Dividend Café

Behaving Thyself - Feb. 22, 2019


Dear Valued Clients and Friends,

We appear to be set for another positive week in the markets, though I type this in advance of how the end of the week will end up.  The modest increases of this week, combined with nine consecutive weeks of price increase prior certainly create a feeling that we may be due to lighten up a bit (of course, it is that very un-investible feeling that probably keeps the market moving higher, as the gods punish those guilty of the unpardonable sin of timing).  But while this week’s visit to the Dividend Cafe will delve into reasons for caution in the markets, it also will offer a firm reminder as to the most vital lesson of them all.  Tax refunds, credit markets, politics, and even marijuana stocks, all make this week’s cut in the Dividend Cafe …

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Behavioral realities

I do not spend enough time in Dividend Cafe talking about the significance of our behavior on investing outcomes even though I actually devote a lot of time and attention to the subject on these pages.  To spend “enough time” on it means it would represent 90-95% of our attention, as behavioral decisions surely represent 90-95% of what matters in our investing results.

A close resource sent me an article this week that reminded me of that never-ending truism: More information for investors does not necessarily lead to better decisions; but it does lead to more confidence in one’s decisions.  And that can be dangerous.  The application of information is, of course, at the heart of our job, but so is the management of one’s over-confidence (including our own).  Asking what the risk is in a particular position or strategy or what might go wrong under certain scenarios is not so easy to do if one has allowed a large over-confidence to build up.  Additionally, the reality of confirmation bias can then kick in where the plethora of information surely out there affirming one’s over-confident view can be found and clung to.  The absorption of perspectives you know differ with your view is very important. If nothing else, it allows you to at least challenge your own convictions and think through things from all angles.

Behaviorally, investors are wired to find support for positions they already agree with or have invested in.  And indeed, the formation of evidence-based convictions is important and admirable.  But we can never lose sight of the risk embedded in this simple reality: More information can lead to more confidence, and more confidence can lead to less objectivity.  Humility and foundational principles are cornerstones to behaviorally sound investing.

Caution on aisle two

The market rally since Christmas Day has been something to behold, just as the sell-off throughout October and December was.  Is all right in the world?  The cautious side of us reminds readers that the trade deal outcome with China is hardly a foregone conclusion, and that the most defensive parts of the market (Utilities in stocks, and Treasuries in bonds) have not exactly been abandoned – but have in fact held up just fine.  Global bond yields are brutally low, which bullishly means that the U.S. would simply be an outlier against the backdrop of a globally slowing economy, and bearishly means that the U.S. will soon be joining the rest of the world in this slowing malaise (the latter is not our view).  Interest-rate sensitive parts of the economy are struggling as late year monetary tightening is working its way through the economy.  And the transition to a capex-driven extension of economic recovery is still lingering in uncertainty.

Are there reasons to be bullish?  Of course. Perhaps the preponderance of data points to bullish conclusions.  But is there a justification for defensive caution?  Certainly.  Balance.  Allocation.  Prudence.  Discipline.  It’s almost like these should be permanent conditions in investing.

Stop the presses – the Fed Minutes …

I talked a bit about this week’s release of the Fed Minutes on Reuters a couple days ago (though the brief clip also covered the China-trade war, emerging markets, and more).

But to elaborate more on the lay of the land in Fed-ville, the minutes were actually even more telling than I expected them to be.  There was virtually no doubt that the Fed governors were saying, “we need to stop shrinking our balance sheet later in the year,” a reversal of the previous “auto-pilot” rhetoric that suggested they would just automate the process of $50 billion of maturing assets per month “rolling off” at maturity.  Rather, the minutes discussed reinvesting the matured proceeds of mortgage-backed securities into Treasuries in the near future, meaning they would leave the assets on their balance sheet (that serves as the fodder for bank’s excess reserves in the economy) at or near the levels they are (even if the composition changes to less mortgage-related and more treasury-related).

As I have said dozens of times in these very pages – this matters, despite the wonkiness of it all, because it speaks to the liquidity available in the credit markets – a key aspect of the current economic expansion.  The Fed’s explicit statements about their plans for their balance sheet for the rest of 2019 align well with what Chairman Powell has said in his last two public appearances (and reverse what he said in his public appearances prior to that, primarily in December and October).  For now, the expectation investors ought to have is that the Fed’s idea of substantial reduction of their balance sheet (allowing bonds they bought to mature and not reinvesting the proceeds) is not going to play out.  This means continued support for the credit markets with greater liquidity, and even the potential of downward pressure on rates as the Fed becomes a buyer again of our own national debt.

Central bank reserves redux

How serious am I that the issue for investors around Fed balance sheet decisions is about liquidity in the economy?  The monetary base in the U.S. fell 12.6% year-over-year in January, the largest such shrinkage since 1937!  This is a direct result of the Fed’s intentional efforts to reduce excess U.S. dollars from the system.  Ultimately, if you believe the reserves held at the Federal Reserve will be higher than had been previously expected, the logical conclusion from such is that those dollars migrate into risk assets pushing up their prices along the way. Fear of the inverse was pushing markets lower in Q4 of last year.  It is just stunning how quickly the narrative changed.

More clarity on tax refunds

I spoke last week about the reasons that hand-wringing over tax refunds year-to-date were misguided.  Refunds are now ahead of 2016 at this pace, adding merit to the argument that the processing delays from the government shutdown were the real source of refund lags.

No joke or pun coming in this headline

I find humor without wit to be non-humorous, and I find jokes about “being high if you buy marijuana stocks” to be unwitty.  That said, I was impressed to see Barrons magazine take on this latest craze last weekend.  Out of the plethora of publicly traded companies staking out ground in the marijuana industry, only two have generated any sorts of profits.  And while different states have passed different versions of legalization, pot remains illegal under federal law, keeping these stocks off of major exchanges, and exposing these companies to a wide array of unknown uncertainties and vulnerabilities.  But more importantly, the self-dealing that has been rampant in the sector – the sub-par options for securities exchange listing and the heavy insider ownership (leaving the share prices susceptible to quick dumping) – all point to a space beneath the quality that many investors would like to see in their portfolios.  Oh, and as a sector, it currently trades at 30x revenue, so there’s that.

Insert your own joke here, but this space is not for us.

Correlation Contemplation

It is interesting to me that while misunderstandings about the correlation of MLP’s (oil and gas pipelines) to oil prices are nothing new, there continues to be a belief that MLP’s trade heavily in line with other high yielding instruments such as Utility stocks.  In fact, the correlation between Utilities and MLP’s has broken down entirely during the last five years.  Oil and gas pipelines are disconnected from so many traditional ways of understanding them, and these disconnections have created so much of the opportunity in the sector we continue to enjoy.

* JP Morgan Weekly Market Recap, Feb. 18, 2019

Calm before the storm?  Or just plain good news

The default rate on speculative bond debt (lower credit quality bonds) stood at 2.1% last month, the lowest level in four years despite a full year of Fed tightening.  The average default rate since 1983 has been 4.2%, fully double the present level.  The default rate on senior loans stands at 1.4%, also very low.

The question is not what this means about the environment we have just come out of, but rather the environment we are now going into.  It is good news and does point to a healthy credit environment, but it does speak to the idea that at some point conditions are likely to be not as good as they are now.  The Fed sitting on their hands in 2019 perhaps delays this reality, but we do believe credit is in the process of building up some risks that at some point will come to fruition.  We doubt those fears will manifest themselves imminently, though.

As an aside, High Yield bond spreads were around 300 basis points last fall – a level we felt was really under-pricing risk and reflecting apathy in the marketplace.  As the wheels fell off risk assets in December, spreads reached as high as 550 basis points, not a code red crisis level, but a material move above the mean.  As I type, high yield spreads are at 412 basis points, really right in the middle of the two levels, capturing the balanced view of headwinds and tailwinds that we write about frequently.

Politics & Money: Beltway Bulls and Bears

Next week leading executives from the nation’s largest pharmaceutical companies will be brought in front of a Senate committee, cameras on, to discuss drug pricing.  It ought to be interesting to take the temperature of a politician’s appetite for drug price fixing and how savvy big pharma has to be to deal with this populist challenge.  It also ought to be a sickening display of Senatorial political grandstanding, but I digress.

Chart of the Week

How does one know when a stock market rally is “reflationary” as opposed to merely reactionary?  In other words, while inflationary forces or disinflationary forces can wreak havoc in stock markets, the anticipation of “reflation” (see my earlier paragraphs about the Fed revamping its planned reserves) causes markets to rise.  And what we have seen in these last two months that accompanies the stock market’s reversal is an unambiguous rally in commodity prices.  From oil to gold to copper to sugar, commodity prices have been moving higher, lending support to the idea that this has been a reflationary rally in risk assets, led by the Fed’s reversal in planned tighter (deflationary) policies.

* Strategas Research, Feb. 20, 2019

Quote of the Week

“Time flies over us, but leaves its shadow behind.” 

~ Nathaniel Hawthorne

* * *
I will be flying home from New York Sunday with my family, and I am praying that I will get on the plane with my beloved Pacifica Christian High School Tritons the CIF Champions in men’s basketball.  No, this is not my alma mater, but the high school that I helped launch five years ago, and where I remain an active trustee to this day.  I do love the school (my oldest son will begin as a freshman there in the fall), but I also love basketball, and it brings me great joy that our team will be in the championship game Saturday night (they are just amazing to watch play).

So if you miss the anxiety of what the stock market had been doing in late 2018, join me in anxiety around Pacifica winning the championship!  =)  And in the meantime, enjoy your weekends, and avoid the danger of investor over-confidence (I promise the Tritons will not be taking the court Saturday with any over-confidence – just humble preparation).

With regards,


David L. Bahnsen
Chief Investment Officer, Managing Partner


The Bahnsen Group
The Bahnsen Group is a team of investment professionals registered with HighTower Securities, LLC, member FINRA, SIPC & HighTower Advisors, LLC a registered investment advisor with the SEC. All securities are offered through HighTower Securities, LLC and advisory services are offered through HighTower Advisors, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Investors may lose all of their investments. Past performance is not indicative of current or future performance and is not a guarantee.

This document was created for informational purposes only; the opinions expressed are solely those of the author, and do not represent those of HighTower Advisors, LLC or any of its affiliates.

The Bahnsen Group is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.

All data and information reference herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary, it does not constitute investment advice. The team and HighTower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.

This document was created for informational purposes only; the opinions expressed are solely those of the team and do not represent those of HighTower Advisors, LLC, or any of its affiliates.