Dividend Café

The [March] Madness of Non-Partisan Markets - March 15, 2018


Dear Valued Clients and Friends,

We celebrated the nine-year anniversary last week of the beginning of this bull market, the official bottom in the stock market out of the financial crisis (666 on the S&P 500; 6,500-ish in the Dow Jones).  And nine years later, the same principles are at play in what drives returns for equity investors – growing earnings, cash flows, and dividends.  There is no better place to discuss all this and the key issues of the here and now (trade, Europe, oil prices, the President’s economic team, energy sector valuation, bull market history, and more) then in the Dividend Café.  So come on in!

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Did Goldilocks just come back from the dead?

The jobs report showed two things that most certainly make short-term market watchers thrilled: (1) A huge monthly jobs report, with 313,000 new jobs created (as big as any number we have seen in forever); and (2) Wage growth was nowhere near robust or accelerating, as inflation-watchers feared (like last month).  So in other words, you got (at least for this month’s report), the perfect formula for markets: Job growth and indication of a robust economy that doesn’t (by their measures) indicate inflationary wage growth.

The best news of the week

At press time, no formal announcement has been made, though the President explicitly stated to the press that Larry Kudlow was his  candidate to head replace Gary Cohn as head of the National Economic Council.  I freely confess my obscene lack of partiality or objectivity on this, as Larry Kudlow is a mentor of mine, and more significantly, one of my dearest friends.  However, this news is one of the most encouraging things I have seen from this White House since the inauguration.  Larry Kudlow is a pro-free trade, pro-growth, pro-America patriot who knows economics, monetary policy, and the engine of incentives as much as any thought leader in the country.  The fears when Gary Cohn left were that the President would go the opposite direction – and name someone more protectionist, isolationist, and we would argue, dangerous for markets, in this extremely important position.  Our excitement for this position is not merely in the quality of work and thinking and messaging we expect from the brutally gifted Kudlow, but also in what it reflects about President Trump’s intentions on the backs of those ill-conceived tariffs a couple weeks back.

Markets are so, so non-partisan

The markets did not drop 1,000 points the week of the tariff announcement because they were opposing Trump, per se.  They did not move a bit higher in the aftermath of the actual tariff announcement because they had decided to support Trump (on this issue).  Markets are brutally apolitical.  They price in what they know and believe and see, and that will always be more meaningful than a press conference or political speech.  For good or for bad, spin drives politics.  Spin does not drive markets.

So what is the distinction between the spin of the actual tariff announcement, and how markets digested it?  In other words – what is the truth?  The truth is that the exemptions of the bill are night and day different than what the Trump administration originally announced, and frankly. what they insisted would be the final product.  Contrary to his trade advisor’s Sunday morning talk show insistence, Canada and Mexico WERE exempted from the tariffs.  And the White House themselves said that “once you exempt some countries, it is a slippery slope until more and more countries are exempted.”  We think they are (thankfully) right!  No one can call what happened a win for free trade, but it was significantly diluted, and of course, investors should be grateful at least for that.

Causes of this bull market

The chart of the week below demonstrates some profound realities about the bull market we have been living in since March 2009.  But there is much debate on  a subject the chart does not deal with – and that is the primary causation of the bull market itself.  Much conversation has centered around the unprecedented monetary policy of the last nine years, wherein the “discount rate” (the short term “safe rate” by which risk assets have to be measured) was so artificially low (as in, 0%, for most of the time) that it forced investors to pour capital into risk assets such as stocks and real estate.  And there is no question that this has occurred.  However, this narrative ignores the basic reality of earnings themselves, which post-crisis have skyrocketed as companies tightened the belt, improved operating efficiency, and experienced profit margins never before seen.  Yes, one of the inputs into that reality (interest rates as a company expense for debt service) were held down by central banks, but the extraordinary profit growth of the last nine years is the story of this bull market.

But all the data and support and presentation of frankly obvious validation of this causation does not speak to the length of the bull market, per se.  What has extended the bull market, and allowed for new legs up and multiple expansion along the way (versus just getting to a full bull market value all at once) has been the extraordinary skepticism that has marked this bull market each and every step of the way.  In other words, investor psychology has been playing constant catch up to the realities of this earning bull market, and that disconnect leading to catch-up has served as a time lag that has pushed things out longer.  And still is.

This new volatility is crazy – or is it?

Not a lot to add to this message:

* Strategas Research, p. 6, March 9, 2018


While the news focus on potential trade conflicts between the U.S. and China, we would chime in with our obligatory reminder that China’s overall health and stability in “slowing” of growth remains the primary factor that has last caused dismay in global markets.  When foreign exchange reserves in China collapsed in 2015 and early 2016, markets paused at best, and went panic attack at worst.  When that outflow of foreign reserves was stemmed, markets worldwide began a historical recovery that has now lasted two years.  Do we have any reason to believe China is about to reverse course?  No.  And do we remain cautious but prudent bulls on global markets?  Yes.  But we continue to believe that taking out eyes off of China and what they represent to the global economy would be a very bad idea.

The case for energy

One of the challenges of being a value-oriented investor is the discipline of patience that inevitably is required to achieve the desired outcome.  And yet, such patience is richly rewarded when mean reversion takes place and the value opportunity that has identified turns out to have been rightly identified as such.  Our conviction is that the energy sector represents one of the great value stories of this decade, and we make our case often, and with conviction.

Basic valuation metrics are the easiest place to start.  An S&P 500 that sees every other sector (besides telecom) trading above its historical median P/E level would indicate that relatively speaking, the Energy sector valuation is quite cheap.  Let’s illustrate this another way: When oil was $26 in February of 2016, energy stocks represented 5.5% of the S&P 500’s total market capitalization.  Today, with oil comfortably above $60, it represents, well, 5.5% of the S&P 500’s total market capitalization.

The four FANG stocks alone (four companies) now exceed in value the entire market cap of the entire U.S. energy sector (which admittedly, may speak to FANG’s over-valuation as much as it does the energy sector’s under-valuation).

Beyond valuation, the OPEC supply constraints implemented last year have actually gone far better than expected (meaning, less cheating), and the demand side has remained absolutely under-appreciated.  The world is needing 1 million barrels of oil per day more than it needed the year before year after year after year (those who predicted the death of fossil fuel demand have some very inconvenient truths to deal with in the data).

Break-even levels for the producers have come way down here in the United States (in the high 30’s in some of the most robust fields, like the Bakken and Eagle Ford), and productivity/efficiency is skyrocketing.  So better production at higher profit margins is coming at a time of price stabilization on the commodity front and at a time where corporate boardrooms are instilling significant levels of capital discipline. When cash flow goals are aligned with capital expenditures, and boardrooms are demanding more cash flow be returned to shareholders, you have the kind of shareholder-friendly environment we spend much of our time searching out.

Taking this improved outlook for the “upstream” operators (producers and drillers), and combining it with the macro outlook sector-wide, the prospects for the midstream sector become very compelling.  Natural Gas and Natural Gas Liquids remain the great growth engine of volumes in the energy sector, and the storage and transportation of such requires a robust midstream energy sector.

So yes, patience.  But value requires patience, just as natural gas requires a pipeline to ship it.  There’s a correlation we like!

What is holding back European equities?

The recovery in stocks since the early February panic attack has not been evenly distributed.  The S&P 500 sits 7% above its 200-day moving average at press time even as the MSCI Europe index sits 2% below it.  And yet, European GDP growth has been on the climb (+2.7% in Q4 on annualized basis) and stock market earnings have been great (+10% year over year).  The most logical explanation to us is the 10% rise in the Euro relative to the dollar since the middle of last year.  The pending presumed adjustment in European monetary policy has allowed a currency re-pricing which has hurt exporters short term.  But I think even more significantly than that is the continued valuation overhang of the political risk diversified across the continent (controversial elections, populist uprisings, unpredictable outcomes, difficult circumstances for reform, etc.).  It is entirely possible that when Draghi actually acts, the currency will reverse direction, much as the U.S. dollar rallied in anticipation of a tightening cycle, but sold off when it actually commenced (counter-intuitively).  And more importantly, the headwinds remain as to what an economic union looks like with monetary connectedness but fiscal fragmentation, and a debt cycle whose can has been kicked down the road repeatedly.

Chart of the Week

We celebrate the 9th anniversary of this historic post-crisis bull market by looking at market action since the recovery began.  Is this a chart that should devastate those who abandoned stocks during the financial crisis?  Sure.  And is it a chart that reflects the reality of markets (the red circles I added reflecting the various volatility interruptions that even bull markets are highly susceptible to?  That’s right.  But more than anything else, it is a testimony to the wisdom of behavioral investing – of developing an intelligent and appropriate investment plan, and staying the right course.  It is a testimony to the folly of panic.  And for each one of you who were with us in the trying days of 2008, we say congratulations.

* Strategas Research, p. 3, March 9, 2018

Quote of the Week

“Truth is not concerned with how many it persuades.”

~Paul Claudel 

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You may have noticed that this week’s Dividend Café is hitting your inbox on a Thursday instead of our standard Friday.  I would say that the reason is that I wanted you to have more time to read and digest it before a weekend of March Madness college basketball, but the more accurate reason would be that I wanted ME to have more time to write and send it before MY weekend of March Madness college basketball.  This is indeed one of my favorite weekends of the year, and I wish your brackets as much good fortunes this weekend as I wish our portfolios every weekend.

With regards,


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

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.