business investment? I find it impossible to believe that if this is the path we're going to stay on, that you will not see that reversal of capital expenditures that has been necessary for extending the U.S. rally.

And ultimately, I think we're now at the point of being an inning or two away from this having to end if they cannot generate a resolution. So I'm taking a more macro perspective as opposed to the direct micro impact in company portfolio holdings. What say you, Julian? I'm like nodding, thinking I agree. I mean, I'm worried about the overall impact of this trade war and FX war because the impact it has on business and confidence and we haven't seen translate into

any impact on the job market but ultimately when corporates will stop investing in CapEx and hiring you're going to start seeing the jobless numbers claims deteriorating and then that could start impacting the consumer. Let me reverse engineer that.

Our thesis bullishlyly, has been capital expense, business confidence leads to business investment. Business investment leads to productivity. Productivity leads to job growth, economic growth. So if the opposite takes place, declining business confidence leads to declining business investment,

which eventually then leads to suffering productivity, which then surfaces itself in suffering productivity, which then surfaces itself in job loss, aka recession. And that's where we are. That's where we are, and we could go both ways, I guess. We're at the point where we could, if business confidence comes back and this trade-wise just goes away again in a few weeks, we'd be fine. But if it goes on like that for six months, I think you could compare that to what's happening

with the UK and Brexit. I think the worst thing that's happening there happening with the UK and Brexit. I think the worst thing that's happening there is the fact that there's no decision one way or another. It's worse than doing a Brexit or doing no Brexit. It's just delaying a decision. And if you do the same with trade war and China, I think that's the worst that could happen to the economy. Having no decision, having this lingering for years. Yeah, I think all of those things speak to weaker fundamental growth, and all of those things speak to lower interest rates. And rates are already negative for $14 trillion of sovereign debt across the world. And we've cut rates last week. I think all of that stuff, as it starts to permeate

through earnings, and we actually get fundamental reasons to cut rates rather than sort of a quote-unquote insurance cut, I think he speaks to lower interest rates and things like that too. So I thought trade wars were inflationary. Yeah, exactly. I think the yield curve and where interest rates are and are heading is telling you that it's the opposite personally. That's amazing. You're exactly right, Brian. And this is a discussion we've had a lot over. I believe it's a philosophical tenet for us, but it's something a lot of people in capital markets are missing. The expectation is, oh, there's a trade war, there's more tariffs,

it raises prices, that's inflationary. And then for people to afford it, employers have to raise wages. For people to afford it, a higher price level in the economy. No. It suppresses demand, drives yields lower, and it speaks to low growth. And the deflationary impact of the trade war is what I think you're seeing in the bond market right now. Yeah.

And heightened volatility like that does depress demand, I think. And that's the big deal. So, yeah, I agree with that completely. Jump in. I was just going to say, if there's one thing that Donald Trump achieved, after the white card, he was disappointed. He was only one and clearly once more than that. And the implied probability right after was 50 percent chance on one cut by, you know, in September.

So he really managed to lower expectations. You know, the Fed basically, their hawkish, I guess, comments changed the implied expectation. And a week later, it's amazing. If you look today, the implied probability of a cut in September is now 100%. It's 80% of one cut and now even 20% of two. So what Julia means by implied expectation, because we talk about it a lot with Dividend Cafe, is the Fed funds futures market.

So you just kind of look at futures, how they're pricing it, and our term would be implied expectation as you're referring to. It's at 100%. So is Trump happy? He's going to get his second rate cut. Within a week, he managed to get another, you know, I guess the meeting is still 45 days away, so who knows what happens.

But at the moment, you know, the market is saying we need another one or two cuts by September. I will go on record as saying I vehemently repudiate the conspiracy theory that this is all Trump playing chess with the Fed, that he's purposely escalating trade war to trick them into lowering rates. I get why some people want to think that, but that may be in the top five stupidest things I've ever heard in my life, actually. Yeah.

I should tell you the other four sometime, because they're really dumb. I would want to ask you, because I'm trying to understand, what is he trying to achieve, and you're the best place to know. I mean, being a foreigner, I think he must have an agenda. He's not stupid. He's not doing this just to get the fat to— No, so there's—I mean, look, on the political handicapping of this all, there are people that just loathe Donald Trump so much that they can only interpret it in the worst possible lens. And there's people that are the polar opposite. They just have to assume he's playing this masterful fourth dimensional chess. I think what we do well is

to offer a more sober analysis of it. And I'm quite confident in my assessment of what he is doing. It doesn't mean I agree with it because I really don't. But I think that what he believes is that this is impacting China's economy worse than ours. Therefore, he has an upper hand. And when he speaks to his base, the votes he most needs in Pennsylvania, Michigan, Wisconsin, they're largely not coastal people with a lot of stocks in their portfolio. And he says, I can take on a little heat with this because I'm standing up to China. That's good for my base. Ultimately, China's going to come around. I'm going to get a deal.

It's all going to work. Now, I think he's wrong. And I don't think that any president, this is not about President Trump. I don't think any president can get reelected when the stock market's collapsing. I wrote an article about this recently. He got 100 years of precedent. It just really doesn't happen. But in this case, the market's still up. I've said this several times. The best thing that could have happened to end this trade war sooner is if the market had just taken its medicine worse last year. But that cycle that we've talked about

has repeated itself over and over. The market drops in fear of a trade war and it comes rallying back around. Do you remember the Mexico thing a couple months ago? Yeah. And this time may be a little different in the sense that now the likelihood is a lot higher that this whole thing go nuclear. So I'm not sure what Trump, what kind of rhetoric he could come out with that might appease markets. I think this thing is in later innings now, and who knows how this thing could unravel. I think that Trump actually thought that China would back down by now, or give him some hint that they were backing down, and they absolutely have

not done so, and they've gone the other way. So, you know, I don't know if Trump's going to dig his heels in or not, but it'll be, I know the market's watching. know if Trump's going to dig his heels in or not, but I know the market's watching. What about this scenario? Let's say we get trade escalations, we get some slower fundamental growth, we get lower interest rates in the United States and across the world. Then we have something like Trump doing something along the lines of indexing capital gains for inflation, which would be stimulative from a capital expenditure standpoint in the country, I think. And then also you get sort of a deal that ends up getting done right around the election. Then it gets reelected.

Where do you think markets would be? If we're 2,900 on S&P now, where would they be then? Yeah, in that scenario, markets would be a lot higher. And a lot of it depends on who Trump is running against and what the posture that opponent ends up taking. And so that's one of my thesis. I have a lot of people saying, hey, what are we going to do with our portfolio if Elizabeth Warren gets elected? And I'm going to save that conversation because that's something we're going to be talking about a lot in the months ahead. A lot of it's going to depend on who the nominee is and how they run their own rhetoric, not in the primary. Assume they're all going to pretend that they're Karl Marx through the primary. But in the general election, if the candidate's Joe Biden, is he going to run on an anti-market message? I don't really think so. But I think that that capital gains issue you brought up, to give listeners context, there is a belief for some in the Treasury Department that they have the discretion without going to Congress to interpret the capital gain rules

as such that they can affect them at IRS implementation level with an indexing to inflation. So if somebody bought something for $100 30 years ago, it's now $200, but $50 of that $100 gain is considered part of inflation, they would only have to pay capital gain taxes on $50, not the whole $100. The problem with that is that the Treasury Department could implement it or announce it, but it will go to court immediately. And so there's really no scenario that I believe that that could be affected into law in time for it to have an impact on the election. My understanding is Attorney General Barr disagrees with that assessment.

The Justice Department does not believe the Treasury has the authority to do that. It would be overwhelmingly stimulative. It would be really interesting. And it would be a more ethical, I think, execution of capital gain intent. I don't think people should be paying taxes on gains that were not in fact gains. Agreed. So that could be an offset. But let's talk about that whole idea of an offset.

Like we got let's call 100 billion of stimulus out of the tax cuts year one. And now we've had 60 billion taken out from the trade war. So so people what you're doing, you know, to me, I'm saying let's say that's going to be worth 50 billion of stimulus. It's going to offset something else. Well, why do we have to have things offsetting it? It's going to offset something else. Well, why do we have to have things offsetting it? Let's just get pro-growth policy to play out and let this economy find some legs because the 2% to 2.5% GDP growth is not what we signed up for. He needs 2.5% to 3.5% base case.

And so I think that the trade war is the only thing I can point to that is suppressing it right now. And you think that he'll go back as far as the tariffs and all that? You think he'll go ahead and put up the white flag? Well, see, that's the question. Okay, let's start with what I don't think he will do. But one of the more reasonable policy scenarios in terms of it being serious but absolutely catastrophic is the Steve Bannon, Kyle Bass camp. I think Pete Navarro in his own administration. It's an awful idea. So when I say serious, that doesn't mean I'm complimenting it. But there is a school of thought that says, sorry, this really is multi-generational.

This is hemispheric power. We're going to have to take a significant short-term lump to go do something that's best for the country for 50 years. That's generally the way you talk in a second term, not a first term. And my impression of President Trump is that he cares about his legacy and how people talk about him. So I don't really believe that there is a sense in which President Trump could go a sort of kamikaze route. Like, I'll blow up my own campaign and re-election chances. But gosh darn it, I'm going to save this U.S. thing with China for 50 years. But that is something that continues to be discussed.

And there are voices in his ear that are very seriously saying, let the Dow drop 20 percent. But let's make clear to China that we're going to utterly redefine the nature of the economic relationship between our two countries. Then you say, what does Trump think? And all I can do is go off of past precedent. And I've written about this for over a year now. You guys have seen it. It was so easy with steel and aluminum to pretend he got a big victory. He kind of pump faked with Mexico and six days later was saying, okay, they're coming around and now they're going to stop, you know, Guatemalans from coming in and everything. The European auto tariffs, he pump faked around. Nothing has actually really

been serious and had to get to the point of implementation. The soybean thing has hurt farmers. The washing machine thing hurt Peoria, Illinois or whatever. But ultimately, the systemic stuff has not actually hit the fan yet. And I really don't know how it doesn't at this point other than in the next month, him doing another Mexico thing where he says, OK, China, I just got the phone from President Xi. They're buying a bunch of agricultural stuff. point other than in the next month him doing another mexico thing where he says okay china i just got the phone president g they're buying a bunch of agricultural stuff they faxed me the purchase order a lot of soybeans this is the greatest soybean order ever uh we're we're not going to do the 10 because it's supposed to kick in september 1 right yeah so he could do that

now look who in the world will take it seriously if he does that again? I mean, come on. It wouldn't be the first time. It would be the fourth time. I would think at that point it would really weaken the hand of the man who wrote the art of the deal. So he has to look strong. He's got to try to save face. The whole idea of the trade war doesn't make a lot of sense knowing you. I mean, it's not going to bring back these jobs to the US. They're going to go from China to Vietnam, maybe.

But this is part of the problem, Joey, for us as investors, is that communication. You can listen to President Trump on one day say, we're doing this to bring jobs back. And on another day, you can say, we're not going to let them steal our intellectual property anymore. And on a different day, it's more like when Bannon talks, it's a bit more high level and this sort of a hemispheric conflict. And then other days, President Trump has famously said trade wars are just so easy to win and we're making so much money off of China. And he's banking on the fact that the people he's speaking to don't know that it's utterly false. But my point is, how do we address what the reasoning is, his motives, and our expectation of outcome

when the messaging has been all over the map? I think what you have to assume is that it's really about intellectual property, that there are people who actually believe that these jobs are coming back to Ohio. Yeah, I think so, too. It's really about the intellectual property in China playing ball with the West. I think that, I mean, for Trump to save face, he has to get at least one concession out of China. Maybe it'll be those agricultural orders, like you said. I mean, I doubt that he will be able to come out with just some fluff and everybody can pretend it's okay and then markets will rally again.

But why would China give him the benefit of a cosmetic victory? Well, they won't give him a victory, but he will spin it as a victory. They'll give him nothing, but he'll spin it as a victory somehow. Yeah, it'll be overwhelming, fundamentally be in their favor, in their interest, but he can spin it as a victory. So, yeah, but I do feel that there is something genuine that Trump feels about China raping us, as he said over and over again in his own words. I think there's also a part of him that will feel that if he doesn't get this deal that he's not the strong man or something. So I don't know what other kind of psychological stuff is going on there. But I do think this does matter to him, and he does want to win it. Whether or not he'll just kind of throw up the white flag and admit defeat,

oh, that I don't think will happen. But as Julian said, spin any sort of concession into a victory I think is more likely. The U.S. economy is doing so well, you will know why you want to break the engine. Consumer is doing well, there's no unemployment, growth is better than anywhere in the world. It's like, okay, you go after China, I complain, because of the trade imbalances, but the world can take it. The world wants the U.S. dollar anyway, so it's kind of strange.

Yeah. Well, I mean, the last increase of 10% of the last $300 billion is basically consumer goods. And so I think he was holding out on doing that, knowing that prices would go up for consumers in the United States and obviously slow the economy. And I think he sort of showed this week that he's sort of willing to, quote-unquote, shoot the hostage type of thing to get what he wants to get it done. And to David's point, I mean, I think— Do you think he—I mean, you're right. He's posturing that way. Do you think he really is willing to shoot the hostage?

That was my next point. I think there's a small probability. I don't know, and I hope not. Even with the soybean thing with the farmers, they did those stupid bailouts. So on one hand, he let the farmers get hit with $10 billion of suffrage to their soybean orders, and then he did the kind of bailout back channel. Yeah. Yeah, I mean, I think if you're trying to, I mean, yeah,

what's the motivation to give him anything before the election? I don't think there's a whole lot, really. It would have to be him. Well, the motivation is if you think he's going to get reelected. So that's the tension point. I wish the election was this November. Then I would know the market will be much higher than it is. But we have another year.

So I would bet you in a will be much higher than it is. But we have another year, so I would bet you we're higher than we are. But he has plenty of time to let the market puke 20% and this play out and get his two, three Fed cuts and then change his rhetoric on China and have a strong market for the election day. And that was my comment earlier. I mean, I could see that actually playing out.

We have a lot of time, unfortunately. In the meantime, it could be volatile. And then really take the fight to China during his second term? Well, there's a lot he could do in a second term he can't do in a first term. But this is sort of the problem is I've long thought China had more leverage from the political side. They don't have to run re-election. The thing I was unaware of that is far is adding a lot more to my thinking is we have a lot of clients that have business interests in China. They're telling me when they're over there meeting with their manufacturers, when they're, you know, the optics on the ground, the Chinese people do not want Xi to capitulate to U.S. And his quote unquoteunquote board of directors is kind of equivalent to a cabinet.

They are adamant that China, to them this is a thing of national pride. And I would have thought that the angle was, nah, he doesn't have to be re-elected, so he doesn't care. It's not just he doesn't have to be re-elected, he doesn't care. He does care the other way,

like that he has to maintain a strong posture as well. Not for re-election, does care the other way, like that he has to maintain a strong posture as well, not for reelection, but his people are not asking him to go get this resolved, that the Chinese people want this fight with the U.S., that they have a sort of 75-year history of believing that they've been mistreated on the global stage. So that's not going to end well if that's in fact the case. But the issue of leverage politically, I really think the president's thinking, which is not totally irrational, has been, hey, they would like a better deal with a new Democrat president later. But frankly, it looks like I probably can win.

The other field looks a little questionable. Economy's good. looks a little questionable. Economy's good. So then China is motivated to get a better deal done now at risk that I end up winning reelection and they're in a much less leveraged position. The part that seems to me to be ignored, I emailed you guys about this morning, is does China have a self-fulfilling prophecy in this that they can impact the result of that election? In other words, can this thing get ugly enough that it hurts Trump and therefore hurts his chances for re-election, then gives China that better outcome later? You talk about foreign interference in an election. What keeps China from

really messing around with the global economy if they think this thing is not going to get resolved. I think at the end of the day, sure, the communist regime in China doesn't have term elections. They don't need to worry about getting reelected. But I think, and I'm not so sure about a lot of the data that comes out of China. I feel like every time I'm listening to a Chinese official or somebody who's a CEO of a company in China, they're always under some influence from the communist regime. So I don't know exactly how all the citizens in China feel, but I have to assume that if this thing's going to put China in some sort of recession, being at war with the U.S., is this thing's going to put China in some sort of recession, being at war with the U.S., that it has to matter to the top brass at some point.

They're already starting off at the slowest economy they've had in 30 years, so it's not like they're starting off in a great spot. And so I would agree with that. And I think as far as the people kind of not wanting a trade deal done just out of maybe spite or just to show strength in that, I can't speak to it, but I would imagine that's true. But at the end of the day, you get supply chains that start moving out of China and going to Vietnam and other parts of the world, and I think that can happen in today's world pretty fast.

Then I think that feeling of let's just show strength for the sake of doing that will go away, and you get fundamental deterioration further in the Chinese economy, and then you kind of have that. But I actually think in this whole thing, the U.S. really isn't a stronger place to negotiate other than the political side of it, which makes things tough. Well said. So the word, but see, I also believe that there are, I don't know if the number's 300 million, it's more than that, or if it's all the way up to 900 million, it's probably less

than that. But there's, let's call it half a billion people in China that are not economically sensitive. They're not sitting there going, oh, I hope GDP growth doesn't drop from 6.2 to 4.7. There are almost no people in the U.S. that are not GDP sensitive, either consciously or unaware. That's very fair. As we sit here and talk, we're getting a real-time tweet from the President of the United States. About us? Yes.

He wants to know that. He's listening in. Said something about the Dividend Cafe group, the Investing Committee, the Bonson group. Those guys know their stuff. I'll be calling them. We'll settle. Oh, the things I could tell you. Based on historic currency manipulation by China, it's now even more obvious to everyone

that Americans are not paying for the tariffs. They're being paid for compliments of China, and the U.S. is taking in tens of billions of dollars. China has always used currency manipulation to steal our businesses and factories, hurt our jobs, depress our workers' wages, and harm our farmers' prices. Well, not anymore. It's a smart tweet, as long as he doesn't mean any of it. Like it's a smart tweet politically. That's got to be their narrative politically. There will be some legs to that story. It is across the board.

Every parenthetical phrase of it is inaccurate, but it's a politically potent message. Yeah, it's the us versus them and, you know, gets that nationalistic blood flowing. Yeah, appeals to his base. Yeah, I think he could. and gets that nationalistic, blood-flowing appeals to his base. Yeah, I think he could. I mean, I don't know what the market would. I know that you study the precedents as far as market drops and reelections. Do you think that if the market dropped another 15% from here,

it's possible for him to get reelected or 10%? Where is it in the summer of 2020? Like if it drops 15% from here and rallies back 20%, that's different. If we're down 15% from here in the summer of next year, then we are going to have a new president in the United States. And a lot of people say, well, no, the blue-collar workers in Ohio don't care about Wall Street. See, that's just not what this is about.

The stock market is both a chicken and egg in this. There's a cause and effect. The market is reflecting confidence. It's creating confidence. It is reflecting economic conditions. It has a sort of wealth effect to it, but also the IRAs, 401ks. The main people that are going to switch this election, look, I don't really think those blue-collar workers in the Rust Belt are going to turn on Trump anyways. I'm just taking for granted he has them.

I got some bad news. There ain't that many of them. There's enough to flip the election against Hillary Clinton by 70,000 votes total in three states put together. That's amazing. So on the margin, I think you have to look to the independent voters that maybe might be upper middle class, suburban, that are looking at their 401ks and saying, look, this is kind of the story. And I think the most really, really big Trump advocates would say the same. They would say, okay, you have this sort of temperamental thing. A lot of people are tired of Twitter and this and that.

But then you have this strong economy. And I've got to be honest. He's doing great for the economy. I'll put up with his antics to get the economy. How do you keep the economy narrative to offset this other stuff, the behavior that very few people like outside of his base if the market has dropped 15%? I think it submarines the other narrative. Julian, what say you as the US political observer here? I guess there's one number we haven't talked about and that's the tenure.

Like the economy, I guess at the end of the day, we really should focus on earnings and valuations, right? And so valuation is based on relative valuation to, I think, the one number that matters, which is the 10-year U.S. government bond yield, which used to be at 3%. So when you can make 3% owning U.S. government bond, it's less attractive to own equities. But if you can only make 1.7% like today, that makes equities relatively cheaper.

So as long as earnings can stay here, at the moment, the expectation is that the S&P earnings are going to be flat this year, so that's why we kind of stuck around this. But S&P earnings are expected to grow again next year. If that's the case and you have the rates lower, then you can see the market trading higher in 12 months, much higher. So you're saying that even with a little bit of this tariffs, suppose it continues, this

escalation, trade war escalation continues? As long as earnings are not impacted, we're okay, I guess. Because if earnings are doing fine and you have cheaper rates environment, then that should push valuations up, basically. Because how are you going to make a return? You're going to make a return on earning government bonds, and you're going to make 1.8% today. Yes, stocks are more attractive.

Corporates are going to have 50% extra, maybe 2, 2.5% on the stocks. You make, you know, on 17 times speed, I mean, there's 3, 3.5%, 4% yield, right, equivalent. So, the risk premium is actually, compared to historical averages, is not that high. Yeah, I mean, I think you're absolutely right. I think at the end of the day, so long as fundamentals are intact, lower interest rates, the lower risk-free rate of return should mean a little bit higher multiple in market and or supportive of 17X or whatever it's trading at now, 17.5 or so.

I would agree with that. I think it's really just when the fundamentals actually do start to show up, then what happens to that thesis. But I agree. I think as of now, it's rhetoric. It's kind of a trade cold war kind of back and forth. And there's been tariffs and such. But as far as actually affecting earnings of J&J and companies that we own, I haven't seen it yet. In fact, actually on the calls with the last earnings report, they were more positive than I would have assumed given the strength of the dollar.

Yeah, but see, our companies are, for the most part, a lot more insulated directly. So you're really talking about more of overall market multiple. And then within our holdings and some of our technology companies that have a big supply chain relevance out of China. And we do have several there that have been impacted in price loss a couple of days. But they don't tend to be really monumental size holdings. But, Brian, you've done this a long time on an asset allocation front. Julian's bringing up the unattractiveness of a 10-year treasury yield at 1.7%. Who could disagree? Did the 2.5% 10-year treasury yield at 1.7%. Who could disagree?

Did the 2.5% 10-year treasury yield look very attractive? I would say no. Right now, people are going to be flabbergasted at how much money they've made in their bond portfolios. Yeah. I was just looking at it this morning. TLT is up 15% as of today. This is the 20-year proxy for the treasury bond. I mean, it was up 15% last year. And spreads, it's not even just the peer bonds in the treasuries and, of today, this is the 20-year proxy for the Treasury bond. I mean, it was up 15% last year. And spreads, it's not even just the peer bonds in the Treasuries and, of course, in the municipal market. Even corporate bonds, investment grade, spreads have not widened much. There's been a little widening, but that's off of an extraordinary tightening that had taken place earlier in the year. So let's bring this back to something more applicable to our clients, to investors at large.

Asset allocation lessons out of this. Would you be selling bonds at a 1.7 yield right now, Brian? I think I would be taking some, reallocating. Not trimming. Would you be eliminating? No, definitely not. It's tough to really eliminate an asset class like that. I mean, it's there for stability, for safety.

It's there for, I mean, like we just said, I mean, it's year-to-date in our bond portfolio. I'm not looking at the number, but I'm assuming it's up something like 8%, 7%, something like that. So, it's done its job. I think trimming and things always make sense from an asset allocation standpoint when you have valuations that get stretched, and I could argue that for the fixed income market. I do think that as far as where to go and where we're looking at from an asset allocation standpoint, it's really in that alternative sector where I think we can get return that's more absolute-based rather than relative, meaning that, yes, rates are low. Stocks are, in my opinion, pretty close to fully valued at 17 or 18 times earnings.

You've got trade war things, stuff like that. What's an investment that can make money with a lower amount of volatility based on all of those things? And I think alternatives in that space are where we'd probably look towards. I know we've been discussing that already. So, Dale, we talked earlier that we think that a lot of these things playing out are deflationary threats, not inflationary. Bonds are pretty defensive here, right? Bonds are pretty defensive here, right? Yeah, I think bonds are... We have them in the portfolio for that specific reason, because it is a defensive asset class. Obviously, bonds are less attractive today than they were eight months ago, but I have a hard time eliminating them in the portfolio you know i who knows what rates are

going to do i don't know is this part of some sort of uh lengthening cycle to uh to lower rates i don't know and bonds could it was a julian i talked about it the other day he heard some quote that said people are buying uh equities for yield and bonds for price appreciation. Well, that's been going on for a while now, right? So is the 10-year at 1%, is that a complete impossibility? No. And, I mean, look at German boons are negative 53 basis points. UK gilts are 50 basis points, which is an all-time low, I think, going back forever. So is there room for the U.S. Treasury to go to 1%?

Absolutely. So, Julian, what do you think about this from an asset allocation lesson? There's volatility we're experiencing in the equity portfolio. A lot of gains this year. You talk about the water we've taken on the last few days. It's minuscule compared to the upside equities we've experienced. Even with this little sell-off, multiples are not cheap, and bonds have proven to be very defensive here,

is some modest allocation to fixed income with the deflationary hedge in mind, is that still appropriate? I think anything but cash, really. So I guess if you look just at Germany, Japan, you look like the democracies with aging population that have a problem with getting growth. They're ready to do very aggressive, going negative interest rates, buying the central bank by the markets. So I guess if you look at that, you think maybe that's what's coming to the U.S. next. So I think it's very possible that the 10-year goes to one,

goes even lower. Maybe the Fed doesn't have the Monday today, but talk about buying the equity market. So I think to me that means you just stay long. You just want to stay long anything but cash, which is fixed income, equities, alternatives. If you want to be a bit more tactical, given the performance of the markets,

you go into alternatives, that's going to be more market neutral and probably should do better in a high volatile environment. But see, this is really important. What you guys have said really reinforces such a big part of our philosophy. We asset allocate because we don't know exactly what will happen. So if the 10-year reverses and at 1.7 and all of a sudden we close the week at 2.25, how much higher equity prices? We probably made back that 1,000 points and then some.

Because that means the economy is doing well, I guess. That's right. So you have this sort of zigs and zags. Because that means the economy is doing well, I guess. That's right. So you have this sort of zigs and zags. And unless one wants to go all in on a call, and here's the problem with that, by the way. The call they would be making is a call that they could very well have been making at any number of other catalysts over the last 10 years and would have been wrong every single time.

And so the right call has consistently been an allocation into fixed income. Perhaps you turn it down a little, perhaps turn it up a little, and an allocation to equity in line with your own risk appetite, comfort level volatility, over-weighting and under-weighting the securities, of course, that we actively manage around dividend growth. And then I think the alternative piece is important just from that absolute return objective that you talked about, Brian. I can't think of a more cliche lesson and a more applicable lesson than what's going on right now than a reinforcement of the merits of asset allocation. What say you, Dan?

Absolutely. We want to approach portfolio management from the risk side first. We want to prepare portfolios for a range of outcomes. It's not a stock approach. It's not a bond approach. It's not a cash approach, not an alternatives approach. A portfolio approach is needed. But don't our clients pay us to know exactly what's going to happen tomorrow? Absolutely not. So with alternatives, it was a big theme of ours

coming in the year. We lightened up a little bit on fixed income. Went into alternatives. We wanted to reduce some equity beta in the portfolio. I think it was the right thing to do. Took a bit more moderate posture because just as we've been discussing here today, there is this outcome of melt-up that could take place. Frankly, the earnings recession has not really surfaced. Earnings growth has been strong enough to add a turn into the multiple of the market. Our companies have continued to grow their dividends above and beyond even my optimistic expectations. So you wanted that juice in the portfolio. You're aware of trade war. You're aware of Fed tightening. The Fed ended up being more dovish than we expected. So alternatives are another allocation there. From where we are right now and our waiting in alternatives,

a year out from now, do we want to probably have more in alternatives, same or less, Brian? I think a little more. Again, it's all client-specific and it's all portfolio-related, just like Daya said. This is a general statement, but I would say, generally speaking, we want to look where values are attractive for us, where there's the right risk-reward skew for clients. I think that that sector does make more sense. Of course, this year, we've been moving a lot in there, but I suspect even going through next year, it's the place to be for even a little bit more capital. So if we were 15% before, maybe it's up to 20,

something like that. Julian, you have a significant professional experience in the hedge fund world. It's where you've cut your teeth as a portfolio manager over the years in the alternative world. Look, is it easier for alternative manager to be managing in an environment when the Fed is just quantitative easing like crazy, interest rates are zero,

the market's starting off at a 10 multiple and coming up to an 18? That was the environment that lost 10 years. That was the environment for hedge funds. Is that the environment hedge funds like being in, or is this the environment hedge funds like being in or is this the environment hedge funds like being in currency volatility i'm looking at this chart right now uh from our friends at golf cal you've had almost no dollar volatility over the last couple years since the shanghai agreement early 2016 you look at the 10 years before that significant isn't this higher volatility more uncertainty deflationary issues isn't this a better environment for hedge funds? Definitely. This is when alternatives earn their high fees because typically it's impossible to outperform when the S&P goes up 20% every year with 5% vol.

Then you have the S&P having a sharp ratio, which we call, which is the return divided by the volatility of the return. And it's been amazing since the last few years except for maybe a few stops just before the correction last year. So nobody can beat that. But maybe this is over,

and that's when you have volatility again and when over a period of one, two years, the S&P is flat. That's when they earn their money because they generate alpha. And you pay them these high fees to be able to generate alpha regardless of the market environment. And so you would think this is a good environment for them.

So I'm going to ask each of you to share a closing thought and then I'll give my closing thought to wrap up our podcast and kind of this little information session for our clients. Who wants to go first? Quick 30-second closing thought on the environment we're in, trade war, China, market. Yeah, I'll speak to the uncertainty of it all. And going back to one of our tenets of portfolio allocation, we talked about the trade war a lot. We talked about tenure.

It's difficult to understand how these things will play out. Like Julian said, maybe this trade war does escalate, but because the tenure is what it is, We talked about tenure. It's difficult to understand how these things will play out. Like Julian said, like maybe this trade war does escalate. But because the tenure is what it is, the market, we get back what we lost and we're flat, you know, 12 months from now. I don't know what's going to happen. I don't think I don't think anybody does. I think you need to, you know, discipline Trump's conviction at the end of the day. And we need to have some discipline, even in this environment. It's okay to make tactical calls, but at the end of the day, asset allocation is what prevails.

I think so, too. I guess I would start off and just say it is, like Deya said before, it is about the portfolio. That's what we're managing for. So you get things that come up like this, and it's not, when we're talking about tactical changes, maybe adding new alternatives, it's not because of today. It's because of where markets have moved over the last year and just where we see things going forward. I would say if 2015 was any sort of just glimpse of how markets react when China does tend to devalue their currency, then I would say I would be prepared for short-term volatility. VIX is at 20. I think it was 30 last time they did this. I would say that. And then I would say, at the end of it all, I care about all that stuff. I

mean, we obsess about it. We've got a table full of paper, and we read it over the weekend, and we love it all. But at the end of the day, it's all fundamentals. So, fundamentals right now, we just went through every earnings call with every company that we own. What, 80% were probably better than expected and guidance was good. And so those are the things that we care about. It's the fundamentals that matter in the portfolio. I would just finish on the Fed, I guess, because something extraordinary happened last week. I mean, we cut rates and that was the first time in, what, 10 years or something? And it only happened seven times, I think, since 1984.

And I guess Chair Powell said it was a mid-cycle easing. And that's what he's hoping for. I think he doesn't have the answer. Nobody has the answer. But if he's right, that it's a mid-cycle easing, then that means

we're not going into recession. That means it's maybe a rough patch like we had in 2015-16 and we go higher from here. I think nobody has the answer. Even the Fed doesn't have the answer either. But if that's the case, then we're going higher from here. Okay, so great closing thoughts, by the way.

I agree with everything you guys have said. Let me just wrap this up for clients looking for kind of a key takeaway. Investors wondering what to do. You're sitting here as we've gone on about this, the market is still down over 500 points. And I think, Brian, you're very right. VIX at 22, that's not capturing the level of volatility you really could end up with here. But I don't say that as a negative or a bearish thing. I believe for every ounce of breath in my body that enhanced volatility enhances long-term investor returns. It is nice to be able to do this out of a position of strength

and essentially seven months of really strong equity market returns. You have the ability to be able to kind of hang tight. I would not be panic buying right now any more than panic selling. I think we have some discussions to have on an individual basis of companies we were sort of opportunistically looking to add to anyways that right now might look even more attractive. But really, I'm not feeling very prone to deplete the dry powder cash we have built up because I want to be prepared for the possibility of things even getting worse before they get better. But I do think that coming back to dividend growth, which is the gospel that we have adopted at the Bonson Group, I'm sitting here looking at the positions that we hold in our portfolio.

Julian referred earlier to a really strong earnings season that we had. There are some companies, mostly tech industry, that are more sensitive to the China trade war. You know what you have right now? It's portfolio companies that have grown their dividend knowing we were in a trade war, knowing that the dollar had already moved up a whole lot, knowing that the easiest ploy that China had available was to weaken their own currency. And you have company operators that are extremely wise, diligent stewards of company capital, making long-term decisions, and through that use of capital, saying, we want to continue returning cash to shareholders. When a PE drops because you have

a sell-off day, people lose sight of it. But I will tell you right now, a company that's down 2% today in stock price, their sales did not go down 2% over the weekend. Their earnings are not going down 2%. Their dividend's not going down 2%. So if we bought for the right reason, then we hold for the right reason. And I really believe that dividends reinvesting at these lower prices create long-term wealth and long-term enhanced returns. I think to the extent that the overall portfolio construction, we're getting to a point where we may have an opportunity for rebalance, not even waiting all the way until January, potentially taking a bit out of bonds earlier to add to equity and very likely add alternatives. I could see that happening. We're not there yet. But ultimately, I would not expect that this is

just going to be another sort of Trumpian trick like the Mexico deal where this thing goes away. Whatever allocation decisions are being made right now, the four guys you've been listening to here and our partner, Kimberly, Robert, Trevor, Don, the team here would say the same thing. We're not making these decisions because we have a forecast on how this trade war is going to come out. I think very few people that live in the White House have a forecast of how this whole thing is going to end. From an investment standpoint, what we do have a forecast on is the merits of asset allocation, the embedded defensiveness we've already built into client portfolios, the opportunism of dividend growth,

and from a top-down level where alternatives can come in with some absolute return strategy around that. Those are the things I'd be holding on to. Specific questions, particulars along the way, please reach out to your advisor, reach out to myself along the way, please reach out to your advisor. Reach out to myself as Chief Investment Officer. Reach out to our investment committee.

Anytime, we'll answer your questions. We hope you've gotten a lot out of this. Thank you, Julian, Brian, and Daya. And we look forward to another issue of the Dividend Cafe later this week. Good job, guys. Really good. and with Hightower Advisors LLC, a registered investment advisor of the SEC. Securities are offered through Hightower Securities LLC. Advisory services are offered through Hightower Advisors LLC.

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