Dividend Café

This Oily China Problem - Nov. 16, 2018


Dear Valued Clients and Friends,

Markets reversed their bullish movements of the last two weeks this week, as headwinds over global economic conditions persist.  We have a significant focus on politics and trade this week (see our Politics & Money section), for rather obvious reasons.  But we also visit present market sentiment, look at catalysts to growth, and do a sobering analysis of both headwinds, and valuations.  So jump on into this week’s Dividend Café!

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The New Normal: Directionless Range-Bound

Markets are in a funk, no doubt, and I believe will stay in one until better clarity exists around U.S./China trade relations.  Over-priced technology names are re-pricing and have not stopped doing so.  And yet at the same time, a cadre of stable, blue-chip names are making new highs, or experiencing double-digit gains, even as risk assets have sold off 7-10% since early October.  The market may very well resume an up-trend, and it may very well see a sell-off accelerate, but the most likely scenario to me seems to be some sort of range bound movements of up-and-down volatility while different market actors try to wait out the headwinds of uncertainty that cloud over things.

Credit market realities

If your eyes glaze over when I start talking about “credit markets” and “corporate debt,” then they will really glaze over when you hear about things like triple-B bonds, etc.  But this is very important stuff to all of us, for it speaks to the heart of the real tension in the economy.  In a nutshell, corporate America successfully re-levered post-financial crisis.  Along with that re-leveraging has come the inevitable, and somewhat modest, deterioration of credit quality conditions (for example, the % of the investment grade bond universe represented by the lowest possible investment grade bonds).  This speaks to the risks embedded in the economy at the next downturn, and the challenge the Fed has in normalizing monetary policy without jacking up vulnerabilities in corporate credit conditions.

Brexit bonanza

The minister negotiating Britain’s exit from the European Union, Dominic Raab, resigned Thursday, citing components to the deal he could not support.  This makes it less likely that Prime Minister May’s plan (generally a considered a very soft Brexit) will have the support of Parliament.  And at the end of the day, it is uncertainty the market hates, and it is uncertainty that continues to reign over the Brexit drama.  The good citizens of Britain, of course, were not so uncertain.

Being prepared for what you can not know is coming

The market suffered sharp drops in February and October this year, and I am sure there is a camp of investors who would like to believe that these two drops were foreseeable.  They were not.  The various fundamentals, facts, and conditions that drove markets higher in January, in Q3, in early November, etc., were all equally present in February and October when markets declined.

The fact of the matter is that markets declined in those months because they declined in those months – that the inherent conditions of markets in short-term periods are unpredictable, temperamental, and certainly emotional.  Risks and rewards – fear of missing out and fear of downside participation – these tensions exist perpetually and are manifested in different ways, without warning.

What is the solution?

The defense for an investor against the erraticism of markets that I describe can be found in:

(1) Asset allocation – one’s blend of assets in a portfolio to execute against a given risk profile remains the best way to absorb the realities of asset class volatility while maintaining the needed return aspiration

(2) Contrarianism – do not continually go with the crowd.  Resist the temptation.  Stick with our customized, thoughtful, proper plan for asset allocation.  And if anything, invest patiently against the crowd.

(3) Behavioral wisdom – avoid the mistakes that generally make the problems described in the above paragraph fatal.

Investible theme du jour

The U.S. energy production industry has exploded, with our crude oil output of 11.4 million barrels per day (holy cow) now trumping the Saudi and Russian daily output.  And yet, capex is still 30% below the 2014 peak.  That energy infrastructure story remains the great untapped need, and while oil prices have declined in the last month, natural gas prices are up over 20%.  Consumption growth of natural gas is far outpacing production growth.  Storage levels are 17% below five-year averages.  Electric power use is not slowing, and the percentage of power generation coming from natty gas is rapidly accelerating.

Our view is not remotely based on weather outlook for a given year, and the fickle nature of commodity prices.  It is based on the infrastructure need we have and the infrastructure opportunity we have.  Our country is facing a growth catalyst for the ages right in the eye.

Pipelines further de-correlate

MLP’s (master limited partnerships) and the broad oil/gas pipeline sector advanced 3% last week, which is not necessarily noteworthy given the increase in markets and particularly strong pick-up in high-income sectors like utilities.  However, given that oil suffered its fifth straight negative week, has dropped nearly 10% in the last two weeks alone, and recently endured ten negative days in a row for the first time since I was in fifth grade.  Pipelines have relatively held up as volumes and cash flows continue to grow.  Natural gas projects needed to sustain growing volumes continue to be announced.  And the Colorado defeat of Proposition 112 took away a certain headwind.  I can see the sector running in place for a bit, and yet the cash flows spread to other income alternatives, are fundamentally attractive.

Lowest hanging fruit

If you noticed that I talk a lot about the trade war with China, and the energy infrastructure story in America, you should also notice that I do not consider those two separate and distinct stories.  In other words, one may be the problem, and one may be the solution.

* Strategas Research, Trade Deficit in Petroleum, Nov. 9, 2018, p. 2

Politics & Money: Beltway Bulls and Bears

  • What a difference a week makes.  The GOP Senate lead appears to be 53 vs. the 54 or 55 it was thought it could be.  And the Dem House flip appears to be 36-40 vs. the 26-30 it originally appeared it would be.  Some recounts continue, but overall, the election results have mostly settled, with some pretty discouraging results for both sides to stew on.
  • This smackdown of White House trade advisor, Peter Navarro, but National Economic Council Director, Larry Kudlow, warmed my heart.  I take it to mean that the free trade wing of the President’s advisory team has taken a leg up in the discussions with China.

“Look, Peter Navarro is a friend of mine, truly. We’ve known each other for 20 years, but he was not speaking for the president, nor was he speaking for the administration. His remarks were way off base. They were not authorized by anybody. I actually think he did the president a great disservice. Look, the president can talk to whomever he can talk to. He talks to people on Wall Street, yes. He talks to union leaders.

“I’ve been in some of those meetings. He talks to other outside advisers. He has every right to do so. And the president has said … that if there is a deal to be had with China, it’s a deal that has to be in American interests. So I think Peter very badly misspoke. He was freelancing and he’s not representing the president or the administration.”  Larry Kudlow

  • And then it was announced Tuesday that there would not be a movement to put tariffs on auto imports at this time
  • Poland signed a 24-year deal with the United States to buy liquefied natural gas from us, a harbinger of things to come
  • No one can really predict anything around this stuff, but I do believe the midterm results puts more pressure on the President to get a trade deal with China done.  A more sellable plan centered around market access (likely to be somewhat token), which addresses intellectual property theft, and focuses on agricultural imports is a very viable solution to a claim for victory, and a settlement in markets.  The results of such an announcement would be strong for the United States, but massive for emerging markets.

Chart of the Week

For all the talk about valuations in the market, and indeed, certain companies certainly proved to be horrifically over-valued, the broad market multiple does not look anything like past bubbles – not even the same stratosphere

* Strategas Research, Investment Strategy Report, Nov. 12, 2018, p. 3

Quote of the Week

“If you want to test your memory, try to recall what you were worrying about one year ago today.”

~ E. Joseph Cossman

* * *
I hope everyone enjoys their final weekend going into Thanksgiving week.  Next week’s Dividend Café will come on Wednesday, not Friday, and will primarily focus on my annual Thanksgiving list, not standard Dividend Café market fare.  But before we get there, we have several more market days to navigate, and a USC-UCLA game to watch (talk about a stinker year).  So fight on, and enjoy your pre-Thanksgiving weekend!

With regards,


David L. Bahnsen
Chief Investment Officer, Managing Partner


The Bahnsen Group

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.

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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.

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