Earnings Trump Politics
Without so much as a nap in between, I returned from NYC last Sunday and re-entered office life bright and early Monday. From the developments in the Presidential race to the somewhat volatile market to the onset of Q3 earnings season, it was not a quiet week. We take a look at all these issues and more this week, and share a lot of the takeaways we think you will care about from our recent due diligence trip to New York City. So off we go …
Do we need to get out those broomsticks after all?
It is our opinion that the “smart” money has believed ever since Donald Trump secured the GOP nomination that while Hillary Clinton was widely-favored to win the Presidency (betting markets, polls, etc.), there was virtually no scenario any credible pundit could point to whereby the Democrats would take a majority position in the Congress, so therefore “status quo” was the most likely (and acceptable to markets) scenario. Has Donald Trump’s recent collapse in the polls increased the chances of a Democratic sweep (taking the House and the Presidency)? We don’t think so, though certainly it bears watching as we get closer to election day. Many critics are fond of saying that they do not trust the polls, and that is fine, but the empirical indicators at this point still favor a Republican House and Democratic President. Can things change in the next few weeks? Sure. But this is the scenario we think is most likely, and that we think is most priced into markets. As an aside, I plan to write a piece for Forbes this weekend (which we will also post to www.dividendcafe.com) evaluating the five most important ramifications of such a political scenario.
She loves me, she loves me not
Are MLP’s correlated to oil, or not? One month all the buzz is “oil is dropping – the pipelines are doomed” (despite all the evidence to the contrary). And another month the story has totally changed (“oil is rallying – where are the MLP’s??”). The fact of the matter is that oil has gone from $40 to $50 in the last two months (+25%), while the MLP index is actually down a couple pennies in that time frame. And in other parts of the year, oil was dropping while MLP’s were advancing dramatically. Non-correlation means non-correlation, and the reason the pipelines do not respond in perfect concert (or even remote concert) with the price of oil is because (a) The revenue model of MLP’s (pipelines) is VOLUME-driven, not PRICE; and (b) So many pipeline companies now are driven by natural gas and natural gas liquids – not crude oil.
The only thing to fear is the antidote to fear itself
I actually do not believe in the short or medium term there is a lot of risk to bond yields going significantly higher, pushing bond prices dramatically lower. Unfortunately the reason for this is I do not believe the economy is strong enough to put out 10-year yield too high into the 2%+ range (it sits at 1.75% now). A 10-year at 1.75% and a 30-year treasury at 2.5% is not reflecting a super-strong economy, and we are sitting on a pretty flat yield curve altogether (the “flatness” refers to how close together the yields are compared to different maturities; “steepness” would mean a larger gap from 2-year to 10-year, and 10-year to 30-year, etc.). But even though I see the 10-year bond yield reasonably contained for the time being, I also recognize that even a modest upside surprise in inflation could push that incrementally higher, and cause the asset classes most people think of as their “safe money” (high quality treasuries, corporate bonds, municipal bonds) to drop in price. Yes, all investments have a risk associated with them; we just prefer to be compensated for the risks we take!
A little bit of this, not so much of that
Much of the story of Q3 in stocks depended on what sectors one was invested in. Certain technology names, especially chips and semiconductors, did quite well, and the whole sector was strong. Energy and Financials were two other sectors that were quite strong. Utilities, on other hand, were down nearly 10% over the last three months. “Widow and orphan stocks” no more!
Pick a country, any country
Where does the most risk and catalyst for volatility exist around the world right now? Most would suggest China, and we are pretty much in that camp. The September exports figure was terrible, and even the imports were disappointing after what had been a strong August. But the way in which the BREXIT gets administered (as UK goes forward exiting the troubled European Union) has plenty of chance to stir up some volatility. And let’s not forget Italy either, where their deeply troubled economy has many EU loyalists in the country wondering if there is a path to Italia-exit as well that may be useful. There are various macro events and situations around the globe that could be troublesome at given moments in the months and years ahead. But then again, when exactly has that ever not been true?
The “New China” is like the “new normal” – a new pile of nonsense
We heard over and over again eight years ago about a “new normal” in capital markets, and what exactly it was supposed to mean and how it was supposed to be invested was never quite made clear. A theme in global investing for several years has been the idea that Indonesia, Malaysia, Vietnam, the Philippines, and other southeast Asian countries were replacing China as the sort of trade and labor hub. The reality is that each of those countries has their own particulars that matter – they are not monolithic – they are not a singular entity. Some have strong economic fundamentals; some do not. But to treat a group of four or five sovereign countries with different deficits, interest rates, labor markets, specialties as one and the same is bad economics.
All roads lead to debt
If you want to talk about anything impacting markets, threatening countries, damaging companies, hurting families (fiscally), or generally impairing a portfolio result, it will always and forever have something to do with debt. On the offensive side of the ball, investors need organic growth – free cash flow – profits – earnings -dividends. We know that. But what ultimately does damage – what doesn’t merely fail to add offense, but actually subtracts and often destroys, is excessive debt. Over-leverage is what does companies in; period. A period of easy money, low cost money, and anxious attempts to stir up credit, all do good things in the moment. They stir activity. And productive debt can often generate productive and even sustainable growth. But what we just cannot take our eyes off of right now is that companies have added more debt to the balance sheet than they have added earnings. This matters, and it behooves us to play offense, without ever failing to play defense.
Income where you least expect it
We have seen investors pour capital into emerging markets bonds these last four months (though largely institutional investors; not as heavy on the retail side), and we have rightly proclaimed that this was largely a “yield grab,” driven by the desire to generate extra income relative to what was available in other developed country bond markets (where yields are either negative or barely above zero). What has not gotten enough attention is how the income story may be quite attractive for years to come in emerging markets stocks, as well. More and more EM companies are paying a dividend, a good percentage pay a much more attractive dividend than their developed counterparts, and most importantly, there is ample room to grow these dividends as these companies and countries mature past a “fixed payout ratio” and into a more opportunistic program.
Chart of the Week
To sort of further back up our belief that there is a secular move coming over the next ten years of very attractive dividends out of the Emerging Markets space (see the reasons above), note the following two charts. The first one shows how the number of companies in the Emerging Markets world vs. those in the Developing Markets world has completely accelerated in the last 15-20 years. The second one shows the more attractive income opportunity set from EM equity than other world stocks markets.
Quote of the Week
“You don’t need the big plays to win. You just have to eliminate the dumb ones.”
– Lou Holtz
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We want to remind those of you who didn’t get the memo (a figure of speech, and literal use of the phrase here) that we are hosting a national conference call on Wednesday the 19th at 11:00am pacific time to discuss our recent New York trip and share the nitty-gritty from various meetings, money managers, etc. in more detail. RSVP to JOHare@hightoweradvisors.com to receive the call-in info (clients and non-clients are welcome on the call).
We also are thrilled beyond words to announce that our very own, Kimberlee Davis, has become a partner at The Bahnsen Group, and will now join Brian and myself as the Managing Directors of the firm. Kimberlee is a gifted Advisor, has brought wonderful financial planning acumen to our business, and has proven to be a valued leader in our business. Kimberlee is a client-centered professional, and that’s what we care about The Bahnsen Group – deep talent and ability that is channeled towards creating an extraordinary experience for our clients. I speak for Brian and myself when I say that we are thrilled to welcome her to the echelon of partnership, and we know this will serve as a further enhancement of the value we deliver to our clients. So to that end, we work.
Courtesy of The Bahnsen Viewpoint.
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