The Dividend Cafe - What Is the Fed Worried About? Just About Everything.

Episode Date: September 28, 2018

Topics discussed: Capex, the key ingredient in higher productivity China's Currency Manipulation Mitigates Tariffs Tax Reform Results in Huge On-Shore Spending 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. This is David Bonson. I am the Chief Investment Officer and Managing Partner here at the Bonson Group with our weekly Dividend Cafe commentary for you podcast listeners. Very quick housekeeping the advice and insights podcast this week is the favorite one i've ever done besides the time i interviewed ron barron on small cap growth investing the podcast this week had to do with this subject of tarp and

whether or not tarp was responsible for the stock market repair back when the bear market ended and bull market began nine years ago. So if you're interested in that topic, check out our Advice and Insights podcast. Next week, we're going to have a regular, normal Dividend Cafe podcast like the one you're listening to here and our normal DividendCafe.com commentary. But I'm going to do a special video and then a special advice and insights podcast on a kind of longer summary of the takeaways of the great financial crisis recession of 2008, wrap up our sort of 10 year commemoration of that event. So please check that out next week. And then if you've been following our series, marketepicarian.com, the 10th and final contribution to the series of the financial

crisis that I've been writing will appear on Tuesday, October the 2nd, if you're interested. But in the meantime, let's look at the markets this week. Let's kind of look at the big things that I think are pertinent from an investor standpoint. And as is always the case, if you want to get some of the charts that go along with the things I'm talking about, go to DividendCafe.com. Looks like about a roughly flattish week in the markets as of the time that I'm recording, midday Thursday. The markets are up about 150 points today. And I think they're down roughly 150 coming into today. So you should be close to even on the week.

But we're going to wrap up the third quarter at the close of the day Friday, and it's been a real heck of a quarter. It's been another good month in September for risk assets. Not a great quarter for a lot of risk assets. The global markets have continued to struggle, although Japan has caught a bid here recently. Our UK investments have caught a bid recently, but more or less a pretty sleepy quarter overall, and then a downright negative quarter in a lot of the emerging markets, particularly,

of course, China. How is the U.S. economy doing? You know, from a capital expenditure standpoint, the big theme we're talking about, and the reason we're talking about that is because it's an important domino in the overall kind of syllogism that we have, which is that CapEx will drive business. The business investment will drive CapEx. CapEx will drive productivity. Productivity will be necessary to see profit growth continue. And profit growth will enable this rally to extend, particularly coming out of the weakness of the economic rally that we saw for the bulk of the initial years out of the financial crisis. When I look at the year-over-year numbers in business equipment, in our capacity utilization getting near

its kind of full capacity level, up to about almost 80% really would be an adjusted full capacity from an industrial production standpoint. Our capital goods orders and shipments both exploding in growth and then just the broader industrial production which has always largely correlated. There's a chart at dividendcafe.com showing its correlation with GDP growth over the years. They really tightly correlate. And now you see industrial production getting out in front of GDP growth, which would argue that there is a gap for GDP growth to catch up to. I can only say that these metrics may not be as exciting as the monthly jobs report or the quarterly GDP report. But these types of readings tell us if we're right about our forecast on CapEx and the boom will be necessary to sustain this economic expansion. And I will tell you, it is hard to interpret any of this pessimistically. Now, what do you think the Fed thinks about all of it? I mean,

in a second, I'm going to make a couple of comments as to why the whole narrative of what the Fed thinks has to be blown up. But for those who are sitting on pins and needles wishing the Fed would stop raising rates, it's nearly impossible to believe the Fed will be swayed to delay tightening what is still an accommodative monetary policy when they see unemployment at 3.8 percent and capacity utilization basically full. You know, the industrial side of the economy matters too. And the Fed believes that is full steam ahead. It isn't like they're looking at jobs and consumer going, oh, those are doing great, but the industrial side of the economy is weak, so we have an excuse to kind of slow down. They see strength in all comers.

But let me set a couple things straight on that topic. One of the things that you're asked to believe in this current environment is that the best thing to root for is A, strong economic performance, and B, a Fed that stops raising rates and normalizing monetary policy. This pedestrian narrative is that the Fed helps investors by distorting the natural price of money, and that there can be a sort of hangover-less drinking binge if the Fed would just stay out of the way. Of course, I agree with the first point, strong economic performance is to be desired. And I also agree that we are seeing it. I just gave you a lot of the reasons why I think we're seeing it and how we're seeing it. But while I understand short-termism as much as the next guy, it is factually inaccurate. That Fed-induced distortions in

the marketplace are an ipso facto positive for investors. It's brutally inaccurate. Markets respond to clarity and certainty. Delaying the inevitable adds to uncertainty, a distorted price signal creates a bad investment. It might feel good for a little while or not, but in the end, the way of excessively distorted markets is bubbles. And you know what happens to bubbles. My comments are not specific to any actual Fed decision here and now that they ought to make or ought not to make. My comments are to the general and I believe destructive narrative that a permanently accommodative Fed is what we really ought to wish for. It just is not so. Just a few months ago the great weight on markets, I'm referring to both stock and bond markets, was the threat of

impending inflation allegedly. As we enter the fourth quarter gold is down over 8% this year and it is 35% down its high earlier this decade. The consolation for gold is the stable alternative to the US dollar which by the way is up 3% on a trade-weighted basis this year is that Bitcoin to the other alternative currency is down 55% on the year, making gold look positively stable. A post-crisis milestone happened this week, and apparently no one seems to notice. I think it's a big deal. The Fed's increase of the Fed funds rate this week by another 25 basis points,

another quarter point, to an effective 2.25% level. We actually now have a positive real interest rate for the first time since the Fed's crisis era monetary policy began 10 years ago. With a 2% inflation rate as measured by the personal consumption expenditure index, that PCE, by the way, has long been the Fed's favorite measure of inflation. And you have a Fed funds rate now just higher than that. It does represent the first time in almost 10 years that the real rate is not actually negative so why have higher rates not hurt the stock market you know the 30-year bond yield was about 2.1 2.2 percent 30 years ago and it's now 3 percent plus change and of course we know what's happened to the short-term

rates and that tightness of the yield curve along the way, the flatness. Well, most importantly, the thing is that higher rates have gone very slowly. It's been very cheap and very shallow, the way people have sort of understood these things. You have a slow and gradual increase in rates, you have a slow and gradual increase in rates where the 10-year treasury yield is up 0.5%. It was up 1.3% in just a few months in 2013, back when the taper tantrum happened. So the slow magnitude of the rate increase has largely buffered the effect on risk markets. increase has largely buffered the effect on risk markets. But also, if you want to get in the weeds a little bit, the corporate bond yields have just not moved at the same rate as treasury yields. The relationship between credit and treasury is more important than the absolute rate themselves. That tells you about growth and confidence and things like that. Great chart at DividendCafe.com this week about the growth of

each sector in the S&P 500 and if you took its actual profits growth and through the 20-year average PE ratio, their average multiple valuation indicator on each sector and you would see evaluation indicator on each sector and you would see that it is only energy and telecom and financials especially telecom and energy that are lower that are right now actually cheap relative to 20-year average evaluation but then you actually consumer and technology and real estate are above those uh averages um so that's taking actual earnings numbers and applying a non-actual S&P market multiple around their sector to it. I think it's interesting.

If you don't follow me, you're going to have to see it on the website. It'll make perfect sense there. So you know you got oil up 50% over the last 12 months, but the energy index is only up 12% or 13%. I continue to believe you have a great opportunity in that space. And then our chart of the week at DividendCafe.com shows why I think President Trump has been a little emboldened. I've used this chart before, but just to continue

kind of showing where we are in the trade and tariff issue. S&P 500 going up the way it's now gone up in the year, up against the Shanghai composite, which has just gone straight down since this trade war began. Granted, they've lowered their currency 10%. They've allowed the currency to weaken relative to the dollar, which has then had an impact on other dollar-denominated investments. But the fact of the matter is with our market higher, their market lower, you could probably see why the president feels emboldened.

The other thing I want to draw your attention to at DividendCafe.com is the use of excess profits from tax reform year over year. And obviously this chart is done middle of this year, so I still kind of want to see the data at the end of 2018. But the share buybacks are up 51% year over year. That's to be expected. Obviously, it's the easiest way for companies to spend excess profits from a capacity standpoint. You have an infinite amount of shares you can buy back. There's only an infinite amount of CapEx you can do and things like that. But speaking of CapEx, up 22.5% year over year. Absolutely incredible number. And dividends in the S&P 500 up 9.6% year over year. We suspect that number will go higher as the year continues. And then I would make a comment too. That's what

the whole S&P 500, within the kind of intentional focus on dividend growth that we really believe in, you'll see much higher. And I think that's an important distinction between companies that find themselves with extra cash, they have to figure out what to do with it, and the mentality of companies whose culture is inclined towards dividend growth. Let me leave it there for the week. Covered a lot of ground. But thank you for listening, Dividend Cafe. We hope you like the podcast. We hope you review it and share it and give us five stars

or whatever else it is you want to do. But also do listen to the Advice and Insights podcast this week. And we look forward to coming back to you next week with another regular old stroll down Dividend Cafe lane. Thank you for listening. Have a wonderful weekend. The Thank you. the data and other information or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice. This document was created for informational purposes only.

The opinions expressed are solely those of the team and do not represent those of Hightower Advisors LLC or any of its affiliates.