Dear Valued Clients and Friends,
As of press time Thursday it has been another strong week in markets, with the formal signing of the phase one-U.S/China trade deal, a strong start to earnings season, and the continued general feeling that this is a good market in a good economy. Of course, life is never that simple, and markets are really never that simple, so we have a lot more to say about everything. Let’s jump into this week’s Dividend Cafe, and get ready for a real awakening! First, do not miss out on the brand new Bahnsen Group website here! We feel it is a huge improvement in presenting who we are and offers a lot more information, content, and value than is typical for wealth management sites. And we’re just getting started … Also, please click here for a convenient link to the annual white paper, complete with a 2019 review and key 2020 themes … Without further delay, this week’s Dividend Cafe …
Dividend Cafe – Podcast
Dividend Cafe – Video
Phase One has us thinking about Phase Two
The details of the China trade deal did not disappoint markets this week and in fact mildly pleased markets even above and beyond the huge move up of the last few months. What both sides of this issue are saying (politically) have kernels of truth – (a) It is a constructive deal in slowing the tariff escalations we had been facing, and it does provide substantive commitments around additional Chinese purchases of U.S. products, but (b) It does not rectify the larger issues that linger around intellectual property theft, and it does not solve for the economic cost of the initial 2018 tariffs. The Trump administration has called it “phase one” because they believe some of the meatier issues will be addressed in a subsequent deal. All eyes will be on how China complies with the terms of this deal, first.
But if the deal is so modest, why do markets like it so much?
Well maybe, just maybe, it isn’t as modest as some have suggested. Financial conditions have loosened, the yield curve has un-inverted, and the renminbi per dollar exchange rate has substantially stabilized. Whenever the media tells you something doesn’t matter much, and the stock, bond, and currency markets (all three) tell you otherwise at once, it requires consideration as to whether or not something else is at play. * Strategas Research, Policy Outlook, Jan. 15, 2020, p. 1 The markets, no doubt, are higher partially because things stopped getting worse. A lack of bad news becomes good news when the expectation of bad news begins getting priced into markets. This is an important market pricing dynamic to understand. But with that said, there are positive elements in this deal that ought not to be ignored, regardless of what one wanted to believe about the deal politically.
Devil in the details
So what are those positive components worthy of elaboration?
- While the resolution of the Intellectual Property challenges is by no means exhaustive, it is noteworthy how much acknowledgment there is around trade secrets, pharma, piracy, and counterfeiting. The first step to solving a problem is admitting you have one. This deal offers much more Chinese acknowledgment than I anticipated.
- There are significant and binding requirements put on China to stop the transfer of technology secrets as a requirement for a U.S. company to gaining access to Chinese markets. Enforcement around all of this is admittedly the bigger issue, but technology transfer was far more addressed than is being given credit for.
- I remain skeptical that there is a demand for this volume, but the deal specifies $32 billion in additional farm purchases from China.
- The energy commitments of $52 billion are the most encouraging part of the deal to me. We don’t have the volume capacity right now to meet the commitment, meaning this will either not happen, or – the part I like – we will have to take seriously our need to increase infrastructure development (transportation, storage, terminals, etc.).
- The deal allows U.S. asset managers to buy non-performing Chinese loans (how nice of them!)
- Currency interventions are seriously limited, and enforcement mechanisms (via greater transparency) seem legitimate
- Other allowances were made for U.S. financial companies, from payment services to investment banking
- Total increases of $200 billion over the next two years in total U.S. purchases, with the non-energy and non-agriculture piece primarily being in services
Trading out topics
Enough China/trade, let’s talk earnings … More importantly, let’s talk earnings valuations. We are way too early to dig deep into earnings season though we did get some solid results out of the financial sector this week (I comment more on it here on Bloomberg). The heart of earnings season will play out over the next two weeks so I will withhold comment until we know more, but simply offer this: Fewer companies have “guided down” before earnings season this time around (meaning, less chance to beat the recently-deflated expectations). The question as we proceed through earnings season and beyond is this – how much do market multiples already reflect expected good earnings, and where will companies perform well but actually disappoint such expectations.
When is the last time one decade’s investment leadership group proved to be the leadership group of the next decade? As best I can tell from history, it’s never happened. From the commodity rush of the ’70s to Japan in the ’80s to dotcom tech in the ’90s to China in the 2000s, each decade was met not only with a new leadership group from one decade to the next, but also with the prior leadership group substantially lagging. Apply the historical lesson how you wish to the FANG/new tech/big tech/cool tech sector of the 2010s, but we believe there will be a leadership group in the 2020s, and we do not believe it will be the same as last decade.
Economics Lesson of the Week
With gratitude to Canadian economist, William White, chair of the Economic Development & Review Committee at the OECD, the following represents a list of major “false beliefs” primary actors in our economy hold on to, false beliefs that serve as underpinnings to economic instability. I believe White is correct in each one of these categories (correct that the category label holds to their corresponding false belief, and correct that the proposition in question is, in fact, a false and even dangerous belief): (1) Borrowers – often believe that borrowing is a sustainable alternative to earned income (2) Lenders – believe that lower volatility means there is less risk in the world (3) Central banks – believe low price inflation for consumers means we have no fear of macroeconomic instability (4) Academic economists – truly accept that their models have relevance in the real world (5) Voters – believe there are easy answers and short-term solutions out there to complicated problems and long-term challenges Note that in each case, these wrong beliefs are not restricted to the intellectual zone – they are actionable beliefs that
Are tariffs inflationary or deflationary?
Yes. The inflationary argument is that tariffs raise prices on imports and rising prices are inflationary. True enough. But here is what is being missed … After an initially inflationary impact, tariffs also suppress aggregate demand – they lead to lower overall trade volume – i.e. textbook deflationary pressure. I believe tariffs are deflationary when sustained, yet have an inflationary transitory impact.
Politics & Money: Beltway Bulls and Bears
- It did not get a ton of attention, but the Trump administration reversing course Tuesday on labeling China a currency manipulator was a big story. No issue caused me bigger angst last August than the possibility of a spiraling currency war. Tensions will continue around China’s currency interventions, not to mention U.S. monetary policy (hardly irrelevant to the currency conversation), but as we have laid out extensively in the past, China’s interventions for some time now have been to prop up their currency (to protect from capital outflows), not the other way around.
- Do I believe Bernie Sanders will be the nominee for President on the Democratic side? No, I don’t. Do I believe he could be? Absolutely. Do I believe he would beat Donald Trump? No, I really don’t. Do I think he has the worst chance of defeating Trump of all the Democrats running? Pretty much. But do I think he could win? Sure. And I’d be very skeptical of anyone who tells you that so-and-so just absolutely cannot win. We. Don’t. Know. Anything can happen. More on Bernie Sanders’ chance for the Democratic primary next week! The Senate impeachment trial couldn’t come at a better time for Joe Biden …
Chart of the Week
One can believe there are nine other criteria than these that are better indicators of bear market trouble ahead, but I don’t believe one can dispute that these nine were prevalent foreshadows in 2000 and 2007 and that these nine fail to hit the radar now in 2020. Anything can change, but take this for what it is worth. My view is that flattish, choppy markets are a bigger risk right now than a secular bear market is. For now. * Strategas Research, Investment Strategy Report, Jan. 15, 2020, p. 3
Quote of the Week
“ When desire and data are in collision, evidence loses out to emotion.”
~ Brian Keating
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I send this week’s Dividend Cafe from New York City where I have had multiple media appearances around my new Elizabeth Warren book, amongst countless other work meetings. We executed the largest volume of trades in TBG history today as we re-balanced client accounts comprehensively. We re-balance because we believe in risk management and because it represents a behavior driven by discipline. These are “buzz words” that mean something, and in this case, what they mean is the optimization of a portfolio toward the achievement of one’s financial goals. It is to that end that we work.
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