The Dividend Cafe - What is Shiny Becomes Dull

Episode Date: January 21, 2022

I telegraphed last week a special Dividend Cafe on energy today, and I reiterated that plan several times in DC Today this last week. But as I began pulling it all together in my hotel room here in Washington D.C. at 4:00 this morning, it occurred to me that we appear to be living through a market doing much of what I have been talking about for a very long time, and that I have an obligation to make Dividend Cafe as current and relevant as possible. The treatment on the Energy sector I want to present must be written, but it can wait one more week. That topic is no less significant, but from a timeliness standpoint, the market events of the week (and really of all 2022 thus far) provide a golden opportunity to reinforce some more practical investment lessons right now. As a general rule I do not like the idea of making Dividend Cafe a weekly response to headlines or market circumstances, and have mostly avoided doing so for quite some time now. But this week’s Dividend Cafe is not a mere “this week in markets” play. Rather, I want to use the obviously predominant story in financial markets to illuminate a few key elements of our thinking at The Bahnsen Group. In other words, the inspiration is some current market action, but the lesson is far, far more evergreen. And I think it is going to really surprise you. So jump on in to the Dividend Cafe … Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Well, hello and welcome to another Dividend Cafe. I am sitting in a hotel room in Washington, D.C., and I will be heading back to New York City in a few hours. I'm recording in the middle of the morning. The market's already open on Friday. And I talked last week and even reiterated it throughout D.C. today, this week, that I wanted to do a special Dividend Cafe today about the energy sector. There's a lot I want to say and update and forecast and kind of dive into around U.S. oil and gas and the overall outlook for

energy infrastructure and energy independence. And I did make the call this morning at about 4 a.m. Eastern time to scrap that for one more week. I'm going to still do exactly what I want to do. I'm just going to put it off to next Friday. I don't want to say it's not timely. I think it is timely, but I don't think it's so timely that it can't wait a week. Where it did seem to me that there is something playing out in markets right now that is really, really important to me. And it made more sense to strike in this moment on what I'm going to talk about instead today with Dividend Cafe. And a lot of that is provoked by the realities in the market right now. So it could seem that there's sort of a timeliness to it.

But honestly, I don't like the idea of me making Dividend Cafe a sort of response to the headlines or market events of the week. I haven't done that for quite some time. But what I'm doing here today is cheating a little bit because there's a current market environment I want to address. That's true. But the reason I'm doing it is to extract from that opportunity, a more evergreen and permanent and principle-based lesson that I think is just great. It's very timely, shall we say, now. And so it's the type of thing I could write about in Dividend Cafe and have written about anytime, but I want to utilize the current environment to do so. And then we'll pick up the energy story next week. So what do I mean? What's going on? Well, as I'm sitting here talking, the NASDAQ's down 13.5% from its high. It's down 10% on the year

since the calendar year began just a few weeks ago, but it was already a few percent off of its highs. Unlike the S&P and Dow, which made some new highs in 2022. And so there was a little bit of cracks in the armor already surfacing in the NASDAQ before the new year. the armor already surfacing in the NASDAQ before the new year. But by the way, the Dow is down over 5%. The S&P is down over 6%. So this is not just the NASDAQ. There's some collateral damage and overall risk off that's definitely playing out. The Nikkei in Japan is down roughly about 9%, I believe, as of last night's close. So there's definitely a general kind of poor appetite right now on the risk side. But you look at Bitcoin, you look at the really shiny objects in the technology space. The average tech stock is down 20%. Now, because of the market

cap weighted nature of market indices, the indices are not down as much, but the average tech stock's down quite a bit more. And I've talked for a couple months now about a lot of the big 2020 winners being down far, far more than that. That's really almost old news now. The hottest kind of innovation technology strategy from the 2020 period has now given back basically 50%. And that was one of the highest accumulators of new capital that we had ever seen. Billions of dollars after these big gains receiving that kind of money. And so I'm going to come back to that thing about the flows of new money that goes into things in a moment. Because that's really kind of the whole point I'm going to be making here today.

But I guess just to kind of set the table a bit, there is some stuff that's been working. Dividend growth has been mostly up on the year. Energy is up. Oil is up. Emerging markets are up. And a lot of those things we have sizable investments in. Some of them we don't. Some of the commodity side, we tend to be a bit more commodity price agnostic, just not being able to extract an internal rate of return and not wanting to subject our investment thesis to speculation about supply and demand characteristics. I made a decision well over, oh, I guess it was not well over. It was about a decade ago that direct commodity investment was not something we wanted to do. We wanted to be more company centric and cashflow

centric. But regardless, when you look at emerging markets and oil and energy and dividend growth, I can and have, and we'll talk about our thesis for those investments till you literally can't stand my voice. That's how much I love talking about it. It's how much I do talk about it. And it is something I'm incredibly passionate and convicted about. And none of it has anything to do with three weeks of good returns

or three months of good returns or what we think will happen in the next three weeks or three months. It is entirely driven by what we believe to be a rational and defensible conviction going out three decades, not three weeks. Okay. So in periods that investments are in favor, it no more rattles us than when they may be a tad out of favor, which we certainly are subject to as well. In this current environment, though, I am a little bit more prone to think that assets are not likely to find a bottom immediately because of the fact that I don't really think there is a catalyst to this sell-off. And I think that's worse than when there is a catalyst. In other words, sometimes the worst reason for a risk assets to fall is for no reason at all. Because I use Omicron and Delta from 2021 as the great analogy here.

When you have a reason for something falling, and particularly when it's an incredibly stupid reason, you have a reason for it to reverse. You have a reason for it to go the other way. And it is not my belief that this is event-driven in what has caused things to fall. It is essentially the reality of valuation. That valuation just does not seem to matter and can even trump bad news when one is allowing valuations to kind of exuberantly expand. exuberantly expand, but that when valuation does matter and laws of gravity and laws of logic return to investment processes, then valuation trumps even good news, even good news. And

there's a big, huge brand name streaming company today that's down 25% as I'm talking. Who knows what will end up later today. But my point is that they beat earnings expectations. They outperformed what was expected. But you get a dynamic of pricing and perfection increasing imperfection on a forward basis and any inability to see those numbers achieved. In the streaming world, it's heavily driven by subscriber growth. It could be other metrics and other sectors. But what elevated valuations do is at some point, which is totally untimable, it's been untimable by us for a long time, and it's untimable by anybody. But when that point comes, then valuations are all that matter. And I think when I talk about valuation sensitivities, I have strong opinions about the valuation levels of

FANG. But FANG are really profitable companies and big companies and powerful companies. But what I want people to understand out of this shiny object theme, when we look at deterioration in the crypto space right now, and what I think could end up being at some point, maybe now, maybe not till much later, but I mean, really significant deterioration there. When I look at all the people a few years ago that were asking us about cannabis investments that have, in most cases, declined over 90 percent. a love affair with the media and a love affair with retail investors and subsequently drop 50%. The shiny object theme is not because we're making a judgment call on a given investment. Oh, we knew that work from home was bad, or we knew crypto was bad, or we knew innovation. Some of these I may like, some I may not like, but that's never been my point ever. Shiny objects are not bad because one of them has an investment theme we don't like

or do like. They're bad because they're shiny objects. And what does that mean? It means it's an investment that becomes bought by an investor population for its popularity, for its sex appeal, for a sensationalism around it, for a popularity dynamic, not for fundamentals of the investment itself. And every time someone says, we don't care about that stuff, look it, it's going higher, it's going higher, everyone loves it. And then the worst thing that could ever happen happens, which is that that proves right for a sustained period of time, emboldening investors who do not know what they're doing

and emboldening a conviction in nothingness that ends up leading to tears. And I'm not even saying this is that moment because I don't know. I do know this, 13% in the NASDAQ, if it were to hit a bottom here, that's a cakewalk. The average tech stock is down 20. The average tech stock generally has gone down 30% since the financial crisis before a bottom was formed. And that was all in periods of quantitative easing, not in periods of quantitative tightening. So I don't know where FANG goes. FANG has been

until more recently, mostly immune from a lot of this. I don't know where crypto goes and other things that are purely speculation oriented versus intrinsic value definable. But what I do know is that shiny objects are to be avoided only because they are shiny objects, that the popularity of an investment has an inevitability, a reversal, has an inevitability, a reversal, and the ethos of contrarianism, the sort of countercultural ethos that we have adopted at the Bonson Group, I like it when people make fun of dividend-paying companies because, to me, that reinforces the truisms we believe in. We do not adopt dividend growth because of their popularity. The popular investments I'm aware of in my adult life are things that have ended up blowing up at some point in time

because that is a dynamic about human nature, about human psychology, about greed and fear cycles in the human mind, in the financial markets. I have no ability to reverse any of this. I have no ability or no forecast that it will be reversed. All I can do is in my own investing habits and in the way we steward client capital, avoid those traps in the way we manage client money. Will there be times in which the things we are invested in seem very out of favor? I sure hope so. I think things are out of favor, produce better buying opportunities and better expected rates of return? Will there be times that it feels very uncomfortable and painful? Most certainly. And yet, ultimately,

I don't know of an exception to the idea that when something is bought merely for its kind of shiny object-ness, that it ends well. Now, one could say, well, I got into this and I got out of that. And so that's right. One can speculate and exit at a big profit. And then by exiting, they take away the risk of losing money. Of course, the problem is that that's not sustainable. Our clients have always hired us for sustainable investment results because they have sustainable goals and objectives. If one were to trade speculatively, make money, and then stop, they would have avoided the risk of perpetual speculation, but then they have to do something with that money. And generally what a speculator does with profits from speculation is speculate again.

And yeah, I'm not going to bet on that perpetually working. So I hope I'm articulating. I don't want to say dumbing down because I'm not trying to be condescending, but I mean just generally articulating this in a way that you can understand and appreciate. The economic outlook on shiny objects is unnecessary. It is most certainly not offered by those who are behind those investments. The whole point to them is often that economic outlook is for the birds, all this valuation stuff and free cash flow analysis and PE ratios. These are all obsolete concepts. They are not and they never will be. is always in forever. The attempt to make money off of

discounting future cash flows into the present. And you have to apply a discount rate to that. And and there are plenty of ways to get that wrong. The discount rate assumption can be wrong, the actual generation of future cash flows can be wrong. But that is what investing ultimately amounts to. And even when one says it's pure growth or pure price appreciation, the price appreciation is a byproduct of assumptions about future cash flow generations. That's what this is about. And in that world and with those parameters, we end up missing some things that can be fun and shiny and exciting at a time.

I don't know. This is a period right now where I do expect things to get worse before they get better. And I hope that that will entail a number of other asset classes that I don't think are as susceptible to the shiny object phenomena. Because if you get a lot of high quality value stocks or dividend growth stocks or emerging markets, other things that we think are more defensible, if they can kind of get some price depreciation in the whole morass, you might get really good buying opportunities. So there's a lot to think about in that situation, but I really want to be very clear about what we're thinking right now. I don't have any idea where bottoms are for

the NASDAQ. I don't believe this is purely limited to technology. Consumer discretionary is down 13% as well. Most risk assets have dropped in the last couple of weeks. And yet some are performing better than others for now. But what is a sustainable investment philosophy is not relying on the sensationalism of the day. And that's a lesson that is unfortunately countercultural, but it is one of the ethos of our firm and the way in which I think about managing money and my partners think about managing money. And that is today's lesson in Dividend Cafe. I hope it was worth the absolutely painful agony of making you wait an entire another week for a prolonged energy edition Dividend Cafe, but it's coming. And I thank you for your patience

and forbearance. I hope that those of you listening to Dividend Cafe podcast or watching the video have gotten something out of this. Reach out with any questions, anytime, please subscribe, put us in your feed, give us a five-star rating, do nice things for us. But whether you do or not, we're going to continue doing our best to do nice things for you, which will never involve promoting shiny objects. Thanks for listening to The Dividend Cafe. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, member 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.

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