Dear Valued Clients and Friends,
From the seat of a person who dispenses financial advice for a living, one could be forgiven for believing there must have been a time in the recent past that was quite idyllic. Why? The constant chorus of those concerned about “new instability” or “these difficult times” or “all this uncertainty” all implies one thing: That there must have been a time when stability and certainty ruled the roost.
Today we are going to do a little history lesson, and by the end, we’ll draw a few conclusions. The point will not be to wrap current economic or political circumstances in a pretty bow – but rather, to contrast the present to the past with history and logic.
The conclusions will either concern you or encourage you. But the information will be informative.
So jump on in to the Dividend Cafe.
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Nothing to see here
Our Core Dividend portfolio is up since the Russia/Ukraine tensions began (thanks to an overweight Energy position), and the Dow Jones is up +500 points versus the pre-invasion level (did you know that?). The Dow is down about -5% from its all time high, but the invasion has more been a headline event than a market event.
But let me ask you a question? Would it be news if the Dow was down a whopping -5% on the year, and there hadn’t been a Russia/Ukraine invasion? I mean, there have been three years in the last 42 years where the market DIDN’T draw down at least 5%, so it sure seems like market volatility is pretty vanilla? Put differently, 93% of the time for the last 42 years, there has been a drop of 5% or more in the market within a calendar year. In 93% of the years.
So is the takeaway here that we are all lucky at the market response (so far) to Russia/Ukraine, or is the takeaway something else about the last 42 years?
What’s new is old again
I would argue that the combined headlines of “pending Fed tightening” and “Russia/Ukraine conflict” are worth exacerbated market volatility. The market was down more a few weeks ago, and the hit in the Nasdaq has been more (though that far pre-dated the Russia/Ukraine moment), so I want to paint an overly sanguine view of where we have been. But I also don’t want to dramatize things beyond reality – we have experienced something either LESS THAN or EQUAL TO – totally normal and expected market volatility.
“Yes, but the uncertainty is just greater this time!”
Is it?
First, the bad news
Russia is acting like a very, very bad actor (shocking). Their military invasion of Ukraine is an unfathomable violation of modern conventions, an unforgivable attack on a completely sovereign nation. The extraordinary response of the Ukrainian people notwithstanding, Putin is a pariah on the world stage and his assault on the rules-based international order is a problematic threat to world peace and harmony.
And yes, the Fed is in a very challenging monetary pickle. This should be old news to readers of the Dividend Cafe since I have obsessed over this reality on these very pages for years. Regardless of the reasons people believe it needs to happen, some normalization of monetary policy does need to happen, yet the yield curve, the electoral cycle, the cost of financing government debt, and so much more, all make normalization a tall task in the years ahead.
Economic growth is subpar. Yes, unemployment is low (thank God), but productivity has been sub-optimal for a long time, and GDP growth has averaged half of its post-war (WWII) average for 13 years.
American domestic politics are highly polarized, and while partisan rancor goes hand in hand with politics, I would be the first admit this feels different. I would take exception with those who would say we are the “most divided we have ever been” (so would those at Gettysburg in the 1860’s), but I certainly do feel this cultural moment to be worse than what I have observed since my 1974 birth.
Geopolitical tensions exist outside of this Russian mess. China is an authoritarian and globally prominent superpower who controls much of the global supply chain, and is, well, a Communist country (for those of you on faculty at an Ivy League school or a Hollywood actor, many of us still feel that is a bad thing). There are a variety of pivot points in this relationship that present unique risk and turbulence (trade, Taiwan, currency, debt).
Our geopolitical list crosses the Asian continent. As I wrote two weeks ago, for the first time in 75 years, there is a true transformation underway in our relationship with the major economic, cultural, and religious center of the Middle East, Saudi Arabia. From world energy needs to dollar prominence to basic national security, this transformation is not insignificant.
We have $30 trillion of national debt.
And we are not even close to being in the worst state of debt and fiscal positioning relative to other countries.
Our markets are not trading at cheap valuations. They are not trading at average valuations. Across all sectors and market indices, valuations are on the high side. The same can be said of most asset classes, perhaps more so with real estate (measured by cap rates) than stocks (measured by P/E ratios), but regardless – asset values are on the list of things with which investors must grapple.
But now, the moral of the story
With no intent of diminishing the significance of any of the aforementioned stories or concerns, and no claim that the above do not represent various degrees of uncertainty, I am here to tell you that not a single thing on the list is new. Not a one.
And this is the point of today’s Dividend Cafe: Uncertainty is not new; just the things we are being uncertain over. (h/t Nick Murray)
And this is the longest-playing song in the history of music.
We experienced two world wars in the first half of the 20th century. We were engaged in the Cold War for 80% of the second half of the 20th century. We have seen significant conflicts and uncertainties in most continents on planet earth just in the first 20 years of this century. We have dealt with countless despots, dictators, authoritarians, and lunatics. Five years ago I was pillaged with emails wondering what we would do if North Korea started a nuclear war. North Korea.
The Fed’s current position is awful, in some ways self-created (I would argue not in all ways, since fundamentally I believe the central bank to be a creature of the state, and I believe the state to be a creature of the people). But creative monetary policy, excessive use of discretion, over-confidence in intervention, new alphabet soup of facilities and conventions and tools – these have been the evolution of monetary policy for decades. I find the uncertainty here to be the one I will most have to address in my career as a portfolio manager, but I do not find that uncertainty to be unmanageable or terminally unique.
Economic growth is subpar. We have had long periods of subpar growth in the past. We may never, ever, ever, ever do anything about it. Our entire society may decide that we will take 1-2% growth in perpetuity (or in Japan’s case, 0-1%). First of all, the world does not fall into a volcano in such a scenario (though if we really did accept this, maybe we would deserve to). But does anyone doubt that we could increase growth if we had the will to? I am not saying we will ever get the will to – maybe the cravings for higher taxes, higher regulation, and greater suppression of success and opportunity will win. But do you see my point? That would be a decision, not an outcome. In fact, against that end, I work.
I do believe the political polarization is not likely to last. Outside of twitter and cable news, most people are already tired of it. The Presidential election cycle and COVID have already been good for societal cohesion, but I think most of us have studied a cyclical nature to these things. And for regular people who do not bow at the altar of partisan or performative angst, is this really something that will suppress the productivity and profit motive of the American people? Wall Street and Silicon Valley and Small Business and so forth and so on would all say no. Humans act.
How does this new relationship with Saudi Arabia play out? I do not know. I did not know how things would play out with Japan after 1945, either. What about the currently strained relationship with China? Germany says hi. I mean, are we looking for a total planet of peace and harmony to invest? If so, good luck. I hope heaven has brokerage accounts. But in the meantime, no one can say with a straight face that nations hating each other is new, or uninvestible, or historically unpredictable. Here is a certainty on my list of uncertainties. There will be geopolitical angst until the King of Kings returns. I wish it weren’t so, but it is.
Does the national debt matter? Of course. But didn’t you think that $5 trillion ago, and $10 trillion ago, and $20 trillion ago? When the national debt was $2.8 trillion when Reagan left office and the 10-year bond yield was 8.5% didn’t you think it was a problem? I did, but I was 15 years old and no one would listen.
No the debt is up over 10-fold and interest rates are down over 75%. That alone should cause all hand-wringing to end. Markets exist to make fools of us.
The valuation thing does require a comment, because I am not an index investor. I do believe that a new index investor can, to some degree, expect a different return based on an entry point relative to one who entered at a cheaper valuation. But that statement is worthless in a practical sense, other than by point out 15 is a lower number than 20. That index investor still has to do something with her money. Timing has been unkind to those who have tried it. Do I believe someone who buys at 15x earnings will have a higher return over 20 years than someone who buys at 20x earnings? Yes, because of math. But do I believe someone who misses four years of returns waiting for a valuation that may never come underperforms everyone? Yep. I do.
All things being equal, I still see indexing as a subpar alternative to active dividend growth equity investing, but yes, I do see it as superior to cash. Again, because math.
Past is Prologue, or Something to Be Afraid Of
Here is what I would fear: Being an investor with a financial advisor who has no regard for history. The things happening in the present are not a walk in the park, but they are a lot easier to understand, appreciate, absorb, and apply when one actually has some interest in how things have played out in the past, and in learning what lessons past events can teach us about the challenge of the present.
Conclusion
In my capacity as an investment professional, I am deeply interested in what is happening in the world today. I see monetary policy as the most relevant of the categories of things I have brought up today, and I study it obsessively. In my capacity as an economic student and teacher, I never, ever, ever take my eye off of this ball – economics is the study of humans’ actions around scarcity. I have a belief in human anthropology that commands a bullish view of outcomes. Humans act with reason and in self-interest. And when combined with resources and incentives, we do things like go from caves to resorts. We move from the wheel to the smartphone. Out of the vulnerability of a garden we now find ourselves in the accoutrements of modern life. Forgive me for not being uncomfortable with that uncertainty. I am long humanity (h/t John Mauldin).
Incentives matter. Capital allocation matters. This is not an easy journey. But it never was. Buckle up. If anything, we are deeply spoiled as risk asset investors. This “volatility” is child’s play and any honest student of market history knows it.
What does matter is as certain as the certainty of uncertainty – the behavior of the investor. Emotional investing undermines financial success. Discipline is the tool of the successful, and it is to be used in the times that feel good and the times that do not.
To that end, we work.
Chart of the Week
The prelude to this is above. One could argue this is a graphic representation of everything I said today.
*Volatility Opportunity Guide, Calamos Investments
Quote of the Week
“Do you see the same truth, or at least care about the same truth? … these questions are ultimately at the heart of every enduring friendship. Friends may or may not agree on all the details, but what binds true friends together, beyond pleasure and utility, is a common quest or vision. Thus, you will not find the warrior, the poet, the philosopher, or the Christian by staring in his eyes as if he were your mistress: better fight beside him, read with him, argue with him, pray with him.”
– Archbishop Charles Chaput
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Off to California for the weekend then back to New York for next week with a jaunt to Pennsylvania in between. Then back to California for Easter weekend (and a few weeks thereafter). Which reminds me – Dividend Cafe comes next Thursday as markets and offices are closed on Friday for Good Friday …
Be of good cheer. And enjoy your weekend. It’s what we are supposed to do.
With regards,
David L. Bahnsen
Chief Investment Officer, Managing Partner
dbahnsen@thebahnsengroup.com
The Bahnsen Group
www.thebahnsengroup.com
This week’s Dividend Cafe features research from S&P, Baird, Barclays, Goldman Sachs, and the IRN research platform of FactSet
