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.

Trade Truce?

Did you hear? The US – China trade war is off! China agreed to improve intellectual property protections and buy an unspecified large amount of US-made goods, primarily from the agricultural arena, and both sides agreed not to pursue new tariffs at this time. That means the Trump administration’s tariffs on $50 billion of Chinese goods, China’s retaliatory tariffs on $50 billion of US goods, Trump’s mooted retaliation-to-the-retaliation of tariffs on $100 billion of additional Chinese goods, and China’s mooted retaliation-to-the-retaliation-to-the-retaliation of tariffs on $100 billion more US goods are all on ice. For now. Markets seem happy with this development, and far be it from us to quibble with a happy stock market. But this also strikes us as much ado about nothing—the “resolution” is as symbolic as the tariff threats were. China’s vague promises probably amount to very little actual change in bilateral trade. On the bright side, getting past the stalemate could give investors one less thing to worry about, perhaps lifting sentiment and helping folks move out of the correction mindset.

As Exhibit 1 shows, the direct impact of all tariffs adopted and threatened so far would have amounted to, at most, $53.44 billion, or just under 0.2% of combined US and China GDP. For the US alone, the impact would have been $40.2 billion. That sounds big, but in 2017 alone, nominal US GDP grew by $766.1 billion.[i] The new tariffs, on their own, would have been nowhere near enough to sink the US into recession. Not having them will be nice, but it isn’t some whopping positive—just the absence of a tiny potential negative folks have overrated for months.

Exhibit 1: Scaling the Tariffs

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Rhetoric Versus Reality on Prescription Drug Plans

Ever since the presidential campaign, President Trump’s rhetoric on drug prices and companies sparked fears of sweeping change potentially creating winners and losers in the Health Care sector, particularly the Pharmaceuticals industry. Trump has repeatedly said drug companies are “getting away with murder” and promised to bring prescription costs way down—perhaps by allowing Medicare to start negotiating drug prices with pharmaceutical companies or loosening rules on importing cheaper drugs. But after all the talk, hype and rumors, a May 11 Rose Garden announcement gave investors a lot more clarity on what the administration has in mind. Turns out, it isn’t much, and gridlock likely blocks most of it. This shows how campaign rhetoric is often far removed from actual policy—a typically bullish force. Big campaign promises spur fears of sweeping change, which a more moderate reality assuages.

If you haven’t gotten around to perusing the Department of Health and Human Services’(HHS) 44-page policy blueprint,[i] allow me to summarize its most important planks. The first addresses the issue of rebates, which Pharmacy Benefit Managers (PBMs) typically secure when negotiating drug prices with pharmaceutical companies on behalf of the health plans and patients they represent. Instead of reducing the drug’s list price, drug makers offer rebates to PBMs in order to get their products on PBMs’ “formulary lists,” which allow the relevant health plans to cover them. Terms differ among health plans, but industry groups estimate PBMs pass back approximately 90% of total rebate dollars to health plans and employers. Yet patients don’t always benefit directly, as surveys show health plans most often use the rebates to reduce their own costs. One study by the Drug Channels Institute found that just 15% of rebates end up offsetting patient premiums and out-of-pocket costs. As a result, PBMs take a lot of heat as “middlemen” driving consumer costs higher.

To address this, the plan would require PBMs to pass along at least one third of these rebates to Medicare Part D patients at the pharmacy counter. (Medicare Part D covers prescription drugs.) Some feared the plan would force PBMs to pass through all rebate dollars, so this is a relief for pharmacies as well as health insurers. Moreover, HHS can’t implement this without Congressional action—likely a major hurdle.

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This Week in US Data

While Americans spent this week obsessing over Saturday’s Royal Wedding and whether that soundbite said “Yanny” or “Laurel,” a healthy spate of US economic data hit the wires, giving some strong evidence that Q1’s economic slowdown was indeed a temporary soft patch. While past data aren’t predictive for forward-looking stocks, the latest roundup does suggest economic fundamentals remain quite nice and should keep supporting earnings and revenues.

The fun started Tuesday, when the Census Bureau released April’s retail sales results. Overall, sales rose 0.3% m/m, adding to March’s revised 0.8% increase. So for those keeping score, we had two nicely positive months follow three rocky ones, with the lean times concentrated in winter. While rising gas prices bear some of the responsibility for April’s rise, they don’t explain it. Even excluding the 0.8% month-over-month rise in gas station sales, total sales still rose 0.25%, a rounding error behind headline sales’ 0.298% rise. (Literally—both round to 0.3%.) Some coverage interpreted this as Americans finally spending their gains from tax cuts, but that seems a smidge overstated to us. As do worries about higher gas prices eventually cutting into spending—that presumes lower prices were huge stimulus. They weren’t. As Exhibit 1 shows, non-gas station sales growth didn’t change much after June 2014, when oil prices began their long, deep tumble. In our view, recent months’ growth is consistent with the long-term trend, which existed well before tax cuts, of spending inching up in sympathy with incomes.

Exhibit 1: Gas Prices Have Less Impact on Discretionary Spending Than Many Folks Think

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Italy's Populist Coalition Not as Populist as Feared

After weeks of negotiations and bizarre media leaks, Italy’s populist parties—the League and Five Star Movement (M5S) have an official deal. Sort of. Party leaders have agreed on a coalition plan, which they published for all to see, but rank-and-file party members could still upend it. Come Monday, Italy could have a government or fresh elections. But while uncertainty probably lingers as they deliberate and try to clear the final hurdles, a close look at the final plan shows Italy should avoid investors’ worst fear: a populist government dead-set on leaving the euro.

Despite that better-than-expected outcome, Italian stocks tumbled again Friday, and some parts of the plan have investors concerned. It contains an aggressive anti-immigration platform, including plans to deport nearly 500,000 recent immigrants. The budget also remains a source of worry, as it targets fiscal expansion that pushes up against the EU’s 3% deficit limit. Major provisions include a €780 monthly income for the poor—paid for by EU contributions to Italy’s budget—and a two-tier tax rate, with deductions. It also calls for the removal of EU sanctions against Russia and altering bank bailout rules to undo the late-2016 Monte Paschi bailout. Investors largely see all of these terms as confrontational with EU rules. At the same time, however, most of them were leaked in recent days and aren’t a big surprise, aside from the aggressive deportation plans.

At the same time, consider what isn’t in the plan. The provision in this week’s leaked draft calling for the ECB to forgive €250 billion in Italian debt was dropped. So was the call for a formal pathway to leave the euro. Additionally, there is no demand for a referendum on leaving the euro or EU. A populist-run government withdrawing Italy from the eurozone or EU was the biggest fear going into the election—now, markets can get over it. Dropping the debt clause is also a positive. Any time a government mentions messing with the sovereign debt market, even in a draft, it doesn’t instill bond market confidence. Silencing that talk, for now at least, should at least partially restore bond investors’ confidence.

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Australia’s Banking Royal Commission Has Takeaways for US Investors, Too

Conflicts of interest aren’t unique to any single country. (Photo by Greg Sullavan/iStock by Getty Images.)

Last month, the SEC announced the results of its long-awaited deliberations over whether to pursue a fiduciary standard for brokers, potentially bringing them under the stricter regulatory umbrella covering registered investment advisers (RIAs). The verdict: keep separate rules for investment sales (brokers) and service (RIAs), but strengthen the sales rules and make the line between the two stronger. Predictably, opinions about the effectiveness of this are split. Right now, supporters and opponents are filing public comments, which the SEC will then review and perhaps use as the basis for revisions before a final vote on the new standard. But while the debate continues, we think the latest happenings in Australia show why investors shouldn’t rely on rules alone—no matter how well-intended or carefully crafted—when evaluating an investment professional.

Australia’s financial system is under the microscope after a string of recent scandals prompted an official public inquiry into banking and financial service practices. This is being conducted by a Royal Commission, which tells you the extent of the problem once you know a little about how Australia and other Commonwealth nations work. Ordinarily, when evidence of wrongdoing surfaces, you might expect lawmakers to deal with it. But in certain situations, the government might deem the problem beyond the its resources—in other words, cabinet ministries and regulatory agencies might not have the manpower or clout necessary to investigate, ferret out all problems and recommend solutions. The Royal Commission—a public inquiry called by the head of state—is Australia’s solution. Prime Minister Malcom Turnbull called the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Banking Royal Commission, or BRC) last November, amid mounting public backlash over recent scandals and investigations into interest rate rigging and money laundering, as well as other alleged wrongdoing.

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Exports Couldn't Rescue Japanese Growth in Q1

As the sports world waits to see whether LeBron James’ consecutive NBA finals streak will hit eight years, another streak snapped this week: A preliminary estimate showed Q1 Japanese GDP fell -0.6% annualized, missing expectations for a milder -0.2% contraction and ending Japan’s run of consecutive positive quarters at eight (its longest in nearly three decades). The previous two quarters were also revised down, including Q4’s sharp downgrade from 1.6% annualized growth to 0.6%. While the poor showing doesn’t necessarily presage further weakness, it highlights Japan’s reliance on trade to make up for tepid domestic demand. This quarter, it couldn’t—evidence Japan’s largest exporters probably provide global investors more opportunities than domestically focused firms.

Trade was a lonely bright spot in Q1, but it still dimmed. Exports rose 2.6% annualized, a sharp deceleration from Q4’s 9.2% pace and Q3’s 8.2%. Imports—one marker of domestic demand—also slowed dramatically, rising just 1.2% annualized after notching 12.9% growth in Q4. Household spending and private nonresidential investment dipped, while overall domestic demand shrunk -0.9% annualized, its worst showing since Q4 2015. While these figures are subject to revision (either higher or lower), they indicate Japanese growth still mostly hinges on external demand. If exports falter—or domestic consumption has an especially bad quarter—headline growth probably struggles.

Exhibit 1: Ex. Exports, Japanese Growth Struggles

Source: Japan Cabinet Office, as of 5/16/2018. Japanese quarter-over-quarter annualized GDP growth with and without exports’ contribution, Q1 2016 – Q1 2018.

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Italy’s Populist Opera Probably Has a Familiar Ending

After more than two months, the antiestablishment Five Star Movement (M5S) and the far-right League look close to forming a populist ruling coalition in Italy, stirring concerns of future instability and uncertainty in the eurozone’s third-largest economy—particularly after a leaked draft of their proposed agenda that made its way to the Internet on Wednesday included items like, ask the ECB to cancel €250 billion in debt. Italian stocks were properly spooked, falling 3.3% on the day.[i] Whether or not party leaders’ claims that this memo was “old” and doesn’t resemble their current agenda turn out to be true, we think a radical, negative shift in policy is unlikely. Gridlock probably prevents a M5S-League coalition from passing the sort of major, sweeping changes stocks typically dislike.

For the Reader’s Digest version of recent Italian politics, President Sergio Mattarella dissolved Parliament in late December 2017 and called a general election for March 4. M5S, which led opinion polls, won the most votes of any single party but fell far short of a majority. A center-right coalition won the most seats, but contrary to expectations, Matteo Salvini’s League did better than coalition leader Silvio Berlusconi’s Forza Italia—putting Salvini in charge of his coalition’s efforts to form a government. Since then, he and M5S leader Luigi Di Maio have alternately tried to come to terms and argued over which party should lead any potential alliance.

After several rounds of failed talks, Di Maio and Salvini called for new elections last week—a scenario Mattarella tried shooting down. But then M5S and the League announced progress on a coalition deal after Berlusconi agreed not to be involved in the government—a major sticking point for M5S. The two parties talked through the weekend and met with Mattarella on Monday to provide an update, saying they needed more time to hammer home the final details but were getting close. 

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Your Global Investing Lesson From Malaysia's 'Populist' Victory

On May 9, Malaysia held an election in which a ragtag populist coalition took on the establishment party that had governed since the country’s 1957 independence. Defying polls and expectations, the populists won, drawing comparisons with Brexit and President Trump’s election. Echoing both of those events—and scared of anything associated with the P-word—headlines warned of market mayhem in the aftermath. Incoming Prime Minister Mahathir Mohamad called a three-day market holiday, leaving investors on the edge of their seats. But some folks didn’t wait for markets to reopen, instead trading the US-listed iShares MSCI Malaysia ETF (EWM)—just as they traded a Greek ETF when Greek markets were closed after the infamous 2015 referendum on the bailout. Needless to say, it plunged. But then it bounced. By market close on Monday, it was back at pre-election levels. Meanwhile, when Malaysian markets re-opened Monday, they rose a wee bit. Let this be a lesson: Markets don’t have preset reactions to geopolitical events and often do what few expect.


Exhibit 1, which plots EWM and its underlying index before and after the election, underscores the benefits of staying patient and not overreacting to loud media narratives.

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Deal or No Deal, Iran Likely Doesn’t Sway Global Energy Markets

Last Tuesday, President Trump announced the United States’ withdrawal from the Joint Comprehensive Plan of Action, better known as the Iran nuclear deal. Under the agreement—which the US, UK, Iran, Russia, China and the EU signed in July 2015—Iran agreed to scale back its nuclear activity and accept international inspections to monitor compliance in exchange for the removal of sweeping economic sanctions in place since 2012. While a lot of the discussion focuses on how the decision might affect Iran’s nuclear ambitions, this is a long-term question—not super relevant for stocks, which focus most on the next 3 – 30(ish) months. Others, though, touted an immediate economic takeaway: higher oil prices as renewed sanctions slash Iran’s contribution to global supply. But while talk of the US’s likely withdrawal may have contributed to the recent oil price uptick, this strikes us more as short-term commodity price volatility than the start of a sustained march upwards. In our view, global supply and demand forces likely overwhelm the deal’s impact on Iranian oil shipments. Presently, these forces appear roughly balanced, arguing against huge price swings in the near future.

Predictions for plummeting Iranian production strike us as premature for a couple reasons. First, the US government hasn’t announced details on potential sanctions’ scope or strictness. They wouldn’t go into effect for three to six months (depending on the activity involved)—perhaps allowing time for negotiations or even a revised deal lifting them. Treasury Secretary Steven Mnuchin’s call for “a new deal” could turn out to be mere words, but given the Trump administration’s penchant for threatening huge changes before watering them down, we wouldn’t rule out further talks or a compromise just yet.

Sanctions’ impact on Iranian oil exports also depends on how other countries—particularly in Europe—respond. The US hasn’t imported Iranian oil since 1991, so nothing changes there. The EU wants to preserve the deal and nascent Iranian trade ties, but US sanctions might thwart this by penalizing banks (based in the US or elsewhere) that finance investments in Iran or handle dollar-based payments between Iranian and outside businesses. This includes oil contracts: As one oil industry exec explained, “We’re all backed by European banks who are not going to provide any financing for trades with Iran, even if we wanted to.”

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May the 14th of May Spell Mayday for Muni and Corporate Bond Mark-Ups

Good news for all you corporate and muni bond investors! Beginning on Monday, you will finally know exactly how much you are paying for your bonds … and how much the seller is pocketing.

When you trade a stock, pricing is very straightforward. Your broker charges you the stock’s price plus a small commission—usually a flat fee or a few cents per share. Because these commissions are visible, brokers have big incentives to compete for your business by keeping them low. Hence, over the years, commissions have fallen—from $49 per trade (or more) before the May Day reforms took effect in 1975 to as little as $10 (or less) per trade at many online brokers today. Ah, the benefits of transparency!

But bond markets have historically been more opaque—especially corporate and muni bond markets. Unlike stocks, bonds don’t trade on open exchanges. They trade over-the-counter, between private parties. Individual issues often don’t trade frequently, making it hard for the individual investor buying or selling the bond to know the actual price in advance. Until now, dealers have been able to further cloud the picture by marking up the bond’s price when they sell it and not telling the buyers how much the markup was. These markups are unlimited beyond regulatory requirements that they be “reasonable.” Over the years, some investigators found markups could be 4% or more of the bond’s price, potentially eating a year’s worth of interest payments. Exhibit 1 is an oversimplified (entirely hypothetical!) stick figure example of how this worked.

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