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What do Atari’s E.T. the Extra-Terrestrial video game, the movie Waterworld and April’s US jobs report have in common? All were considered huge busts. One analyst called the Bureau of Labor Statistics’ (BLS) latest release the “most disappointing jobs report of all time.”[i] Now, we think that takes it a bit far. But even so, employment numbers are late-lagging indicators. Economic growth drives employment, not the other way around—and stocks pre-price all of it, in our view.
April jobs numbers disappointed pundits on myriad fronts. Nonfarm payrolls rose 266,000, far short of expectations for nearly 1 million.[ii] Besides that big miss, the BLS revised March’s gains down to 770,000 from 916,000.[iii] The unemployment rate ticked up from 6.0% to 6.1%—and some worried this understated reality since many dropped out of the labor force in the past year.[iv] While a fair concern, that seemingly ignores the existence of the U-6 unemployment rate, which tracks those who are neither currently working nor looking for work but indicate they want and are available for a job (the April U-6 rate dipped to 10.4% from March’s 10.7%).[v] Now, this of course excludes people forced out of work by childcare responsibilities during the pandemic, but in our view, that is a sociological issue—outside the sphere of markets. (That goes for other factors potentially keeping people from seeking jobs, including the supplemental federal unemployment benefits.)
While we don’t think any of this is predictive, it is worth putting April’s report in context—especially since the surrounding discussion has read a lot into one month of data. Despite the dour tone, this was still a positive read, and a 266,000 gain would be big for a “normal” month. Monthly noise is also normal, and seasonal or short-term factors may explain declines in certain industries. For example, within the professional and business services sector, temporary employment fell by -111,000—yet some of those losses likely reflect workers getting full-time positions.[vi] Manufacturing employment dropped by -18,000, but the weakness was primarily in motor vehicles, as semiconductor chip shortages have idled factories.[vii]
Editors’ Note: Our political commentary is intentionally nonpartisan. We favor no politician nor any political party or initiative and assess political developments for their potential economic or market impact only.
Results from last Thursday’s UK local elections took a few days to trickle in given some COVID-related counting delays. But now they are in, so cue the multitude of fearful headlines. For even though they were in line with expectations, those expectations included the Scottish National Party (SNP) winning the Scottish Parliamentary vote and—together with the pro-independence Green Party—claiming a mandate for a second Scottish independence referendum. That makes this the rare recent election that extends uncertainty rather than reducing it, which is worth watching from an investment standpoint. However, we think all of this week’s “Scexit” dread is premature. The process from here will be long and grinding, with any potential surprise power fizzling gradually. We don’t think this is bearish for UK or global markets.
The SNP fell one seat short of a majority, winning 64 of the Scottish Parliament’s 129 seats. The pro-Union Conservatives and Labour took second and third, respectively, winning 31 and 22 seats. That left eight for the Greens, four for the Liberal Democrats and zero for the upstart Alba, an SNP rival party started by scandal-plagued former SNP leader Alex Salmond. But due to the complexities of Scotland’s electoral system, which mixes constituency and at-large seats, pro-independence parties didn’t win a majority of votes cast—close, at 49.2%, but not quite.[i]
After significant will-they-or-won’t-they speculation among onlookers, the Bank of Canada (BoC) slowed its long-term bond purchases—or, tapered its quantitative easing (QE) program—on April 21. Nothing untoward happened. Its economy and markets haven’t tanked. Yields haven’t soared. The UK’s Bank of England (BoE) followed suit last Thursday. While it has only been a couple of days since, there has been no identifiable market impact. With two major global central banks dialing back QE, more chatter over the timing of an eventual Fed taper—and its effects—is probably coming soon. Tune it down. Central bank decisions can’t be forecast, and available evidence shows tapering isn’t negative.
Off the bat, attempts to predict Fed and other central bank moves are pointless. In the US, it isn’t 100% clear who will make those decisions, considering the rotating cast of Fed heads and committee voters. For example, speculation is rife over whether President Joe Biden will reappoint current Fed head Jerome Powell when his term expires next February—if he still wants the job. But even if the Fed folks don’t change, central bankers—being human—can change their minds on their own accord without any preset rationale. The Fed and BoE defied their own forward guidance multiple times over the past decade. Former Fed head Ben Bernanke made a big show of providing “numerical thresholds” for conducting monetary policy in 2012, saying a 6.5% unemployment rate would trigger hike rates, only for his successor, now Treasury Secretary Janet Yellen, to scrap it when she took the reins in 2014. Then that year, when Yellen (seemingly) clarified the Fed would hike rates six months after QE’s end, that didn’t happen either. The “dot plot” of Fed forecasts, published quarterly, is no more reliable a guide.
More importantly for investors, divining central banks’ will is unnecessary—there is no evidence tapering QE is a game changer for markets. In the few weeks since the BoC reduced weekly bond buying to C$3 billion from C$4 billion, and the few days the BoE dropped its weekly purchases to £3.4 billion from £4.4 billion, markets have taken tapering in stride. Both the MSCI Canada and UK Indexes have made new highs since their central banks’ announcements. Meanwhile, 10-year Canada and UK government yields are practically unchanged. While we wouldn’t read too much into short-term market moves, tapering so far has had no discernable effects.
Eleven years ago yesterday, I had a late-morning dentist appointment and didn’t get to the office until around lunchtime on the West Coast. Ordinarily, this would not be noteworthy. But when I arrived, the whole floor at Fisher Investments’ San Mateo office was buzzing. Something about the market crashing almost -10% in an instant, orders getting canceled and phones ringing off the hook? And I was a bit confused because when I fired up the old Internet machine, the S&P 500 was down only about -3% on the day—a big daily move, but also a lot less than -10%. That is the story of how I experienced the Flash Crash: as a strange intellectual curiosity that must not have mattered much—it was literally over before I heard about it.
To the rest of the financial world, though, it seemed like a very big deal—and remained so for years. The general consensus held that this 36-minute freakout must be evidence of something very wrong in markets. A July 2010 Atlantic article summed up the general mood: “How could our vaunted markets be so brittle? Did anyone know what the hell was going on? All kinds of hypotheses were floated. Hackers! A buggy automated trading program! Something more sinister! No one knew quite what happened, but it was clear that computers trading stocks had something to do with it.”[i]
Headlines chewed over it for months, speculating over the causes, potential technical glitches and the risk of a repeat. Regulators’ official report, released five months later, only entrenched those fears by pinning the crash on a single institutional investor selling $4.1 billion worth of stock index futures at warp speed (apparently without trying to mitigate market impact or other implicit costs), which then triggered an avalanche of algorithmic orders as the market fell.[ii] That fanned fears of weak plumbing, and for the next several years, every May 6, the anniversary retrospectives rolled in, all recapping what went wrong and speculating over whether the problem was fixed. “Why We Could Easily Have Another Flash Crash” was an actual headline in 2013 that summed up the general mood.[iii]
After its Q1 GDP slip, the eurozone fell into a “double-dip” recession, i.e., when GDP contracts for at least two consecutive quarters following a short-lived recovery from an earlier recession. The GDP dip was widely expected, but it also seems to defy widely watched business surveys. However, seemingly contradictory datasets aren’t strange once you look under the hood—a big reason why we think digging into the data can be worthwhile for investors.
Of the eurozone’s four largest economies, only France (0.4% q/q) grew in Q1.[i] Italy (-0.4% q/q), Spain (-0.5% q/q) and Germany (-1.7% q/q) contracted, contributing to the eurozone’s -0.6% q/q decline.[ii] The results didn’t surprise experts, many of whom rationally noted that ongoing lockdowns drove down eurozone output in the quarter. See Germany, where COVID restrictions persisted in Q1 and may linger until the end of May or mid-June. That is a stark contrast with America, where states began easing restrictions in early March.
Astute data observers may notice a seeming contradiction in this contraction: Why was GDP so weak even as business surveys reported growth? Take Germany, whose IHS Markit Composite Purchasing Managers’ Index (PMI) registered 50.8, 51.0, and 57.3 in January, February and March, respectively.[iii] A Composite PMI combines output from both the services and manufacturing sectors, and readings above 50 imply expansion. Yet German GDP’s quarterly decline was sharpest among major eurozone economies.
Timber! Well, lumber to be precise. That is what businesses are in short supply of, along with semiconductors, copper and steel. With supply down and prices up, pundits globally are increasingly worried that the recovery from lockdowns is at risk. Demand may be hopping, but they warn that is no help if factories and builders can’t make enough gadgets and structures to meet it. We agree there are some challenges ahead, but a little perspective is in order. While this may present some headwinds to select areas of the economy, it seems overstated as a macroeconomic headwind. It is also well-known to stocks, sapping surprise power.
Yes, it is true that if businesses can’t make things, people can’t buy them. Since the US calculates GDP by adding up all transactions in the public and private sector, when people can’t buy stuff, it detracts from growth.[i] That is well-known math. But the keyword there is stuff. The US economy actually isn’t heavy on stuff—services accounts for the lion’s share of economic activity. In 2019, the last full year before lockdowns skewed the picture, sales of (or investment in) physical objects totaled 33.6% of GDP.[ii] That includes consumer spending on goods, residential real estate investment, commercial real estate investment and business investment in equipment—all things that, to varying degrees, might incorporate lumber, steel, copper or computer chips. Even last year, when goods consumption rose as GDP fell, the “stuff economy” was only 34.9% of GDP.[iii] So right off the bat, just one-third of GDP, give or take, is directly vulnerable to shortages.
Then too, “shortage” is not synonymous with “none.” Semiconductor foundries are still running flat-out, especially now that the Renesas plant shut down by a fire last month in Japan is back online. It should be at full capacity in July, according to the company’s estimates. Blast furnaces, copper mines and saw mills are also chugging away. Now, current capacity isn’t enough to satisfy demand, but that doesn’t mean production of physical goods and structures grinds to a halt. Instead, it means producers compete for a limited supply. Purchasing managers will have their work cut out for them as they navigate price increases and negotiate with vendors—vendors who are trying to juggle an entire roster of demanding clients. That means, for the time being, there will be winners and losers at the industry and company levels.
May is off and running, and in a fresh and somewhat sensible twist, the vast majority of this week’s financial commentary does not think you should sell in May and go away until a certain British horse race or Halloween, depending on your preferred version of that old investing adage. We agree! But a quick exploration of why pundits aren’t all aboard the Sell in May train this year is telling about sentiment.
Much of this year’s Sell in May commentary didn’t outright dismiss the age-old myth, which states investors are best off skipping the summer months. The adage began life as a snappy saying that referred to old British traders’ penchant for taking the summer off until the mid-September St. Leger Day horse race, leaving liquidity low and making it appear beneficial to simply sit out the season.[i] Then as the years went by and the six-month stretch from April 30 to October 31 delivered weaker average returns than its opposite six months, “weaker” incorrectly became synonymous with “bad,” and Sell in May became all about trying to avoid a pullback.
Now, the full range of S&P 500 data, which stretches back to 1925, shows this is a terrible idea. The six months from April 30 to Halloween have delivered positive returns in 69 of 95 years, a 73% frequency of positivity.[ii] Its 4.3% average return may not sound astronomical, but it compounds over time, and if you don’t capture it, you miss a big chunk of stocks’ long-term returns.[iii]
GDP is within spitting distance of its pre-pandemic level after the Bureau of Economic Analysis reported initial Q1 growth estimates yesterday. With economic activity now a hair’s breadth from its high, what should investors expect going forward? In our view, a likely return to more normal growth rates.
With GDP’s 6.4% annualized Q1 surge, it is now just -0.9% below its Q4 2019 peak.[i] Since Q2 2020’s lockdown-driven depths, when GDP stood -10.1% below that peak after two successive declines, consumer spending has unsurprisingly led growth as America reopens. This remained true in Q1, with overall personal consumption expenditures (PCE) up 10.7% annualized, leading all major categories.[ii]
But growth in PCE—the lion’s share of GDP—hasn’t been uniform. Services PCE growth, notably, continues to lag. It grew only 4.6% annualized in Q1 versus goods PCE’s 23.6%.[iii] This is because demand for services is generally more “inelastic” than demand for goods, which is econo-jargon for less sensitive to economic trends. While some services—say travel and entertainment—are discretionary, most aren’t. Think: many healthcare expenditures, insurance payments, monthly utilities and rent. As Exhibit 1 shows, whereas goods PCE is now 12.5% above its pre-pandemic high, services PCE remains -5.7% below.
Some widely watched business surveys hit record highs in April, generating plenty of headlines. However, we think the more interesting takeaway was the overall optimistic reaction to the readings—rational, though a sign the bull market is a step closer to euphoria. That makes tracking sentiment’s evolution critical going forward—and one way investors can do that is through monitoring what pundits and analysts say (and don’t say) about economic data.
Purchasing managers’ indexes (PMIs) are monthly surveys measuring the percentage of businesses reporting increased activity, with readings above 50 implying expansion. Preliminary (or “flash”) readings represent about 80% - 90% of total responses and are the timeliest economic reading out there. IHS Markit’s April flash PMIs for several major developed economies broadly improved on March. (Exhibit 1)
Exhibit 1: Developed Economies’ Recent PMIs
In just four short months, big headlines have barraged investors. The year began with the Georgia runoffs and Capitol insurrection, stirring political fears galore. Then came COVID waves, variants and Europe’s vaccine hiccups. The GameStop trading frenzy. Last month’s Archegos hedge fund collapse. Interest rates’ surge. Tax hike fears. The jam-packed news cycle may give you the impression markets have been unusually rocky these last few months. But no. Rather than outsized volatility, stocks have kept their cool—a timely reminder for investors to tune down attention-grabbing events, in our view.
In terms of daily stock swings, 2021 has been relatively calm. Since 1928, when daily data begin, the S&P 500 has moved up or down by 1% or more on 34% of trading days.[i] In 2021 so far? Just 30%, or 24, with only 3 daily moves bigger than 2% (up or down), far lower than the historical average of 11%. No daily percentage swing has exceeded 3% up or down this year. Globally, a similar story holds. For the MSCI World Index, daily moves of 1% or greater in either direction occur 23% of the time since daily data start in 1980. That is a right around this year’s 22% (17 days), but this year has seen far fewer days swinging more than 2%.[ii] There have been just two.
Perhaps even more tellingly, most of those bigger daily moves have been up. Big down days—more than -1% declines—have been notably absent. Only 9 daily S&P 500 declines have exceeded -1% this year—11% of trading days, below the 17% historical average.[iii] For MSCI World, there have just been 6 to date in 2021, or 8% of trading days.[iv] The average is 11%.