Dear Valued Clients and Friends,
This week’s Dividend Café comes from New York City where snow has been dropping and capital markets are in the air. People ask me a lot why I love New York City so much, and I remind them that outside my family, my two favorite things on earth are capital markets and food. That tells you all you need to know about my love of New York. But this week’s Dividend Café, while written in New York City, goes all over the world, and I invite you to jump in with both feet. I always especially enjoy the Dividend Cafes I write here in the city (more morning time, more investment inspiration, etc.).
Dividend Café Video
Dividend Café Podcast
Before you get excited, get more excited
Earnings season got closer to completion this week (the Q1 period of reporting Q4 results), and we saw yet again more dividend increases, a really encouraging validator to what has been a great start to the year in the market. Investors understandably have been most pleased with the mere movement higher of stock prices relative to the damage done in market pricing last quarter. But the fact of the matter is that dividend growth is what we invest for at The Bahnsen Group, as we pay our clients their withdrawal needs (present or future) from real cash, and dividends both serve as that cash and speak to the sustainability of that cash in the future. Earnings “beats” and stock price advancement are lovely, but it is dividend growth that is the meat & potatoes of what we are doing. By that metric, this quarter has really outperformed our expectations.
Earnings watch 2019
Earnings in the fourth quarter grew 14% vs. the year prior, whereas the third quarter saw a 24% growth of year-over-year earnings. I never in my career thought I would be writing to defend a 14% YOY earnings growth as a positive thing, but such is the state of the affairs we find ourselves. What will full-year earnings indicate? Could they even go negative on the year (less earnings in 2019 than 2018)? Some point to the impact of tax reform in 2018 as if it were a one-time event, but I assume you all know that the lower tax rates of 2018 are also the tax rates for 2019, right? Ultimately, an increase in borrowing costs may have been the biggest threat to earnings growth in 2019, and inflationary pressures on input costs. Both of those threats seem subdued, and we believe earnings growth will be positive for 2019.
Capex watch 2019
Nondefense capital goods orders in January declined 0.6% month-over-month in January. The government shutdown and late-year slowdown and seasonality make the numbers somewhat antiquated, but the point remains that business investment went from exemplary to muted several months ago, and the data has not yet reflected the pick-up needed to argue for an ongoing economic expansion. Our view remains that the trade war forced a pause in sentiment and activity, so therefore resolution to the trade war is needed to evaluate if that pause was transitory or something to be more concerned about.
But on the other hand …
On a full year basis, the incremental increase in corporate cash for the first nine months of 2018 do point to a $208 billion increase in capex, vs. a $191 billion increase in stock buybacks. This is not quite within one of the narratives we often hear about the corporate tax reduction.
Spreading the wealth
I want to make sure those of you who read Dividend Café know that we have other thought leadership oozing out of the brain trust at The Bahnsen Group. We incubate all of our content at the Advice & Insights section of our company website.
Partner, Kimberlee Davis, has recently posted her most recent Fiscal Feminist on “the sandwich generation.”
Partner, Don Saulic, has done immense work with The Financierge, and the most recent offers great value about estate planning.
Advisor, Trevor Cummings, continues to receive rave reviews for his weekly Thoughts on Money, last week covering emerging markets and this week on stock buybacks.
A Municipal Conundrum
The demand for high-tax state municipals was intensified by the loss of the SALT deduction (state and local taxes being deductible against one’s federal income tax return), as the greater tax liability on the margin at the state level made the tax-freeness of in-state municipal bonds more valuable. But the other side to this is paradoxically true and factually fascinating: The loss of SALT has also made those same higher-in-demand bonds more risky on a credit basis! As citizens migrate out of high tax states where they can no longer write off on their federal returns the excessive taxes they were paying on their state returns, it becomes a net gain in revenue for those low tax states receiving these taxpayers, and a net loss for those states losing them. So the credit risk goes up even as the demand for the bonds goes up!
UK is OK?
Checking in on our friends across the pond, there is not a particular political update on how things are expected to unfold as far as it pertains to the nature of Britain’s pending exit from the European Union. What we do know is that real GDP growth was 1.3% last year, a tepid number that was still better than its European Union counterparts. Unemployment is at a 50-year low. Wage growth has been steadily improving. And manufacturing and productivity numbers have been far better than the critics had anticipated. Will the post-Brexit UK maintain its economic superiority to the rest of the European Union? That will depend on how the final Brexit particulars are handled, in theory, but the operative thesis remains: Where there is greater freedom, there can be greater prosperity.
And the rest of Europe …
Since 2009, the first year of this post-crisis decade we have just completed, China’s economy has grown 139%; India has grown 96%; the United States has grown 34%; and Europe has grown …
Negative 2%
Source: Walter Russell Mead, Wall Street Journal, February 11, 2019
A cultural phenomena
The fastest-growing group of renters in the United States is now in the higher income brackets versus lower income brackets for the first time in history. Those with annual pay above $150,000 who rent vs. own has grown 170% over the last ten years – from 774,000 to 2.1 million people (while home ownership in that segment has only grown by 67%). This speaks to the ghastly affordability problem, that even those in higher income levels find the costs of ownership too severe. But it also speaks to the broader reality of the culture – that more people are finding renting an attractive lifestyle option (even when they have the freedom to choose).
Source: First Trust Market Watch, RENTCafe, February 11, 2019
The truth about tax reform
There is a lot of chatter about how the 2017 tax reform bill is translating to tax liability for individuals in tax year 2018. Much of the commentary is loaded with political agenda, but I thought a few nuggets may be useful for those interested in empirical facts. There will be more people paying taxes with their returns this year (21% of filers vs. 18% last year), but a smaller tax base overall (roughly 4% fewer people who owe taxes). There are those with over $1 million of annual income who may pay more in taxes than the prior law due to the loss of deductions, and in the highest four state-income-tax states that income threshold for being a higher payer may be somewhere between $500,000 and $1 million (it is not less). But the fact of the matter is that the near elimination of the Alternative Minimum Tax (AMT), the reforms around small business taxation, and the doubling of the child tax credit, the loss of the SALT deduction (state and local taxes) in high tax states was largely offset. The rates were lowered across the board, so the loss of certain deductions is pitted against lower tax rates. The reduction in refunds year-to-date is much more likely a by-product of processing around the government shutdown.
I really do recommend this week’s special Advice & Insights podcast on this very subject!
Politics & Money: Beltway Bulls and Bears
- As of press time, it appears that the President will sign the compromise deal lawmakers has given him, though by the time you are reading this he may have reversed course, or it may be a done deal. The deal gives $1.4 billion of funding for new border security, less than the President wanted, increasing the chances that he will declare a national emergency to get additional measures funded.
- In case you were worried, sugar beet trucks in rural Oregon are exempted in the new budget compromise bill from federal limits on trucking length. But there was no cronyism here – just truly detailed legislative work (ay yi yi)
- You may hear more about that old subject of the “debt ceiling” in the weeks ahead. Technically we run up against the legal limit on March 2, but there are a plethora of short term tools Treasury has which likely suspend the real date to this fall. What happens then? We go through this at least once a year, and they generally push this and push that and pull this and pull that, and we continue with the charade that we even have a debt ceiling, and life goes on. I do not believe it is, or ever has been, a material event for markets and economics; it is a purely political one. Now, would a credit rating downgrade be a material event (as Fitch has threatened to do)? That is hard to say. The substantive answer is, of course not – who takes these people seriously anyways? But there is a sense in which noise is noise, and should a downgrade take place I am sure there would be some degree of noise.
- Why don’t they downgrade our debt? We run $1 trillion of annual deficits right now and have $21 trillion of national debt. The idea that political commotion around the “debt ceiling” charade may trigger a credit downgrade but a trillion dollars of the budget deficit does not tell you all you need to know about the credibility of this credit rating discussion.
Chart of the Week
There was a surge of fear about wages growing 3% year-over-year one year ago this week. As we sit here a year later, wages have continued growing year-over-year as a by-product of the healthy U.S. economy, but the 4% level many fear will indicate inflation has not surfaced. The two things I note from the chart below is that (a) Wage growth is a good thing, and not at past peak levels; (b) If 4% wage growth means the Fed will respond to stave off inflation, and in doing so create a recession, the time from one to the other has generally been about two years from that 4% point …
Quote of the Week
“If I have been able to see farther than others, it was because I stood on the shoulder of giants.”
~ Isaac Newton
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I will leave it there for the week. Next week’s Dividend Café will also come from here in NYC, though it is a short market week with Monday closed for President’s Day. My family is out with me in New York for the long holiday weekend, so we plan to enjoy the cold, the park, and the food. Enjoy your weekends, and reach out with any questions, any time.
With regards,
David L. Bahnsen
Chief Investment Officer, Managing Partner
dbahnsen@thebahnsengroup.com
The Bahnsen Group
www.thebahnsengroup.com
