Capital Markets Update Excerpts—October 2021

Full Episode Transcript

Naj Srinivas:

Hello and welcome to the Fisher Investments’ Market Insights podcast, where we discuss our firm’s latest thinking on global capital markets and current events.

I’m Naj Srinivas, Senior Vice President of Corporate Communications here at the firm.

In this episode, we’ll round up some of the latest thinking from Fisher Investments’ Investment Policy Committee—the primary portfolio decision makers at Fisher Investments. They recently held a special video session for clients called the Capital Markets Update video. In this Update, which was recorded on August 31, the Investment Policy Committee answered some of our clients’ more commonly asked recent questions.

I’ll guide you through some excerpts from that conversation on topics such as inflation worries; the potential for renewed market volatility, which we’re experiencing today; the state of the current bull market; and the potential risks for a bear market in the future.

Before we dive in, I do have a favor to ask. If you enjoy what you hear on Market Insights, take a few minutes to rate and review the podcast wherever you listen. It’s easy and it helps us share this valuable information with even more people.

With that, let’s get started. There’s a ton of great information in this episode—please enjoy!

[TRANSITION MUSIC]

Naj Srinivas:

Through most of 2021, stocks have pushed upward despite potential concerns like the COVID-19 Delta variant and slower economic growth. Some investors worry these issues may serve as a headwind for stocks. So we’re going to start the episode with Aaron Anderson, our Senior Vice President of Research, explaining why slower economic growth and continued COVID worries don’t necessarily signal dark times ahead for stocks.

Aaron Anderson:

Well, first off, with regard to the Delta variant and just the ongoing COVID issues, obviously there's a big humanitarian impact there, and a lot of controversy surrounding vaccines and so forth. And I don't want to get into to any of that because, of course, what we're most concerned with is how all of this going to impact the economy and markets and all of our client's portfolios. And there, I would say, look at the market, you've had a pretty good resurgence with the Delta variant; markets have been largely unfazed by that. If you just look all the way back, you know, over the course of the past year plus, and look at things like vaccine rollouts and how effective they've been in different parts of the world, or where you are getting spikes or not, it's hard to tie that back to performance of equities.

So it's not as if the countries that have done really well with their vaccine rollouts are doing so much better than the ones that have been lagging, and then as that's oscillated over time, you really haven't seen that impacting equities much. And so I think there's this view out there that, well, maybe Delta is a big threat—and that's not to say it isn't entirely—but clearly you're seeing it's not impacting markets a ton. What I get asked all the time as well, are these more successful vaccine countries going to do better than the less successful ones? That really hasn't been the case to this point.

And I think a big reason that COVID-19 isn't having the impact, say, it did early last year is just tied to uncertainty. I mean, go back to that time. I know it's a little bit hard to remember now that's a year and a half ago, but we were in a period where we had this brand new pandemic, a new virus. We really didn't know anything about it. We didn't know what cohorts were going to be most affected by it. We didn't know if we'd be able to create effective vaccines for it. We didn't know that economies were going to be locked down and once they were, we didn't know how long that was going to last. Just on every level, so much uncertainty.

And while resurgence of the virus is not a good thing, of course, it's terrible for many people. There's not that level of uncertainty anymore. We know that we've got some pretty durable protection coming from vaccines that have been just tremendous here. And we know that with the economic impacts of that are most likely to be and if whether or not there's a willingness to keep economies locked down for a long time, it doesn't appear that that's the case. We know that companies have been actually exceptionally good at adapting to these conditions. I mean, it's been just remarkable how companies have adapted to lockdowns and so forth, and many have actually thrived through this period.

So I think the level of uncertainty tied to COVID now is just so much different than it was then. And that's a key reason that it's not having the impact on markets that it did in the initial onset.

Now, in terms of what does that mean for the economy? You know, I do think that it maybe slows economic reopening a little bit. The fact that we are getting these resurgences—but nothing like we saw last year—and maybe that leads to a little bit of a slower economic recovery, but we would argue, and we have argued for a while, that expectations have been too high for sustained economic growth for some time. And so the fact that you're seeing some economic disappointment here, and you're seeing signs of a slow down—maybe it has a little bit to do with COVID. But I think more than anything, it's just getting past that rebound period in the economy, settling into more, a trend economic growth rate, which to us looks a lot more like it did pre-COVID than something different, which was the common expectation.

And I think the reason that many people expected the economy to suddenly surge and inflation to move higher and interest rates move higher was this mistaken, but consistent, belief that things like quantitative easing, and other monetary policy measures that have been put in place have this stimulative effect, or the fiscal that have been put in place, you're going to stimulate the economy and lead to faster growth.

We've never really bought into any of that. We look at the history of quantitative easing—we've argued this for many, many years, really, since quantitative easing's onset, argued that it's actually depressive, not stimulative. And yet, every time we get into this situation where we're doing more quantitative easing, everybody seems to think, well, here comes a big economic boom. And of course they always end up disappointed.

You can look at Japan over the past decade. You can look in Europe; they never ended their quantitative-easing programs. Those are actually some of the economies of the world that have been struggling most, at least relative to others. They haven't had a lot of inflation. There's really no sign of an economic or inflation pickup there. And yet, suddenly there is this expectation that maybe it's the combination of fiscal stimulus and monetary stimulus and economic reopening. And here comes your boom. Really what we saw as a big contraction.

Last year, we saw a recovery. Now we're starting to settle into more of a slower-trend growth rate, which is perfectly fine for equities. That's basically what we saw for most of the last economic expansion was slow growth; slow, low interest rates; low inflation. That was great for equities, particularly for more growth-oriented equities. We think that's what we're likely to settle into going forward.

So an economic environment that's perfectly fine to allow the bull market to continue, but one that isn't a big booming economy. It's a stable economy. And that tends to favor higher-quality growth-oriented equities, which is where we're more oriented today versus the more cyclical value-type companies that many people expected to outperform as we came into this year.

Naj Srinivas:

Inflation is another common concern for investors and in the headlines today. Besides its long-term tendency to eat away at purchasing power, inflation has the potential to affect the overall economy, and subsequently, returns for stocks and bonds. Here’s Jeff Silk, Vice Chairman and Co-Chief Investment Officer, to explain our current thinking on inflation.  

Jeff Silk:

So, we wouldn't expect inflation to be a material problem for current economic conditions. As a result of that, we would expect interest rates to stay in a pretty tight band in a benign fashion. We don't think that rates are going to skyrocket.

Let me explain why that's the case. So, when you talk about interest rates and you talk about inflation and inflation expectations, it's really a global phenomenon. People have a tendency just to focus what's going on in the US, but when you look overseas, you see inflation expectations—fairly low—you see interest rates—fairly low—and in part, in some parts of the world right now, interest rates are actually negative—lower than low. Anyways, the point that I'm making is it's a global phenomenon and that those forces keep interest rates low here. Those forces should keep inflation in check here.

There's another piece about inflation that's, I think is, worth noting. And that is really what causes inflation is lots of money in circulation—that's getting turned over. There's a high amount of velocity going on with that money, but that's not really going on right now. So, there's a lot of features that people think are scary as it relates to inflation. But if you don't have high circulation and you don't have money velocity, you wouldn't expect what's going on with the economy to create long-lasting inflation, which would be troublesome. Which might be a cause of the next bear market, but as of right now, that's not the case.

Naj Srinivas:

Many inflation conversations focus on just a couple concepts: base effects and supply constraints. Here’s Bill Glaser, Executive Vice President of Portfolio Management, talking about those concepts and how inflation can affect investors’ asset allocation, or their mix of stocks, bonds and cash in your portfolio.

Bill Glaser:  

Well, to be sure, you know, starting out on the year, you have seen longer-term interest rates rise. You have seen inflation expectations rise, and our view was that it should be transitory in nature.

And in some ways those higher rates and higher levels of inflation should be expected. Because if you just think about a few factors that that relate to that one, you've got these base effects, and clients might have heard this concept being talked about a lot. And it's true because the base effect really measures prices today compared to 12 months ago. And when you compare prices in, let's say, May of this year to May of last year, June of this year to June of last year, July of this year to July of last year, those base effects are pretty pronounced because in May, June and July of last year, things were really depressed.

And so you've got kind of those base effects, really feeding its way in to these year-over-year changes in these inflation ratings. And not to mention as the global economy starts to slowly reopen, you've got increased demand and that's against a backdrop where we've talked a little bit about some of the supply constraints. That's all kind of leading to these inflationary pressures, but we think will be temporary in nature.

Speaking of the supply constraints, I mean, clearly there's lots of labor shortages in certain parts of the economy and that's playing into it. But if you look at capacity utilization in various industries, I mean, we're not near a hundred percent in terms of capacity utilization. And so there's still a lot of capacity that can come online and that's going to take time and that should help alleviate some of these inflationary impacts. Again, leading to our belief that it should be more temporary in nature.

But I always like, just ask the question, what if we're wrong with that? And what if inflation is persistently high and what's the impact on portfolios and how should we deal with that? And in some ways, the fact of the matter is, if you think about the performance of stocks versus bonds and cash, so long as that inflationary environment is measured in terms of how it evolves, I would make the argument that stocks are better able to withstand that environment than bonds or cash. I mean, clearly cash, your purchasing power gets eroded. In terms of fixed income, those fixed-interest payments are eroded. But to think about a company's ability to adapt to that inflationary environment.

I mean, theoretically, given the time they can increase prices, which will then flow through to the revenues, which then should flow through to their earnings. And you've seen stocks have been able to weather the inflationary environments much better than some of the alternatives.

Naj Srinivas:

While stocks are overall positive here in 2021, in late September and early October, as we’re recording this, we’ve started to experience a short bout of volatility. Bill talked a little bit about volatility and what it means for investors in the Capital Markets Update video. And although this was recorded on August 21^st—before this most recent bout of volatility, he still shares some very important and salient points for investors. Here’s Bill.

Bill Glaser:

Well, in my view is that, you know, folks always tend to overestimate current volatility and underestimate historical volatility. But, the fact of the matter of volatility also cuts both ways, right? You've got the good kind of the upside. You've got the bad kind of the downside. This year we've seen a lot of the good type of volatility with global stocks up, you know, darn near 20% here as we, as we sit here today. And they've also notched a number of record highs. But just because you hit a new record high doesn't mean or portend bad things for the stock market on a forward-looking basis. It doesn't mean you're due for a correction. It doesn't mean you're due for more volatility.

And the fact of the matter is, if you look at 12-month returns after each all-time high, stocks are up 80% of the time on a 12-month-forward basis. Of course the only all-time high that matters is the last all-time high. But as we sit here today and we look 12 to 18 months forward, we don't envision an environment where you're going to see big, massive declines in the equity markets.

Now, as you think about the potential for correction, I mean, what we've always said is you can get a correction in any perfectly random time for any perfectly random reason, but we don't know of anybody that's been able to consistently and successfully sidestep a correction. And we won't try and do so either. I mean, the fact of the matter is corrections—they tend to be short. They tend to be sharp, psychologically driven events. They recede as quickly as they come about and, as emotionally uncomfortable as they may be, the best course of action is to remain disciplined, and ride them out because they typically end as quickly as they came.

Naj Srinivas:

As Bill mentioned, equity market volatility is primarily a short-term phenomenon. And while volatility can be scary for investors, it’s important for long-term goal-oriented investors and retirement savers not to focus single-mindedly on those short-term bumps and dips. Aaron Anderson, Senior Vice President of Research, explains why.

Aaron Anderson:

I mean, here you look back at 2020, at least for a period there—one of the most volatile years you've seen earlier in the year tied to COVID tied to the lockdown, tied to all the uncertainty that we've mentioned, and yet overall 2020, a pretty darn good year for global equities. Here we are in 2021—not done yet, of course—but you know, off to a very good—more than just start—we're more than halfway through the year now, and it's been a relatively low volatile year and a pretty darn good one again for global equities.

And so, I think it's just a good illustration of the fact that short-term volatility really doesn't impair the longer-term potential for equities and the role they play in your portfolios. Yes. To the point we've made, we want to be vigilant about looking for bear markets, trying to side step them when we can. But short-term volatility happens all the time, even extreme short-term volatility, rarely like we saw last year, that's a really extreme example. But it shows you how a short-term market movement that tends to come and go real quickly. It's impossible to sidestep. There's no point in doing it because it really doesn't impair the long-term potential for the stock market.

Naj Srinivas:

Now we return to discuss the current bull market. Ever since equity markets recovered from their stunning 2020 drop, investors have debated whether the recovery was a new bull market or, in fact, a continuation of the previous one. It’s an important question because the answer could affect how you position your investment portfolio.

In our view, the new bull market is behaving as if it were a continuation of the previous one.

Here's Bill Glaser to describe the implications.

Bill Glaser:

As you think about today's market environment in many ways, our belief is that it's a continuation of the bull market that began in March of 2009. Whereas most of the consensus would have you believe this is a new bull market that began in March of last year. And, there's some implications to that right? Early in a bull, you want to own small, more cyclical, value-oriented stocks. Later in a bull, you want to own the big, high-quality growth-oriented firms.

And so as we look at the landscape today, there's a number of things that lead us to believe that this is a late-market cycle. If you just think about the levels of margin debt today. If you look at the new number of brokerage accounts that are being opened on a day-in day-out basis. If you look at equity allocations as a percent of one's total financial assets. I mean, it's approaching all-time highs. That and many, many more are classic indicators of a late market cycle.

I mean, think about just the number of new brokerage accounts that are being open today. If you're coming off a bear market and you just got burned by the stock market, are you wanting to go out and open a new brokerage account and start dabbling in the stock market? Not at all, but that's what we're seeing. And you're seeing that translate through in higher and higher equity allocations as a percent of one's total assets. And so, you know, from our perspective, that leads us to believe that this is in fact late market cycle and not, not an early market.

Naj Srinivas:

That's significant because, as Aaron said, the types of stocks that do the best in the later stages of a bull market tend to be large, well-known companies with strong balance sheets and hefty profit margins—rather than cyclical value stocks that do well in new bull markets. But, the next question for investors is how long will this late-stage bull market last. Here’s our founder, Executive Chairman and Co-Chief Investment Officer Ken Fisher to provide some context.

Ken Fisher:

People need to be careful because the natural human reaction is to think, gee, you know, if it's rained a whole heck of a lot, it's probably going to not rain so much now. If it's been super dry, well, after the drought's over, we'll probably get some rain eventually. And they extend that kind of natural way of thinking off to the notion that if it's late-stage bull market and late-stage bull market characteristics, it's got to be over really soon.

And the fact is, that in stock markets and capital markets in general, there is no part about length that is predictive. And therefore, there should not be an inherent fear that because it's later-stage bull market and been going on longer than people think that it's eminent that it ends, which is a natural reaction for people to have. Oh, late-stage bull market's going to be over, I got to get out!

The fact is I just had a long tiring day yesterday and a really normal human reaction after a long, tiring day is to want to get a good night's sleep. And after a good night's sleep, then you feel good, off to the next day.

Last year had a quality for investor sentiment that's a little bit like a good night's sleep. It sets sentiment back, it created the fear tied to all of the things of COVID that then is in a sense, the sentiment refresh that allows the bull market to keep moving on and therefore have even more length, even though it's—the way we would think of it, not the way others would think of it—the longest bull market in history.

Naj Srinivas:

Even with a positive outlook for stocks, there are still issues to keep an eye on. So we’ll end this episode with my good friend, Michael Hanson, Senior Vice President of Research, discussing some of the potential “large-scale market risks” that they’re watching as 2021 winds to a close.  

Michael Hanson:

I think it's really important to talk about what actually is a large-scale market risk, because I observe this quite often. People worry about a lot of things in a lot of different ways, and so one of the things you have to do first is define your terms: How do global bear markets happen and what are their criteria?

I have about three concepts that I think of. First one is scalability. Is it simply big enough to create a catastrophe in global capital markets? And that takes quite a bit of scale, usually on the scale of trillions of dollars, at a minimum.

Second piece though is time domain, and I think this one gets forgotten about a little bit. Market's price in maybe a year to maybe 30 months into the future—something like that. But, people worry about things that are going to happen that only last for a few days. And people worry about things that are going to happen in 10 or 20 years. And yet, markets aren't necessarily going to price those things in, in the way they may expect. So, you need that time domain criteria as well.

Last piece is, is it widely talked about and or expected? Because we say this all the time—it's bedrock to our philosophical foundation of what we do—if something is widely discussed, believed, top of the headlines in the market, it means it's lacking a lot of its pricing power because people have already considered this issue. So, if you can fulfill those three criteria, you can start to talk about real risks that could take down a global capital market.

The other nice piece is you can look through history and see how do bear markets actually unfold and you can make some comparisons. There's always new ways to get bear markets, and perhaps we should put into the category of how bears happen: global pandemics. I think it's debatable, but perhaps we could. But there are other archetypal ways it does.

And so when I think of risks that are on the table today, there are a few things that I guess you could say are maybe flashing a yellow caution light, but nothing that's flashing red as an imminent bear market. There is legislative risk, but we think it to be relatively minor and mitigated relative to what the fears are out there, but certainly bears watching. Share issuance and overall investor sentiment. There's been heightened IPO activity: SPACs and so forth. Those have taken a step back over the course of the last couple of months, but it's been elevated in the last year and it's something that we really watch because when you have a lot of new share supply and holding demand relatively constant, that's depressing to prices. It's happened in the past.

Afghanistan's kind of an interesting concept in the sense that what we're talking about today is ostensibly at least the sun-setting of the conflict there. And I think it's a really good one to think about because global large-scale wars can in fact create a bear market—they have in the past. But go back to our criteria. It's all about scale. We have a long history of regional conflicts all around the world, whether America is involved or not. And while it's been very ugly to watch, of course, and very difficult, you know, to see the headlines, the fact is regional conflicts just don't have a history of creating bear markets.

(43:08) And so, for me, there are a few things that are flashing yellow. I would also even include what's going on in China at the moment.

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There are some regulatory worries that have in fact caused certain stocks in China, including some of our holdings that we've been wrong about this year to not do very well. But even for a country as large as China, you'll notice that the larger global bull market has continued. And so right now, those three criteria we have, there's nothing that really meets that, but there are things of course that are flashing that caution sign and we are always vigilant.

And as we go on and as our clients go on with their lives, we're the ones who will be worrying about this and taking time each and every day as really one of our top-line ideas to think about when the next bear comes.

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Naj Srinivas:

That’s it for this episode of Market Insights featuring members from the Fisher Investments’ Investment Policy Committee.

If you want to learn more about some of the topics we discussed on the podcast, the MarketMinder section of our website—fisherinvestments.com—is a great place to check in regularly. That’s where we post all of our latest capital markets insights.

You can also subscribe to the MarketMinder digest, which will be sent to you weekly so those insights will be in you inbox.

And if you have questions about investing or capital markets that we can cover in a future episode of Market Insights, email us at marketinsights@fi.com.

We’ll answer as many questions as we can in an upcoming Listener Mailbag episode.

Join us for our next episode. Until then, I’m Naj Srinivas. Be well and stay safe.

Disclosure:

Investing in securities involves the risk of loss. Past performance is no guarantee of future returns. The content of this podcast represents the opinions and viewpoints of Fisher Investments, and should not be regarded as personal investment advice. No assurances are made we will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. Copyright Fisher Investments, 2021.