Dear Valued Clients and Friends,
Greetings from New York City where we are approaching the end of an intense week of meetings, discussions, debates, analysis, and soon, decisions. It has been invigorating and we still have a couple of days of meetings to go, so a more comprehensive download will linger for another week. But in the meantime, this week’s Dividend Cafe will recap the week in markets, offer an update on the Fed, explore the latest on NAFTA 2.0, seek to scare you a bit, and seek to encourage you a bit. There is also yet another pretty comprehensive analysis of the political landscape and what it means to markets right now. So jump on into the Dividend Cafe, and let’s explore the latest and greatest in the world of investing.
Dividend Café – Podcast
Dividend Café – Vidcast
The week in markets
We have thus far this week been up a tad Monday, down a tad Tuesday, up a tad a Wednesday, and as of press time Thursday morning, up a tad Thursday, Basically, no major directional move and very little volatility to boot (sometimes I think God smiles on me when I am traveling and in meetings all day, every day, knowing that dealing with hyper-volatile markets on this annual New York due diligence trip would potentially exceed what I could bear).
A DC event that matters
As an investor and investment advisor, I am ten times more interested in NAFTA 2.0 being ratified than I am this impeachment circus. The legislative calendar is tightening and despite both sides still indicating they think it is going to happen, the labor unions are not on board yet and there remains some detail issues not yet resolved.
We are back to very close to 100% odds that the Fed will be cutting rates another quarter-point next week:
* CME Group, October 24, 2019
However, the odds of that second rate cut in December have now decreased, with markets pricing in about a 25% chance for the second cut (vs. a roughly 40-50% probability previously).
* CME Group, October 24, 2019
I think we have exhausted this subject enough already, yet it has to be covered and discussed and there are plenty of moving parts to it that are not likely to allow us to leave it alone any time soon. The reasons for why the Fed will do or not do what it does or does not do change quite a bit, often from one conversation to the next. Performing a constructive analysis on whether or not something they may do (such as another quarter-point cut in the Fed Funds rate market) really requires some connection to the “why” behind a decision, and yet in this case there is (a) Talk of an “insurance” cut to protect against global economic weakness, (b) Talk of the Fed’s inflation target being evasive, (c) Fears of the trade war impact, (d) Talk of the global drag on yields from countries in negative interest rates and the need for the Fed to manage lower based on global pressures, etc. I could probably come up with a few more reasons as well.
At the end of the day, I generally believe that anything that requires four different rationalizations, each of which seems to rotate day by day in terms of its use, is probably a dubious decision. But our viewpoint is not that the Fed should cut next week, but rather that they will. The impact on markets is not very controversial as we see it:
(1) By reducing the risk-free rate which all assets are valued against, it increases the value of risk assets short term
(2) In terms of providing economic stimulus which gets to the heart of what actually does threaten our economy, it does nothing at all, and likely makes it worse
Before the real Politics and Money section …
We offer more elaboration and charts in Politics and Money below, but it is worth noting that there is one factor more relevant than maybe getting attention in the whole impeachment story – and that is the possibility of pulling Senator Warren (and other Senate candidates, too, but Booker, Klobuchar, Harris are after-thoughts in the polls right now) off the campaign trail, potentially for a 4-6 week period. If indeed the House goes forward with an impeachment of the President, particularly by the end of this year, it would mean a Senate trial to follow. Former Vice President Joe Biden and Mayor Pete Buttigieg would possibly benefit the most from that, as campaigning in the final month before Iowa and New Hampshire is crucial.
Investor surveys and market betting odds continue to place Elizabeth Warren in the lead for whom people expect to secure the nomination, and investors continue to indicate that her policy agenda is most concerning to their investor confidence, but the next couple of months are likely to be quite a roller coaster.
I pointed out a couple of weeks ago that the PMI and ISM data in manufacturing and services (survey driven) was indeed negative, and yet there was economic activity data not matching the survey/sentiment results. Indeed, the delta between the two is well higher than its historical average. The possibility that survey pessimism will revert to activity optimism cannot be discounted if a trade war agreement is reached.
Brexit exit schmexit
So Parliament did something this week they had never done through all the Brexit drama of the past few years – they approved the basic structure of what the Prime Minister and European Union have conceptually agreed to. But then 20 minutes later, they narrowly failed to approve getting it all done by the deadline. So we go into the weekend not really knowing, but more or less assuming that the deal presently on the table will happen, but not on time, so another extension coming …
Office drop or something worse?
A theme I will be elaborating on in the post-trip processing is a very (very) bearish theme on Office product in commercial real estate (deeply overvalued, minimal net operating income if any, high capex, insane expectations in a “Wework” millennial culture for amenities, etc.). Our Investment Committee is evaluating if this belief is at odds with our otherwise bullish position on Commercial Backed Mortgage Securities. Our major research partners and alternative partners and even fixed income partners love the CMBS thesis, but we want to work through if there is any contradiction to the thesis, with our beliefs about a significant deterioration in the office segment. I really do believe the two theses are not inherently contradictory – that mortgages can perform just fine even when the underlying asset proves to be a disappointing investment for buyers. Not all bad-performing investments lead to defaults; in fact very few do. If rents are being paid even as the underlying asset value is deteriorating, it may not matter. But I don’t want to be complacent here.
The real fear of the
Something I am going to elaborate a lot on in both my debriefs from this week’s New York meetings, but also as we proceed through the final quarter of 2019 and prepare to enter the new year of 2020, is a proper understanding of the health of the corporate sector and the American household in the domestic economy. Ramifications of Fed actions over the last ten years are subject to debate, and in that debate, we think a lot of assumptions are made and conclusions are drawn that are really subject to error.
We know that banks are much less leveraged than pre-crisis (thank God). We know that many corporations have more leverage, or lower quality credit conditions, than pre-crisis (let alone at the bottom of the crisis). And we know that households have largely de-levered, partially from the liquidation of bad debt post-crisis, and partially from the resurgence of value in household assets (stocks and real estate).
The idea that all of the risk in the economy is because of the incentive central bankers provided to borrow and spend is somewhat incomplete. My thesis is increasingly becoming that the Fed shifted risks and that they unintentionally created different risks than anticipated. Households are more leveraged to capital markets than they were before, but less to credit conditions; and companies are more levered to credit conditions and less levered to capital markets.
But I think the conclusions one draws from all those things we know are not as black and white as some may wish, and deciphering where risks exist and don’t exist inside the corporate, household, and government sectors of our economy are the real need of the hour. Expect more on all of this in the weeks to come, particularly as I unpack much of the takeaways from this week’s meetings.
Politics & Money: Beltway Bulls and Bears
- I am increasingly of the belief that even more than Health Care and Financials, it is Energy that faces the greatest threat from a Warren administration (hardly a sector that could use even more headwinds after the last five years). The talking down of exports of oil and gas, the ban on terminal construction (for importing or exporting liquefied natural gas), the hit to confidence necessary for capital expenditures feeding 21st-century growth – these policy particulars are a grave threat and will be closely watched in 2020. U.S. manufacturing is already struggling out of the trade war; a war on U.S. energy production would be highly problematic for America’s blue-collar workers.
- Of course, Elizabeth Warren’s path to the White House is nowhere near assured, as her path to the Democratic nomination is nowhere near assured. This week polls showed Joe Biden substantially picking up and Warren coming down a bit, perhaps in response to last week’s debate performances. What many on the right are likely watching is President Trump’s approval rating ticking down. It is interesting to see the correlation with President Obama’s rating at this time. As the chart shows, the real question will be whether or not President Trump is able to generate the move off of this level that President Obama did.
* Strategas Research, Policy Outlook, Oct. 23, 2019, p. 6
Chart of the Week
Is this because of the phase one China/U.S. trade deal? Is it because the Fed has been easing on the short end of the curve? Is it because the Fed stopped quantitative tightening further out in the term structure? Is it because of an overall more relaxed global economic mood than we saw two months ago? The answer to all questions, is yes. But the yield curve has uninverted, and while remaining quite flat, it has very much reversed its indicator of late summer.
* Strategas Research
Quote of the Week
“There are no patents in finance.”
~ Stephen A. Schwarzman
* * *
I will leave it there and trust that you understand that the slightly shorter version of Dividend Cafe this week is a by-product of the six 18-hour days I have had in a row, and the need to better process two dozen meetings of due diligence. Our views on real estate, credit, risk allocation, recession timing, political risk, and so much more are all being challenged out here, and it will bring me great joy to organize my thoughts and conclusions and present to you more comprehensively and coherently in the week or so ahead. In the meantime, reach out with any questions you may have, and have a wonderful fall weekend.
David L. Bahnsen
Chief Investment Officer, Managing Partner
The Bahnsen Group
This week’s Dividend Café features research from S&P, Baird, Barclays, Goldman Sachs, and the IRN research platform of FactSet