Believing in the Lessons of History
This week we delve into some key historical lessons in the Dividend Café, and attempt to extract from those lessons some real practical guidance for the present. There are so many things of interest to investors moving so incredibly fast that it is really important to us to touch upon all of those things that we believe are pertinent to investors. The topics this week are all, to our minds, of great interest and relevance, so dive in. And as always, reach out with questions or comments.
The most common trend of history: Not believing in the lessons of history
Much has been made of the fact that while the S&P 500 is beating the Dow Year-to-Date, with both posting nice high single-digit returns in less than half a year thus far, there are ten names out of five hundred – literally just ten, accounting for over 75% of the index’s return. And yes, those names are big behemoth technology names, and yes, they are popular companies.
I read a simple remarkable report this week by Louis-Vincent Gave (Deja Vu All Over Again, Gavekal Research, May 30, 2017) that analyzed the current predicament in terms of history. He walked through the last four decades and how investors would have fared entering new decades by not owning the hot dot at that time – the area of the market for a global equity investor that it seemed incomprehensible to not own. From commodities and energy entering the 1980’s, to the hype of Japan entering the 1990’s, to the famous boom in technology and telecom entering the 2000’s, to China entering the 2010’s, these are all investment sectors that were on top of the world – unshakeable – unbreakable – unfadeable – that all became extremely advantageous to not own in the years that followed. Am I saying that the Facebooks and Googles and Amazons of the world will prove to be the same in the years (or decade?) ahead? I am not. Well, not exactly. I am saying that on a risk/reward basis, investors are wise to be prudent, defensive, and stay disciplined and diversified within a prudent asset allocation strategy. A heavy concentration in any hot dot is not wise; let alone the one that has defied all valuation expectations.
In defense of technology
A worse interpretation of our above paragraph could not be formulated than to conclude that we are opposed to investing in the technology sector. We find the changes in the economy that have taken place and are taking place to be profound, to be attractive, and to be investible. Many technology companies have shed the old model of vertical integration where design, manufacturing, and sales all take place in house, and have instead focused on becoming platform leaders who literally have vast applications for how their platform can be monetized. This divisibility of the technology supply chain is quite interesting to us, and yet many retail investors are only jumping to the big names and brand names in the space, when in fact the entire success of the brand names involves the various companies involved in this division of labor. The “infrastructure” of technology is a cash-flow generative sector (we call it “old tech”), and this is all part of a bullish view on “new tech.” Our thesis is not that all investors must avoid all new tech names; rather, it is that believing the new tech names to be risk-free is a recipe for disaster, and ignoring the less popular names that make the new tech names possible could be a high opportunity cost.
The Senate GOP’s ability to pass an ObamaCare repeal/replace bill (either in reconciliation with the House bill that has already passed or as a somewhat new bill) has been a subject of much discussion, and at one point early this week the sentiment was that there was a real uphill battle ahead to see this move through. By mid-week the sentiment had dramatically changed and much momentum appears to have picked up to get this done. On the tax reform front, the whole process gets much easier once the ObamaCare matter is handled, because the repeal for ObamaCare takes $1 trillion of spending out of the budget. Market actors continue to believe that, despite uncertainty around specific details, some form of tax relief is coming, particularly on the corporate side. The House passed on Thursday a phenomenal bill from Representative Henserling rolling back Dodd-Frank and seeking to improve and optimize financial regulation. The bill has an uncertain future moving to the Senate, though, and our reading of the tea leaves is that it could go either way. A couple nominees to the Energy & Natural Resources Committee are finally set to be approved and when they do it will open up the door to significant energy infrastructure project approvals. Finally, President Trump released his infrastructure plans this week and we will have more to say on that in next week’s Dividend Café.
Jobs report says what?
We saw 138,000 jobs created in the month of May, well below the 182,000 consensus expectation. Revisions for the March and April reports brought those numbers lower as well. The report was soft, but not soft enough to cause the Fed to pause at the June meeting. Another quarter point rate hike is coming. The U-6 under-employment report did come down, by the way, and average hourly earnings did tick up a tad. Not a lot to report on this report.
The Investability of Climate Change
The entire climate change debate is rather controversial, as was President Trump’s decision to pull the United States from the non-ratified Paris Treaty (technically an “accord”, as a “treaty” would have required Senate ratification). Rather than chime in on the areas where controversy lies, we’d rather point out the obvious market implications that come from this whole chain of events. Promised reductions in greenhouse emissions have been achieved (and then some), because of horizontal drilling and hydraulic fracturing (the process commonly referred to as “fracking”), and it created an abundance of natural gas supply which replaced coal in short order as the nation’s primary electricity fuel. Whatever edicts were involved in the Paris accord, they pale in comparison to the present and future capacity for natural gas to serve as a greater clean fuel source for our nation’s power needs. Investment into natural gas infrastructure is aligned with that view.
The other piece I would add is the significantly improved movement both environmentally and economically out of lifting restrictions on liquefied natural gas producers in the United States from dealing with Chinese buyers. A strong Chinese investment into natural gas is a significant needle mover regarding both carbon omissions reduction, and US economic growth.
When all that was, isn’t
The yield curve is now the flattest it has been since before the election (the gap between short term interest rates and long term interest rates).
Commodity prices have come down. Nominal bond yields are way, way down. The dollar has been a dud. Utilities went from the big dud to a short term flyer. Financials and Energy are down. In other words, the “reflation” or “inflation” story post-election has almost died. The market rally hasn’t died. Investor optimism is strong. Corporate earnings and earnings growth have been gigantic. But the rationale has totally changed. The market perception around nominal GDP growth and inflation expectations is an inherently volatile thing, but stock market volatility has been very low, even as a lot of the perceptions around these things have changed in a pretty short period of time. This warrants watching. And by the way, it warrants humility.
Not so fast inflationistas!
So expectations for inflation have collapsed. The bond market has priced in lowest implied inflation expectations in over a year. And what has gold done? Rallied to 2017 highs. For those who believe the movement of gold can be forecasted, understood, or invested in based on some rational or predictable or fundamental metric, I would simply say, you’re wrong. Speculators rule the precious metals world.
One of these things is not like the others
One will note here with great visual clarity what the divergence of central bank policies has looked like the last few years. The Fed, when QE3 was “tapered off” in 2014, has flat-lined their own balance sheet, neither reducing or adding to the positions they own (meaning, they stopped buying assets with money that didn’t exist, meaning, they stopped adding to liquidity and excess bank reserves in the economy – a form of very modest tightening). But notice the balance sheet growth in Europe and Japan, as both central banks have aggressively added to their own asset base, continuing policies of monetary easing even as the U.S. Fed has not.
Originally published on Dividend Cafe.
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