Daily Commentary

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.


The Benefits of Falling Uncertainty: Aussie Edition

Last week, a yearlong inquiry into Australian Financials’ misconduct—officially known as the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Banking Royal Commission or BRC)—wrapped up. The resolution is a good example of how removing a long-lingering fear—and allowing companies and investors to move on with life—is often positive for stocks.

In this bull market’s early years, Australian banks enjoyed a stellar reputation—particularly since they got through the 2008 Financial Crisis largely unscathed. However, allegations of misconduct began cropping up soon thereafter. Some claimed Australia’s biggest banks manipulated the market by rigging the primary interest rate—inflating their profits at the expense of borrowers. Others suggested banks were complacent and allowed illicit practices like money laundering. Many also alleged they knowingly sold poor investment products to retirement savers, targeting fat commissions. By late 2017, politicians—particularly in the opposition Labor Party—were talking of action. The government couldn’t ignore the pressure. Initially, then-Prime Minister Malcolm Turnbull tapped the government’s Productivity Commission to investigate. But its power is limited, queuing calls for a much stronger response—namely, a Royal Commission. For Commonwealth nations like Australia, the government calls commissions when an issue looks to be beyond its resources, as existing ministries and regulatory agencies may not have the manpower or authority to tackle the problem. Eventually, Turnbull caved and convened the BRC.

After the BRC started in March 2018, there were 68 public hearings—and every major financial institution admitted some form of misconduct. The fallout: significant management turnover. Numerous CEOs, chairmen and senior managers at big Aussie Financials have either been sacked or stepped down recently—primarily related to this scandal. Many feared the BRC wasn’t done there—speculating it could split up Australia’s four biggest banks, which dominate the industry.  

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Reports of Tech’s Demise Remain Greatly Exaggerated

Editors Note: MarketMinder does not recommend individual securities. The companies mentioned herein merely represent a broader theme we wish to highlight.

For years, many have treated Tech and Tech-like stocks[i] as the only thing sustaining the bull. Headlines hype FAANG[ii] fluctuations and treat daily Tech news as make-or-break for markets. So when the sector’s stocks tanked amid late-2018 volatility, folks feared they—and the bull—were running out of steam. We believe these concerns are too hasty. Recent Tech news highlights the sector’s strong fundamentals and the importance of looking past short-term sentiment swings.

Tech stocks ended 2018 on a sour note. As global stocks sunk during what we believe was a correction—a sharp, sentiment-driven decline of -10% to -20% or so—Tech underperformed, falling -22.8% between US markets’ most recent peak on September 20 and the correction’s low on December 24, trailing most sectors.[iii] Many blamed slowing global growth—particularly in China. There, folks fear US tariffs are sapping Chinese growth—dinging demand for Tech goods and services—and disrupting Tech firms’ supply chains. But when markets rebounded, Tech surged 19.6%, topping all sectors but Industrials.[iv] While not predictive, we think this highlights the perils of drawing large conclusions from short-term, largely sentiment-driven swings.

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Why the Slew of 2020 Plans Shouldn’t Tax Investors

Editors’ note: Our political analysis is intended to be nonpartisan and focuses exclusively on political developments’ potential market impact. We favor no party, politician or ideology and believe political bias causes investing errors.

We are more than 600 days away from Election Day 2020, but presidential hopefuls have already started tossing their hats into the ring and spouting big ideas. Accordingly, financial media have begun dissecting these ideas—particularly those related to taxes, a thorny issue assured of getting eyeballs, especially with April 15 approaching. It seems every would-be candidate has a tax plan, from direct wealth taxes to financial transactions taxes. Even a charismatic freshman congressperson with a big social media following has gotten into the game. However, trying to predict the economic or market impact of any of these tax plans now is an exercise in futility, in our view. It falls under the realm of possibility, not probability—too many variables can change, and investing based on speculation is a mistake, in our view.    

Before diving into the specifics, we believe tax changes aren’t meaningful market drivers. Tax plans—and the surrounding debate—tend to involve a lot of sociology, which can affect people’s lives in many different ways. However, contrary to conventional wisdom, tax changes don’t have a preset market impact. Cuts aren’t inherently bullish; hikes aren’t innately bearish. Moreover, since tax policy is widely watched and usually takes a while before going into effect, forward-looking stocks have plenty of time to digest and price in their effect—sapping surprise power. So whether you love or loathe a certain tax plan, don’t let those biases affect your investment decisions—a difficult task considering how dramatic and radical some plans sound.

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Is Italy’s Recession About to Go Viral?

Italian GDP fell -0.2% q/q in Q4, its second straight quarterly contraction, meeting one popular definition of a recession.[i] With this news come fears the eurozone’s third-largest economy is a bellwether for the entire bloc. Yet a look under the hood suggests this is a hasty judgment. While Italy and the eurozone share some headwinds, some unique local factors seemingly made Italy more vulnerable. With those headwinds likely to fade, we expect economic reality to soon top today’s dreary expectations, delivering eurozone stocks plenty of positive surprise.

Q4’s contraction builds on Q3’s -0.1% q/q dip.[ii] Although GDP details remain scarce, data suggest weakness was concentrated in fixed investment, manufacturing and exports. Weak fixed investment likely resulted from spiking Italian interest rates during autumn’s budget standoff with the EU. Rising rates seem to have temporarily deterred borrowing—and business investment, which credit growth often drives. The budget spat drove 10-year Italian government bond yields up to 3.6% in October from 2.8% in September.[iii] While 3.6% isn’t exactly lofty, the sharp spike may have given borrowers pause, especially since it looked sentiment-driven and likely temporary. In that case, businesses are likely to wait for rates to subside before locking in years’ worth of interest expenses. It is simply sound financial management to take a wait-and-see approach before making a long-term decision. With Italy’s budget standoff now over and rates lower, firms can unleash business plans, borrowing and investment they shelved last autumn. The result may just be some economic activity pushed from late 2018 to early 2019.

Italy also felt a pinch from a regional issue: new EU emissions standards. These likely impacted industrial production, which fell in all three months in Q4, dropping -0.8% m/m in December. Ditto for deteriorating manufacturing purchasing managers’ indexes (PMIs).[iv] The new standards took effect in September, creating production hiccups as automakers worked to adapt. For example, Volkswagen estimated higher standards would interrupt production of 200,000 – 250,000 vehicles in 2018’s second half.[v] While Germany is more known for auto production and felt a related GDP hit in Q3 (as did Sweden), Italy is also vulnerable as many Italian manufacturers supply German carmakers. Auto sales figures show consumers front-ran the new regulations, with sales jumping before the rules took effect and falling through yearend. (Exhibit 1) This is normal when changes like this take effect, and it usually proves short-lived as everyone adapts to the new regime.

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Market Insights Podcast: Trade Wars, Yield Curves, Government Shutdowns and Other Recent Client Questions

In this episode, Client Communications Group Vice President Naj Srinivas speaks with Research Analyst Scott Botterman about recent common client questions. Recorded February 1, 2019.

Timestamps:

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Much Ado About Hypothetical Fed Moves

Last Wednesday, Fed head Jerome Powell and his merry board of governors treated Fed-watchers to a monetary policy twofer: In addition to holding rates steady, the Fed issued guidance on its balance sheet unwinding plans that some believe reflects a newfound willingness to pause, reverse or stop reducing its balance sheet sooner than previously planned—maybe even immediately. Many breathed a sigh of relief, presuming recent volatility shows the Fed’s balance sheet unwinding removes a key support from the economy and stocks. In our view, however, it was never a threat to either—and the Fed’s new guidance (to the extent it even amounts to that) changes little.

First, a bit of history. The Fed’s QE program had two purposes: Bolstering bank balance sheets gutted during the Financial Crisis and boosting lending by lowering long-term interest rates. Purchasing bonds from banks en masse—QE’s basic premise—did improve their balance sheets, and thanks to higher demand for long-term bonds, long yields fell. Superficially, this looks like a success. But the lower long-term yields negated QE’s other goal. When long rates fell while the Fed kept short rates fixed near zero, the yield curve flattened, discouraging lending. To see why, consider banks’ business models. Long rates determine their loan revenues (think of mortgage and corporate lending), while short rates represent a cost—primarily, interest paid on deposits. Hence, long rates minus short rates constitute a proxy for banks’ lending profits—and a smaller gap means fewer profits. The consequence: Broad US money supply growth—which lending fuels—has grown the slowest of any expansion on record. That makes the “easing” part of QE a misnomer, in our view—it actually tightened financial conditions.

So we welcomed the Fed’s 2013 decision to “taper” QE—reduce asset purchases—as well as its 2017 decision to start letting bonds on its balance sheet mature rather than reinvesting the proceeds. This process is called “balance sheet unwinding” or “quantitative tightening” (QT)—but again, we don’t buy the “tightening” part. Less downward pressure on long rates promotes an incrementally steeper yield curve than we might otherwise have—a positive. Though a very small one, as the pace of sales—$50 billion per month currently—pales next to the $15.6 trillion in outstanding Treasurys.[i] This helps explain why 10-year yields have risen just 0.36 percentage point since QT began in October 2017.[ii]

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A (Non-Brexit) Look at European Politics

Nowadays, the words “European politics” seemingly mean “the latest in Brexit talks.” But other things are happening! In Greece, Italy and Sweden, recent developments again show widely feared European populism isn’t threatening. Rather than radicals upending the status quo, Continental gridlock reigns.

Greece’s Lesson in Moderation

While Greek government theatrics perked recently, they resolved just as fast—and to little fanfare—likely ensuring leftist-firebrand-turned-economic-liberalizer Alexis Tsipras and his Syriza-led government stay in power at least a few more months. Last June, Tsipras negotiated an agreement with Macedonia—Greece’s northern neighbor—to change its name to North Macedonia, but his government splintered over Friday’s parliamentary vote. Since Yugoslavia broke up, Greece has called Macedonia the Former Yugoslav Republic of Macedonia, or FYROM, and the naming dispute has prevented it from joining NATO and the EU. Part of Greece’s objection rests on historical grounds,[i] but Greek leaders have also long pointed out that using “Macedonia” implies a claim on northern Greek territory that was also part of ancient Macedonia and retains the name. Perhaps supporting this claim, (now-North) Macedonian leaders once gave a presentation with a map of their country in the background—with the southern border enveloping Greek territory. Greece, for obvious reasons, didn’t enjoy the symbolism. But both sides accepted renaming Macedonia/FYROM as North Macedonia, which implicitly recognizes there is a southern portion of ancient Macedonia outside of its control. However, Syriza’s coalition partner, the nationalist Independent Greeks party, quit the government January 13 in protest. Tsipras survived the ensuing no-confidence vote January 16, but if Parliament didn’t approve the deal, it likely would have triggered snap elections. In the end, Parliament approved it last Friday, 153 – 146 with 1 abstention, avoiding a snap election before October’s regularly scheduled contest.

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Why We Don't Think December's US LEI Dip Signals Trouble

Last week, The Conference Board reported its US Leading Economic Index (LEI) declined -0.1% m/m—the second dip in three months. To some, this may seem concerning—especially with economic worries running high. But in our view, a look under the hood suggests LEI’s dip likely isn’t foreshadowing recession.

LEI mashes together 10 components, an effort to craft a broad-based forward-looking indicator. It is useful—LEI has declined for a period of months before every US recession since 1959.[i] But, like any economic indicator, there are false signals. Exhibit 1 shows a fair number of false warnings just since 2002.

Exhibit 1: LEI False Signals

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How Tuesday's Brexit Vote Solved Everything and Nothing

As you may have heard, UK parliamentarians (MPs) gathered this evening to vote on a smorgasbord of amendments to Prime Minister Theresa May’s “Plan B” for Brexit following the defeat of her deal with Brussels two weeks ago. Plan B looked a lot like the initial deal, plus a few small concessions aimed at rallying support from the pro-Brexit wing of May’s Conservative Party and perhaps a few from the opposition Labour Party. That was too close to the status quo for many MPs, who tabled 14 amendments this week. House of Commons Speaker John Bercow selected seven for a vote, but once MPs had their say, only two passed—two that don’t much change the calculus. These votes appear to take some of the more extreme options off the table, perhaps reducing uncertainty a bit, but the endgame remains unclear. With the next vote—the much-anticipated “meaningful vote”—set for mid-February, it will be at least a couple weeks before businesses, investors and markets get a better view of the lay of the land.

Exhibit 1 is a reductive flow chart summarizing the many confusing ways Brexit could have gone before today’s vote. The starting point is May’s Plan B—her original deal, plus provisions giving MPs more input into a potential free trade deal with the EU, pledging to renegotiate the Irish backstop and increasing protections for workers. The second row is an oversimplified aggregation of the proposed amendments, which combines overlapping amendments into general categories in order to avoid hurting readers’ eyeballs with four different extend the Brexit deadline amendments. The third row specifies whether each would have been legally binding. The fourth, at last, attempts to show how all led, in different ways, to one of four outcomes: a Brexit deal, a delay, a no-deal Brexit and a second referendum. As you will see, the possibilities were perhaps juuuuuuuuuuust a bit hard to keep track of.

Exhibit 1: An Oversimplified Rendering of Those Brexit Amendments

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The Shutdown Shuts Down

It is over! Thirty-five days after this partial government shutdown began, Congress and the White House shook on a stopgap bill to restore funding for three weeks—just enough time to send out a couple rounds of back paychecks, update government websites’ security certificates, clean up the national parks and, we imagine, update and publish some delayed economic data. Alas, the break from that was fun while it lasted. Oh, and on the political side of things, it gives them three weeks to continue haggling over border security/don’t-call-it-a-wall funding while not depriving civil servants of much-needed income. That means we could very well find ourselves staring down another shutdown in three weeks. But in the meantime, it is worth taking a quick look back at history’s longest government shutdown and what we know so far about its effect on stocks and the US economy.

Presuming this new funding bill does get passed, signed, sealed and delivered, this shutdown won’t just be the longest ever—it will also be the most bullish! The S&P 500’s cumulative 10.3% price return since the government shut is miles above any other shutdown’s return. It makes the 2.4% return during 2013’s government shutdown, which was the biggest until now, look like peanuts.

Exhibit 1: Returns During and After Government Shutdowns

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