Dividend Café

So Markets CAN Move Up and Down? - Feb. 2, 2018


Dear Valued Clients and Friends,

By far the most encouraging thing to me this week was the couple of down days in the market!  Down 175 points Monday and down 360 points Tuesday, it was actually refreshing to be reminded that markets can and do go down.  The “percentage” volatility was actually very minimal now that the price denominator of the market is so high, but on a point basis, a two-day drop of over 500 points has not happened in a long, long time.  And I mean it when I say – I love it!  This is normal market behavior!

But even with this early week volatility, it did not stop January from being one of the strongest market months in history.  We wouldn’t consider a 1% drop much to sweat about, but we do think you can find some other things to concern you in this week’s Dividend Café!  And of course there is plenty to lift your spirits as well, so before that Super Bowl begins let’s jump into the market, the economy, the dollar, and all things investing …

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Most encouraging thing about the economy

If you had told me a year ago that the Q4 REAL GDP growth would come in at +2.6%, and that some would be bad-mouthing it, I would have laughed.  The prior two quarters came above 3%, and the blended annualized of the last three quarters is over 3%.  And all of this is pre-tax reform.  Once Q1 of 2018 comes in, I expect we will have our first trailing year of +3% real economic growth in forever.  So what is so encouraging?  The idea of 2.6% as disappointing – that is what is encouraging.

But under the hood comes from much more important comments.  The single element most suppressing GDP growth for years has been a lack of business investment. While the net exports part of the equation kept the GDP number from truly exploding this last quarter, business investment grew a stunning 8% on an annualized basis.

State of the Union

Say what you will about President Trump – his use of Twitter, the controversies around temperament, and the various policies one may agree with and others may disagree with; but this speech was extremely well-received, and provided a glimpse into a more pro-growth and unifying message, and a less protectionist message, than perhaps people had feared.  As is often the case, one knows not what the next 48 hours may produce, but as far as State of the Union addresses go, both the general population and the market seemed to particularly like it!

Early onset euphoria

The BofA/ML “Bull and Bear Indicator” which tracks 19 different signals for varying levels of market euphoria and excess reflected 11 different market signals triggered this month, or 58% (1).  This is not quite the 100% that were signaled in October 2007 and March 2000, but it is far off of the low levels of bullishness that existed in the marketplace just one year ago (when equities were trading 30% lower).  Our weighting of equities reflects this reality, and captures the prudent caution we think is warranted.  Further euphoria would warrant further trimming.

* Haver Analytics, Conference Board, Jan. 30, 2018

Back to that Monday/Tuesday drop …

Obviously a 1-2% drop after a 7% monthly increase (which itself came off of a +20% year) is hardly anything to agonize over, but to the extent it was the first 1%+ drop in a single day in over 120 days, and worst two-days in 350 market days, it was at least some reminder that markets do, in fact, go down too.  I am not being disingenuous when I say that it really was a very healthy development.  If there is any sign to counteract the “early onset euphoria” I describe in the above paragraph, it is things like a down 300-point day.  The catalyst behind the two bad days is not completely clear, but the combination of rising bond yields and investors simply recognizing the reallocation of risk and reward makes plenty of sense to me!

Did someone say rising interest rates?

Yes indeed …  the yield on a 10-year treasury bond hit a four-year high this week (as of press time sitting about 2.74%).  Essentially, a rising 10-year bond yield is what one would expect if (a) We are getting economic growth (we are), and (b) Inflation expectations begin to tick up (they likely will).  One of the arguments against inflation ticking higher (and bringing interest rates up with it) is the lack of wage growth we have endured for quite some time.  Can inflation move higher without robust wage growth?  In theory, yes, but it is not common.  The major piece to watch in my mind is whether or not productivity picks up enough to “absorb” inflationary pressures (inflation is “too much money chasing too few goods”; productivity increases capacity for goods and services, thereby putting downward pressure on inflation).  The way everyone will be watching this whole escapade is in bond yields, and so far they are moving higher.  But bond yields will be telling us a lot more than the mere level of interest rates – they will be telling us about productive growth vs. inflation in the economy.

Alexander Hamilton spinning in his grave

We made the most successful Broadway show in history about our nation’s most brilliant founding father, but we have not maintained his doctrine of a strong U.S. dollar.   I made a comment last week that we resonated more with the Hamiltonian teaching on our currency than the last 15-20 years of thinking, and it generated some question as to what that meant.  Where is that contrast?

The point being made there was that he was the ultimate advocate of economic strength and competitive advantage through a strong and sound dollar – that a nation which paid its bills will attract investor confidence, and that a sound currency would attract capital flows. Today the idea is that a weaker currency will give an export advantage relative to other currencies, which would make Zimbabwe the most prosperous country on the planet if it were true.  The idea that a sound currency would actually be a magnet for other countries is believed but cast aside for the expediency of short-termism – largely because most countries (including us) carry such a debt burden that we prefer to essentially export our deflation to other countries.

Hamilton would have none of it.

Dollar confusion

Regardless of the policy propriety regarding the U.S. dollar, and regardless of what one believes will happen in the short term, there is a particular portfolio approach that may go a long way towards neutering the effect of either a weak dollar in the short term or a strong dollar in the short term – and that is to have both emerging markets exposure and Japan exposure all in one portfolio.   Short term, the emerging would benefit from a weaker dollar, and Japan would benefit from a stronger dollar (as would Europe, by the way).  Now, this entire thinking is confused and unhelpful.  No one needs to take equity positions to offset the short term currency impact of anything.  But to the extent one wants to avoid one-sidedness in currency exposure, we do think EM and Japan play opposite sides of this discussion.

Hipsters and the Dollar

It is one thing for me to say that Alexander Hamilton would not like a weak U.S. dollar policy.  But might I also point out that those who love high growth, hip, cool tech/growth stocks shouldn’t love it either?  Why would growth stocks care about the U.S. dollar?  Simply put, the very high P/E ratios in this space become very unattractive for the foreign investors necessary to bid those stocks up.  Their attraction to the high valuations of high growth stocks inevitably comes down when it is being offset by the adjustment for currency.

Hedging deflation and buying growth

In a disinflationary environment, the performance of stocks will depend on whether or not growth is advancing.  Rising growth with declining inflation is not just possible, but it is common as the Chart of the Week below shows!  Stocks do well when growth is rising, and bonds do well when inflation is dropping, so disinflationary booms or pretty darn good for stock and bond investors.  There is little I want to own more to hedge against disinflation than a long-dated bond (cheap and liquid and transparent).  And there is nothing I ever want to own more when there is growth than stocks.

I plan to write a Market Epicurean piece next week essentially making the point that “hedging risk” or “defending against risk” is not adequate.  One must know which risk they are trying to address, as rising inflation and declining growth are both risks, but they are different risks.  On that axis hangs a significant amount of importance in capital markets.

Disappointment of the week

I am reading more and more economists, including some I hold in high regard, not merely lamenting the challenge central banks have had in creating 2% inflation (their admitted target), but suggesting that 2% is too low of a target (“maybe we need to target 3-4% inflation to get this economy popping”).  Inflation is not synonymous with economic growth; it is the opposite of growth.  It is a hidden tax.  Besides being immoral, it is unproductive.  The solution to our need for economic growth, is, well economic growth.  Skewing the way we measure growth doesn’t create it.  There was a time we all knew this!

Chart of the Week

I absolutely love this chart from my friends at Gavekal Research this week.  Each “category” of era (either inflationary or deflationary, and either boom or bust), creates a certain environment where different categories of investment are more seasonally appropriate and suitable.  Disinflation has carried the day for quite some time, albeit with booms and busts therein.  Should deflation take a backseat to a tick up in inflation expectations, yet with economic growth ruling the day, the “yellow” bars below may take center stage.  What tends to do best during such periods?  Value stocks (rising dividends), emerging markets, and commodity-oriented investments.

Quote of the Week

“The man who asks a question is a fool for a minute; the man who does not ask is a fool for life.”

~ Confucius

* * *
We have decided to dedicate our Advice & Insights Podcast the second week of February to a total engagement of READER AND LISTENER QUESTIONS.  Basically, I want to really encourage you to email any questions you may have about investing, the stock market, capital markets, financial planning, risk, and anything else you can think of, to bahnsengroup@hightoweradvisors.com now.  We will collect questions this week and next, and on a special Valentine’s Day edition of the A&I Podcast we will go through all the questions we collected and provide raw, candid, thorough, unwavering answers to all! =)

What a first month to the year it has been!  U.S. stock markets are up roughly 5-6% on the month despite the give-back this week.  Bonds have sold off as rates have risen.  Emerging markets and commodities have rallied as the U.S. dollar decline has extended.   And whole volatility has finally picked up a tad (just a tad), the overall risk-on environment remains alive and well.  The U.S. economy prepares to absorb the benefits of tax reform, and sentiment, animal spirits, and confidence are all very high.

And we keep doing what we do at The Bahnsen Group.  Maintaining asset allocations for each client individually suitable to their particular circumstances, adjusting for tactical opportunities and outlook, and seeking cash flow-generative investments that give us the offense and defense we need.  And then, above all else, modify behavior and decisions so as to avoid the big financial mistakes …  And to that end, we work!

With regards,


David L. Bahnsen, CFP®, CIMA®
Chief Investment Officer, Managing Partner

The Bahnsen Group, HighTower
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.

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.

(1) BofA Merrill Lynch Global Investment Strategy, January 2018

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.