Dear Valued Clients and Friends,
Volatility in the markets this week had been virtually non-existent (right up until press time) and then the President tweeted this:
The markets ripped higher and I will unpack more details when you click into this week’s Dividend Cafe …
Since the market’s massive rally last Friday after mind-numbing good jobs numbers the market had barely budged this week. The Democrats in the House filed articles of impeachment against the President this week. The Fed stood still on interest rates. And the British voters headed to the polls to elect their Prime Minister. It wasn’t a boring week in the world, just in the market (until Thursday morning).
So this week we’ll dive into the jobs data, the strength of the economy, the vulnerabilities in the economy, the pending tariff deadline, and all sorts of big things. It’s a whopper of info, so let’s get caffeinated in the Dividend Cafe …
Dividend Cafe – Podcast
Dividend Cafe – Vidcast
“A Big Deal with China”
As of press time, a dead-flat market week Monday through Wednesday has led to a +300 point day on Thursday (in a matter of minutes), as speculation is high that a China/trade deal is imminent, and that the cutting of existing tariffs is in fact on the table. This is the piece I have written over and over again was not yet priced in and if – if – if – if – if it happens, is a really, really big deal. It could be what gets business investment rolling again. It could be what restores confidence and capital expenditures and manufacturing. I find it hard to believe that the White House is allowing this information out if it is not real, but you just never know. For the President to pull back tariffs without the enforcement mechanisms he wanted a year ago would be great for the economy, and somewhat humorous in terms of the posturing of the last year. I am watching and waiting with bated breath.
The last last last update as of press time (so assume there has been more news since I wrote this) is that China and U.S. negotiators have agreed to a deal and that tariffs will be coming down, but it is all still pending the President’s approval.
Holy jobs number!
The market rallied 350 points last Friday as the November jobs number blew away expectations, with 266,000 jobs added. Consensus expectations themselves were high (at 180,.000) and those were blown away. Revisions to two prior months of data also added 48,000 jobs. It further suggests that the Fed has no need to move rates lower, and it certainly speaks to a very strong domestic economy.
Death to the Phillips Curve
The economic theory that a strong labor market is inherently inflationary has been left for dead by the testimony of reality. The theory suggests an inverse relationship between inflation and unemployment. We do not have runaway inflation – we have a Fed frustrated that they can’t create more inflation; and we do have record-setting employment.
So is all rosy in the economy?
It is imperative that this nuance – and accurate, holistic picture – not be compromised:
(1) The economy is strong, yes
(2) The labor and wages data are hugely supportive
(3) And yet, cracks in the business investment, capital expenditures, manufacturing side of the economy point to a future vulnerability
There is nothing remotely contradictory in all three of these statements, and that is a good thing since all three are indisputably true.
What the Fed said, not what they did
As expected, the Fed sat on their hands this week, neither raising nor cutting rates. However, their language about continuing to assess “global developments” and “muted inflation expectations” makes it very clear (to us) that they are biased toward accommodation not tightening for the foreseeable future. I continue to believe their posture will last throughout the 2020 election year. The Fed dot plots show otherwise. Eight governors are indicating they see rates higher in a year. The futures market doesn’t believe it and I don’t either. Comments from Chairman Powell centered around the rather obvious fact that recession risks have dramatically decreased since last summer, and that what could re-provoke concerns is a re-escalation in the trade war.
Have I ever mentioned that I hate writing right before a news event?
Here is what I had written just below Thursday morning’s tweet from the President:
The supposed December 15 deadline regarding a further round of China tariffs is coming Sunday and we simply do not know what to expect (yet). I remain highly skeptical that the President will implement tariffs on the “section 4” list of imports. China has moved in the right direction on agriculture and I still think the phase one compromise will be an easy give for China on soybeans and such. China needs tariff relief; they don’t want it – they need it. And yet the President has serious concerns about giving the relief without enforcement mechanisms. There is always a small chance the President institutes this next round of tariffs, and there is always a chance he cancels the list altogether. But I believe he will “delay” implementation this weekend..
By the time you are reading this, markets may be trading down because of the uncertainty over the weekend, or there may be certainty (for good or for bad). But at press time, I am on record as believing risks exist on the edges to a really bad outcome and a really good one, with the 80% likelihood for a tariff delay (no new ones, but no elimination of old ones), and a positive announcement on phase one.
Well, I guess I need to adjust those odds from 80% delay, 10% unexpected bad, 10% unexpected good, to:
45% delay, 10% unexpected bad, 45% unexpected good
The election is here!
No, not the U.S. Presidential election … For that, you only have to wait a mere 326 more days. By the time you are reading these votes will have been cast in the UK election for Prime Minister, largely between Boris Johnson of the conservative party and Jeremy Corbyn of the Labour Party. Johnson is expected to win and gain the strategic advantage he needs to facilitate the final Brexit passage, but really anything can happen in UK elections.
The deep end of the pool is liquid
There is (for good reason) an increasing amount of discussion about the potential for liquidity to be challenged in a period of market distress. The theory goes, and I buy into it completely, that many fixed income managers have been willing to sacrifice certain standards of liquidity (i.e. the ability to sell a position easily should the need arise) in their “reach” for higher yield. What needs to be appreciated is the role that regulation (i.e. Dodd-Frank) has played in limiting liquidity in the marketplace as so many would-be dealers have been sidelined from holding and trading bonds (where previously they were big liquidity providers in the marketplace).
But regardless of why liquidity could be challenged in the future, it is important that investors appreciate and manage this risk. Underlying assets in a bond portfolio matter. And, the mix of highly liquid vs. less liquid assets in a bond portfolio matter (i.e. having access to easy sources of liquidity to avoid forced sales at distressed prices of less liquid assets). We do not want our fixed income managers to merely rely on regulatory requirements for liquidity management (though we sure want that minimally).
It is imperative that investment managers be cautious of “hard to get” parts of the bond portfolio (“hard to get” means “hard to sell”), and that there be intentional attention paid to this area. The main reason I bring it up now is because it has not been an issue. It is when people are not worried about a risk that we think it ought to be addressed. Bookmark this.
But it’s all just buybacks??
One idea that may be smart to throw in the dustbin of intellectual embarrassments is the oft-cited (media) idea that the market is relying on increasing money into stock buybacks to “prop itself up” … When one looks at the combined sums of money spent on dividends and stock buybacks, we see that the number has basically been totally level for six years, with the one exception of 2018 where there was the very initial jump in free cash flow from corporate tax reform (oh, and the market was down that year). The market had sizable gains in 2016, 2017, and 2019, and in each year the capital return was no higher than the year before.
* Strategas Research, Investment Strategy Report, Dec. 9, 2019, p. 3
Two conclusions I would offer from this chart: (1) The market is not relying on stock buybacks to be “propped up”; (2) Companies that sustainably belong in our portfolio will sustainably grow their dividends, the far superior way for investors to receive a capital return.
Is there room for more dividend growth?
Forget for a moment that our focus on The Bahnsen Group is not remotely focused on the overall S&P 500 capacity for dividend growth; we are completely limited to the universe of companies that meet our very tight quantitative and qualitative criteria. But even within the broader market index. It bears mention that the S&P 500 payout ratio of dividends (percentage of profits paid as dividends) was 48.5% for the last 80+ years, and is 37.3% now. And furthermore, cash on balance sheets is significantly above its trend-line as well (pointing to greater flexibility and capacity).
* Strategas Research, Investment Strategy Report, Dec. 9, 2019, p. 5
Politics & Money: Beltway Bulls and Bears
- The House filed articles of impeachment on two grounds this week against the President. The market was up 20 points and down 20 points in the two days of this announcement (flat, flat, flat). The consensus expectation is that the House will vote to impeach, though there is debate as to whether the Democrats who defect and vote against it will number between five and twenty. Over ten defectors are expected to be pretty humiliated for their effort, but that really is the only outstanding question. The Senate is expected to acquit, and life will go back to normal from there. That, of course, assumes anyone’s life is not normal now from this, and it would appear from my observation that the interest level in this nationally is a little bit below the national interest in paint drying.
Chart of the Week
I spent a little more time than normal this week on my obsession topic of dividend growth, so let me use the same for the Chart of the Week. Coming back to my favorite objection to dividend growth that “it is great for lowering risk or producing income but causes an investor to give up a little in return.” My objection to this (here in these pages, and exhaustively in my book on the subject) is multi-layered. Of course, I could point out that for a withdrawer, “reducing risk” is to enhance return (via the avoidance of negative compounding and sequence of return risk). And I could point out that “those needing income” is, ummm, everyone (it is just a question of when, how, and for whom). But I also could just go to data, and point out that it is simply untrue. Dividend growers have outperformed the other categories of possibility, substantially, and with less volatility – much less – along the way.
* Strategas Research, Investment Strategy Report, Dec. 9, 2019, p. 6
Quote of the Week
“Luck is the residue of design.”
~ Branch Rickey
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I will leave it there for now. Monday we will release a podcast from the entire Investment Committee addressing what did and did not happen over the weekend both in Britain and especially in the U.S./China trade war. It will be a doozy! In the meantime, may your weekend be festive, cheerful, and family-filled … Tis’ the Season!
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