Dear Valued Clients and Friends,
I realize after USC’s win over Stanford last weekend a lot of you paid no attention to markets at all this week, instead opting to just celebrate 24 hours per day all week long. But some of us had to go to work, and this week of work presented a lot to talk about in this week’s Dividend Cafe … As of press time, the market is really quite close to new all-time highs. We simply have to cover a plethora of things this week (from the trade war to negative interest rates to politics to the energy sector – and more). So dive on in, and take a break from celebrating the Trojan weekend.
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Did the trade war end?
One can be forgiven for assuming the trade war ended in looking at the market. On August 14 (one month ago) the Dow was below 25,500. At press time this week, the Dow is at 27,200, so nearly a 2,000 point recovery in one month (and back to the market level we were at before the re-provocation of the trade war leaving July and entering August). How is this possible?
I will return you all to a graphic I used in the Dividend Cafe over a month ago. At the time, note where I placed us in the cycle of all this …
*MarketSmith, Investor’s Business Daily, Aug.1, 2019
So on that “dial,” if we were previously in the 4:00 position, perhaps now we are at the 9:00 or 10:00 position? In other words, has anything really changed? This cycle has played out several times over the last 18 months. Where markets go from here in this diagram really depends on whether or not “any progress is made.” My goal is to unpack some of that this week!
Why does it feel like the trade side is softening?
A month ago the President’s rhetoric was “along the lines” of President Xi being our enemy, of tariffs being wonderful things that we were using to make a lot of money for our country and simultaneously destroy the Chinese economy, etc. This week he tweeted that he was “delaying some of the planned tariff escalations” and doing so “as a gesture of goodwill” to respect the “People’s Republic of China 70th anniversary.” It was quite sweet and tender.
But in reality, I am convinced that the escalation of the trade war 4-6 weeks ago had a lot to do with gaining leverage in the Hong Kong matter, and that the correlation between the Hong Kong matter and the tariff weapon is higher than conventional analysts have understood. I am not suggesting this is a good or bad thing – I am merely suggesting that the policy tactic of using tariffs, or tariff threats, to accomplish policy objectives that are even non-trade related, is something we have now seen on a number of occasions.
So where from here in “As the Trade War Turns?”
It is a bit of a soap opera, no doubt. Beijing does appear to be increasing U.S. agriculture purchases as of late, they have stabilized the currency exchange rate (another big factor in markets acting better), and they have made progress in discussions (and plans for additional discussions). The China trip to DC is the next big event in all of this, and if it goes forward as planned (that is a big “if” at this point), there will very likely be either one of two scenarios playing out:
(1) The clear demonstration of an “off-ramp” for both sides to bring down this trade war, and find some form of agreement, OR
(2) Another can-kicking exercise (or outright breakdown) that leads to the above cycle re-playing itself out again.
What do we think?
There is a lot going on in the U.S.-China trade issue that transcends the obvious. How alliances are playing out with Europe. The North Korea factor. Obviously, the Hong Kong issues. Currency exchange (not just with the U.S. and China, but all over the world). The U.S.-Japan trade deal. What the Fed does Sept. 18. What the UN says about China on Sept. 23. The expected update from Trade Representative, Robert Lighthizer, on Sept. 24 at the WTO. And of course, with the obvious – there is the tension between political pressures for the President and economic pressures in China. So it is complicated, multi-layered, and not predictable. What we think, is that investors should be prepared for more volatility, even if there is an extended period of calm over the next few weeks. And is there a possibility of a very happy ending here for investors? Yes. And would we bet huge on that? No. We just want to be humble enough to navigate all the places it can go. And there are a lot of places this can go.
Conclusion
Re-read the above paragraph for our conclusion on trade war talk right now. That is the best we can do. But I have to re-state the broader conclusion that is most pertinent to all that we care about in our investment thinking:
The outlook for corporate profits has been fine, and indeed, better than expected. Should the outlook for corporate profits turn south, whether because of the trade war or anything else, it will not bode well for market valuations. A Fed rate cut may impact this to some degree (lowering of borrowing costs), but we still favor less cyclical opportunities and more defensive ones. We want to be exposed to the right balance of “risk assets,” yet take a neutral position in the short term (balanced) as to how it may play out. Oh, and we want to remind you – volatility ahead is absolutely likely.
What’s on the line?
For the American economy, the cost of the projected tariffs for 2020 will outweigh the stimulus of the corporate tax cuts if things go forward “as threatened.”
* Strategas Research, Policy Outlook, Sept. 5, 2019, p.1
Who is benefiting?
I think this chart needs to be continually updated as time evolves. Yes, the trade war with China has lowered the business we are doing with them. But has that led to open doors with American blue-collar workers and Rust Belt states? Note the increase that the China issues have led to in trade with Vietnam, Mexico, etc.
* Strategas Research, Policy Outlook, Sept. 5, 2019, p.2
If only we had a precedent
Shockingly, the President of the United States suggested this week that the Federal Reserve should be lowering our interest rates to “zero percent, or less.” It warrants an examination of how negative interest rates are working for our friends across the pond.
Besides being one of the most market-distortive and dishonest measures any central bank could ever dare take, negative interest rates also, ummmm, don’t work. They crush demand as banks must cut back on lending. They create panic as savers realize their deposits are not safe. The low savings rate offsets the low borrowing costs across the aggregate economy.
They are deflationary, meaning, they are caused by deflation, and they cause deflation, the most vicious of vicious cycles.
Speaking of bubbles …
Does anyone think bonds trading at a negative interest rate has created a “bubble” in bond prices that actually have a positive coupon? If so, let’s put it this way:
There are $16 trillion of bonds around the world at a negative interest rate. This is a total dollar value more than the tech bubble of 2000 and the mortgage bubble of 2008, combined.
Now, is it systemic, you ask? Here’s the thing – who actually owns these negative-yielding bonds? No one you know, and no one I know. Yet there are $15 trillion of them out there. They sit on the balance sheets of the sovereign wealth funds of various countries, enabling their debt mechanics to work, not actually circulating in the investment system. So it is huge, it is a bubble, it is distortive, and yet, it is mechanical, not real.
Politics & Money: Beltway Bulls and Bears
- Far be it from me to talk about something other than the trade war or the Democratic primary when talking politics and money, but the Trump administration efforts to overhaul Fannie Mae and Freddie Mac have the potential to be among the biggest achievements of the administration. The proposal is to release government control of the two mortgage behemoths, a control taken out of their financial insolvency at the beginning of the financial crisis. The federal government can release control without Congressional approval (it is a Treasury Department action), but the legislation around how they function going forward will require Congressional approval. Shockingly for those who remember the ancient history that was the first decade of the 2000s, some on the far left are begging the White House to “make it easier for people to buy homes” through the programs that are Fannie and Freddie. Details like new capital rules are still TBD.
- Back to election talk: I didn’t have time to include last night’s Democratic debate commentary in this week’s Politics & Money but I will try to get something done on this next week, earlier than later. In the meantime, it is worthwhile that people note the jobs data below … Some of the states where job gains have been most troubled (even negative) are the ones that President Trump critically won, but by the lowest margins (PA, MI, WI). The national jobs data is unequivocally positive, but it is worth wondering if the granularity of such may tell different stories in different places, with electoral consequences to think about …
* Strategas Research, Policy Outlook, Sept. 10, 2019
Chart of the Week
I love this chart … Note the de-leveraging that has taken place within the energy sector in recent years. This has a profound impact for future profit growth, balance sheet safety, and risk/reward trade-off …
* Strategas Research, Quantitative Report, Sept. 12, 2019, p. 9
This week’s investment committee podcast offers a digestible, succinct, informative talk on how portfolios are often constructed, and how they ought to be.
Dividend Café – Investment Committee Podcast
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Quote of the Week
“What the world needs are people of accomplishment. People who do something. People who stand for something. No one should be known just for having money; just for being social. You are what you do.”
~ Steven Hellian
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I could have done a Dividend Cafe double the length this week – there is so much more I wanted to say. Time constraints mean I need to roll some of these thoughts over to next week. I will be in the New York office next week and will commit to a “double issue” Dividend Cafe. In the meantime, reach out with any questions or comments, and stay focused on the storms beneath the calm. Both calm and storm are part of what equity investors sign up for, or they can’t be equity investors. The potential exists for either to take precedence over the other at any time. We’ve had some calm these last couple of weeks. But storm or calm, we know this – our financial outcomes are not impacted positively or negatively by a tweet this week or a treaty next week or a breakdown the week after that. Our financial outcomes are always and forever about the discipline of good behavior. No panic. No reaching. Easy does it. And look at all those dividends …
With regards,
David L. Bahnsen
Chief Investment Officer, Managing Partner
dbahnsen@thebahnsengroup.com
The Bahnsen Group
www.thebahnsengroup.com
This week’s Dividend Café features research from S&P, Baird, Barclays, Goldman Sachs, and the IRN research platform of FactSet
