The Dividend Cafe - What to Worry About is Different Than You Think

Episode Date: February 23, 2017

What to Worry About is Different Than You Think by The Bahnsen Group

Hello and welcome to this week's Dividend Cafe podcast. Markets enjoyed some more upside this week and are tying or setting various records here, there, and everywhere. It provokes conversation. It does risk complacency. Most importantly, it creates the need for behavioral counseling from top shelf wealth management practitioners. behavioral counseling from top shelf wealth management practitioners. Some of the brightest people I've ever met are highly prone to incredibly destructive behavioral decisions in the investment

world. So we work. Hopefully you'll enjoy this week's Dividend Cafe podcast. Intelligent caution needs an intelligent basis. For all the things we want to accomplish with Dividend Cafe, whether it's our podcast form, our YouTube videos, or the written website commentary, the number one priority has always been giving our clients a look at what is in our minds week by week. To that end, it needs to be said that high yield bond spreads at 380 basis points is taking up more mental shelf space for me right now than anything else, much more than the price level of the Dow. What this means is simpler than the jargon sounds. The average spread or pickup in the yield one gets from buying treasury bonds guaranteed by the United States government versus a basket of very credit risky corporate

bonds, that spread is only 3.8%. This is not the insanely low spread of 2.5% we saw in 2007, but it sure isn't the 8% spread we saw a year ago or the 5% spread we generally average. It implies a very low fear of risk from investors about risky credit. It can be a very positive thing, speaking to a good environment in corporate markets, but it also risks serving as a sign that investors are too darn complacent about risk and that the pedestrian and even justifiable fear an investor may have when the Dow hits new levels, while it may be fair enough, it doesn't really tell us as much as the risk that we see out of high yield bond spreads, the complacency it implies across capital markets. So we are watching it. We are thinking, but we are not being complacent.

Asset allocation does not neutralize courage. It mitigates risk. One of the most painful things for an asset allocator to do is pull the trigger on a significant systemic change in the big picture paradigm that has been driving asset allocation decisions for a particular period of time. Trimming equities from 58% to 55% for a given period of time may or may not be the right thing to do, but it's hardly the stuff paradigm shifts are made of. However, determining that the significant global condition is being altogether replaced, say, with inflationary forces would be a bold and challenging step to take. We have been carefully mitigating global deflation risk for eight years now,

and we think we've done so wisely, effectively, and prudently. The question in front of asset allocators right now is whether or not the forces of the last eight years, global deflation risk, are now obsolete, with there being upside risk for exploding nominal growth. Several analysts I respect are predicting just this. It's certainly true that global yield curves have steepened. The spreads between short-term and long-term rates have expanded. Even as all points on the yield curve are relatively low compared to historical levels. This does imply higher nominal growth. So why are we not going beyond tweaking of asset allocation levels and going all in for cyclical stocks, commodities,

and other reflationary beneficiaries in the capital markets of risk. In a sense, we've done just that. Our bond portfolio is very short duration, very focused on credit risk, bank loans, high yield. We're overweight in emerging markets as solid belief in rapidly expanding nominal growth. However, we've made the decision to use real-life companies as a medium for reflationary exposure, not direct commodity investments. This is a simple belief about risk and reward. The quality of stocks we own has never been an expression of a particular cycle's outlook, but rather the permanent bias we have for growing cash flows. Are there periods

where risk gets redefined and one portfolio may stutter while circumstances around it recalibrate? You bet. But our belief in how to best combat deflationary and inflationary forces is not at all cyclical. We have plenty of courage driving our asset allocation decisions, but they're never devoid of prudent risk assessment. We're going to leave things there for the week. We know it's kind of a short podcast, but we want to drive you to the website to see some of the other charts and some of the other items that we cover. It would be a little bit harder without the visual aid. I'm going to close you with this wonderful quote from Ray Bradbury, living at risk is jumping off the cliff and building your wings on the way down.

We believe in risk management. We believe in effective asset allocation before it's needed, not after it's needed. So with that said, enjoy your weekends and thank you for listening to Dividend Cafe.