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.
Happy Friday! In this week’s we-still-swear-it-isn’t-weekly roundup of financial news, we bring you a premature epitaph for stocks, an ETF that doesn’t quite live up to its billing, a wild theory on Italian politics and more.
40 Years Later, Equities Are Alive and Kicking
August 13 marked 40 years since BusinessWeek published what may be the most iconic stock market call ever: The Death of Equities: How Inflation Is Destroying the Stock Market. Its thesis: Persistently high inflation was eroding corporate profits and undermining investors’ confidence in stocks. Combined with shifting demographics and the end of Wall Street’s fixed commission schedule (which would mean brokers had less incentive to advertise stock investing), this meant the stock market’s days of booming were over. Kaput. Dead. This wasn’t merely a flashy cover and edgy title: The text literally argued a near-permanent end to the good times for US stocks loomed.
-0.1%. 0.2%. 0.4%. -0.1%. These, in chronological order, are Germany’s real, quarter-over-quarter GDP growth rates in each of the past four quarters.[i] To hear headlines tell the tale, the most recent result—announced Wednesday—is a sign Germany’s “golden decade” is ending and recession is nigh. Never mind that when GDP shrank by the same percentage in Q3 2018, it snapped back and reached new heights in each of the next two quarters. That should be your first clue that Q2’s wee contraction is neither predictive nor automatically the end of the line—for Germany’s economy, the world or stocks.
The popular narrative claims Germany is collateral damage from Brexit dread and the US and China’s trade war. Pundits cite Germany’s export-heavy economy and claim these headwinds to trade are severe threats. Industry analysts see falling car demand in China, connect it to the trade spat, and pen laments for Germany’s vaunted car industry. Those who acknowledge Germany’s services sector is chugging along fine warn weak manufacturing is a bellwether and the entire country will soon catch the malaise. With Germany widely considered the eurozone’s pillar of strength, most presume it is only a matter of time before the broader eurozone economy gets sucked into the vortex.
Nothing is ever black and white, and there are kernels of truth in some of these claims. German exports to the UK stumbled hard in Q2, a sign of Brexit uncertainty’s international reach. When Brits thought Brexit would happen on March 29 and feared it could be a no-deal exit, they stockpiled goods—including finished goods and components from Germany and other eurozone trading partners. When Brexit got delayed, Brits had unnecessary stockpiles to work through, relieving them of the need to send German suppliers new orders. This isn’t a long-term headwind, as events like this usually just pull demand forward temporarily, but it probably was a factor in Q2.
Amid a volatile market stretch, worries about the global economy are running amok—including the dreaded “r” word: recession. Some economists think the likelihood of a US recession is up. Others see weak German industrial numbers and presume recession looms for Europe’s economic powerhouse. A few even project worldwide trouble. In our view, those concerns are overwrought. Recent data show continued global growth—despite pockets of weakness.
Our evidence: July purchasing managers’ indexes (PMIs). PMIs are business surveys covering major economic sectors like manufacturing and services. Businesses report their activity in a given month, and PMI aggregators crunch the numbers on how many respondents grew. Readings above 50 indicate more firms expanded; those below 50 suggest more contracted. While these monthly reports are a timely snapshot of broad economic conditions, they don’t share the magnitude of growth—or provide the level of detail “hard data” reports like GDP illustrate. With that said, July’s PMIs were consistent with the general theme of this year’s economic data: Heavy industry data were soft, but services expanded.
Exhibit 1: Around the World in July PMIs
Hello again! This week, in our not-at-all-weekly, not-at-all-regular, not-at-all-planned roundup of quirky financial news, we bring you a bizarre theory on negative interest rates, a weird observation about currency war fears, a European politician’s odd beach tour—and more!
Negative Rates Aren’t Puzzling. But This Isn’t Why.
This week, Bloomberg ran an article arguing negative interest rates aren’t so strange—presuming you thought they were to begin with. The piece leans heavily on the “savings glut” theory, claiming the supply of savings (deposits at banks, etc.) far outstrips banks’ demand for short term funding, making it totally commonplace supply-and-demand logic that rates would be negative. Not that different from commodity markets like pork bellies or wheat. Hey, depositors demand a place to put money and if banks don’t need the money, they won’t pay. Boom. Pure and simple. Basic Econ 101. Except.
Trade war jitters spooked markets again on Wednesday, with the implication being that if tariffs aren’t going away any time soon, the world had better buckle up. With that in mind, we thought it might be helpful to highlight an interesting piece in Friday’s Wall Street Journal. It dissected tariffs’ impact on US trade year to date and included a neat chart showing how trade with various countries has changed. The headline finding: China is no longer the US’s top trading partner, dropping from 15.7% of total US trade in 2018 to 13.2% year to date through June. An interesting observation! But also not surprising, given the vast majority of new tariffs apply to bilateral trade between the US and China. Perhaps more meaningful for investors, the tariffs have created winners and losers, but they haven’t bushwhacked US trade overall. Hopefully, understanding how this works might help investors stay cool throughout this latest spate of market volatility.
Overall, there just isn’t much evidence tariffs are wrecking US trade. Total US exports are down just -0.9% year to date, as higher exports to Europe, India, Japan, Korea and Taiwan have more than offset the drop in exports to China.[i] If it weren’t for a -2.3% drop in exports to NAFTA (exempt from new tariffs) and OPEC (hurt by Venezuela’s turmoil and local economic troubles tied to weak oil prices), exports would be up year to date. Even the small drop is a rounding error relative to GDP. Literally. Exports are down by all of $7.8 billion year to date. Nominal GDP finished Q2 at $21.338 trillion.[ii] The tiny drop in exports is 0.037% of GDP, which rounds to zero. Exhibits 1 and 2 show the regional year-to-date change in exports, both in percentage and dollar terms.
Exhibit 1: Year-to-Date Percentage Change in US Exports
Global markets continued their slide Monday as the world reacted to the latest salvo in President Trump’s trade tiff with China, leaving the S&P 500 price level -6.0% below its prior high.[i] The US doesn’t export enough to China for officials to retaliate to Trump’s latest tariff announcement (10% on all remaining $300 billion of previously untaxed Chinese imports), so Chinese policymakers got creative: They directed state-owned firms to stop buying US agricultural products and allowed the yuan to fall below seven to the dollar, the lowest level since the financial crisis. Headlines warned of a trade war without end snowballing into a currency war, potentially destabilizing the entire global financial system. We think this is just a bit overwrought. Not only does it ignore some key issues Chinese central bankers have been dealing with, but it ascribes currencies too much power over markets. Volatility could very well continue as sentiment deteriorates, and this pullback may even hit correction territory (i.e., breech -10%), but a bear market (prolonged decline below -20% with fundamental causes) appears as remote as ever.
We have seen a lot of talk about China now “weaponizing” the yuan, as if today’s move is only the start in a deeper currency devaluation. Only time will tell whether this turns out to be true, but we have our doubts. While the Trump administration has been jawboning endlessly about Chinese currency manipulation, all indications suggest the People’s Bank of China (PBOC) has been intervening to push the yuan higher in recent months, not lower. Exhibit 1 shows the USD/CNY exchange rate and the Fed’s trade-weighted dollar index since the start of 2018. Note the yuan’s suspiciously flat stretch since mid-June, even as the dollar strengthened against the Fed’s broad currency basket. We don’t know what goes on behind closed doors, but that is a strong indication PBOC officials were intervening to keep the yuan from weakening against the dollar. When officials allow the market more say-so over the yuan’s value, its moves tend to track the dollar index much more closely.
Exhibit 1: The Suspiciously Stable Yuan
This week’s not-every-Friday selection of random and bizarre financial and economic related news brings you robo-umpires in baseball, some questions about Bitcoin-as-reserve-asset, the IRS is coming for cryptoholders and a modest proposal to improve the Democratic debates. Please enjoy the read!
Random Musing on Baseball, Because We Can
Over halfway through the season, this is proving to be a banner year for baseball. Not only do Elisabeth’s beloved Astros have the best record in the American League (and now, Zack Greinke), but those staid suits who run the game are finally waking up to new ideas. First, we got the tantalizing possibility of the Tampa Bay Rays-Expos of Montreal. Now, the independent Atlantic League is running a pilot test for—wait for it—automated home plate umpiring. If it works, it could be coming to a major league park near you.
As the world obsessed over Wednesday’s interest rate cut, a certain politician who lives in a large white house decided to interpret it through the lens of currency wars and made some tweets about how it didn’t go far enough to compete with other major exporters’ currencies. Naturally this attracted many headlines, which we mostly shrugged at, seeing as how managing the currency isn’t in the Fed’s mandate. But some plucky senators introduced a bipartisan bill on Wednesday that would seek to change just that by giving the Fed a third mandate: balancing the current account within five years. The logic: Too much foreign investment made the dollar too high, hurting exporters, so the Fed must tax said foreign investment to make it drop while adjusting interest rates as needed to further discourage capital. In our view, this ignores basic economics. Forcing the Fed to fight currency wars is a solution in search of a problem, making us thankful Congress is likely too gridlocked for this bill to go anywhere.
Economic data have repeatedly disproven the theory that weak currencies boost exports, making them magical economic mojo. If currency wars were actually worth fighting and winning—whatever that even means—then Japan would have had the world’s strongest economy from 2013 on thanks to the BoJ’s stalwart effort to weaken the yen. Instead, Japanese exporters chose to keep production and prices steady and live off the easy profits from currency conversion. Hence, the weak yen didn’t stimulate Japanese output much. It was an accounting gimmick. Meanwhile, it also made imports more expensive, which wasn’t so great for a nation that imports most of its energy (e.g., oil and natural gas).
Over on our shores, there is no visible relationship between the dollar’s value (versus a broad trade-weighted currency basket), imports and exports. Across the pond, UK exports didn’t skyrocket when the pound tanked after the Brexit vote three years ago. Even today, as the BoE warned a no-deal Brexit could send the pound to a 34-year low, no one cheered about a coming manufacturing renaissance. People intuitively know currency valuations are only a small input into decisions on where to locate factories. Labor costs, geography and local know-how generally matter a lot more, especially because they are more fixed than currencies, which are inherently volatile.
Thursday, US President Donald Trump took to the outlet everyone uses to drop foreign policy news these days and sent a series of four tweets targeting China. In them, Trump again claimed China had reneged on a trade deal in May. Additionally, he claimed they failed to follow through on making “big” purchases of US agricultural goods and banning exports of Fentanyl (a dangerous drug). Trump added: “Trade talks are continuing, and during the talks the U.S. will start, on September 1st, putting a small additional Tariff of 10% on the remaining 300 Billion Dollars of goods and products coming from China into our Country. This does not include the 250 Billion Dollars already Tariffed at 25%.” Headlines and breaking news banners immediately flipped into overdrive, warning of another shot in Trump’s “trade war.” But this latest move does nothing to change our view: While they may roil sentiment in the near term, tariffs, as threatened and implemented to date, are simply too small and unsurprising to upend this bull market.
Consider Exhibit 1, which Fisher Investments clients just received in our latest quarterly update. It plots all of Trump’s threatened and implemented tariffs to date—plus trading partners’ retaliatory moves—scaling them relative to world GDP. Note the italicized line four rows up from the bottom on China. This included Trump’s earlier threat to tax the remaining $300 billion in Chinese goods at 25%. This is the same $300 billion Trump now says he will tax at 10%. Hence, today’s move is a) not shocking and b) smaller than we (and, likely, many other investors) had already weighed. Moreover, whether taxed at 10% or 25%, the cumulative impact of tariff payments is less than 0.3% of world GDP—not the multi-trillion dollar shock we think it takes to wallop a bull market.
Exhibit 1: Major US Tariff Actions and Retaliatory Moves (Implemented and Threatened)
Source: US International Trade Commission, IMF and Fisher Investments Research, as of 7/12/2019. US tariffs and global retaliation, 11/2/2017 – 6/28/2019. Italicized lines indicate figure includes threatened tariffs. Cumulative maximum assumes no overlap between items. GDP data are as of Q1 2019.
Yesterday, the Fed lowered its fed-funds target range for the first time in this expansion—by 0.25 percentage point to 2% – 2.25%—and ended its scheduled balance sheet reduction two months earlier than planned. The S&P 500 dipped -1.1% on the day—not much, really—but enough to set off a major tizzy among financial pundits.[i] This snippet from a Wall Street Journal article sums up the common interpretation of stocks’ reaction and the rate cut’s significance: “Stocks fell, Treasury yields rose and the dollar strengthened after the Fed decision was announced, and during Mr. Powell’s news conference, apparently because many investors were disappointed the rate cut wasn’t bigger or that he didn’t firmly signal more reductions to come.”[ii] This indicates to us folks still credit Powell & Co. with sustaining this expansion and bull market—a false narrative we think stores up positive surprise ahead.
As we wrote in our 6/5/2019 piece, “No, the Fed Doesn’t Need to Cut Rates, But …,” a rate cut probably wasn’t necessary. Sure, this means the 10-year minus fed-funds rate’s shallow inversion is now even shallower, but this probably just diminishes banks’ interest rate arbitrage opportunities—they might borrow a bit more at home and a bit less abroad to fund lending here. Then again, if the ECB also cuts rates in its next meeting—as several ECB board members have hinted—the US/eurozone interest rate difference would revert to pre-Fed cut levels, restoring said arbitrage. In other words, the eventual impact is likely zero sum. As regards the Fed’s ending its balance sheet wind-down now rather than two months from now, we see this as mostly symbolic. The wind-down’s pace was too slow to meaningfully impact the market for Treasurys anyway.
Markets’ supposedly sour reaction strikes us as a typical “buy the rumor, sell the news” situation—it shows the rate cut was priced in beforehand, and that is about it. We wouldn’t read into it. Plus, this is just one day! Even if the narrative of market disappointment were correct, it wouldn’t be actionable for investors, as it doesn’t automatically signal further declines. By this logic, initial market dips in the aftermath of Brexit and President Trump’s election ought to have ushered in prolonged slides. They didn’t.