Retail investors are in love with dividends more than they should be with significant fan followings and discussion forums online dedicated to the worship of dividend stocks. Clearly, dividends are seen as important because public companies love to brag about how consistent their dividend payments have been and how much they’ve raised them. Dividends are beloved because they give investors the allure of safety. Retail investors feel that a dividend payment is secure which means the investment is secure. However, in the financial crisis, dividend stocks fell about the same amount as the S&P 500.

To be clear, dividend payments are more secure than buybacks because companies know investors hate when dividends are cut. Investors don’t care as much about buyback cuts, so buybacks are the first to go in a downturn. Firms give themselves a cushion by paying relatively low dividends to be sure they won’t need to be cut in a recession. One other way dividends make investors feel good is that the yield goes up when stocks fall. Obvioulsy, stocks which don’t have dividends also get cheaper when they fall, but dividend yields make investors feel like there’s a floor under the stock. That is true as long as the dividend isn’t cut. Dividends look amazing when they are raised over time; the yield on an investment made years ago can be in the double or even the triple digits.

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The Fed funds rate is a hotly debated topic because it’s the main policy tool the Fed uses. There is economic data which can be interpreted to support every argument. Furthermore, after the metrics are taken into account, the goals are subject to interpretation. Just because the core inflation rate goes above 2%, doesn’t mean the Fed needs to hike rates, as we have previously discussed. The Fed could determine that its mandate of creating stable prices is hit when the core inflation is 3%, as an example.

We’ve seen the Fed ignore the data in 2017 because it felt the decline in inflation was transitory. The entire cycle has been confusing if you look at GDP growth. The average real GDP growth during QE and zero percent interest rates was 2.2% and the average GDP growth during the 5 rate hikes and no QE has been 2.1%. This makes it look like the Fed ignores the strength of the economy when setting policy.

Because it can appear policy and the data aren’t related, the market sometimes overreacts to guidance. For example, the stock market sold off after Powell’s Congressional testimony on February 27^th because it felt he was slightly hawkish. Fed policy appears to be impacted by the market and forward guidance. Sometimes the FOMC moves the Fed fund futures and sometimes the market causes the Fed to change its tune.

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In the financial media, it’s easy to see what the economists and analysts think about the current economy because usually they propose more of the same when asked about the future. It’s simple to extend the current trend indefinitely, but that’s not always a good idea, nor is it realistic. Even during economic expansions, there are mid-cycle slowdowns. While a slowdown doesn’t mean a bear market is coming for the overall market, it could mean a correction is coming in at least a few sectors. Therefore, it should affect how you allocate capital.

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Investors are trying to get a reading on where inflation will go in the next 12 months because it’s a key variable for forecasting asset prices and the Fed funds rate. As you can see from the chart below, the year over year core CPI will hit near 2.5% in late 2018 if the month over month increase is 0.16% in February and 0.19% going forward.

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We’re going to dedicate another article to re-discovering the relationship between the 10 year bond and the stock market. With bond yields skyrocketing in the 4^th quarter of 2017 and the first 2 months of 2018, it’s more important now than ever to understand the relationship. The confusing aspect, which started during the correction in early February 2018, is that the financial media headlines blame yields going up for the stock market decline, but the yields and stocks often act in correlation. In a previous article, we discussed that historically when the 10 year bond yield gets to 5%, stocks start declining when yields higher. The addendum to that point was that, based on recent action, it was concluded 3.5% was the new marker.

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Some analysts speculated if the Fed would try to keep rates low to support the government’s spending binge. However, instead of worrying about the debt, the $400 billion spending plan and the tax cuts are being used as an excuse to raise interest rates and let the government bonds on the Fed’s balance sheet expire.

At a conference on February 27^th, which was right after Powell’s first Congressional testimony, Yellen and Bernanke were asked about the biggest risk factor facing the economy. Bernanke said geopolitical events and Yellen worries about how the Fed balances growth versus inflation. While these are risks, it’s amazing to see how many of the mainstream economists ignore the debt bomb facing America. Many Fed critics predict the Fed will go through with some sort of extremely dovish policy to solve the debt problem. However, the Fed isn’t focused on this issue, so it may be behind the curve in coming up with a solution.

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With the first stock market correction in over a year, having occurred in early February, there were many media narratives about what caused the selloff. We think it was driven by the unwind of the short VIX trade. Buying protection wasn’t considered important with the VIX at record lows in 2017. However, when nobody thinks there’s a need for protection, it’s probably a good idea to buy some especially since it’s cheap. Shorting the VIX is shorting protection. The stock market was like a car driving 80 miles per hour where the riders were betting against the need for air bags. The tail wagged the dog as the derivatives market moved stocks instead of the reverse.

For some reason, the 10 year bond yield got blamed for the selloff even though it had been increasing for months beforehand while stocks rallied. Furthermore, when the selling occurred, yields actually fell and then they rose after the correction ended. Some analysis implies the 10 year bond yield needs to hit 3.5% to affect stocks and other analysis shows stocks rally with every 100 basis point movement higher in bond yields. The chart below supports the latter point.

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We’ve discussed the price to income ratio of housing in a previous article. This gave us an idea of how expensive housing has become. We’ll discuss some of best points why real estate is too expensive and then provide the counterpoint explaining why housing isn’t in a bubble.

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