Dear Valued Clients and Friends,
In this week’s Dividend Cafe, I again decided not to limit myself to one topic but to take the recent avalanche of questions we have received and go through them all, one by one, creating quite a “multi-topic” Dividend Cafe for you. I think you will find the questions intriguing, and I hope you will find the answers satisfying. From questions about student loans to the Fed to depositor insurance to how to select a wealth advisor, we have it all this week (and then some).
Let’s jump into the Dividend Cafe …
Inflation and Flat Markets
“One comment I have on your secular chart, if you counted inflation wouldn’t some of those flat periods end up being bear markets (typically the 70’s) ? Also, if you think that we are approaching a flattish market decade (which I agree is highly probable) would you say it is going to be more of a trader’s market – and I don’t mean day-trading or anything like that, but that we may expect an increased portfolio turnover and above average activity in the coming years ?
I will say the same thing I always say when one thinks about the inflationary impact on an asset class – you can chart the nominal returns of all assets or the real (net of inflation) charts of all assets, but you can’t chart the nominal of some and the reality of others. When we look at the performance of a market index over time, we are talking about numbers that are not adjusted for inflation and are investing in these things with dollars not adjusted for inflation. So to then adjust the chart for inflation to reflect that performance but not the dollars that went in would be inaccurate. If stocks generate 5% and there is 4% inflation, and bonds generate 3%, and there is 4% inflation, the inflationary impact is the same for each, but the net difference is only because of the different nominal rates of return, so as long as one is consistent in how this is presented, I think it is accurate and ideal.
I am certain there will be some who will call it a trader’s market, but in a flattish market of range-bound activity, I will dare say there will be more traders who lose in that environment than win in it. I do not have any reason to believe there will be higher activity in these environments.
The Tax Tail and the Index Fund Dog
“For the many in your audience who may be semi- or- fully retired, with a taxable chunk of equity in market index funds, a flat market is an unpleasant prospect. But to rebalance out of equity index funds with low cost base is not all that attractive. Curious how you would handle that quandary…maybe just ride out the index without getting much real growth while living on the dividends?”
Living on the dividends of an index fund is pretty hard to do when those yields are barely 1,5%.
I would never, ever, ever, ever let tax ramifications dictate investment policy. Without specifics of dollars, tax details, cash flow needs, and all the other pertinent matters, I could not give specific and exact advice. But philosophically, there is no question we would guide that general scenario into dividend growth and not allow one’s principal to deteriorate through withdrawals in a flattish market.
Run a model of what would have happened from 2000-2009. When I discovered these mathematical realities, it finalized my conversion to dividend growth investing (with passion and urgency).
Moral Hazard and Depositor Bailouts
“What does the FDIC making everyone whole mean for depositors and the banking industry going forward? Has the FDIC now acknowledged it will rescue and make whole depositors in future bank failures? With no limitation on depositor’s exposure, Is it appropriate for the taxpayer to be bailing out these weak institutions. Where does this all stop? p.s. Let’s not even get into the government backstopping the ‘shiny object’ operators”
There are some nuances here I want to address. I do not think it is accurate to say that this is “bailing out these weak institutions” – just in the sense that the institutions are dead and gone with their equity value and unsecured bond value fully wiped out. The only “bailout” is to the uninsured depositors, not the institutions, and it will come from a backstop funded by FDIC insurance premiums (paid by the banks, so in other words, paid by the customers of the banks). Now, I am against it and actually think the truth is more found in your P.S. than anything else – that these depositors were largely “shiny object” operators, and I doubt they would have done this for a bank that catered to churches or farmers. But be that as it may, I don’t think they did it for the shiny objects themselves, but rather to avoid contagion because a “run on the banks” (other regionals and small/mid banks) was underway, and they all know the quiet part: In a fractional reserve banking system, confidence is your main asset, and a lack of confidence is your funeral.
Rather than being for or against the backstop of uninsured depositors, per se, my two bigger points are that: (a) They must must must must provide clarity about FDIC limits going forward explicitly and not leave this implicit assumption standing; and (b) They must must must address the causes of what happened – namely, a Fed creating the boom and then the bust, and a regulatory apparatus that is incompetent on top of this bank’s risk management team being incompetent (but at least politically correct!).
Appropriate for Alternatives?
“I recently read an article where the author suggested only those with $10 million of net worth should be investing in alternatives, and that the prerequisites for doing so are expertise, time, risk tolerance, new money and size of portfolio. Do you agree with this, and if not, what criteria do you believe in for alternative investing?”
I do not agree with the arbitrariness of a $10 million net worth to have a non-correlated diversifier in one’s portfolio, no. But I do believe there should be a tolerance for illiquidity to get the right quality of alternatives (something I have written on before), and in theory, things like risk tolerance and portfolio size fit into that. But generally speaking, I advocate for alternatives on the basis of the non-correlated pursuit of absolute returns, and I think illiquidity is an important part of a quality alternative portfolio. I think tolerance for permanent erosion of capital is different from volatility and illiquidity, and I certainly think manager selection matters a lot.
Forward Guidance from the Fed
“Would an increasingly creative Fed lean on intentionally pushing misleading narratives as one of it’s levers of influence? What I am asking is would Powell threaten continued rate hikes so people price them in with no intention of actually increasing rates?”
It is a tricky question to answer because there may be an assumption of something nefarious or duplicitous behind the question, and yet even in answering affirmatively, I am really more referring to the policy tool of forward guidance than I am something “intentionally misleading.” In other words, there is no question that the Fed believes by stating certain things up front (that is, a willingness or intention to do something), they may avoid the need (or limit the severity) of actually having to do it. But of course, using forward guidance in an overly manipulative way is hardly an effective policy tool, as credibility risks being shot. I believe most of the time when central banks are using forward guidance they are not bluffing and are stating an intent that is true on its face, and yet could also become unnecessary if enough people take the guidance seriously.
The Third Rail of Social Security Ideas
“Has anyone ever proposed, or do you see any merit, to the idea of changing how social security works from what is essentially a defined benefit plan to more of a defined contribution plan? I feel like this structure would be beneficial to both parties, by gradually removing (and ultimately eliminating) the liability from the government’s books while creating a retirement benefit that wouldn’t end at death but could be passed to successive generations. Let me know what I’m missing.”
Well, President Bush Jr. proposed a very mild version of private accounts within Social Security after his 2004 re-election and was widely destroyed in the press for wanting to “gut” social security. Republicans responded to the slanderous attacks by surrendering together. A defined contribution structure has been recommended for decades and has gone nowhere politically whatsoever.
Student Loans and Consumer Spending
“Will people having to begin repayment of student loans again adversely affect the economy (less consumer spending)? And is there any potential for this to actually help on the inflation front (reduced demand) that everyone still seem worried about?
No, it is way too small of an amount (those who have been paying nothing relative to the total amount of consumer spending going on) to move the needle whatsoever. I do not think student payment resumption (where it is still not being made) moves the needle of aggregate demand, and I also do not believe that reducing demand is the key to combatting inflation.
Modern Monetary Theory
“Forgive me if you have covered this before but considering your thesis on Japanification and excessive debt leading to anemic growth, can you comment on your understanding of Modern Monetary Theory and it’s relation to this issue. Is it possible the lack of appetite in Congress for reducing debt is because they are putting stock in this theory?”
I do not believe five people in Congress have any idea what Modern Monetary Theory (MMT) is, and I do not think it matters. It is not a credible or serious theory (in theory), but in practice, it’s getting a little traction – for now.
How to Select a Wealth Advisor
“How does one go about knowing how to select a wealth advisor, and whether or not they need to change wealth advisors?”
I have always advocated for the idea that the core of a relationship between a client and a wealth advisor has to be trust, and so much of trust is subjective – do you feel a connection with the advisor rooted in trust – trust in their integrity and trust in their competence? That feeling is very important and perhaps trumps most of the other things I am about to say.
I also feel the category of the advisor matters – are they a legal fiduciary, paid exclusively by you, accountable only to their clients, or are they a paid salesman masquerading as an advisor (even if they are a pretty honest paid salesman)? I believe the clarity and transparency of their compensation is a huge consideration, and it should fully align with your interests as a client.
This next criterion takes out so many of the financial advisors I have met in my career, but it is really important – do they have a coherent, defensible, foundational belief system about how to manage money, or are they (a) Making it up as they go, (b) Just peddling whatever is popular at the moment, or (c) Just parroting what their firm or employer is saying. I think most are guilty of all three in some form or another, and it would be a dealbreaker for me.
Finally, I think the depth and breadth of services matters. A client needing real financial planning ought to make sure their advisor does more than pick investment products. A client needing an elegant and customized portfolio ought to make sure their firm does more than just run financial plans. I am certainly talking about my own book here, but I think an offering from one’s advisor that is thorough, sophisticated, and resourced matters a lot.
And did I mention trust? Never, ever, ever work with an advisor who is not trustworthy. How can you tell (besides your own gut)? Do they tell you only what you want to hear, or do they tell you the unvarnished truth? And do they have a point of view they are willing to communicate early and often … Those who don’t speak don’t earn trust. Those who demonstrate a thoughtful point of view celebrate accountability and transparency and, in my estimation, earn trust.
Quote of the Week
“Nothing so undermines your financial judgment as the sight of your neighbor getting rich.”
~ John Pierpont Morgan
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I am off to Vegas for my annual March Madness opening weekend trip. It has been a ride in markets this week, and next week will be another fun ride. In the meantime, enjoy your brackets, your TV, and your friends, and thank God there is something worth watching on TV for a few days besides financial news.
David L. Bahnsen
Chief Investment Officer, Managing Partner
The Bahnsen Group
This week’s Dividend Cafe features research from S&P, Baird, Barclays, Goldman Sachs, and the IRN research platform of FactSet