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.
Interest rate jitters took on a new flavor late last week, when the 10-year US Treasury yield briefly jumped higher than the S&P 500’s dividend yield. If bonds pay more than stocks, the thinking goes, then there is no alternative goes out the window as a thesis to own stocks. People investing for income will allegedly flip from dividend-paying stocks back to bonds, removing one of this bull market’s—and the 2009 – 2020 bull market’s—supposedly key drivers. We have long seen these pure yield chasers as mostly mythical, considering people whose long-term goals and time horizon require low expected volatility probably won’t rush headlong into a more volatile asset class for its yield alone. But philosophy isn’t the only strike against that thesis. Throughout history, bond yields have topped dividend yields much, much more often than not, and we don’t see any evidence that has been bearish for stocks.
Exhibit 1 shows the S&P 500’s dividend yield and 10-year US Treasury yield since 1995, which is as far back as daily data go. As you will see, the last 11-ish months are an anomaly. Before that stretch, dividend yields topped bond yields consistently only eight times—twice during stock bear markets and six times during bull markets. That split and the overall rarity, in our view, is your first hint that this isn’t a significant market driver.
Exhibit 1: A Brief History of S&P 500 Dividend Yields and Bond Yields
Thursday, US 10-year Treasury yields continued a recent jump higher, hitting 1.49% at the close—their highest level in a year.[i] Many blame this jump for the day’s -2.5% S&P 500 selloff—and worry there is more to come.[ii] But in our view, this is an extremely hasty conclusion to reach. For one, we don’t expect yields to end 2021 much higher than current levels, and they may even give up some of the recent rise. But even if they do climb from here, the idea this is automatically a problem for stocks is bogus logic.
First, stay cool. Short-term volatility is part and parcel of even the best bull market years. Getting carried away and extrapolating recent rate-and-stock swings forward is a common investing error too many folks make. Yes, last August, 10-year Treasury yields hit a record low 0.5% before rising to 0.9% at 2020’s end.[iii] Yes, consensus expectations were for another small rise in 2021, with the median forecast eyeing a 1.2% 10-year yield at year end.[iv] Yes, rates are above that level now. But projecting much more from here based on this move is risky business.
Part of the reason why: The recent jump looks mostly like a sentiment-based move—one unlikely to last or extend from here. We don’t see a sudden, material change in bond supply and demand fundamentals. On the supply side, there is currently a dearth of long-term Treasury issuance. Although Uncle Sam’s borrowing exploded in 2020, more than 80% of its record-breaking $21 trillion worth of debt sales were for one year or less and over 90% for five years or less.[v] Some speculate this will reverse with the government selling more longer-dated bonds. But judging by the Treasury Borrowing Advisory Committee’s recommended financing tables for Q1 and Q2, issuance is set to stay concentrated at the short end for the foreseeable future.[vi]
If you drew a Venn Diagram involving short sellers, retail traders, social media posts, newfangled brokerages, boring stock clearing technicalities, a possibly beleaguered mall retailer and a Congressional committee, we think you would find only one point of intersection: last week’s House Financial Services Committee (HFS) hearing entitled, “Game Stopped: Who Wins and Loses When Short Sellers, Social Media, and Retail Investors Collide.” It was an investigation, HFS Chair Maxine Waters said, into whether regulations were needed following the late-January surge-and-crash in a number of “meme” stocks. We watched this endlessly entertaining five-plus-hour hearing so you didn’t have to. What follows is our summary of the highlights and lowlights. You can decide which is which.
Before we go further, please consider our disclosure: This piece will meander through the happenings in a Congressional committee hearing. Along the way, it will discuss a few individual securities. Please remember that MarketMinder doesn’t make individual security recommendations. The piece will also, by nature, touch on politics. Our commentary in this regard is intentionally non-partisan and aims solely to explore how these issues intersect with markets.[i]
Cast of Characters
In the 11 months since this bull market’s birth, sentiment has come a long, long way. Deep despair and skepticism dominated most of last year, but now that has given way to optimism—even some pockets of froth. Many pundits see this emerging euphoria and extrapolate it across the entire market, calling it a bubble. But in our view, this is premature. While it wouldn’t surprise us if such a scenario developed in time, we think most recent bubble warnings mistake rational optimism for broad euphoria. In our view, these concerns are an opportunity to review what a true euphoria-inflated bubble is—and why we don’t think investors need to act right now.
Today’s bubble chatter runs the gamut. Some focus on stocks in certain markets (e.g., Asia) as evidence of froth.[i] Others go further, arguing irrational exuberance has taken hold on Wall Street thanks to monetary “stimulus,” fueling “the mother-of-all asset bubbles” in global equities.[ii] The evidence of the alleged broad euphoria also runs the gamut. Some analysts cite high valuations and equity fund inflows while others make historical comparisons—e.g., the Tech sector’s share of global stock market capitalization now rivaling its proportion during the late-1990s dot-com bubble.[iii] Anecdotes of individual investors buying shares of unprofitable companies seemingly echo past bubbly periods, too.
Pundits may use the term bubble loosely, but we think investors must dig into the why behind rising prices. In our view, euphoric sentiment is a key bubble ingredient, as it inflates prices and supply simultaneously. Prices jump exponentially due mostly to hype, greed and the fear of missing out (FOMO). Blinding euphoria convinces investors they can see the future of an asset 15, 20 or even 30 years out—and they lose sight of whether reality can meet expectations. Stock supply also surges during a bubble. Companies issue shares, eager to take advantage of higher prices. Investment banks see investors happily buying new offerings at high prices and respond by bringing more initial public offerings (IPOs) with increasingly dubious quality to satisfy this runaway demand. Eventually they overshoot massively, and when demand dries up as investors gradually realize their earlier expectations were too outlandish, prices tank.
Stocks had a nice Wednesday, and headlines seem certain there is one reason why: Fed head Jerome Powell. You see, he told Congress the Fed plans to keep rates near zero and quantitative easing (QE) going for “some time.” Allegedly, that means monetary “stimulus” will keep pumping indefinitely and investors can cross Fed pulling the punch bowl early off their list of fears. We have written many an article explaining why QE is more sleep aid than stimulant and won’t rehash that here. Even if QE and near-zero interest rates were a net benefit, we wouldn’t see much point in cheering Powell’s words. Forward guidance isn’t ironclad, and that goes extra right now for reasons we will explain.
Trying to predict Fed moves is never a productive use of time, in our view. For one, markets have no pre-set reactions to monetary policy decisions. Even more worrisome developments, like an inverted yield curve, usually impact the broader economy at a delay, giving investors ample time to judge each Fed move carefully. There is no need to make a knee-jerk portfolio reaction to an interest rate hike or cut, and even successfully predicting the Fed’s move won’t give you an edge.
That is good, because Fed moves aren’t predictable. They are data-dependent, as policymakers have reiterated time and again, but there isn’t a flow chart saying to raise rates if the inflation rate crosses above 2% or cut them if unemployment ticks higher. Heck, the Fed’s 2% inflation target is really nothing of the sort, as policymakers are aiming for 2% to be the long-term average. That gives them a world of wiggle room.
12 months ago today, the S&P 500 hit its final all-time high of a bull market that began way, way back in March 2009. What markets endured over the next five weeks was awful, as was the pandemic’s toll on humanity—which we are still living through even now. Yet despite all the terrible things that have happened, the S&P 500 is now up 17.7% since that prior peak, illustrating the timeless value of discipline and a cool head.[i]
The list of struggles and tragedy endured worldwide over the past year is overwhelming, to say the least. Beyond the pandemic and its horrible death toll, we had wildfires, tornadoes, floods and deep freezes. Locusts wiping out harvests throughout Africa. Deep political divisiveness. Societal unrest. These events have touched many lives, and as a society, we have learned many lessons from them. But for investors, there is one big takeaway: Markets rose as the vast majority of these troubles unfolded. Even the pandemic’s worst effects, from the mounting death toll to the deep economic contraction resulting from lockdowns, occurred after stocks bottomed in March. That sharp downturn was stocks’ way of anticipating the economic trouble to come. Keeping a forward-looking perspective—and staying disciplined—was key to capturing the recovery and reaping the cumulative gains since 2020 began.
Saying that in hindsight is one thing. Doing it at the time, in the heat of panic, was likely exceedingly difficult for the vast majority of readers. Between February 19 and March 23, the S&P 500 plunged -33.8%.[ii] Adding to the panic was the handful of sheer vertical daily drops—like March 9’s -7.6%, March 12’s -9.9% and March 16’s -12.0%.[iii] Like pretty much any bear market and early recovery, big swings clustered together, adding to the sense of panic. While this bear market’s suddenness was unusual, volatility coming in clumps is normal in a bear market year, as the very long table at the end of this piece depicting daily moves of greater than 1%, 2% or 3% (up or down) shows. But that heightened volatility cuts both ways, as bear market years also feature more big up days than pure bull market years—particularly in calendar years when a new bull market began midstream. Many of those big up days cluster around the bear market’s lowpoint, making it crucial to be invested when a bull market begins. This is why selling after a big decline is among the most devastating errors a long-term growth investor can make.
It is official. A little over a month after former Prime Minister Matteo Renzi and his small Italia Viva party withdrew from Italy’s multiparty coalition—leading to that coalition’s eventual dissolution—uncertainty over the shape of the country’s government fell this week. Former ECB head Mario Draghi—aka, “Super Mario”—is now Italy’s prime minister, charged with deploying EU coronavirus aid and leading a unity government comprised of virtually every major party in Italian politics. But while uncertainty is down and Draghi may have success in deploying EU aid, we think the government’s structure suggests Italian politics are as gridlocked as ever. Whether you are bullish or bearish on the idea of a much-heralded central banker leading the country, don’t overrate Draghi’s ability to enact big reforms and change—which should be fine for stocks.
Draghi’s victories in twin confidence votes—first Wednesday’s 262 – 40 in the Senate, then the 535 – 56 win in the Chamber of Deputies on Thursday—were decisive. He will head a broad-based government with the support of the Five-Star Movement, Lega, Democratic Party, Forza Italia and Renzi’s Italia Viva. Ministerial posts will be divided among these supporters, with a few going to non-partisan technocrats. As for the opposition, it chiefly comprises the far-right Brothers of Italy, who object to Draghi’s staunchly pro-EU line. They were joined by a group from the Five-Star Movement—a group the party now says it will eject, so we sort of figure Italy will have a new political party in Parliament soon. Regardless, though, Draghi’s new government has broad support at its dawn.
The new government’s chief task is determining how to spend €209 billion in EU coronavirus aid. Most plans loosely target aiding the tourism industry and health service in the near term, with green infrastructure, education and transportation spending getting larger, if longer-term, allocations. Disagreements over how to dole this money out were the proximate cause of the prior Prime Minister Giuseppe Conte government’s collapse. Now Italy ostensibly has until April 30 to present the EU with its plan, although we will note that EU politicians are extremely adept at moving self-imposed deadlines. Regardless, we figure the Draghi government could quite easily get a deal done on a non-contentious matter like this over the next month and a half or so.
So much for contraction. With 410 S&P 500 companies reporting Q4 results as of today, profits grew for the first time since 2019. That is a huge turnabout from the continued decline analysts expected. That earnings beat expectations, in and of itself, isn’t anything earth shattering. It happens much more often than not. But in this environment, it is more noteworthy. Sentiment has improved markedly in recent months, and as it did, analysts revised their Q4 earnings expectations higher. That reality still beat those higher benchmarks is, in our view, a good sign sentiment isn’t yet irrationally high.
The S&P 500’s Q4 blended earnings—combining reported results with remaining consensus expectations—are now up 3.0% y/y.[i] If this holds through the rest of reporting, it will snap a three-quarter string of year-over-year contractions and blow away analysts’ -9.3% y/y consensus estimate at last year’s end. About 80% of companies reporting beat analysts’ earnings and revenue growth estimates—both well above average historically.[ii] That is even more remarkable considering analysts ratcheted up their expectations as sentiment improved last autumn. In September, they anticipated a -13% y/y drop in Q4 earnings.[iii] With vaccinations rolling out in the new year and sentiment riding high, analyst consensus had cut this in half. By mid-January, with only 26 companies reporting, the consensus saw a much milder -7% y/y earnings contraction. Instead, profits are up, illustrating the unexpected speed with which Corporate America has climbed out of its deep lockdown-induced hole.
In a typical expansion, it isn’t unusual for earnings to return to growth less than a year after a bear market ends. But a big chunk of that early growth usually comes from cost cuts. Firms get lean and mean during a recession and keep trimming the fat early in a recovery, hoping to drive growth through productivity gains. Favorable year-over-year comparisons also help if the recession drags on for a while. For example, after the global financial crisis, S&P 500 earnings returned to growth in Q4 2009. Their growth rate, thanks to a depressed comparison, topped 100%.[iv] But revenues grew just 5.8% y/y off their own depressed comparison.[v]
Editors’ Note: MarketMinder doesn’t make individual securities recommendations. The below simply represents a broader theme we wish to highlight.
Japan got a double dose of good news on Monday. First came Q4 2020 GDP, which grew the fastest among developed-world nations reporting thus far—but not enough to recoup all of the earlier decline. Then the Nikkei 225 index hit 30,000 for the first time since its bubble imploded in 1990—a nice milestone, yet also not quite enough to recoup all of the earlier decline. We wouldn’t read much into either development, although we do think there are a few interesting nuggets for investors.
Take GDP. Q4 growth did indeed hit 12.5% annualized, beating the US, UK and all eurozone nations reporting thus far.[i] As much of the coverage has noted, Japan’s COVID experience deserves some of the credit here. The second wave didn’t hit Japan as hard as it did America and Europe, helping the country avoid a second round of lockdowns last year. While westerners stayed hunkered down, Japanese folks were largely able to travel and enjoy some winter revelry.
Lately, politicians aren’t the only ones fighting over whether the Biden administration’s proposed go-big $1.9 trillion COVID fiscal response plan is too big. Economists are increasingly weighing in and, this week, inflation fear seems to be dominating the zeitgeist—hinging on the notion the plan will “overstimulate” America’s economy, especially after the $900 billion bill that passed Congress in December. In our view, while it makes sense to monitor inflation now, the argument currently circulating seems a little hollow. Positively, though, the more it makes the rounds, the less of a threat inflation seems to be to stocks.
At its root, the overstimulation case rests on estimates of potential GDP. Potential GDP, for the uninitiated, is an estimate of where growth should be, were it not for shocks like the COVID lockdowns. Many also see it as a ceiling of sorts—the level at which GDP can grow without sparking hot inflation.
The overstimulation argument holds that growth is nowhere near $1.9 trillion below potential GDP. Most prominently, former Clinton administration Treasury Secretary and Obama advisor Lawrence Summers argued in a recent Washington Post op-ed that the gap is actually only about a third of that, or a bit over $600 billion—a figure likely to shrink as 2021 progresses, with or without Biden’s plan passing.[i] His view isn’t the only one. Many now say pumping $1.9 trillion into America’s economy would overshoot potential GDP and stoke hot inflation—particularly given the degree of money supply growth the Fed has engineered over the last year.