Dividend Café

The Death of the PermaBear (Dare to Dream) - Jan. 12, 2018


Dear Valued Clients and Friends,

This week brought me down to Washington D.C. for heavy discussion on the policy landscape of 2018 and how it ought to color the 2018 investing landscape (which is the subject of our launch edition of the brand new Advice and Insights Podcast).  But politics is not the sole subject of this week’s Dividend Café.  Read on to look at what Dow 25,000 really means, how I feel about perma-bears, and some timely coverage about value investing, the Fed, and all sorts of things that matter to you as an investor.

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Does Dow 25,000 matter?

It does not matter if one means, “What does it tell us about where we go next?”  It does not matter in that whatever investment decisions one did or did not make before the Dow hit 25,000 are not able to be changed now.  But does it have tremendous symbolic significance to the greatness of American enterprise?  You bet it does.  Is it a sort of vindication for those who maintained their belief in the basic reality of markets even through the great bear markets of 2000 and 2008?  I sure think so.  Would I argue that 25,000 matters because it “pulls in” more people and gets them excited about Dow 30,000 or some such thing?  No, I wouldn’t stoop to an argument so stupid.  It matters because faith in the risk/reward principles embedded in equity investing (“you take on the pain and aggravation of perpetual price volatility, and in exchange receive the risk premium of compounded returns through time that is higher than bonds and cash”) have been validated (though that was true for the last one hundred years too).  Bottom line – it matters, it’s worth taking in, and yet markets never sleep.  So to that end, we work.

Where are the perma-bears now?

The charlatan class of newsletter writers, fear-mongers, and click-baiters who were screaming for a 50-90% drop in stock prices at Dow 10,000, then again 12,000, then again 15,000, then again (you get the idea), are still getting clicks and hits (perma-pessimism is a sociological condition, if not a psychological one, and is not an economic worldview; the fearmongering industry knows this, and has no interruption in their pursuit of people who want to pick up what they’re putting down).  At some point stock prices will drop, and these people will come out from their holes claiming they “called it.”  Stock prices that AFTER the next correction which are up 200-300% from when these clowns made their calls will do nothing to embarrass or silence them.  They are the ultimate argument for “skin in the game” as a necessary precondition to listening to anyone, about anything.

But no, I do not believe this class of degenerates is going away.  They have a permanent customer base.  Our job is to keep good people from being led astray by their schtick.

Some Value vs. Growth education

Readers of our 2018 outlook white paper (see below) will see that one of our themes for 2018 is the rotation of assets from growth-oriented equities to value-oriented ones, two widely used investment categories we actually do not really care for, but that are fine as it goes.  Growth is often said to be the category of investing that is less valuation conscious, less cash flow sensitive, and more momentum oriented (a high P/E ratio that goes higher because of the rapid growth prospects of the company).  Value is often said to be “deep bargain,” where though a company’s growth is slowing, the price level has made the company a compelling buy in terms of the bargain its price represents.  We find this binary thinking unhelpful, and have long stated that our goal is for a good value price to pay for a great growing company.  We do all of this in the context of dividend growth investing.

But there is a reason “value” can be expected to outperform “growth” in a period of rising interest rates.  “Growth” stocks are said to have value because of what their company will do “over time.”  Rising inflation eats away at that value.  Rising interest rates lower the comparative value.  But “value” stocks have value “now” – via current cash flows.  Are we entering a period of rising interest rates?  I will let you answer that question for yourself.  But as for which category of equities would make more sense in such a period, we stand behind our proposition that value stocks rooted in strong balance sheets and attractive CURRENT cash flows are the way to be positioned.

But are bond yields moving higher?

We shall see.  A breakout of the downward trend does not look to be out of the question, but as I have said in other forums, more money has been lost predicting higher interest rates these last nine years than by almost non-mania event  I have seen in my lifetime.

New band members, same songs

Several months ago I was convinced that one of the greatest unknowns in markets was what a new Federal Reserve Board composition would mean for the yield curve, for monetary philosophy, for global rates, etc. Most of that questioning went away once President Trump nominated Jerome Powell to chair the Fed. The new vice-chair selected to replace Stanley Fischer or the new Fed governors may not end up being carbon copies of Powell, but essentially I am convinced that there will be no significant change in thinking at the Fed through this transition of personnel. And what is that thinking? More or less that normalization of monetary policy needs to take place as slowly as possible to avoid disrupting capital markets. A pace this cautious in rate hikes and balance sheet reduction has thus far proven to be immaterial to risk assets.

But tightening is tightening, or is it?

If you believe as I do, that a significant amount of risk asset pricing is relative to the monetary framework in which the assets are being priced, then it is perfectly reasonable to believe that the Fed, however modest the pace may be, hiking interest rates and taking liquidity out of the financial system, eventually catches up to markets. And I don’t disagree at all. But the problem is that we are not in a state of central bank tightening, on a global basis. Even after factoring in the snail’s pace of Fed normalization, the fact of the matter is that Europe is still adding liquidity to the system through their own QE program, as is Japan. Net net, global central banks are in accommodation mode, making the ability to handicap what the Fed is doing or will do very difficult.

Reiterating the Japanese thesis

I have read paper #100 this year suggesting that the big question mark in Japan in 2018 is whether or not their central bank continues with QE and other loose monetary policy tools versus the possibility of surprise tightening.  Sorry, but I find the whole discussion silly.  If Japan’s central bank, which has over the last few years acted as the most dovish and accommodative and desperate central bank in world history were to all of a sudden tighten, the only possible reasons would be them seeing the achievement of inflation targets.  A steeper yield curve in Japan would benefit their financial sector, and would be reflective of a highly opportunistic corporate sector.

In reality, our thesis for Japanese equities is not dependent on what their central bank will or will not do this year (all of which can always be expected to generate volatility).  It centers around the expectation of rising corporate profits for years to come, combined with a secular cycle of growing dividend payouts.

What has been driving MLP’s higher this last month?

We would say it is as much technical as it is fundamental.  The steady price improvement since late November has allured more investors in who were previously waiting for a reason to jump back in the water.  We expect the fundamentals will trump the technical as the year progresses, with the ability to self-fund projects being a pivotal differentiator from those relying on favorable conditions in capital markets to fund.  But low fund flows served as a technical headwind through most of 2017, and increased fund flows have been a tailwind the last six weeks.  Organic growth and healthy funding mechanisms are what the market wants (needs) to see here; excessive equity issuance and deals that reek of desperation are not going to fly.

Oh, and the tax bill helped too.

* MLPDATA.com, Turn the Page, Dec. 31, 2017

High Yield Anxiety

Our view in exiting high yield on a tactical basis last year was that they were trading with equity level risk, and if we wanted equity level risk we would buy equities.  Credit spreads were (and are) so tight, that the space stuck us as lacking compelling value on a risk/reward basis.  That being said, there is an argument to be made for new tax law actually helping high yield investors …  Essentially, the new tax law limits the deductibility of debt interest (subjecting it to a limit of earnings).  One would think this is a negative for the companies used to issuing this kind of debt, and it is.  But it does two other things that force us to think more intelligently about all of this: (a) It encourages companies to de-lever their own balance sheets, a net positive for the asset class; and (b) It limits supply if it cuts down on new issuance.  In both of these cases, a negative for the companies issuing high yield debt could very well prove to be a positive for the investors owning said debt.  Food for thought …

First ban is never the last ban

South Korea announced a bill this week to ban trading not just of Bitcoin but all cryptocurrencies.  No further comment.

When it comes to dividend growth,”active” is not a bad word

Don’t look now, but a two-year treasury yield is now paying more than the dividend yield of the S&P 500.  This contrasts with many years of a two-year bond yield well less than 1% while the S&P yielded over 2%.  The combination of ascending stock prices in the S&P and a slow but sure increase of the short-term bond rates has reversed that distinction.  Now, 30% of the S&P 500 still offers a dividend yield higher than the two-year benchmark, and 17% pay higher than the 10-year bond yield.  But finding those companies is an active process, not a passive one, and filtering from those companies into those who have the needed organic cash flow growth and responsible balance sheet management to sustain that [growing] dividend really takes active management!

Chart of the Week

If there was a more emphatic theme over the last few years than “we are so over-supplied in oil the world will never what to do with it all,” I don’t know what it was.  The problem with that theme was that it ignored growing demand, and ignored U.S. ability to rationalize their production costs and stockpile decisions.  As we now face the longest streak of stockpile declines in over ten years, a lot of energy commodity narratives of recent years are being called into question.

Quote of the Week

“It is the precept of ethical and humane behavior, no less than of political wisdom, to adapt economic policy to man, not man to economic policy.”

~ Wilhelm Ropke

* * *
So my annual white paper on all things 2017 and all things 2018 is here.  I believe it to be a good assessment of what transpired in the year behind us, and how we feel about the year ahead.  We encourage you to jump in with both feet!

Do not hesitate to reach out with more questions about our 2018 outlook.  We couldn’t cover every single topic we wanted to, but we covered a lot.  We’ll leave no stone unturned in our quest for you to understand how you ought to be allocated right now, and why.  To that end, we work.

With regards,


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

(1) Strategas Research, Global Synchronized Upturn, Jan. 8, 2018, p. 4

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