Providing succinct, entertaining and savvy thinking on global capital markets. Our goal is to provide discerning investors the most essential information and commentary to stay in tune with what's happening in the markets, while providing unique perspectives on essential financial issues. And just as important, Fisher Investments MarketMinder aims to help investors discern between useful information and potentially misleading hype.
Three. That is how many times the MSCI World Index has tested a low during the autumn spurt of this year’s correction. With such jarring moves, we would forgive you for thinking the correction is worse than its peak-to-trough -11.0% decline.[i] Grinding moves punctuated with big swings have a way of looming large emotionally. Financial headlines seem to be feeling the blues, with many warning this could be the tip of the iceberg. Yet to us, this volatility still looks like a correction, not a bear market—and therefore not a time to flee stocks. One telltale sign, in our view, is the notable deterioration in various sentiment gauges.
As the old Warren Buffett line goes, the time to be greedy is when others are fearful—and the time to be fearful is when others are greedy. Accordingly, pessimism usually runs rampant during corrections—but not early in bear markets. Bear markets usually start gradually, lulling investors into complacency. Often investors are still euphoric, having enjoyed years of strong returns, and choose to dismiss warning signs like an inverted 10-year minus 3-month Treasury yield curve[ii] or a negative trend in The Conference Board’s Leading Economic Indexes. Euphoria can be blinding. The gentle early declines don’t seem scary, creating a false sense of security. Deep pessimism typically doesn’t arrive until the bear market’s darkest days, which usually come in its final one-third or so. By then, it is usually too late for investors to do anything about, lest they risk missing the rebound. But when a correction strikes, sentiment usually darkens quickly. Sometimes corrections start while investors are already scared of some perceived negative. Other times, they start for no apparent reason, triggering folks to seek causes—and then get scared of what they find. The volatility, on its own, can also be enough to send sentiment reeling.
This seems to be where we are today as sentiment gauges across the developed world are falling. The American Association of Individual Investors (AAII) Survey recently showed pessimism at a 33-week high. A New York Fed survey showed Americans are more pessimistic about the economy and markets today than at any other time since President Trump took office. One measure of UK individual investor confidence recently hit a 23-year low. The Sentix, a measure of investor confidence in the eurozone, reached a 2018 low in November, falling for the fourth consecutive month and missing expectations. And a widely followed measure of institutional investor sentiment hit its lowest level since December 2012, when the eurozone was well into a recession and many (wrongly) feared America’s “Fiscal Cliff” combination of tax hikes and budget cuts. Meanwhile, most financial commentary has flipped negative, finding scary reasons for the drop and arguing more tough times lie ahead. There is now plenty of talk about this downturn potentially being a bear market—very different from media’s tone during this year’s earlier bout of volatility. Then, many commentators preached discipline. Now, we see suggestions for defensive positioning and arguments that cash reigns supreme.
As investors grapple with another bout of market volatility, a batch of mostly subpar economic data—plus media’s grim reaction—are seemingly stoking fears of slowing global growth. In our view, these worries overlook generally strong fundamentals and typify currently dour sentiment.
Last month, Germany, Switzerland and Sweden released GDP reports showing Q3 contractions (oddly, all clocked in at -0.2% q/q).[i] This month, revised Italian and Japanese GDP figures put Q3 growth lower—notching -0.1% q/q (down from +0.1%) and -0.6%, respectively. IHS Markit’s Eurozone Composite Purchasing Managers’ Indexes (PMIs) also weakened in November—52.7, versus October’s 53.1—while Italy’s manufacturing gauge slipped below 50, the line dividing expansion and contraction. Headlines declared Italy is “teetering on recession”[ii] and eurozone growth is “set to remain weak.”[iii]
Across the Channel, media hyped weaker UK PMIs—including the worst Services reading since July 2016—and a trio of flattish monthly GDP reports showing rolling 3-month growth decelerated to 0.4% in August – October (versus 0.6% in July – September).[iv] Media proclaim a “virtual standstill” in the UK economy,[v] while the chief economist at IHS Markit (which conducts UK PMI surveys) described it as “flatlining,” warning, “unless demand revives, a slide into economic decline at the turn of the year is a distinct possibility.”[vi]
US midterms and their aftermath have hogged most American political coverage since November’s contest, but they are hardly the only show in town. From Brexit to yellow vests and everything in between, European politics have been churning. While markets have been rocky lately, as we look forward, we think European political gridlock and the potential for more falling uncertainty are underappreciated positives. For more details, read on!
President Macron, les Gilets Jaunes et les Taxes[i]
Until last month, the phrase “yellow jacket” mostly referred to wasps with yellow and black stripes. But in recent weeks, it took on a new meaning, as French citizens wearing yellow vests launched high-profile protests against President Emmanuel Macron’s new fuel tax—a “green” policy aimed at curbing carbon emissions by encouraging folks to drive less. This aim did not go down well with the many people who live in France’s suburbs or countryside and rely on their cars for work. Macron’s offhand comment that they could simply wait for more fuel-efficient cars went over about as well as why don’t they just eat cake?[ii] and had basically the same effect: demonstrations. Not necessarily over flippant comments, but over the perception that Macron had cut taxes for the wealthy while making ordinary working folks foot the bill.
If you read any coverage of UK Prime Minister Theresa May’s decision to delay Parliament’s vote on her Brexit deal yesterday, you likely saw that the root of MPs’ discontent was the so-called Irish backstop. That phrase was everywhere, without much explanation, and we live to explain jargon to normal people (and crazy-in-a-good-way folks who don’t speak Jargonese). So here is our attempt to demystify the topic.
What is a backstop?
It is that fence in baseball that goes behind home plate to stop foul balls from hitting spectators.
The event stock market observers spent days watching for finally occurred on Friday: The S&P 500 Index formed a “death cross,” a technical indicator allegedly indicating dark times ahead (as the name implies). Like its cousin, the colorfully named Hindenburg Omen, the death cross purports to predict a market crash. Yet a quick look at market history shows the death cross isn’t a reliable predictor—no technical indicator is. Investors following it are likely led astray.
A death cross occurs when a stock’s or index’s 50-day moving average crosses below the 200-day average. Supposedly, this marks a downturn gaining steam, signaling further trouble. As recent headlines heralding this intersection attest, the financial media likes to play up death crosses—the ominous name gets clicks and eyeballs. A 50-day’s move below the 200-day by definition happens during pullbacks—when folks are often nervous.
But the death cross is a poor tool, in our view. It is true a death cross generally occurs early in a bear market. But death crosses happen many other times, too. As Exhibit 1 shows, the last four death crosses happened in January 2016, August 2015, August 2011 and July 2010. All these occurred well into corrections. Acting on them would have realized losses and positioned you to miss the rebound—not a great strategy for reaping stocks’ long-term returns.
World stocks hit a new correction low Friday, closing down -11.0% from their January 26 high and giving financial commentators more negativity to chew over.[i] As they did, a common theme emerged: an argument that stocks are only now catching on to the risks of tariffs, Fed rate hikes and a fading tax cut sugar high, and more pain lies in store as these alleged negatives take their toll. In a vacuum, the trifecta of a trade war, tighter monetary policy and phantom earnings growth might sound like the stuff bear markets are made of, but we see a huge flaw with this thesis: It presumes markets aren’t at all efficient. Surprises move markets, and we have a hard time seeing how three topics that have hogged financial headlines for the better part of a year have much surprise power.
“Markets are efficient” is a quick way to say “markets near-instantaneously incorporate and reflect all widely known information.” Now, people can debate the speed at which stocks price in new developments. It could be microseconds, minutes, hours or maybe even days or weeks if it is a slow-moving event. But to say stocks haven’t yet come to grips with things financial media have yapped about for a year is to say said media are firewalled from the rest of society. That Susie Saver, Sally Stockowner and Steven Swingtrader are somehow oblivious to anything that is going on in the world. They don’t catch any glimpse of front-page headlines, nightly news teasers or social media alerts. They don’t hear snippets of conversations or news bulletins while they are out and about. They don’t have friends who occasionally say “dang, did you hear about those tariffs” or “man, that tax cut was great for business, but it sure seems like it will wear off soon.”
Perhaps there are a handful of people who have managed to avoid any and all seemingly bad financial news. If so, we are a tad jealous. But most folks are aware. Even if you don’t watch CNBC, Fox Business or Bloomberg or read The Wall Street Journal or any major daily’s business page, this stuff seeps in. We know, because we sometimes get questions about it from our non-CNBC-watching friends and relatives. “Aren’t those tax cuts just fake growth?” “Isn’t that trade war going to make everything too expensive?” “Are we going to get French-style gas tax hikes that take gas to $7 per gallon?” “If they keep raising interest rates, isn’t that bad?” The zeitgeist is like a big, extra-absorbent paper towel sopping up everything in earshot. The chatter permeates, and no one is immune.
Tuesday, we shared our perspective on the inversion of the 5-year minus 2-year US Treasury yield curve—an article that seems to have struck a chord with readers, generating a good deal of reaction and follow-up questions. Most seemingly agree: The selection of two points in the yield curve’s middle doesn’t amount to inversion of a meaningful spread. However, several readers pose the question: Isn’t this an early warning sign of inversion to come in more-telling spreads, like the 10-year minus 3-month or 10-year minus effective fed-funds rate? In our view, it may be. But that isn’t helpful for investors. You don’t need an early warning sign of an inverted 10-year minus 3-month curve. It is an—imperfect—early warning sign.
Without retreading too much ground we covered Tuesday, yield curve inversion—short-term rates topping long-term rates—does matter. A lot. Banks borrow short term to fund long-term loans, so yield curve spreads heavily influence loan profitability. The reason the 5-year minus 2-year spread is suboptimal, in our view, is the maturities don’t approximate banks’ funding costs. Nor is five years exactly what we would call a long-term loan. More meaningful curves like the 10-year minus effective fed-funds rate or the 10-year minus 3-month aren’t inverted presently.
But is the 5-year minus 2-year spread hinting inversion of the 10-year minus 3-month looms? Perhaps. Historically, inversion of the 5-year minus 2-year spread has preceded most inversions of the 10-year minus effective fed-funds rate or the 10-year minus 3-month. But the thing is, this isn’t useful information for an investor sizing up the equity market.
Public Service Announcement: The yield curve—the difference in rates between various maturities from the same bond issuer—did not invert on Tuesday morning. Yes, some financial media outlets say it did. But they reported on the wrong yield curve. It was the 5-year minus 2-year curve that inverted on Tuesday, following the 5-year minus 3-year’s inversion on Monday. Near as we can tell, these are arbitrary spreads—probably not worth a pixel if global stocks weren’t in a correction and volatility weren’t plaguing us all. The hoopla—and accompanying warnings that this is a recession signal—seem like trying to pin a cause on volatility. In our view, nothing happening in Treasury markets today signals a recession or bear market is likely.
We appreciate media being laser focused on the yield curve, in theory. After all, it is one of the most telling leading indicators in the developed world. But once you understand why the yield curve works, it becomes apparent that the 5-year minus 2-year, 5-year minus 3-year and 10-year minus 2-year curves aren’t very relevant. The yield curve matters because it represents banks’ business models and potential profits—important because profits drive bank lending, which drives money supply growth, which generally drives economic growth. If lending isn’t profitable, banks largely won’t do it.
The yield curve represents profits because banks borrow at short-term interest rates and lend at long-term rates. So short rates are their borrowing costs, long rates are their loan revenues, and long rates minus short rates are their potential profits. An inverted yield curve means long rates are below short rates, making lending a losing proposition. That causes credit markets to freeze, and if the freeze lasts for a meaningful length of time, recession usually follows. Not immediately, as it takes a while for trouble in credit markets to show up in economic data, but eventually.
President Trump’s weekend meeting with Chinese President Xi Jinping at the G20 summit appears to have been fruitful, yielding at least a temporary trade truce. In exchange for China’s pledge to buy more US agricultural and industrial products, Trump agreed not to raise tariffs on Chinese imports on New Year’s Day, as planned, or enact new ones. Also encouraging, they launched 90-day talks on “structural changes” to China’s trade practices, including their handling of intellectual property. Many are now cautiously optimistic for a comprehensive US-China trade deal after months of escalating tariffs (what some call a “trade war”). Some believe a trade truce that sticks is the key to whether global stocks rise or fall, with sell-side investment analysts even putting price targets to different outcomes. To us, this overrates tariffs’ impact. While the weekend’s ceasefire is nice—and while a broader deal would be delightful—whether we get one or not isn’t as momentous as many believe, in our view. One reason: Bilateral tariffs are easily avoided. Here are a few examples of just how companies are doing that presently.
Some firms are avoiding tariffs the direct, transparent way: asking for waivers. The administration has granted thousands of exemptions to its steel and aluminum tariffs. But where waivers aren’t an option, a company can just reroute trade to—or through—countries not subject to tariffs. This isn’t costless, but the extra mileage and fees are likely far less than paying tariffs. To see this at work, consider the latest in global oil markets. China hasn’t added duties on US crude, but it largely stopped buying the stuff during the trade spat, as shippers don’t want to risk tariffs taking effect during a tanker’s typical 45-day voyage from America to the Middle Kingdom. Imports sank from an average of 350,000 barrels per day (bpd) in 2018’s first seven months to a goose egg in August and just 30,000 bpd in September. But markets are adapting. Russia and Saudi Arabia handily met Chinese demand. Meanwhile, US oil exports remain at record highs, with shipments going to Europe, Taiwan and India, among others.
Other goods caught in tariff spats are also finding their way. As one artificial Christmas-tree maker in China says, “If they don’t like my price, I can always sell to buyers from another country.” In global markets, global sellers aren’t at a loss for meeting global buyers’ demand, even if governments make the route a little more circuitous. That is especially evident in the world of soybeans. US soybean exports to China have plummeted, as many feared they would in the run-up to new tariffs. But shipments to Argentina are booming! That may seem a tad odd, given that Argentina is also an exporter of soybeans and processed soybeans. We suspect they are processing US beans to re-export them elsewhere … like maybe China. Or, at least, using American soybeans to meet domestic demand while they boost exports of their own crops. Is this optimal for American growers? Probably not. But it shows there are ways to skirt tariffs and defray some of their impact.
With 10 days passed since Black Friday kicked off the holiday shopping season, financial media and analysts have pored over sales data. Speculation about what they mean for overall holiday season spending—and the economy’s strength—abounds. In our view, however, this overrates the importance of a few days’ spending on a very narrow basket of goods.
A relic of the time when department stores had an unwritten rule not to pre-empt each other with holiday deals before Thanksgiving, Black Friday didn’t get its name from consumers getting bruised black and blue wrestling over doorbusters. Rather, it traditionally refers to the day retailers supposedly start to turn a year-to-date profit, going from “in the red” to “in the black.”[i] Once just a single day, it has bled into the surrounding weeks and spawned several other catchily named shopping days. Some “Black Friday” sales begin on Thanksgiving or earlier in the week—or even early November. Boutiques joined the party with Small Business Saturday, while Sofa Sunday and Cyber Monday—now a full-on Cyber Week—capture online discount-seekers.
These days, most coverage highlights the five days from Thanksgiving through Cyber Monday. Initial estimates indicate these were pretty good to American retailers: Per a National Retail Federation (NRF) survey, 165 million people bought “gifts and other holiday items” during November 22 – 26, down -5.2% from the same period last year.[ii] On average, customers spent $313.29, also down -6.6% from 2017’s total.[iii] Cyber Monday online sales set a record, rising 19.3% y/y, and the NRF estimates retail sales are on pace to rise 5% y/y during the holiday season overall.[iv] A solid showing on balance.