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.

Germany and the UK Take Europe's Political Spotlight

As the dust settled on Italy’s coalition government theatrics in recent days, two new political dust-ups took their place in the headlines. German Chancellor Angela Merkel and UK Prime Minister Theresa May are both fighting for their political survival this month, with their governments seemingly hanging by a thread. Some speculate both leaders could be out of a job within the next couple weeks. We won’t speculate on that potential outcome, as governments’ wheelings and dealings aren’t a market function. However, we do think it is worth noting that in both nations, these sagas are emblematic of political gridlock, which is generally positive for markets. The latest events might heighten uncertainty in the near term, but regardless of how they pan out, both nations likely continue to have governments with limited political capital, internal divisions and little chance of passing radical legislation. Overall and on average, we think stocks in both nations should benefit from this low legislative risk.

On the whole, we don’t find it terribly surprising that either leader is hanging by her fingernails. May heads up a minority government, and her Conservative Party is sharply divided between lawmakers for and against Brexit. The issue that threatens to topple her—an amendment to the EU Withdrawal Bill that could allow MPs to bind the government’s hands in Brexit talks—cut right to the heart of this internal split. Merkel, who heads a fractious coalition, is similarly confronting a long-simmering issue: migration. But the split isn’t between her Christian Democratic Union (CDU) and its coalition partner, the Social Democratic Party. Rather, it is between the CDU and its sister party, the Christian Social Union (CSU), which represents the center-right in Bavaria, and a disagreement over whether to start turning away some migrants at the border. This issue threatened to split the CDU/CSU alliance over the weekend, though Merkel and CSU leader Horst Seehofer bought some time Monday by agreeing to spend two weeks seeking a compromise. Meanwhile, May faces her next crucial parliamentary test on Wednesday.

While the political tensions in both countries are rather acute these days, they don’t represent big changes from the status quo. May hasn’t been able to pass much since emerging from last year’s snap election with no majority, and she has already been defeated on Brexit-related legislation. Merkel has been similarly hamstrung, both in her current government’s short, 100-day lifespan and its prior term, which ran from September 2013 – September 2017. If both leaders hang on, the current gridlock continues. If May were to lose her leadership position, she could be replaced by a new Conservative Party leader who faces the same challenges as her, extending the pre-existing gridlock while putting a new face to it. Meanwhile, if Seehofer pulls the CSU out of government, Merkel could try to win parliamentary backing for a minority government—more gridlock. Or, either (or both) nations could hold snap elections, which polls indicate would stand a high likelihood of producing hung parliaments—again, more gridlock.

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A Primer on Political Risk

Editors’ note: The following commentary is intended to be nonpartisan. We favor no party, politician or candidate, and believe partisan thinking is dangerous for investors.

When you hear the words, “political risk,” what springs to mind? The risk the other guy or gal beats your favored candidate? Or perhaps the risk the latter wins, only to U-turn on campaign trail promises once in office? Voters face these risks every election—and the fact they frequently come true makes many understandably cynical about the whole enterprise. But for investors, “political risk” means something very different: the risk political forces threaten economic growth and roil markets. Alongside investor sentiment and economic fundamentals, politics is one of stock prices’ three broad drivers. Understanding what political risk is—and isn’t—may help you better size up risks and opportunities in the US and other developed markets. Particularly as US midterms approach and campaign rhetoric heats up, a few pointers may come in handy.

Clearing up some common misconceptions is a good spot to begin, so here is what political risk isn’t. For starters, that post-election policy switcheroo (or compromise) habit mentioned above—it may be frustrating, but it often benefits markets, as it means less radical legislation passes. A certain party winning doesn’t constitute political risk, either. While many associate their preferred party with endless prosperity and the other with certain doom, history shows no party or politician is inherently good or bad for stocks or the economy. Republicans and Democrats alike have presided over bull and bear markets, recessions, recoveries and expansions. There isn’t a meaningful statistical connection between party leadership and market performance in the US or other large democracies. The reason: Policies matter, not politicians—and even policies are just one ingredient in the enormous, complex stew of information stocks process.

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Why Inflation Doesn’t Seem Set to Zoom

Is inflation stalking the US economy? The data seem to hint as much: On a year-over-year basis, the Consumer Price Index (CPI) has now risen each month this year, from December’s 2.1% y/y to May’s 2.7%. Core CPI (which excludes the volatile food and energy categories) has done the same, ticking up from 1.8% y/y in December to 2.2% in May. Meanwhile, a big May bump in businesses’ input costs (3.1% y/y versus 2.6% in April)—the highest year-over-year reading in nearly six and a half years—has fueled fears higher prices haven’t finished rippling through the economy, stinging consumers and potentially forcing the Fed to further raise interest rates and cool the expansion. Sure enough, the Fed hiked rates in its Wednesday meeting—perhaps a sign they are “preparing to take the gloves off in [their] fight against accelerating inflation.” But examining where inflation actually comes from suggests surging prices aren’t about to loom over markets.

Underlying current fears is a theory called “cost-push” inflation—the idea higher commodity and other input costs (including trade tariffs) eventually lead companies to raise prices on final products—voilà, inflation. But this logic presumes firms can set prices wherever they like while consumers merely grumble and pay up. This is characteristic of monopolies, not competitive markets with an abundance of sellers battling it out on (among other things) price—which describes the vast majority of the US economy presently. Overwhelmingly, supply and demand in the end market rule, with prices fluctuating primarily based on what consumers are willing and able to pay. Moreover, if businesses could raise prices at will, why would they bother waiting for higher input costs to do so?

Of course, some companies do pass on higher prices to consumers—when the market allows it. This frequently garners headlines—like when popular fast food chains whose names sound kind of like BrickDonald’s and Flipotle announce higher costs are forcing price increases. This may make folks a little hangry, but it isn’t inflation. Higher prices on select goods isn’t the same as a broad price increase across the entire economy. Spotlighting price-hikers can be misleading, too, as in any month, some prices rise as others fall. For example, those on household furnishings and used cars fell in May—but that isn’t deflation, any more than May’s rising medical care, tobacco and new car prices is inflation. Plus, about 60% of the CPI basket is services, which are less vulnerable to rising input costs. Truckloads of raw materials aren’t necessary to prepare taxes or cut hair.

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Neurosis Is Killing Your Returns!

When it comes to achieving the stock market’s long-term return, everyone pays. But you have a choice in how to remunerate. When turbulence hits you can either tough it out (a psychological cost), or you can hedge, trade or take some other action (an explicit cost).

The former (again, for long-term investing) is difficult to do but, in my view, optimal for your financial well-being. The second is flat-out neurotic and takes a good solid whack out of your future compounded returns.

Neurosis is common as air in humans—it is the anxiety-based, stress-induced, often compulsive counterproductive behavior manifesting from the inability to cope with one’s environment. That is about as spot-on a definition for malapropos investing activity as I can conjure. But, for whatever reason, when we study economics and finance we feel forced to use terms like “myopic loss aversion” when simple neurosis will do.

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A Seldom-Discussed Perspective on US Debt

We have seen plenty of chatter about US debt lately, with most attention on an allegedly over-indebted US government and corporations. In our view, much of the commentary fails to consider the issue properly. Pundits usually focus on the absolute level of debt, getting hung up on big numbers. But debt doesn’t exist in a vacuum. Most entities—governments, households, companies—have assets as well as liabilities. As a result, we think the most illuminating way to view debt is by looking at the entire nation’s balance sheet. Our founder and Executive Chairman, Ken Fisher, shared this concept in his 2006 book, The Only Three Questions That Count, presenting an aggregate hard balance sheet of all US assets and liabilities. Of course, in the intervening 12 years, America has tacked on nearly $12 trillion more net public debt and almost $9 trillion more corporate debt. So how does the balance sheet look now?

As Exhibit 1 shows, it still looks great. America’s total assets still dwarf total debt, and total net worth has grown from about $60 trillion then to over $108 trillion now. (In this calculation, checking and savings accounts count as liabilities as they are technically considered bank debt.) The debt-to-equity ratio (debt divided by net worth), 82%, is down a hair from 2006’s 83%. GDP divided by total assets—a quick and dirty way to measure return on assets—is about 10%, far above prevailing interest rates. As Ken wrote in 2006, if return on assets beats borrowing costs, that is a strong indication debt isn’t too high. The government, households and businesses alike have plenty of bandwidth. Now, that doesn’t mean we advocate American businesses, consumers and the government ratchet up debt and spend like the proverbial drunken sailor. Just a way to say that this likely isn’t a crisis brewing.

Exhibit 1: A Complete Look at America’s Assets and Liabilities

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North Korea Is a Long Way From 'Land of Opportunity'

President Trump and North Korean despot Kim Jong-un officially made nicey-nice at Tuesday’s summit, pledging “joint efforts to build a lasting and stable peace regime on the Korean peninsula” and making symbolic gestures to denuclearization and pressing pause on US/South Korean “war games.” While foreign policy wonks, Twitter and body language experts immediately went into full-on dissection mode, investors began salivating over the prospect of a newly open North Korean economy, full of natural resources and development opportunities to exploit. Some investors have already made plays on this thesis, sending some South Korean Industrials firms sky-high this year in anticipation of their winning North Korean contracts. As ever, we would implore readers to cool their jets and remember investing isn’t a get-rich-quick scheme. North Korea may eventually open up and yield actual investing opportunities, but this is probably a long, long, long way off.

Investors’ enthusiasm seems concentrated in two main areas: infrastructure development and North Korea’s vast reserves of rare earths and other natural resources. But there are about a bazillion obstacles standing in the way of these. Not least of all: North Korea is still communist. Most workers don’t earn money, getting by instead on bartering. As The Telegraph explained today: “For the most part workers do not receive wages. Instead, payment in kind is made - if there is any payment at all. It is therefore, by in-large, a barter economy with huge levels of bonded labour. Put another way: swathes of the population are thought to be enslaved in addition to being generally oppressed and are likely to have to trade foods, fabric or coal, in order to get by.” Due to this system and the general ravages of communism, most of the population outside of Pyongyang is malnourished (or toiling away in a gulag) and undereducated. Meanwhile, the country has nothing resembling modern capital markets—no modern monetary system, no national banking network and very few foreign capital links. In short, North Korea is short on the main ingredients of economic growth: human capital, technology, capital and productivity. They have a lot of catching up to do.

As you might imagine, North Korea also lacks a stock market. The only way to “invest” there would be to invest in listed foreign companies that win contracts there—which explains the big run-up in all those South Korean firms. We suspect said run-up is a strong indication that these seemingly breaking developments in the North are already priced in. Moreover, these are all speculative bets, in our view—investors today are just guessing which firms might eventually win contracts if Trump and Kim strike a bigger deal someday. This is all terra incognita and not a market function, making it impossible to assess actual probabilities. We think probabilities are a much sounder basis for investment decisions.

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Wild Week for Trade Produces Tame Result

Over the last several days, a seeming barrage of tariffs and counter-tariffs, threats and retorts, announcements and (we guess) counter-announcements between the US and other countries have seemingly whipped financial media into a trade frenzy. Coverage almost universally characterizes the back-and-forth as a trade war—now a global one. The World Bank piled on, issuing a report on Tuesday warning escalation could sink global trade on par with its fall during the financial crisis.[i] Doomsayers are having a field day. But the moves that sparked this furor don’t live up to the hype, in our view, and a full-blown trade war with the power to end this bull market remains a distant hypothetical.

Let’s take a short (but scenic) walk down Trade Memory Lane, starting 10 days ago. On May 29, the Trump administration announced it planned to slap previously threatened tariffs on $50 billion worth of Chinese goods, with the final list due on June 15. (These same tariffs were supposedly canceled, according to Treasury Secretary Steve Mnuchin eight days prior.) But Tuesday, everyone’s favorite “unnamed sources” claimed China offered to buy almost $70 billion more US goods—narrowing the US’s trade deficit with China, a Trump administration goal—if the US doesn’t impose the aforementioned tariffs. Maybe this sways US negotiators, maybe not. Two days later, the Commerce Department announced a settlement with Chinese smartphone company ZTE over its violation of US sanctions on Iran and North Korea. ZTE will pay a $1 billion fine and let US regulators monitor its operations from within. In exchange (and on condition of good behavior), ZTE will escape a seven-year ban on doing business with American suppliers. While this may resolve one dispute, it shows the US flexing its trade policy muscles. And the saga may not be over, as Congress swiftly introduced a bill to block the deal. Meanwhile, trade negotiations with American allies soured. Last Thursday, the US removed exemptions on steel and aluminum tariffs for Canada, Mexico and the EU, ending their two-month reprieve following the tariffs’ inception in April. Responses were rapid. Canada immediately announced “dollar-for-dollar” tariffs of 10 – 25% on up to $12.8 billion worth of imported American steel, aluminum and other goods.[ii] Mexico followed on Tuesday with 15 – 25% tariffs on about $3 billion worth of assorted American products like pork, cheese and bourbon. That same day, Larry Kudlow (the President’s chief economic adviser) suggested the Administration may prefer killing NAFTA and replacing it with bilateral deals with Canada and Mexico (a comment Trump more or less echoed Friday).

The action-packed week continued Wednesday, when the EU announced it is planning 25% levies on $3.4 billion of to-be-determined American imports. These (and the Canadian duties) would take effect July 1. Stateside, a Republican senator introduced a bill requiring Congressional approval for any tariffs proposed on national security grounds, including those imposed in the last two years (e.g., the steel and aluminum levies). It isn’t clear how the bill will fare—a similar one introduced in early 2017 stalled in committee.

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Don't Overrate the Eurozone Slowdown

IHS Markit’s eurozone Purchasing Managers’ Indexes (PMIs) ticked down and missed expectations in May—building on a trend dating back to February. Q1 2018 GDP growth slowed, as did April retail sales, which also missed expectations.[i] These slowing data—combined with fear surrounding Italian politics—lead many to believe the eurozone is weakening. Possibly even sliding toward recession! Last year’s acceleration? A pipe dream, they claim. Hence, sentiment tallies like ZEW’s surveys are plunging and the financial media is full of fearful headlines. In our view, this is overwrought. The negative reaction to expansionary data shows investor sentiment remains overly dour towards the eurozone—typically a bullish cocktail.

Exhibit 1: Eurozone Composite PMI Dips


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US Sports Betting Probably Isn’t the Next Great Investment Opportunity

In recent years, some investors have been hot to trot for an early play on the supposed next big thing. 3D printing, artificial intelligence, anything blockchain-related and marijuana firms have all taken turns in the spotlight. The latest supposed darling? Sports betting, thanks to a recent Supreme Court decision enabling states to legally offer sports betting, if they so choose. Previously, betting was legal only in Nevada. Investors seem excited about the potential for the estimated $150 billion illegally wagered on sports to turn into legitimate corporate income, and they are focusing most on established European gambling companies that could capitalize. As with marijuana-related firms, however, investors eyeing this space are probably getting too far ahead of themselves.

Some big European gambling firms have made inroads into the American market via mergers and acquisitions in recent years, presumably positioning them well to take advantage of the Supreme Court’s decision. However, it is far from certain they will be able to partner with casinos and participate in a sophisticated online betting market, which seems to be what eager investors hope for. The terms of potential agreements are unknown today, and any participation would be subject to state regulators’ whims. Other unknowns include taxation, so-called “integrity fees” paid to the sports leagues, revenue-sharing agreements with Native American tribes running casinos in states that don’t otherwise permit gaming, and whether any and all states will even choose to legalize sports betting. It will take significant time to work through all these issues and it is impossible to know today how profitable this endeavor would be for European firms trying to get in on the action. They may end up upstaged by players investors can’t fathom entering the market today. Or regional US casinos could end up best-positioned to open up sports betting, especially if states limit where betting can occur.

Markets move most on the gap between reality and expectations over the next 3 – 30 months, and it seems fair to say expectations for gambling firms are quite high right now. Investors excited over this seem to be broadly ignoring the regulatory headwinds and potential progress’s likely glacial pace. Meanwhile, in addition to the structural headwinds, cyclical factors likely work against them for the foreseeable future. These European gambling outfits are all small companies, and small cap tends to underperform in maturing bull markets—a time when investors typically gravitate to the largest global firms with the most diverse revenue streams and the most familiar brand names. They are also in the Consumer Discretionary sector, which tends to do best earlier in bull markets due to the sector’s heightened economic sensitivity. Staples usually have an edge in the world of Consumer stocks late in a bull.

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Social Security Is Still Pretty Secure

Welp, here we go: According to the latest Social Security Trustees Report, out today, benefit payments will exceed receipts this year, forcing the program to draw from the trust fund for the first time since 1982. The trustees’ number-crunchers anticipate the trust will be empty by 2034, a year sooner than last year’s report projected, forcing widespread benefits cuts (and presumably the end of American civilization as we know it). Before you sound the alarm, however, we think it is worthwhile to look back at 1982 in detail. The history surrounding Social Security’s “crisis” then, in our view, shows why fears of its demise are likely far-fetched today.

Back in the go-go 1950s and 1960s, lawmakers’ favorite election-year trick was to ramp up Social Security benefits. The last of these, passed in 1972, included an unfortunate mathematical error when Congress introduced cost-of-living adjustments (COLA), which resulted in that decade’s inflation bringing unsustainably generous benefits. Congress patched that problem in 1977, but the damage was already done, and Social Security entered the 1980s in dire straits.[i] With the economy tipping into recession yet again, the 1980 Trustees Report’s projections looked bleak. The “optimistic” scenario, which presumed a short, partial-year recession in late 1980 and quick recovery, showed the Old Age and Survivors Insurance Trust (OASI)—what we commonly call the Social Security Trust Fund—depleting by 1982. The “pessimistic” scenario, which assumed a longer recession, showed OASI depleted by 1981 and never recovering. (Though the economic forecast here came closer to reality, obviously we still have Social Security.) Combining it with the Disability Insurance Trust (DI)—not permissible under then-current laws—was suggested as a way to delay the pain somewhat, but not avoid the depletion the Trustees thought inevitable.

Hence, during the Reagan Administration’s early years, Social Security was a hot-button issue. If you have a New York Times subscription, you might enjoy using the “Times Machine” feature to dig up coverage of the standoff between Reagan and then-House Speaker Tip O’Neill, as well as fear-mongering from the likes of Peter G. Peterson, then the leader of the Social Security panic bandwagon. Though his infamous warning about insolvent Social Security appeared in The New York Review of Books, the Times referenced it, highlighting his warning that preserving Social Security benefits in the long run would require 44% of Americans’ taxable pay to go to the program. Your local paper’s archives may have similar articles.

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