The Dividend Cafe - Trump and Trade Again...and Again

Episode Date: August 2, 2019

Topics discussed: This week's trip to the Dividend Cafe will look at the overall health of the U.S. economy, at the state of credit markets, at all the context around the Fed's present thinking, and some very important reminders about dividend growth during this crucial time. Investors should be prepared for two things when central bankers add stimulus to asset prices that are already operating as if they do not need any stimulus: (1) What is high is very possibly going to go higher; and (2) Bad investments will get made, and bad investments do not end well, ever. No central banker or politician can change that. The Federal Reserve did something they have not done in nearly eleven years this week - they cut interest rates Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. and that's why I'm recording this a little later than normal. I recorded a little something on Wednesday night when I was in New York City, and my intention was to make that the Dividend Cafe recording for the week, and I was on a plane all day yesterday coming back, and here's what happened. You had a big Fed meeting on Wednesday. Market responded the way it did. It ended up dropping over 400 points, closed down 300. And so there were some things that I was able to talk about with that Wednesday. Then yesterday, the market, and I kind of expected it, but I don't really get into these daily

projections or forecasts. The fact of the matter is it very logically kind of rebounded all that back. It was up over 300 points. It had been down Wednesday for not really much of a good reason. And then near the end of the day, President Trump tweeted. And if I'm ever talking about one of President Trump's tweets, which I would in this context, a dividend cafe, and when I'm talking about investing and things I actually take seriously, then it probably means it was something like really, really dumb and problematic from an economic standpoint. Because a lot of the tweets that might bug people, they happen to bug me at times, you

know, temperamentally and things, I don't bring those up with Diving Cafe, I don't think the market cares, and I don't think think I would talk about it every week. There's nine of them a day sometimes. But if I'm bringing up a tweet, it means there was something market impactful happened. I believe the last one was May 30th, which you'd think I'd remember right away because that's my birthday. And he tweeted out, we're going to implement these tariffs on Mexico. And it was after market closed. And the market dropped 300 points the next day, and it was very temperamental in markets the next week.

And then by the end of the week, he announced, oh, no, we're not doing the tariffs. Mexico is our friends again. Everything's good, and we're moving forward. And so we had a big, big up in June. We had a pretty good up in July. I'm going to talk about that in a moment. But then this is the first time where all of a sudden you got this kind of unexpected volatility out of a tweet. And so everything I wrote this week is kind of worthless and that's frustrating. Now it's not worthless. There's important information here.

And I sure hope those of you that like listening to the podcast and reading dividendcafe.com will do both. But I'm not going to go through everything that's in the paper this week in my commentary here right now because now that I have the ability to be real current in real time, I'm going to try to do that. And we're, like I said, so net-net, if we were up 300, closed down 300, and we're down to the 250, we've given up 800 to 900 points in about four hours of trading the last two hours yesterday in the first two hours today and if the Dow's sitting at about 26 300 right now give or take and again by the time you're listening I don't know where we are we were at 27 400 in the middle of July so we've given up over a thousand points as a percentage it's not very much, actually. But really, that has all happened on the back of very good news in earnings,

okay news economically, some not so good, some pretty good. And then the Fed giving an interest rate cut that, of course, had been priced in. So to try to isolate this to anything primarily other than the trade issue, I think, is really disingenuous. So I got to kind of unpack that here for us today and leave you going into your weekend with as much update as I can. So let's start with earnings season. I'm holding some papers here I want to put down, but let me get this out of the way. 75% of the S&P 500 is now reported, and earnings growth thus far looks set to come in at 1.4% to the negative, meaning earnings will have grown negative 1.4% on this quarter versus last quarter, and it was expected to drop 2.7%.

So only about half of the carnage that had been expected in earnings deterioration. 75% of companies have surpassed earnings expectations. We are nowhere near tracking towards an annual earnings deceleration. Let's see here. This is important on the revenue side, though, okay? The blended revenue growth rate, top line sales to the S&P 500 this quarter is 4%. Now, if you do more than 50% of your sales inside the U.S., it is 6.4%. That's a big coincidence. Is it just because American companies are that much stronger than

where the customers may be in, say, Europe? No, it's currency. So it has behooved companies to not be multinational so far this year. By the way, there's a negative revenue number. It's a decline of 2.4% for companies that do less than 50% inside the U.S. So you've gotten a currency impact that's been the opposite of what we've been experiencing, if you follow me. My point being revenue has grown overall about 4%. Earnings will be down a small degree. We'll be down a small degree. And I really do think that earnings number is a good thing because we're expected to have earnings drop quite a bit more.

You remember earnings growth was supposed to be negative in first quarter. It wasn't. Earnings growth is expected to pick up third and fourth quarter. So the way you blend the numbers, I think that we're tracking to end up the year was somewhere between two and four percent full year growth in earnings in 2019 over 2018. We were, I don't know, 10,000 hours of media time was spent at the beginning of the year talking about earnings recession. We have a negative number in earnings on the year. 75 percent have reported. So there's 25% to go, and I don't know what will happen to those 25. You don't usually get a big trend bucking out of the last quarter of companies. I'm going to do a podcast with our investment committee next week to unpack some details

around the earnings season, actual portfolio companies that we own at the Bonson Group, around the earnings season, actual portfolio companies that we own at the Bonson Group, highlights and lowlights and things that we've seen that I think are very interesting this quarter. You have had that kind of Darwinian thing I've talked about a lot where some companies have gotten schlacked and some companies have done very well. It hasn't been really overstated, though. Nothing has really had a massive run up. I'm really encouraged by some of the results from some of our operating companies. And like I said, I'll get into that next week. But the results really were about in line with what we would have expected so far. And what we expected was positive and was above consensus. That's a good thing. positive and was above consensus. That's a good thing. So then the big news of the week should have been the Fed. If the week had ended on Wednesday night, it would have been the Fed. Fed cut interest rates a quarter point. I've talked about this every week for seven, eight weeks in a row. As long as it's been very obvious, they were going to do that. I have a chart at

DivenCafe.com, really, I think, summarizing why they need to cut the rate. The key policy rate in Switzerland right now is negative 75 basis points. The 10-year government bond yield in Japan is negative 15 basis points. The highest interest rate in the world of any relevance, either a policy rate, which would be equivalent to our Fed funds rate, the overnight rate that other countries use as a reference that they lend overnight against. Canada is at 1.75. Italy, their 10-year is at 1.6. Everything is below 2%. And you have France, Japan, Sweden, Denmark, most importantly Germany, all in negative

interest rates. The highest rate in the world is the U.S.'s Fed Funds Rate, which was 2.25 to 2.5, and now it's been dropped by a quarter point, so somewhere between 2 and 2.25. Our 10-year government bond yield, 10-year Treasury would have been at about a little over 2%. It dropped to a little over 1.9% in the last couple of days. What are we in now? We're in the beginning of August.

It was October, November of last year, 2018. I mean, eight months ago, and our 10-year was at 3.3%, and it's now dropped to a one-handle. That's unbelievable. For a government, a 10-year government bond yield of the world's reserve currency, where arguably the economy is very strong, unemployment is very low, to have dropped 40% from 3.3% to 1.9% in eight months in a growing economy, this is historical stuff going on.

So what I mean by the Fed had to act is that the Fed's being pulled down by everything happening globally. And I don't think that the politics of this are really all that interesting. If anything, I don't really believe this, but if I'm going to have to say anything that the Fed would have done or not done from political pressure, you could argue they may have been more likely to have done the full half a point, two 25 basis point cuts right now, if they were not worried about being accused of capitulating to political pressure. Now, I truly believe, I disagree with these Fed governors on a lot.

I disagree with them on more than I agree with them. But I really do believe that they're not pressured into something or out of something by the president's jawboning on Twitter or in the press. by the president, you could argue that that may have been a factor, if nothing else, subconsciously. But I'm not going to get into the psychology of the Fed governors right now. I will argue until I'm blue in the face that they are doing something right now that I don't think is going to be very helpful. They probably don't have much of a choice. I talk a lot this week about the credit markets. High-yield bond spreads are right now about 4%. They have been as low as 3% before all the tightening last year.

They got up above 5%, 5.5%. Back in December, the markets were panicking. Right now, we have new issuance of corporate debt at record levels. Credit default swap prices are the lowest they've been in a year and a half. They are reliquifying credit markets from where they saw them tightening in late part of 2018. And I just have no idea for the life of me what the end run solution can be to this. That the credit markets benefited from all the monetary easing of our eight, nine year post crisis medicine is indisputable. That they are revolting at the

idea of having that punch bowl taken away is indisputable. That they are now giving him back more of the punch to keep them medicated or whatever verb you want to use on this is indisputable. What they're going to do in the final hours, I just simply don't know. But the beat goes on. I think that the Fed is stuck dealing with the ramifications of what prior administration, meaning Fed administrations, the Yellen regime and the Bernanke regime left them. They did announce this week that they are going to cut the quantitative tightening altogether. And I love getting a little bit wonky with you on this stuff.

By quantitative tightening, they were never selling bonds back into the marketplace. The Fed was buying bonds all through QE1, 2, and 3, which would have been about early 2009 through about October of 2014. So let's call it, you know, give or take a five-year period. They bought close to $4 trillion of United States Treasury bonds and some Fannie, quite a bit of mortgage-backed bonds. By statute, legally, they can only buy government debt. And they called Fannie and Freddie government debt. There's some, you know, hair on that as well, but I'll leave that alone.

So they bought $4 trillion of bonds with money that didn't exist. And we talk about tightening. They were not selling those bonds back, but they had been reinvesting the proceeds a lot of these bonds of short maturities the bonds would mature and and then they would reinvest the money into more bonds so they didn't go up in their total amount of excess reserves or down they were leaving that money in the banking system and that number got to be about four and a half trillion dollars total because we started the financial crisis with around six hundred billion on the balance sheet. They started not reinvesting ten billion a month a couple years ago then it went to

twenty billion a month it got up to fifty billion. That's where the reduction came from it's what we call roll-off they were letting these bonds roll off which had the effect of reducing liquidity in the system so they reduced by about 400 billion they intended to reduce by one and a half trillion I don't know if they ever explicitly stated it but they made a lot of implications around getting it to the level of reserves that are in the banking system to match at parity. There's a number of reasons that I think that they wanted to get down to about $3 trillion from $4.5 trillion. All that to say, they've stopped now.

They had announced earlier in the year they were going to stop in September anyway, so all they did is stop two months early. I don't think it's hugely significant, but at $30 billion a month, let's see here. The actual number was about $35 billion a month. That's $70 billion of excess liquidity now that will end up into the system that was intended not to be in the system. $70 billion, you know,

it's not enough to call real money anymore, but it was intended for them to be somewhat stimulative, like, hey, we're going to, you know, it's not enough to call real money anymore, but it was intended for them to be somewhat stimulative, like, hey, we're going to even give you two months of this, and then they cut the rate a quarter point. So why did the market drop when they did that? Well, a lot of times people would say, yeah, the market always drops, buy the rumor, sell the news. The market knew it was coming, it came, the market sold off.

That's not what happened. The market did not sell off at the announcement they were reducing quarter point. The market was not sitting there going, oh, please give us half a point. The market did not price that in. The Fed Funds Futures market had pretty much said, we're likely to get a quarter point. We think we'll get another quarter in September. That's exactly what happened. Stock market for at least the first hour stayed about even. But during Chairman Powell's press conference, he made a reference to this is not the start of a extended easing cycle. And there's been a lot of talk about, especially in the Greenspan era, your first cut is not your last. Well, first of

all, this cut will not be their last either. But historically, there's a lot of truth around this idea. And he was trying to kind of walk that back like no no we could see this being you know somewhat modest so the market started saying geez maybe we're not going to get that second rate cut market sold off i think a lot of its computer generated there's a lot of algorithmic knee-jerk response and in within like 10 minutes of the press conference he goes i want to be clear we're not saying this is the last cut we're going to look at the data in a couple months. And then all of a sudden, the Fed funds futures priced it right back.

And then the market rallied the very next day. So I think all that stuff was kind of short-term traders and positioning and really the type of stuff I find somewhat repugnant. But that's what explained all the volatility in the market. Just sort of questions around where exactly the Fed's going to be. And our position is that the Fed has in no way, shape, or form surrendered their role as the market enabler-in-chief, the risk-taker enabler-in-chief, the coddler of risk assets. So 20-plus year pattern now, going back to Greenspan, late 90s.

For all I know, this could play out the way it did in the 90s. We were in the middle of a pretty significant economic expansion in 95, certainly in risk assets, real estate, stocks. Greenspan came in and cut rates after this technically was in 96. After in 95 saying he was worried we were going into, you remember the famous quote, irrational exuberance. And then you had a run in the S&P that Mark has never seen, 96, 97, 98, 99.

I don't think we're going to go into a dot-com expansion, that technology expansion. A lot of it was fundamentally driven. We were in an incredible period, balance, budget, globalization. A lot of really, really fundamentally solid things were happening in the late 90s. And we let the fact that pets.com went to 200 bucks a share take away from the fact that there were plenty of rational things happening moving the economy forward in the late

90s and it just got overly euphoric and blew the heck up. Well I think that when he cut rates near the end of the cycle in 98 it was one of the most extravagant declarations of modern monetary policy in the American psyche that you can count on us to come provide a boost to risk-taking. And it has not backed off since. Some have been preventative cuts like that one in 98 where they were saying, oh, we're worried about some stuff we're seeing in Russia and Thailand. And then he famously cut, worried about Y2K. That whole thing was a dud, but he didn't take those cuts back. And then 9-11 happened and he cut significantly. And, you know, some of these things were legitimate, but you got the

housing bubble building up. We got a long history of the Fed. Maybe I should write a book someday about it. Okay, well, here's the thing. Right now, we have 3.7% unemployment. We created 164,000 jobs last month. We've created something in the range of half a million jobs on average every quarter for as many quarters going back as you could count. Best wage growth we've had in over a decade. Highest labor participation force in well over a decade, and we're sitting here cutting rates and barely cutting them. So why? What's the point? Well first of all there's no point in the one cut.

They're gonna have to do a second cut for it to really have any efficacy around the so-called insurance and I think that it primarily just enables those credit markets I talked about sooner to keep swimming. Now is part of it that he is worried about the impact of the trade side? I don't really know. He did make reference to it. It's good cover. He did talk about they're not hitting their inflation target. The inflation data is I hate the fact they have an inflation target unless that target is zero but it's not that far from their inflation target. So really the whole thing is that they buy into the argument that there's a self-fulfilling prophecy at play, that if global economic conditions get bad enough and they can pull, and other countries are successful in

exporting their deflation to the United States, that it could impact our credit markets, pull liquidity out of the system if we're too tight, so let's go be looser. They are not forming the bond market. They are responding to the bond market. The bond market yield curve is inverted, and they would have to cut at least another quarter point just to bring the short-term rate back equal with the 10-year Treasury. So the inversion is the bond market telling the Fed you're too tight. And that's where I think we are. So that should be the end of my podcast now. It should be all

done. I've said everything I got to say. The Fed was a big deal this week. Primarily right now, the market and risk assets have probably made the bulk of the returns they're going to make on the year, putting it mildly, be fundamentally driven, be defensive, be balanced, be focused on the dividends of well-run companies, all the things I would normally say that I believe tooth and nail. But then President Trump tweets on Thursday and says, we're going to go ahead and move forward now with another tariff on China. We still think we're getting a deal. Negotiations are moving along, but China's not going quick enough. So maybe another 10% tariff on $300 billion of imports will push them along. Well, first of all, that's the rest of what we import from China.

He effectively said, we're now going to be tariffing, taxing everything that comes in. Because if it's something in the range of $500 billion that comes in, we're already taxing $200 and he's adding another $300. You've covered the whole gamut. And the gamut that had up till now not been covered is primarily direct consumer goods. You think about the products that are bought when you buy your iPhone, for example, things like that. A lot of technology products are going to be affected, consumer products at the end consumer level. Could he pull this back in the next month? I think this is supposed to kick in September 1. I mean, I suppose anything is possible. It would look really bad on him, I think. I don't expect that. I actually think he intends to go forward, which is why he's at 10%.

But honestly, the bigger issue right now is that there is no rational way for a market observer, a market analyst, and someone making investment decisions to handicap what's going to happen next. People say, well, China's hurting more than we are. It's a ridiculous point in forming an expectation because China's – it's accurate, by the way. China is hurting more economically from it than we are. But I made this analogy to my investment committee yesterday. If the economic pain to us is a four and it's an eight to China, the political pain from our four is an eight, and the political pain from their eight of economic pain is a zero.

Maybe it's a couple points, but they don't have elections, so it's a completely different thing. There's a disproportionality between the economic pain and the political pain. They have more economic pain, we have more political pain. Well, there's an election going on next year. There's an election going on where markets have to start to worry about, is there someone who is going to get elected who is advocating new taxes on investment transactions, wiping away student debt, making college free, making preschool free for

everyone, universal income, Medicare for all, Green New Deal. These are all things. Now, most of them just die at the Senate, and I don't think the market's worried about a lot of those extreme things. But there is not a 0% chance, and not only a 10% chance. There's a significant chance markets have to worry about at some point where a deregulatory president becomes a re-regulatory president, where a corporate tax cutting president becomes a corporate tax increasing president. And separation of powers provides a very big buffer of defense against that. Thank you, James Madison. But the fact of the matter is that now the trade war has to be interpreted through both an economic lens and a political lens. Because when the market drops 800 points in two days and there is no end in sight, there's no way to really figure out how are they going to get out from this. My theory has been all along, he'll find a way to declare a victory.

He'll get a deal. It wasn't really everything they said they wanted, but sort of like what happened with steel and aluminum and stuff, he'll kind of just move on from it. I don't know that he can do that here. This is like really, really big table stakes. And I do not believe China will back down. The pain would have to get far more significant and last a lot longer and to that degree I think it is possible that what President Trump is saying is completely right that they want to wait for the next election and and of course China may be playing a game of chicken because if he is re-elected they'll regret it but their calculus may, if we hold off long enough, it could actually create, what we want is for him to not get re-elected

so we get a better deal in a year or two. And by holding out, we help the odds of him not getting re-elected. And that's where a lot of this feels to me like it's going. So, and in the meantime, that's some of the worst case scenarios of where this thing could go that start to affect consumer, affect election outcome, affect economic growth, affect stock market. But I think that the entire idea about business investment, long-term capital goods, capital investment, capital expenditure, productivity enhancing behavior, that now is completely off the table. I find it utterly unlikely that right now companies are going to make significant 10- and 20-year investments,

even with all the supply side tax incentive to do so, up against the uncertainty of where these global trade matters are going to go. So I'm not really even so much talking about what I think ought to be done or not done. I'm more just saying I don't really know what is going to be done. Both sides are in a very difficult position, including the U.S. And anyone who's sitting there going, oh, no, no, we got all the leverage. It's not true. There's an unpredictability to it. There's an uncertainty to it. And markets don't like uncertainty. Thus far, the market's more or less hung in there. I go back to something I was saying in early 2018.

I know I said it on Varney's show on Fox Business at one point, and I wrote about it a couple times in Dividend Cafe, but almost the best thing that could have happened is if the market had just dropped another 1,000 points when it already started dropping from the trade war, another 2,000 points. Something to wash it out and really give the message this trade war path is going to be very very problematic. Fact of the matter is markets have performed really well as you know

now we ended up being kind of flattish last year you had Federal Reserve stuff Q4 was not good but even then you're talking about mid single-digit drop for the first time in nine years it wasn't that big of a deal. Then this year now markets were up almost 20%. So there's been no reason for the administration to feel that we're generating pain that's hurting us. I think that in the next couple of weeks we'll have to get more clarity as to what the strategy is

to get out from this. Because if the strategy is to let it play out all the way, I think you have to really expect greater volatility all the way through the election. Not because the market's worried about Elizabeth Warren, not because we don't know if the Fed's going to give us another rate cut or not, but because there will be enough uncertainty around these global economic conditions and the potential for enough suppression of trade, which brings down risk premium in the market. So I've said a lot this week. That's because there was a lot going on.

The two-headed monster of Fed and trade are still the primary things we're talking about. I'd like to be talking more about earnings growth. I gave you a little bit of those numbers. We'll do another podcast on that next week. Earnings environment is still pretty good. Never underestimate the profit motive and the rationality of brilliant people to find a way to make more of it. So earnings are not my concern right now. But the notion of top-down suppression in the market

out of trade and out of, well, and at this point, the Fed is not going to be withdrawing liquidity from credit markets. There's your sort of glasses half full here is, yeah, fourth quarter last year. I was talking about a two-headed monster in the sense of, I don't know what's going to happen in the trade deal. And the Fed is extracting liquidity from credit markets and it's starting to really hurt. Now you still have uncertainty trade deal, but you don't have the Fed extracting liquidity from credit markets. You don't have dollars being extracted out of emerging markets.

You don't have overly indebted companies having their borrowing costs go higher, creating a negative feedback loop. So overall, we're in a better position from a macro standpoint than we were, yet there still is uncertainty lingering, and I've got to stay laser focused on it because I'm not convinced at this point that we're headed to an easy cosmetic victory we shall see okay I'm going to leave it there thanks for listening Diven Cafe give us a rating forward this around by rating I mean hit those stars on your iTunes I don't

really know how Stitcher and Google Play and Spotify and some of the other players do their ratings but there's got to be a way so all I know is those things really help us with the kind of algorithm so we appreciate you getting forwarding around to your friends and people you think might be interested and we will have another podcast next week even before the the weekly because we're going to do a little panel with the investment committee to talk about earnings season. So I'll look forward to that getting out to you Monday or Tuesday next week. Thanks for listening to The Dividend Cafe. 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. This is not an offer to buy or sell securities. No investment process is free of risk,

and there's no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors. All data and information referenced herein are from sources believed to be reliable. Any opinion, news, research, analyses, prices, or other information contained in this research is provided as general market commentary. It does not constitute investment advice. Thank you for watching.