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.
Editors' note: MarketMinder does not recommend individual securities. The below simply represent a broader theme we wish to highlight.
As March 29—the UK’s theoretical EU departure date—approaches, it remains unclear what shape the UK and EU’s future relationship will take. After Parliament voted down Prime Minister Theresa May’s initial proposal last week, she returned Monday with a three-pronged “Plan B,” vowing to renegotiate the Irish backstop, increase protections for workers and give Parliament more input in an EU trade deal. Parliament is scheduled to vote on this next week, and MPs are racing to tack on amendments that could delay Brexit or torpedo it altogether. So it is an understatement to say a wide range of outcomes remains possible—prolonging Brexit uncertainty. But while media frequently portray businesses as sitting on their hands hoping catastrophe won’t strike, recent earnings calls suggest they have contingency plans to minimize disruption to normal operations—no matter Brexit’s eventual form.
Brexit may be a unique challenge, but coping with such challenges is what businesses do. They can’t afford to be passive—planning and preparing for the future is critical for survival. This includes anticipating the effects of government policy, then identifying and innovating around potential hurdles. Success isn’t guaranteed and surprises are possible, but Brexit isn’t exactly sneaking up. Brits voted to leave the EU over two and a half years ago—a long time for firms to map out scenarios and contingency plans. Recent earnings call comments show many have done just that.
As folks fret the lack of official data due to the government shutdown, we already have some compelling evidence the US ended 2018 on a growthy note—thanks to the Institute for Supply Management’s (ISM) December manufacturing and non-manufacturing purchasing managers’ indexes (PMIs). Both were in expansionary territory: 54.1 for manufacturing and 57.6 for non-manufacturing. Yet many headlines glossed over this. They instead highlighted December’s relatively weaker readings and fretted their future implications. In our view, this misperceives how PMIs work—an example of dour sentiment clouding folks’ view of positive data.
PMIs are monthly business surveys that track economic activity across various sectors. Businesses report activity in categories ranging from new orders and employment to inventories and prices. PMI aggregators then crunch the numbers to determine how many respondents grew, how many contracted and how many reported no change. Generally speaking, readings above 50 mean more firms expanded; readings below 50 mean more firms contracted. Hence, over 50 implies broad growth, while under 50 suggests contraction.
This quick glance at business activity has limitations. PMIs indicate only the breadth of growth, not the magnitude. As surveys, they are technically opinions and lack the nitty-gritty detail “hard” data provide—so they don’t have a one-to-one relationship with GDP. However, they provide a handy snapshot of the economy, and December’s numbers confirm 2018’s snapshot was expansionary.
When markets swing, we often warn readers of the cost of trying to time corrections—sharp, sentiment-driven stock market drops, usually of -10% to -20% or so. Human nature often drives investors to want to flee stocks at the exact moments market history shows they are far better off holding—or even buying. “Don’t time corrections” is an easy message to swallow when stocks are doing fine, but it is a very tough sell in real time. When stocks fall fast, getting on the sidelines can feel better. But it can also lead to missing big upside when stocks recover, setting you back from your long-term goals.
It is an unfortunate truth that market movement drives many investors’ decision-making. Fund flows are an imperfect measure, but they do suggest many folks buy after stocks rise and sell after they fall. That certainly appeared to be the case last year. The S&P 500 had two corrections—one in winter, one in autumn. The first was basically a double-bottom correction, reaching its low on February 9 and retesting it on March 23. As Exhibit 1 shows, equity fund outflows spiked both times. In March, they continued even after stocks began recovering. That same mentality showed up—on steroids—in December, as US stocks dealt with their second, much sharper correction. Stock fund flows turned negative in December’s second week, when the selloff started in earnest. They bottomed out the week ending December 28, a period including the Christmas Eve low and a big December 26 rally. And they continued the following week, even as stocks rebounded. People were responding to what just happened in the market, presuming it would continue and snowball. But by trying to steel themselves against what just happened, they took themselves out of the running to capitalize on what was to come.
Exhibit 1: US Equity Mutual Fund and ETF Flows
To sum up the UK’s last two days, everything and nothing happened. Yes, UK Prime Minister Theresa May’s controversial Brexit deal bombed in Parliament on Monday, losing by over 200 votes. Then the opposition Labour Party’s leader, Jeremy Corbyn, tabled the obligatory no-confidence motion in May’s government, threatening to bring her down and force new elections. But surprising no one, her party and its Northern Irish allies didn’t want to do anything that could lead to Corbyn taking power, and Parliament voted 325 – 306 to keep May around. So after two days of political theatrics, nothing has changed. A deal no one expected to pass didn’t pass. A PM everyone expected to remain in office remains in office. And still no one knows what Brexit will look like. Our opinion also remains unchanged: Simply getting on with Brexit, whenever that happens and whatever it looks like, should end the uncertainty that has held back risk-taking and investment, enabling investors and stocks to get over it and get on with life.
Officially, May’s next step is to talk with other party leaders and figure out a Brexit compromise Parliament and the EU will support. She has three working days to create this Plan B, which she must present to Parliament on Monday. We suspect she will take advantage of EU leaders’ tendency to hold emergency talks on weekends in order to get their agreement on something by her deadline.
What that “something” will be is far from clear. Labour is as divided over Brexit as the Conservatives are. The party’s anti-Brexit grass roots and (Tony) Blair-ite wing mostly prefer a second referendum. A few dozen other Labour MPs reportedly prefer a deal similar to Norway’s arrangement with the EU, which the Scottish National Party may also support. Corbyn’s own opinion on Brexit is an enigma wrapped in a mystery locked in a box and buried underground. He has proposed a permanent bespoke customs arrangement between the EU and UK, but whether the EU would bless a customs union that would also satisfy the Conservative Party’s arch Brexit supporters, who want national sovereignty over free trade and regulatory policy, is another matter. And then, of course, there is the matter of the Irish backstop, which kept a large swath of May’s party from supporting her Brexit deal. Looming over everything is March 29, the day Brexit is supposed to take effect. May hasn’t ruled out delaying this, and some of her cabinet members have said it is a possibility. Though, this would depend on the EU agreeing to an extension beyond the two-year exit process stipulated in Article 50 of the EU Treaty.
Last year’s yield curve fears centered on some segments of the yield curve we find arbitrary and meaningless—the 10-year minus 2-year, 5-year minus 2-year and 5-year minus 3-year spreads. Because banks generally don’t fund themselves at 2 or 3-year rates, none of these gauges correspond to banks’ business models or propensity to lend. But this year, commentary has started shifting to a more meaningful yield spread—the 10-year minus 3-month—which is near its flattest point of this economic expansion. The question on folks’ minds: Will it invert soon, and if so, do dark times lie immediately ahead?
The yield curve is one of the most telling economic indicators on the planet. It influences and predicts loan growth, because banks borrow at short-term interest rates and lend at long-term rates. If it is positive, with long rates above short, then lending is profitable, incentivizing banks to funnel capital to businesses and households. If it is inverted, with short rates above long rates, then banks’ funding costs exceed potential loan revenues, rendering lending unprofitable. If the yield curve stays inverted for long enough, it can cause credit to freeze, starving businesses of the capital they need to expand.
Yet none of this means the yield curve is a timing tool—especially not any single country’s yield curve, even a country as big as America. While an inverted yield curve has preceded every US recession in modern history, there is usually a lag between inversion and recession. As Exhibit 1 shows, there were even four times where the yield curve inverted without a bear market beginning within the next 12 months. On these occasions, selling stocks when the yield curve inverted would have led to missing out on some occasionally big returns.
In this episode, Client Communications Group Vice President Naj Srinivas speaks with Fisher Investments’ founder, Executive Chairman and Co-Chief Investment Officer Ken Fisher about 2018’s end-of-year volatility and his market forecast for 2019.
Reading financial media lately, you might get the impression the global economy is grinding to a halt, hamstrung by a lack of bank liquidity that is starving businesses of funding. The coverage implies a global credit freeze is underway. Yet the data don’t agree.
Exhibits 1 and 2 show loan and money supply growth for all nations in the MSCI All-Country World Index on a GDP-weighted basis. Despite its name, this gauge doesn’t include every nation on earth—just those classified as developed or emerging by MSCI. However, the 47 nations it presently covers amount to the vast majority of global GDP. Each country’s lending and money supply are weighted according to the country’s share of collective GDP, making the result a reasonable proxy of global lending and money growth. As you will see, while both measures have slowed in recent years, they remain at quite healthy rates. Global lending has risen 6.0% y/y or higher every month since October 2014. M2, which is the broadest measure of money available from all these countries, has slowed, but it remains robust—5.9% y/y in November. These figures are consistent with a growing, thriving global economy—not frozen credit markets. With few folks fathoming capital flowing to businesses and households, the stage seems set for positive surprise.
Exhibit 1: Global GDP-Weighted Loan Growth
Whether stocks are in a correction or bear market, the downturn’s final throes usually have a few common features. Often, they are steep, with end-of-the-world type stories everywhere in financial media. That backdrop, combined with seemingly erratic daily index movement, spooks investors out of the market. To use a bit of jargon, they capitulate to negativity and throw in the towel. Usually, that exodus happens very near the bottom.
Stock mutual fund flows are one, albeit imperfect, way to see this. They aren’t airtight, as they show you only one half of a decision. We can see people selling mutual funds, but we can’t see what they did with the proceeds. For this reason, run-of-the-mill fund outflows tell you very little about market sentiment. However, extremes can. And in December, extreme they were. Stock mutual fund outflows as a percentage of funds’ assets under management were on par with outflows in March 2009—the bottom of the bear market that accompanied the Global Financial Crisis. The only larger months were September 2001 (the 9/11 attacks), July 2002 (when Sarbanes-Oxley passed) and September and October 2008 (Lehman Brothers’ bankruptcy and the Fed and Treasury’s subsequent dismantling of Wall Street).
In other words, retail investors were acting like this is a major bear market or financial crisis. Yet that sentiment isn’t at all consistent with the economic landscape. Unlike 2001, 2008 and 2009, there is no recession—and there is little sign one lurks, based on the US Leading Economic Index’s continued long uptrend. Major, disruptive legislation on par with Sarbanes-Oxley isn’t on the horizon—a government that is one day from achieving history’s longest shutdown isn’t exactly the type to agree on sweeping change. Meanwhile, as of Thursday’s close, the S&P 500 was more than 10% above its Christmas Eve low, whipsawing those who capitulated.[i] Short-term volatility is impossible to predict, and it is possible some new scare story could send stocks careening back down for a bit. But absent that, it seems to us that spiking fund flows once again signaled a good time to buy, rather than a good time to sell.
In this episode, Client Communications Group Vice President Naj Srinivas speaks with Fisher Investments’ founder, Executive Chairman and Co-Chief Investment Officer Ken Fisher about bear markets, how they begin, their anatomy and timing. Recorded October 8, 2018.
The partial US government shutdown notched its 17th day Monday, officially tying 1978’s shutdown as history’s second-longest. It is also currently history’s most bullish shutdown, with a 5.5% S&P 500 return since December 21, the last trading day before the government closed.[i] And if it lasts until the weekend, it will surpass the 1995 – 1996 shutdown to claim the title of history’s longest. Exhibit 1 has the full leaderboard, in chronological order, and following it are some thoughts on a few shutdown-related news items.
Exhibit 1: US Stock Returns Surrounding Government Shutdowns