Outlook on Potential Bear Market Causes, Inflation and the US Dollar

Title Screen Appears, “What are Some Things we’re Watching for That Could Cause a Bear Market In 2021?”

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A disclosure appears, “Fisher Asset Management, LLC does Business as Fisher Investments. Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns.

International Currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of fisher investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients.

No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.

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The screen changes and the following written statement appears, “This is a video excerpt for Fisher Investments clients and recorded on February 4, 2021.”

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A woman appears on the screen wearing a navy suit. Sitting in an office, she begins to speak.

A banner identifies her as Jessica Smith, Client Services Vice President.

Jessica Smith: What are some things that you're watching for in 2021 that could cause a bear market?

A man appears on the screen wearing a navy suit, sitting in an office he begins answering Jessica Smith's question.

A banner Identifies him as Jeff Silk, Vice chairman and Co- Chief Investment Officer.

Jeff Silk: Let me cover the standard big things that cause a bear market.

On the white screen a table appears, the table is titled “Bear Spotting”

The table is describing event types of a bear market.

Jeff Silk: First, an economic recession tied to excess. Well, as we analyse the global economy, really don't see a slowdown in the global economy to the extent that that would cause a global bear market. Other things that cause bear markets that we're paying very close attention to is extreme euphoric sentiment. As we've all talked about today, we don't see those conditions existing often. What happens when you get extreme sentiment? You also have a massive pickup in the global equity supply, and we don't see that right now.

On the screen a chart appears, the chart is titled,” Major Equity Supply Growth? No!”

The chart is comparing the cumulative equity supply as a percentage of market value to world bear over the years 1995/2019

Jeff Silk: Yes, IPOs have become more popular, but people are forgetting that we've been buying back, or corporations been buying back stock for a long time.

Jeff Silk: So, if you look at the ratio of stock buybacks to IPOs, what you really see is the global equity supply is increasing, but not at a huge, fast troubling pace. We're also paying attention to what's going on with the liquidity in the system. And is the liquidity evaporating at a pace that could cause a bear market as well. And we don't see those conditions right now. We talked to you before about the impact of major changes in regulation or major changes in accounting rules and how that could cause a bear market. And we're not seeing that as we look at the impact of regulatory changes on the stock market right now. Obviously, a major world war could cause a bear market. We're not predicting that. We don't think that's on the horizon, but that's something that we watch as well. But the real big focus right now is where are the excesses that have the ability to create an economic recession? Where are the excesses that have the ability to tip the market over into a bear market?

Jeff Silk: So, we're putting a lot of time and effort into looking at various forms of excesses right now. We're looking at the commercial real estate market. It's probably no surprise to anybody that tied to the work from home that fewer people are going into the office. There's less demand from the corporate standpoint, so rents are falling. And so how could that trickle into problem in the financial system? We're also paying attention to looking for excesses that might come out of the banking system. Things like are there a lot of bad loans that are being made? Are banks' balance sheets poor? Other excesses that we're paying attention to that typically happen, that we're not seeing happen, but we're watching are as M & A goes up towards the end of a bull market, how many of those deals or transactions are actually bad transactions that don't make sense, that the M & A environment is just not a good environment for stocks? We're not seeing that right now.

Jeff Silk: Let me point out a few more excesses that we're looking for. The private equity markets, not the public, but the private equity markets have raised a lot of money, so we're paying attention to what's going on in the private equity space as well as the private debt space. When we look at those conditions, we don't see them to be extreme enough to cause a bear market, but we're looking for them.

Jessica Smith appears on screen talking

Jessica Smith: Central banks and governments have provided significant funds in order to ensure liquidity into the credit markets and to sustain the global economy in response to the pandemic. In some cases, they've even restarted quantitative easing. What's our outlook on interest rates and do we expect a weak dollar?

On the screen 6 people appear to be in a video call, all of them are in offices, wearing a navy suit.

The people are Bill Glaser, Jeff Silk, Aaron Anderson, Michael Hanson, Ken Fisher and Jessica Smith.

Aaron Anderson: Well, Jessica, I'm glad you framed that question the way that you did, because you referred to them as funds and not stimulus. Because I think this has been one of the most miscategorized parts of what's transpired over the course of the past year.

Aaron Anderson appears talking

Aaron Anderson: You always hear about government aid being referred to as stimulus. You always hear about quantitative easing, low interest rates by central banks referred to as stimulus. These things aren't stimulative at all, really. In fact, I think that, again, is one of the big misperceptions out there. As people look at the state of the economy today and think about the potential for economic reopening and what the economy might look like afterwards.

Aaron Anderson: I think there’s this view out there that tied to all the fiscal response and the monetary response to COVID-19, that there's just this pile of dry tender out there that once the economy reopens is going to ignite and drive more inflation and faster economic growth, higher interest rates and all those types of things. We tend to view that very, very differently. I think what you've seen fiscally here has simply been a band aid. When you lock down economies and people can't have income and business need to keep people employed and just survive this period, that's really what the government aid has been for. It's not intended to stimulate the economy to higher levels of economic growth. It's simply designed to allow people to survive this period and allow companies to survive this period.

Aaron Anderson: From a monetary policy standpoint here, I would be, in fact, quite a bit more critical. Because even though maybe some of the policies that central banks enacted initially were somewhat effective, because in the onset of COVID-19 and the lockdowns in the period where equity markets were so volatile in the first quarter of last year, you also saw a few strains developing in things like credit markets. Spreads between government bonds and corporate bonds started to widen out quite a bit. Repo markets, that was a big topic at the time, you might recall. Those rates were starting to spike. US. Dollar funding markets that other governments or

entities around the world rely on, those rates were going up quite a bit. And so central banks stepped in to provide liquidity to those markets and help bring some of those rates down.

Aaron Anderson: But that's really the extent of the effectiveness of what they've done. Beyond that, taking interest rates to zero or negative in parts of the world, buying more and more assets through quantitative easing. We've got a long history of that now. And I think it's very clear that our view of quantitative easing for the past decade plus, as it's been going on in various parts of the world, has been spot on and that it isn't stimulative at all. In fact, it tends to be more depressive to economic activity. It creates disincentives for banks to lend, it tends to cause the velocity of money or how quickly those funds are getting through the economy to come down quite dramatically.

Aaron Anderson: So, despite the fact you've seen central banks out there doing a lot of these asset purchases, doing a lot of quantitative easing, that's caused their balance sheets to increase dramatically, and it's also caused the number of monetary aggregate measures to increase, that money is just trickling through the economy. It's not moving very quickly, thus it's not very inflationary.

 Aaron Anderson: So, as we then relate that to our inflation and interest rate expectations, as we mentioned before, we think that's going to be very benign this year. There are a number of forces that are likely to keep both inflation and interest rates at bay. Probably the biggest force from an inflation standpoint is that very low velocity of money. The fact that funds aren't getting through the economy at a normal pace, which keeps the big pool of money that central banks have created from causing a lot of inflation and from just a pure interest rate standpoint, without a lot of inflation, you just don't get a lot of upward pressure on long term interest rates. Here in the US, of course, we've got slightly higher long term interest rates than you see in other parts of the world, and I think that matters quite a bit because there's always international competition for bonds. An investor can decide to own a German bnd or a Japanese long-term bond or one in the UK and so forth.

Aaron Anderson: And so, to the extent interest rates outside of the US remain very low, and we think they're likely to, that also helps put some downward pressure on our interest rates because instead of buying that German long-term bond that yields negative 0.4%, they can decide to own a longer-term US bond that yields more. And so that buying of bonds helps keep yields low.

Aaron Anderson: And there's also a technical aspect to that as well. Whereas you look at the supply of bonds out there at the long end of the yield curve, longer term bonds, there's actually a dearth of those today. So, to the extent there's still a lot of demand for those, there isn't a tremendous amount of supply which also ought to put downward pressure on yields, upward pressure on prices.

Aaron Anderson: Now to your question about what that means for the dollar. I think when you consider the normal macroeconomic forces that drive currency fluctuations for the dollar to be weak or strong or the yen to be weak or strong, often that's a function of things like differences in monetary policies or interest rate differentials or differences in economic growth rates or politics or those types of things. And in many ways a lot of those factors that would normally drive currency fluctuations have been harmonized by COVID-19.

Aaron Anderson: What I mean by that is pretty much all central banks are doing the same thing these days. They have taken interest rates to rock bottom levels, they're buying a lot of assets. Most economies have behaved pretty similarly throughout this period because government response shave been fairly similar. And so, a lot of what is driving currencies now I would tie back to risk aversion. The dollar is very much deemed as a safe haven currency. It tends to do well when people are fearful, and they want the safety of the dollar. But as risk appetite starts to grow and people are less fearful, that safe haven status of the dollar becomes less attractive.

Aaron Anderson: And so, what you saw last year is the dollar strengthened quite a bit as people were very risk averse in February and March. But once that attitude started to change and they started seeking more risk, wanting to own more equities that also tended to weaken the dollar because that safe haven status became less appealing. As we look ahead to 2021, I think you're likely to see some of those similar effects, not huge fluctuations in Currencies, just because there still is that harmonization going on with a lot of the factors that would normally drive currencies to be more volatile.

Aaron Anderson: But as the bull market continues, as we head up that sentiment curve that Ken mentioned, investors get more and more optimistic, maybe creeping their way up to euphoria. I think that increased risk appetite could very well be a modest headwind to the dollar just because its status as a safe haven currency becomes less appealing when people want more risk, not less. But by and large, I would say don't expect currencies to pay to play a real significant role this year.

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A series of disclosures appears on screen: “Investing is Securities involves a risk of loss. Past performance is never a guarantee of future returns. Investing in foreign stock markets involves additional risks, such as the risk of currency fluctuations. The foregoing constitutes the general views of Fisher Investments and should not be regarded as personalized investment advice or a reflection of the performance of fisher investment or its clients. Nothing herein is intended to be a recommendation or a forecast of market conditions. Rather it is intended to illustrate a point. Current and future markets may differ significantly from those illustrated here. Not all past forecasts were, nor future forecasts may be, as accurate as those predicted herein.

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