Dividends, Valuations, and Trade Deficits
How much I weigh depends on the scale I use
Few subjects generate more discussion in our world than that of stock market valuations. Most pedestrian analysis can at least relate to the Price-to-Earnings measurement, and most know that we are trading roughly 17x forward earnings estimates, vs. something closer to 16x historical. Below we highlight many of the valuation metrics our friends at Strategas Research provide for us. What you will see is that the broad market is modestly (not egregiously) above historical median valuations by a lot of metrics, but it is actually below average on a Price-to-Book Value measurement, and especially by a Price-to-Free Cash Flow metric. All in all we think our basic conclusions are wise: (1) Markets are a tad over-valued; (2) They tend to become more than just a tad over-valued before it becomes a problem; (3) Other measurements tell a more nuanced story; and (4) Selectivity is an important posture right now for both defense and offense
A bright light for economic advice
We focus so much on the cabinet appointments in any Presidential administration, and have particularly been so focused on the trade advisors President Trump has surrounded himself with, that we miss some of the more obscure areas where policy advisors reside and have huge impact on economic ideology. Vice President Pence this week selected Mark Calabria as his Chief Economist, and we see this as a positive given how large of a role VP Pence has in influencing administration decisions. Calabria is a solid free market guy and respected expert in banking and housing and mortgage finance.
MLP’s for me and for thee
The basic thesis I talk about over and over again – expanded use of natural gas liquids, combined with new technology in oil and gas production, has made the pipeline transportation story very attractive – is alive and well. What we see happening in this industry around financial metrics and structure is quite remarkable. Lower leverage and more cash flow protections around the dividend are now highly valued. The issue that brought on a negative feedback loop for MLP’s two years ago was fear that they would be cut off from capital needed to fund their growth. What we see now is a systemic migration towards financials that do not require heavy outside capital. We believe in the long term secular story, and we believe in the improved quality of financials around the industry.
Trade Deficit Schrade Meficit
So the trade deficit in December was $44.3 billion, slightly smaller than the $45 billion expected. The current administration likes it when exports grow faster than imports. The number investors should care about, and we think all economic actors, is the TOTAL VOLUME OF TRADE. Total imports, plus total exports. THAT number grew the most in 18 months, and is the real indicator of overall economic health. The U.S. being an attractive place to invest capital inevitably means a higher trade deficit. Who could complain about that? Well, besides him …
Correlation Theory 101
We have written a lot about unbelievably high correlations had been for a long time until late 2016, and how much they broke apart at the end of the year. By “correlations,” we mean the relationship between various securities or investments (how in tandem they are with each other whether up or down). The relative valuation between stocks has largely been locked in by the massive growth of the ETF/index industry. Whether up or down, because so much buying of these stocks has had to happen in equal proportion to each other it has kept relationships between these securities very tight, even when those relationships do not belong close together! This has distorted things, to some degree, and frankly that distortion can be sustainable – but ultimately built-up inefficiencies become opportunities, and that is what we see happening in the market now.
Deja vu all over again
It wouldn’t be a few months before summertime without bulletins starting to come across my desk about a summertime impasse between Greece and their creditors. If this sounds like 2010, 2011, 2012, or 2015, it’s because, well, you know, but yes, there is talk that the Greek government and their creditors are facing a disagreement about fiscal concessions, increasing the chances of a summer flare-up. We’ve seen this movie before. Pass the baklava …
Interest Rate realities and all that is not fit to print
We risk putting you to sleep if we dive too deeply into the complexities of how the world’s financial system works, but we also commit malpractice if we do not at least try to keep you abreast of the most basic and profound realities driving financial markets. We talk a lot about the global economy’s addiction to low interest rates, and what higher rates may mean for us as investors, and what sustained low rates mean for distorting investments and risk/reward trade-offs. These are important subjects. But we think that it is important to understand that when one sees the global bond buying the central banks of Japan and Europe are doing, this money is working its way into the U.S. bond market, and is helping to keep the U.S. bond rates down. There are two implications to this: (1) At least for now, it helps us understand why rates are not and are not likely to any time soon run up dramatically, and (2) It helps us to appreciate the risk embedded in the fact that global central banks still offer so much intervention in the realities of financial markets. How long can this all go? How long will it go? What will it look like along the way? Significant money gets lost when people attempt to bet against reality, but significant money can also be lost when investors fail to understand reality.
How cheap are we talking here?
One of our positions since the election has been that not only is the apparent Trump administration policy platform positive for energy stocks, but that this positivity had not yet been priced in (unlike some of the other sectors that are expected to benefit under President Trump, which perhaps have priced in such positive expectations already). To help quantify our belief that there still exists embedded value in the energy sector, take note of the chart below comparing present valuation to historical valuations in the energy sector (courtesy of my friends at Invesco Asset Management)
Getting Inflation off the Milk Carton
The reality is that slow, small, subtle inflation is the biggest threat to investors, because it numbs them to its effects, it is politically allowable, and yet the effects over time are horrendous. But most investors spend their time looking for big, noticeable, headline inflation, which frankly is hard to find in a world caught in a debt/deflation spiral. With unemployment low, commodity prices having moved higher, and wage growth picking up, not to mention a potential infrastructure spending bill coming, it is no surprise that inflation expectations have picked up. We would think this could also put upwards pressure on interest rates, once again leaving the Fed in a difficult position.
Chart of the Week
One of my very favorite charts in history is this week’s chart of the week. One of the lines I get most often is that while dividend income is nice, and maybe even the risk reduction dividend growers represent is nice, the bottom line return is all that matters. Well, one can see here with their own eyes what the empirical results say about that (comparing the whole S&P 500 index in the light blue line to the Dividend Growing stocks of the S&P 500 in the dark line.
Quote of the Week
“There are only two ways to live your life. One is as if nothing is a miracle. The other is as if everything is a miracle.”
– Albert Einstein
Originally published on Dividend Cafe.
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