The Dividend Cafe - What Do These Record Highs and Volatile Lows Mean?

Episode Date: December 28, 2018

Topics discussed: What Happened in December? High Yield Is Highly Important Volatility, Meet Valuation Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. Hello and welcome to this week's Dividend Cafe podcast. We are recording now two days after Christmas and a few days before New Year's. And so we're in this kind of in-between section of the two holidays at the end of the year where I actually will get a little time away with my family over the weekend. But normally this week, I'd prefer not to be recording a podcast and not to be recording a video and all of that. But the market conditions are such that it's actually really, really important that I do. And I'm sure you probably agree. If you're actually listening to this podcast right now, it must mean that you care enough about what's going on that you want to hear it. And

therefore, if you want to hear it, I want to speak it. So let me give you kind of the rundown of where things are. I'm going to do the best I can to get through the entire dividendcafe.com, but it was a very long one on purpose. I kid you not that it was probably the most time I've spent on writing one, despite it being the Christmas week in the entire 2018 year. As I sit here now, we're down about 400 points in the Dow on Thursday, December 27th. And on Wednesday, December 26th, you had the largest point increase in the history of the market. We were up almost 1100 points on the Dow. It wasn't the biggest percentage increase ever in a day, but up 5% in one day is a pretty

big deal. Now we were down 600 and something points on Monday, Christmas Eve, which the market was only open half day. So it's interesting. As I'm sitting here talking, we're probably dead flat on the week. Down 600, up 1,100, down 400, maybe up a couple points in between there. We'll see how things settle. Listen, I don't have any idea what's going to happen the rest of today what's happened friday we're open full day and

then on monday december 31 we are open again on a half day and then 2018 will be done all i can tell you is that the odds are very high that we're going to close December down over 11% in the market, potentially more. From the peak in the S&P at Monday's close, we were down basically 19.8% or something like that. Really a whisker away from the academic definition of a bear market, which is from a closing high to a closing low, a 20% decline. We didn't quite hit that, even though intraday we did, but that doesn't count. And by the way, who cares about that stuff? Okay. What exactly has happened? Well, you know, the beginning of the December sell-off was on Tuesday, December 4th. Markets were greeted with a I am tariff man tweet from the president.

Markets had rallied 1,000 points higher the week before and entered December with strong momentum after what ended up actually being a positive performing November. We're sitting here now down 3,000 points in the Dow from that level. More than that as Thursday's action gets priced in. And like I said, it's expected to close out the worst December since the Great Depression. And we'll see how that kind of plays in the days ahead. I can't tell you how different December would have been and felt if it had been a month where bond yields flew higher as stock prices collapsed. And that would have indicated this rapidly growing economy, really big concerns about inflation, repricing implications out of the Fed actions. In other words, the negative environment that we had in February.

If that's what the negative environment were now, I think it would just be a really, really different feeling. But see, now you have Fed tightening, but bonds are responding exactly how they traditionally do in a risk-off pummeling, and that is that they're rallying, meaning yields are falling, bond prices are rising. The reason for the market drop in December is categorically different than the reason for the market drop in February. Investors are not fretting runaway growth right now. They're fearing global weakness.

And I think that makes a huge difference in how we think about what's going on in the market. So let me talk about the Fed a little bit, that balance sheet issue. I made the argument in last week's Advice and Insights podcast that the far more relevant matter in present monetary policy impacting markets is their unwinding of the quantitative easing that they have embarked upon. It's often referred to as balance sheet reduction, and we're now using the term quantitative tightening. The initial pace was just about $10 billion per month, that is, of bonds that would mature and that the Fed would now not reinvest the proceeds, essentially allowing that liquidity to evaporate, be removed from the banking system. The pace has now picked up to $50 billion per month, and the total stated goal has been to reduce about $1.5 to $2. half trillion dollars from their balance sheet money that never

entered the money supply but sat on the fed's balance sheet or served as excess reserves in the banking system i am sure you find these nuances captivating but here's the thing 430 billion dollars so far of reduced liquidity on the balance sheet amounts to about five additional rate hikes in terms of its impact to monetary contraction. So if we have seven more rate hikes in the last two years, excuse me, if we have seen seven rate hikes in the last two years, which we have, the fact of the matter is that markets are digesting really more like 12 rate hikes in terms of the combined impact of Fed funds rate tightening and quantitative tightening as that all makes its way through markets. need to at least wonder about Fed policy and actions right now. And perhaps in 2019, there will be plenty to criticize. I don't know yet. I don't happen to think they're going to go all the way forward with some of the projections they're making now, but we'll see. But this much has to be said. Years and years of easy money were never going to be unwound easily. Staying at the zero bound interest rate in 2014 and 15 and 16 the latter years of which seemed

very much driven by global market fears not domestic data it delayed the days of reckoning and the pal fed is presently cleaning up much of the bernanke fed that the yellen fed did not want to deal with now understand what I'm saying and not saying. This does not mean Yellen was right or wrong. It just means that this is what is going on now. We left the punch bowl on the table for hours after everyone was drunk and even added more sauce to the punch. And now we wonder why there's a hangover. Now let's talk about the economy though, because the key predicate in believing this to be a fear-driven meltdown in risk assets versus an actual secular bear market

is that the U.S. economy is in fact not facing a recession anytime soon. That's very much our view. Global economies are in many cases weak or weakening and the U.S. central bank is tightening monetary policy and the trade war has created a severe level of economic anxiety and uncertainty but the U.S. economy has not shown signs of weakening or vulnerability yet. That will be the key determinant of where things go in 2019. And I'll point you to DividendCafe.com this week on this front where I have a chart of the leading economic indicators. And I show, clear as could be, how they're up 4.5% over the last six months. They generally go negative 9 to 18 months before a recession will ensue. But sentiment is so bad. Well, by the way, this would be my very argument. The stock market bulls should be talking about how

sentiment is bad, because what generally precedes a market top is not negative sentiment, but irrational euphoric sentiment. Momentum picks up into a top and in this case the mood was highly skeptical all the way through. If this period were to turn into a bear market it would apparently be the most anticipated bear market in history. Investors have a lot more to fear when sentiment is good than they do when it is bad, especially investors with a timeline for investing longer than just this week or next. Now, one of the things I'm not going to get into too much here on the podcast, but I do want you to read more about it at

dividendcafe.com if you're interested, is why high yield is so important in this environment. I'm working on a white paper that'll come out in early 2019, and we'll do a big video on it, a podcast on it, and also have kind of a, I don't know, 15 to 20 page booklet, really laying out a recap of 2018, but most importantly, our positioning and our perspective on 2019. And I'm going to talk a lot about the high yield bond market, and you're going to go, well, you're not even really all that vested in higher bonds. So why do we care much about that? But see, the reason is that high yield has a lot more to do with what it indicates about other investors, other asset classes, risk in the marketplace, than it does the actual asset class of high yield bonds themselves.

asset class of high yield bonds themselves. Widening high yield credit spreads have been kind of normal over the last few weeks. I mean, obviously they've happened. The spreads have widened out. You would expect that. But it has not been so severe. It would indicate a crack in credit availability. That's true in the levered loan market, too. The indicators do not point right now to systemic breakdown in credit. While business activity is needed to sustain this economy, I don't know that I've talked about anything more than that this year, and suppression of credit would be the best indicator that we'll get that that is breaking down. So far it hasn't been in the cards, but that's why I plan to elaborate on that subject a lot more in the weeks ahead okay um emerging markets interesting flat over the last three months not had a good year the

dollars rallied there's a lot of global weakness global fears emerging markets have certainly not had a good year but as this december swoon in small cap, the S&P, NASDAQ, etc., has been such a disaster. The fact of the matter is that emerging markets have all of a sudden become kind of the relative better performer. By the way, on the trade war front, which is often said to be the blame for a lot of emerging markets weakness, and certainly I'm very much in the camp that think it explains a lot of the weakness in U.S. markets, it doesn't explain all of it. And that's not me lightening my criticism of the trade war. I've been extremely public and unwavering in how bad of an idea I think what we're doing with these tariffs is to the U.S. economy.

However, the FANG stocks, you know, those famous Facebook, Amazon, Netflix, Google, and Vidia, these kind of new tech, cool tech, high tech type companies, they're down 40% in just a couple months. That's not all related to trade war. Fact of the matter is you had some real valuation issues, and then you had sentiment turn, and then in the overall potpourri of the trade war and Fed tightening and concerns about global economic slowdown, it's all stirred together. Look, no matter how problematic the trade war has been for the U.S. economy, there's never one single explanation for anything going on. Please read about equity risk premium at dividendcafe.com. I put a chart up. You right now have the earnings yield of the S&P 500, meaning the total earnings of the index divided by the price of the index, is a full 3% higher than the 10-year treasury yield. This is a full 3% higher than the 10-year treasury yield. This is a new or high level.

That's historically at this level meant, on average, forward returns over the next year in excess of 12%. And we have all of this laid out in a chart for you at DividendCafe.com. All right, I'm going to close up with a comment on behavioral modification. I read a lot. It's been studied, studying for many, many years, the behavioral habits and not to mention investment mantras of some of the great investors of history. has looked and acted and kind of functioned very much like, well, I guess you could argue June of 2017 when the Brexit issue happened, excuse me, June of 16, January 2016, August of 2015, July of 2011, May of 2010, this horrific, not the horrific financial crisis in 2008, which was a categorically different event and then and then there's another period i'm skipping over a lot in the 2000s

but in august 1998 i actually think it's extremely comparable to what we're dealing with now um there you have these different months where we just really really dropped quickly and it didn't last it lasted three four or five weeks and and it didn't last. It lasted three, four, five weeks and it proved not to become a secular bear market. I think that this little playbook is not complicated. It can be very lucrative and it represents what I think is the right behavioral habits for investors as to how they want to function during periods like this. One is to understand, if at all possible, why whatever's happening is happening. And to make sure you understand, secondly, what is happening. I mean, it's one thing to just say the stock

market's dropping, but to look at what sectors are down, what sectors might not be down, what high yield spreads are doing, what commodity prices are doing. Kind of putting together a full puzzle, I think, is a very important step. But then avoiding any temptation to rash behavior or overreaction. Staying deeply connected to history and reality, mainly that market drops actually do happen a lot and the markets recover. Look for ways to exploit the downturn to one's advantage, whether it be from cash deployment, rebalancing, adding new positions to one's portfolio that maybe went on sale. You add all this up, it's very different, isn't it?

Then looking at your portfolio every 10 minutes online or getting sucked into media hype and misinformation. You know, I think the noise of the markets can get very disconnected from our real life goals and objectives. And this is the thing that is so important that we have to do with the Bonson Group. Even in a month like this where admittedly it's been crazy, markets went haywire, there isn't a clearly detectable, definable, measurable, rational reason, and yet it's incumbent upon us to not allow that noise to separate investors from their real long-term goals, what they're trying to accomplish with the money. The fluctuations when they get responded to become far worse than the fluctuations and their cosmetic impact.

So all that to say, this is the final Dividend Cafe podcast of 2018, but it's not our recap of 2018 because we still have a few days to go here. So we're gonna let the markets finish up the year. We're going to let 2018 run its course. And we're going to go into 2019 with a lot to say about the wise positioning and set up for investors, what we believe is going to make the most sense.

In the meantime, this will probably, if we end up this week as a flat week, it'll be the wildest flat week I've ever experienced. A lot of day-by-day volatility. That's been going on for over a month. The bottom did fall out of markets this month. But you saw on the day like yesterday, trying to time your way around it and missing an 1,100-point up day. It's a bad idea. Stay in your seat and hopefully that seat involves you being with your family enjoying the holidays enjoying the new year putting your uh your online you know account app down for a little bit and i promise you if you're

a client of the bonds group we are intensely focused on what needs to be done, what needs to not be done, and getting the asset allocation and the positioning right to both play defense and, where appropriate, play some opportunistic offense in this market environment. But with that said, I will bid adieu to the markets and say instead to you, Happy New Year to you and yours. Thank you for listening to The Dividend Cafe, So happy new year to you and yours. 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 is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and 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 and does not constitute investment advice. Thank you.