The Dividend Cafe - Uncertainty Rattles The Markets

Episode Date: November 30, 2018

Topics discussed: A Two-Headed Friend (or Foe) Making Sense of the U.S. Energy Sector Bitcoin Boondoggle Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. All right, just like that, we've come to the final month of 2018. And with that, I want to welcome you to this week's Dividend Cafe podcast. This is David Bonson. I am the chief investment officer here at the Bonson Group. And I want to give you the kind of weekly download from our Dividend Cafe. For those of you that still enjoy reading, you can always read it on the DividendCafe.com website. And there's a bunch of really pretty charts. Actually, a couple of the charts this

week you're going to want to look at. So take in the podcast, but make a note to go back to the website a little later. Yeah, I'm sure a lot of people are happy to be leaving November. It's been a very volatile month. The fact of the matter was October was pretty much a straight line down. I mean, the first couple of days were good. And then October 3rd down, there was almost no reprieve at all from the market downturn. And then in the month of November, you had really big moves up and really big moves down. And then more big moves up and then more big moves up than

more big moves down. And as it looks like we're going to end the month on a big move up. Yeah, I'm recording this just a little bit before the month has ended. So who knows what happens in the next 36 hours. But my point is that you kind of had big up, big down, big up, big down, big up. So that's three ups, two downs that it may end up being a slightly positive month. So let me kind of dive into where we are right now. I'm phrasing this the two-headed foe or friend, and I want to give you a really helpful paradigm to think about market conditions right now. The two major categories that underlie the tensions that exist in the broad market right now are the uncertainty around the trade war issues with China. We've been talking about that all year. And then the uncertainty around the impact of Federal Reserve normalization of monetary policy.

There's little disagreement that both of these heads exist as far as headwinds go, though there are differing opinions about which one trumps the other and all that kind of stuff. My view is that the answer is both. They're both kind of working together to represent this two-headed foe or friend. And what we've seen in real time last week and then now this week is how these forces end up proving to be a foe to market prices or can become a friend. And what I mean by that is kind of simple. If the trade issues show signs of being resolved in a less disruptive manner,

markets have reason to breathe a sigh of relief. I talk about this in the politics and money section at Dividend Cafe this week. But of course, the inverse is equally true. The indications that it will escalate will increase market volatility. And as I've argued for some time now, The indications that it will escalate will increase market volatility. And as I've argued for some time now, they more fundamentally threaten the primary thesis of this expansion, which is business investment. So there is both a negative and positive potential outcome out of this particular event, neither one of which I think is particularly predictable, to be honest with you, especially in the short term.

But let's look at the second foe-friend, and we'll keep the F alliteration going. It's the Fed. The Fed is foe, the Fed is friend. On Wednesday, Fed Chair Jerome Powell indicated that interest rates were, and I quote, just below the broad range of estimates of the level that would be neutral for the economy. Just below. That's a subjective term. There's nothing in his quote or the overall speech that was given at the Economic Club of New York on Wednesday. There's nothing that really assures markets there will be less tightening than markets have feared. And there certainly is nothing that indicates the Fed will not proceed with their well-planned, thoroughly discussed quarter point hike in December.

However, in October, Powell said we were, quote, a long way from neutral. And this week, he says we're just below neutral. As far as market prices go, there is friend and foe in these two different statements. So all right, well, that's well and good. But what exactly will happen? Is there short-term clarity forthcoming on the trade and monetary issues that most impact the present economic recovery? Probably not. But ultimately, and many of you are on our plane here, where your focus is not and cannot and should not be on the short-term market noise and fluctuations, but rather on the fundamental longer-term impacts to economic growth. All fondness for 600-point up days in the market notwithstanding, my view is resolute that the Fed getting to a neutral rate is extremely important at this stage of the economic cycle. I do believe

that the Fed should get the funds rate to a neutral place and they should continue normalizing their balance sheet, allowing the bonds they bought to roll off their balance sheet, but surely thereby modestly tightening liquidity in the economy. But I'm perfectly fine with the idea that the neutral rate may be slightly less than the 3.5% or 4% many have assumed we're headed to. Ultimately, the worst thing that can happen is for the Fed to blink and inadequately normalize. The other worst thing they could do is to go too far. One of these two things feels better short term and one feels worse long term. Let's make sense of the U.S. energy sector real quickly. I feel that the oil price is probably the least talked about story in the market right now of the various stories that weren't being talked about.

And I'm going to just give you a couple of bullet points here to take in. Oil prices went from $50 to $75 from October 2017 to October 2018, and energy stocks barely moved. Now, oil prices have gone from $75 back to $50 in just the last two months. Guess what? Energy stocks have barely moved, meaning the commodity price dropped 33%, and the Chevrons and Exxons of the world are down maybe 3%, 4%. Nothing proportionate. Now, in the same time, natural gas is up 33% in the last four weeks alone. No one's even talking about it. The fact of matter is that if one believes the commodity prices drive energy sector prices, they not only would be wrong empirically, historically, economically, but they would face

offsetting data conclusions to begin with. Because many of these energy sector companies have significant crude oil franchises and natural gas franchises, and those two commodity prices have moved in divergent directions. Ultimately, oil prices are far more relevant for what they potentially indicate about the global economy, not what they do to the global economy. The present question is whether or not oil prices have dropped because of systemically declining global demand. We are skeptical of that view. It's not to say we don't take the risk seriously, but we're skeptical. We do not believe the present conditions will lead to a reduction

of capital expenditures, which would slow GDP growth, because companies learned in 2014-2015 that shutting down rigs and assuming there will be a secular repricing of oil left many producers way under-resourced when things normalized in 2016-2017. High yield spreads have widened about 100 basis points, 1%, over the last couple of months. That's significant. But the last time oil prices dropped 33%, they widened 700 basis points. At this time, there's no comparison. Our investment positioning around the energy sector is that bears cannot say that commodity prices kill energy stocks when low, but do not help them when high. The fact of the matter is that this correlation between the two things has been very low for a long time. Lower energy prices may very well relieve inflationary pressures and even reposition monetary expectations.

But investors cannot forecast what oil or gas prices will do tomorrow next week next month the smarter investment play is to look at what we do know and that is that president trump wants to trade deal with china and china needs our natural gas buying energy infrastructure companies limits exposure to commodity price volatility and gives exposure to cash flow generating businesses with a growth catalyst. Okay, I can't close out this week's Dividend Cafe podcast without some Bitcoin shade. The 2018 collapse of cryptocurrencies is certainly a more significant event than the fact that the stock and bond markets appear headed to a roughly flat performance for the year.

We know that stock and bond markets have up years, roughly flat performance for the year. We know that stock and bond markets have up years, down years, flat years, but for a new asset class, and heaven help me for even using that term, to get created out of thin air, to have major financial institutions lining up to cater to this mania, and for a mass of people to enter an investment in something that they know nothing about whatsoever is A, unfortunate, B, not new, and C, not going to stop with this mess either. The 80% drop in these crypto values this year was not systemic to our economy, thank God, but it was indicative of a timeless reality of human nature, and that reality is what we work

to counteract each and every day. Please check out the chart at Diffident Cafe, where you can look at the cryptocurrency valuations over the last year. All right, I got to close out with this final thought. You may be expecting me when I talk about the bright side of market corrections to mean something kind of cliche about bargain prices and better opportunities that come with a market decline. And mathematically, it's certainly true. I believe market declines really do mean good things for investors who understand the economics of long-term returns. You either get to purchase good investments at lower prices or reinvest dividends into lower prices. It gives compounding nice juice over time. But no, that's not the angle I'm taking here.

What I will say about periods where overpriced froth, like the FANG stocks, drop 30% in a month or so, is that it forces investors to remember the reality of price and valuation. Remember the reality of price and valuation. What I will say when markets correct 10% in a month is that it forces investors to appreciate asset allocation and diversification. Concepts that just one month ago I was reiterating as concepts that must mean something is underperforming. For investors who have maintained the discipline of well-constructive alternatives in their portfolio, they're much happier today, as are investors who had exposure to fixed income and varying types of equities, etc. But more than anything else, it's my hope that periods like this

re-establish the premium on advice, on counsel, on communication, on planning, on the actual care and work a financial advisor ought to provide. I know how many of those in my industry rely on advancing markets to make up for their service, advice, competence, and counsel deficits. But these are the times that the bright side of real advisory work are exhibited, in my humble opinion. Yeah, you do have to read Politics and Money, dividendcafe.com, because I talk about the three scenarios that could come out of the Trump trade discussions with China's President Xi Jinping this weekend. And I am out of time here on the podcast. And then also the chart of the week

about staying invested and what the outcome has been for those who tried to time their way out of the market after various bad days, all the way going back to 2009. It's amazing to see the different outcomes that have played out. And so the chart there is very much worth going to. So I'm going to close it out there. Listen to Advice and Insights podcast if you want a deeper dive into the Fed. I'm going to close it out there. Listen to Advice and Insights podcast if you want a deeper dive into the Fed.

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