The Dividend Cafe - What Me Worry?

Episode Date: April 23, 2021

This week’s Dividend Cafe took a funny twist over the last 24 hours. First, I ended up flying back to California from New York late Thursday night for a Friday matter that came up (I was supposed to fly to California on Sunday). This substantially altered my reading and writing plans for this commentary, along with work issues. On Thursday the market had a little reaction to the shocking – shocking – news that the Biden administration was looking to raise capital gain taxes on high-income brackets. I say “shocking” because it had been, well, you know, on their campaign website all of last year, and discussed and mentioned 37 times since his inauguration. And because nothing in the announcement came with Bernie Sanders replacing Joe Manchin in West Virginia or Elizabeth Warren replacing Kyrsten Sinema in Arizona. And by the way, as of press time Friday morning, the market is down a whopping ~150 points on the week – a rounding error – after a few up days and down days mostly offset each other this week. Still, though, the cap gain tax issue does matter, so I wanted to address it this week along with a few other things that seem to be a source of worry right now for many investors. But you can’t spell “investor” without “t” and I found that out the hard way when I arrived at JFK’s Admirals Club yesterday and the “t” button on my keyboard was not working. I had a DC Today to finish, and ambitious plans for 5+ hours of work on a cross-country flight. Well, I did all I could, but just so you know, a lot of words in the English language have “t” in them – a lot. And doing a “Ctrl-C” and “Ctrl-V” for all your T’s is enough to make someone want to ask for the bartender (I don’t drink, so had to settle for my typing productivity being, well, diminished). But the use of an iPad Bluetooth keyboard, a munted attempt with the munted keyboard, my desktop at my California office, and a brand new Surface Pro laptop I had overnight shipped the second I discovered the trouble have all coalesced together to make this Dividend Cafe possible. And to think my dad wrote 500-page books on a typewriter!!! Jump on into the Dividend Cafe! 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. Hello and welcome to the Dividend Cafe podcast and video. I am in the California studio because I got back in the middle of the night from New York. And I'm going to start off my comments today with a little explanation as to how I ended up into this topic and the direction I'm going to go with what I want to talk to you all about today. I had intended kind of interesting, I had about four or five different topics I was going to weave together. I had a number of white papers I'd read this week,

and there was a research project I'd done. And I thought I had kind of all Friday morning as I normally do in New York City to wrap all this up. And then something came up where I needed to be in California here today, and so I ended up getting the last flight out last night from JFK and getting back in the middle of the night, like I said. Well, that's fine in and of itself because I can get a lot of work done, both reading and writing on an airplane. But what kind of screwed everything up is, first of all, topically, the market, which had been up 300 points on Wednesday and was kind of flattish Thursday,

all of a sudden dropped in about 30 minutes yesterday, 300 points, which really, quite honestly, is not that big of a deal at all. But the event-driven nature of it around the Biden administration announcing a capital gain tax increase, I felt like, okay, that's something I'd kind of like to address in Diven Cafe. And so it caused me to sort of rethink what I was going to do with some of the other material. And so it caused me to sort of rethink what I was going to do with some of the other material. And then my scheduling and timings all changed because of our press schedule and me flying and when I needed to write and all the things. And then I, and for those of you who read DC Today, you may have heard about this on Thursday, but I all of a sudden got to Admiral's Club on Thursday late afternoon and my T button on my keyboard was just completely, totally broken.

And so, you know, kind of can't really type that way. And so just through a combination of things over the last, what is it now? I guess 18 hours, I pulled it all together and found the topic I wanted to talk about to you. And that's what I'm about to do. We got our written Dividend Cafe done. A lot of charts in it all came together. It just ended up being written on about five different devices instead of the one device I normally write it on. Let me start. Basically, what I'm kind of titling this talk today is what me worry,

Basically, what I'm kind of titling this talk today is What Me Worry, meaning a few different things that you could see prima facie why someone may, in my shoes, want to worry about it and why I'm not where there is even worse news than people really understand in a generational or long-term sense on a separate issue that we never talk about. But that in a shorter-term sense, the issue that kind of took over Thursday may need a little better explanation. Let's start with the capital gain deal. It's kind of boring if all I do is say, well, yes, it would be bad, but it's not going to happen. And I can tell you that sometimes like on Fox, when they invite me to come on and talk about this and they say, what's your perspective? And I say, I'm not worried about such and such because it's never going to happen. They say, OK, well, we want you to talk about it as if it were going to happen. I think that's better for ratings.

And also, I do think there's some people that would like to engage the issue outside of the it will never happen, but into the hypothetical as to if it were. And so I did an appearance of Charles Payne this week, who's a good friend of mine, and I love Charles. But in his question, it was, nevermind if this isn't going to happen. And he was talking about free college for all, which is a Bernie Sanders proposal that he's bringing to the United States Senate. And, and my response of that's never going to get passed was like, okay, well, come on, let's have the conversation. And so I get it.

And I actually think that's an important conversation to have so that we do have a sort of topical and policy understanding around some of the issues, even if they're not necessarily politically feasible. By the way, it sure seems to me some things that one day are not politically feasible become politically feasible down the line. And I'm sure on either side of the aisle, people can think about examples of that

that have proven to be true in recent memory. The issue with the capital gain tax, one of the things that upsets me about the subject is that I think it's a very bad idea and has a negative impact to markets. Yet, I think it's actually for a very different reason than most of the opponents of raising taxes on capital gains are understanding. And it may be that they are understanding it, but they're not articulating it that way. So yes, I will just give you the basic caveat. I don't think it's going to happen.

What he's proposing is to raise the capital gain rate, which right now is 15% on the first $450,000 for married couple, and then 20% beyond that for people over a million of income, to raise it to 39.6%, and to keep the 3.8% Obamacare surtax, which kicks in at $250,000. So you're really talking about, I think it's a 43.4% marginal tax on capital gains for the high earners. tax on capital gains for the high earners. And then if they're in a high state, a high tax state, generally capital gains are taxed at ordinary state income rates. You're really talking about 56% in California. You're talking about 55% in New York when you combine state and federal.

And for other higher tax states, Connecticut, New Jersey, Michigan, Illinois, you know, you're above 50% into the mid 50s. So it's highly progressive. There's some people that think it's a great idea. There is all the normal politics and class warfare and arguments for arguments against that. That's that is what it is. I don't believe that they're going to be able to get it through the Senate. I also don't think they're going to get it through the House. So I've told you I'm going to kind of push it beyond that. The other piece as far as how it affects the overall stock market is just understanding the democratization and the allocation of stock market ownership. Okay, I put a chart in Dividend Cafe this week, and I actually got it from Axios, which I was surprised that they had covered this.

It's over $33 trillion of ownership in the stock market, well, of total assets that belong to retirement accounts. 401ks, pension funds, defined contribution accounts, annuities, things that are tax-deferred type vehicles that therefore are not subject to any impact from capital gain ownership. So I certainly believe on the margin that an increase in capital gain taxation is negative to the valuation of risk assets. But I think that part of the issue, besides the fact that it's going to be an uphill battle to get it done, is that it is not a broad brush, holistic increase, although it is severely punitive, to those that are directly hit by it, those high earners particularly in higher tax states, etc. But I think this misses the mark. I think the biggest impact to the economy and to the

stock market, if we were to see such a thing embraced, is part of the expression, but the trickle-down impact to capital allocation. The impact it would have on capital formation is, I think, really, really underappreciated. And I mean that in the most negative way I possibly can. People saying, OK, I kind of want to sell this uh building this business this stock this investment it's run its course it's give me the return i wanted there's a new opportunity i want to invest in oh but you know what if i sell i gotta pay 50 cents on the dollar in taxes i'm just gonna hold

it it's rational thinking and the way people view their own balance sheets. They have on paper that they have X and if they sell, they're going to have less than X because taxes will take away some part of the value of X. I want to sell it badly enough that I'm willing to pay 20% of that value's gain in taxes, but not badly enough to pay this higher amount. So it becomes a marginal decision in all economics. Always and forever is marginal. I think that you get really, really poor decisions about capital allocation that have a heavy bias towards stale assets when you have a higher tax on capital. People hold assets that they otherwise wouldn't hold, which is distortive to rational economic

decision making. Then they don't have those proceeds from the gain they otherwise would have incurred to invest in new projects, new capital deployment that represents a more productive allocation of resources. This is the problem. It is not just that the value of XYZ stock is technically less because at the gain realization point, there will be less dollars you get to keep from it. That's true. As I've already tried to say, that's actually somewhat limited in its scope. But to the extent that this has a broader spreading of the decision making

that takes place around capital allocation, I think that is the issue. So we're going to watch it closely politically. I don't think Senator Manchin in West Virginia or Sinema in Arizona, and then maybe others too, are going to bend on this. I think that they'll compromise and turn it down a bit, similar to what appears to be happening on the corporate tax side. But who knows? Maybe, you know, politics is a horse trading kind of sausage making business. And maybe they throw a bone to them saying, we're going to do this in the bill you want. We're going to do

this you want. We're going to give this in your state. And then we want your vote on this. And they come around. You know, I can't say for certain. but I think that right now, first of all, it is absolutely not a surprise. This was on the Web page of the Biden campaign all of last year. He has repeated it since becoming president over 30 times. This was the intent. And it's a starting spot. And I don't think it's going to go as is. And that's my feeling about where we are with it. think it's going to go as is. And that's my feeling about where we are with it. Now, I mentioned that there's something out there that I would be more concerned about.

And because it teed up for me a chance to do what I love doing most at Dividend Cafe, which is sort of give a little economics tutorial, I want to share with you something about, it's not just merely demographics. It is specific to population growth. You know, there are only two ways to grow population in a country, and that is new births and new immigration. And if you know of another way that I don't know of, then let me know. You know, I prefer you not come back with something about, you know, factory or laboratory manufacturing or something. You know, look, it's pretty obvious that either new people are coming into your country from outside the country or new people being born in your country or your country isn't growing its headcount, so to speak. And then furthermore, to the extent that we still obviously suffer from the,

on this side of glory, the painful reality of death, the deaths that take place throughout a year in a country have to be offset by the births that take place for there to just be a break even in population. And so when you get downward pressure on the total level of immigration, which we've had for some time, for a variety of reasons, mostly political, some cultural, some bipartisan, and I won't get into all the details around it. I wrote a whole chapter on my feelings on the immigration debate in my book, Crisis of Responsibility.

And my views on it are not really totally partisan with one side or the other. I think I pretty well have views that manage to upset everybody, which is usually, I think, probably a pretty good thing. But regardless, I'm just talking math here. But regardless, I'm just talking math here. This is an economic truism that I want you to remember. And it is not controversial, it's not disputed, but economic growth is population growth plus productivity. And to the extent you have a declining population and let's assume level productivity, you're going to have less economic growth because of math.

And if you have a higher population and level productivity, you're getting more growth. If you have a higher population with more productivity both, then you're getting even more growth. But we're below trendline growth in our country since the financial crisis

and we're below trendline growth in our country since the financial crisis, and we're below trendline population growth, and we're below trendline productivity. So I guess it's not that big of a mystery after all. And you see how much slowing is taking place in population growth in the country, largely because of declining birth rates since the financial crisis. I do think that there is a lot of deferred new babies being born, meaning people having them later in a later stage of their own adulthood than they previously did and and yet either way um we have the the the factor that can really throw off population growth is if you have a very aging population where therefore because of just kind of obvious mortality realities you have a higher rate of your population dying because of their age, and then you don't have as many youngers that are having children that are offsetting that.

So your birth rate goes below your death rate, and you get a declining population. It's a dynamic that Japan has faced. It's a dynamic that Europe has now faced. It's generally a decision a society makes to have less babies and america is is in that space now not to the degree that europe is not to the degree japan is and our aging our average median age of a population is nowhere near where japan is which by the way just obviously speaks to decisions that their society and our society made a generation or two generations ago, right? We have still a massive amount of people in our population that are so-called baby boomers

that came about from the post-World War II era of high birth levels, right? So there's a lot of demographic advantages we've had but they're slowly diminishing and i am sparing you my social or cultural message around um family and around the the idea of robust communities and and and and and all the kind of peripheral things that are non-economic I'd be happy to go into here. But the truth is that I think longer term, you can talk about any tax rate thing or legislation you want. Legislation, executive orders can't sometimes even last for a term, let alone two congressional terms, two presidential terms. There's a lot of fickleness and vulnerability in the political landscape. But these cultural trends, I think, are more important.

So I'm watching that carefully. I also put a chart in, speaking of what me worry about dividends. And there's declining amount of dividend generosity coming out of S&P 500 companies. And the point I kind of make is, if I could talk my book or be a little self-serving here, this is a very positive thing for someone who is focused on that elite and exclusive and limited and finite amount of companies that share the characteristics of alignment with shareholders, philosophical commitment to dividend growth, an income statement and balance sheet that allows for such.

So it is true that you were getting annual dividend growth of 5%, 10%, 15% at certain periods out of the S&P in the 90s, coming out of the tech crash, building up before the financial crisis. And there was even a nice little resurgence of dividend generosity across the S&P in 2013-14, around that period. if you look at the whole entire chart, it's this downward pressure. And it actually was going down for years of how much dividend growth the S&P was really generating. And then before it went actually negative last year with COVID. And the negative piece, I think it's like the seventh time the S&P has gone year over year negative in dividend payment since World War II. It doesn't happen a lot. My preference is it happens zero times ever,

but it's happened seven times in 60, 70 years. That's livable, but it's held up against the simultaneous reality of less pressure existing in corporate boardrooms and in treasurer offices to grow dividends out of the market. My view is that that makes more valuable strategies that are more committed to such. Now, even across the market, you're getting a lot of companies in S&P that are raising dividends now this year because they had held them or cut them or suspended them last year.

There's still kind of a base effect that's helping the numbers improve year over year in the S&P 500. But our view would be that when you find these companies that we obsess over, that outside of market distress, outside of what the trend is, outside of what the index is doing that just simply have that bottom up commitment and capacity around dividend growth uh one need not be influenced by peers and one need not be discouraged by what others are doing this is a really healthy and positive thing likewise you look at the stock buyback thing last year buybacks dropped like 40 something percent and and it was the easiest thing and the quickest thing as it always is in times of market distress for companies to cut back on

stock buybacks as a byproduct of protecting uh cash and and that their capital return that becomes the first sacrificial lamb and then and then you know things get better and you go okay well they're going to come right back to stock buybacks and I say you know you're probably right but the only thing I want to point out is that they're going to be doing that with markets that are 25% higher than their pre-pandemic levels. If you find a track record of companies well timing their commitment to stock buybacks I'd like to see it because I haven't seen it.

When companies should most be buying back their own stock are the periods when companies are least able to buy back the stock. It's just a fact. But when you can maintain consistency, stability, and endurance in your dividend payments, I think you have a really healthy scenario for how you monetize shareholders. So I covered a few different topics here. These are a few things that are on my mind. What me worry? No, I'm not worried about any of these things.

I think there's plenty for investors to understand are out there. I have longer-term concerns that are more substantial to me than short term transitory concerns. I would very much like to be able to deal with the investment impact of what's happening on Biden tax changes, Biden administration tax plans. But it's very hard to do when you don't know what is going to be really proposed, what's really going to end up being agreed to, what's really going to come out of the legislative process, and then what other trade-offs go along with it as well. That's something I did not understand a few weeks ago the way I do now, which is that if they do end up getting a higher marginal rate on corporate taxation, it looks to me like it's going to be very heavily offset

by full expensing of R&D, which is supposed to go to amortization. You go, what are you talking about? R&D, amortization? My point is that one hand might be taking, but another hand might be giving altogether. And you get a little more political optics than you really get economic impact. And in that case, it could end up being positive to markets, not negative. So got to watch all of it. Want to talk about it as intelligently and objectively and thoughtfully as we can. And you may be worried about things.

And if so, that's what I'm here for. Your advisor, the Bonson Group, is here to deal with your worry. Reach out to us anytime. And in the meantime, have a wonderful weekend. And thank you, as always, for listening to Dividend Cafe. Please put us in your podcast feed. Subscribe. It helps us, helps you. And we look forward to talking to you again next week at the Dividend Cafe. The Bonson Group is a group of investment professionals registered with Hightower Securities LLC, member FINRA and SIPC, 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. There is no guarantee that the investment process or investment opportunities referenced herein will be profitable. Thank you. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary and does not constitute investment advice. The Bonser Group and Hightower shall not in any way be liable for claims and make no express or implied representations or warranties as to the accuracy or completeness of 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 Bonson Group and do not represent those

of Hightower Advisors LLC or any of its affiliates. Hightower Advisors do not provide tax or legal advice. This material was not intended or written to be used or presented to any entity as tax advice or tax information. Tax laws vary based on the client's individual circumstances and can change at any time without notice. Clients are urged to consult their tax or legal advisor for any related questions.