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.


On May’s Big Jobs Shock

Surprise! Early Friday morning, the US Bureau of Labor Statistics unveiled its May US Employment Situation report. In a development that shocked nearly every analyst, US employers added—yes, added—2.5 million jobs.[i] In our view, it is a sign the gradual economic reopening in the month is starting to pay predictable dividends, if a bit earlier than most expected. While we don’t think jobs themselves are much of a reason to get bullish (or bearish) on stocks, we think the scope of the positive shock illustrates just how much negative sentiment is baked into markets now.

To put the scope of this surprise in perspective, consider analysts’ estimates coming into the day. According to FactSet, they estimated US employers would cut nonfarm payrolls by a whopping 8 million jobs in the month.[ii] They expected the headline unemployment rate to surge from 14.7% in April to 19.6%. Bloomberg’s survey matched the job cuts and projected a slightly higher unemployment rate, 19.7%.[iii] No analyst they polled projected an improvement in either figure. MarketWatch’s survey was slightly more sanguine, with the consensus expecting 7.25 million job losses and a 19.0% unemployment rate.[iv]

So to say that the 2.5 million nonfarm jobs added—3.1 million private sector jobs—was a surprise is an understatement.[v] It is also, to use a COVID-era cliché, unprecedented: Prior to May 2020, the biggest gain in nonfarm payrolls was September 1983’s 1.11 million; for private payrolls it was the same month’s 1.09 million.[vi] The headline unemployment rate dropped to 13.3%, with the broader U-6 rate (which includes unemployed workers who haven’t sought work in the last four weeks and those working part-time for economic reasons) falling from 22.8% to 21.2%.[vii]

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How We Think You Should Consider the 'Coulds'

Financial news headlines have run the gamut lately, but many that seem to draw the most eyeballs share a commonality: the operative verb is “could.” Some are good coulds. Some are frightening coulds. Even the most careful critical thinker could have a hard time sifting through the flotsam and jetsam to determine what is most meaningful for stocks. An easy place to start, in our view: Remember that markets move most on probabilities, not possibilities. The word “could” renders a theory squarely in possibility-land. Just because something could happen doesn’t mean it is likely to happen.

The array of possibilities we have seen thrown around over the past several days is dizzying. The IMF and others warned COVID-19 could reduce living standards indefinitely, with social distancing required until there is a vaccine—potentially years away. If ever: Some speculate humans could never get lasting immunity from COVID, or the disease could circulate near-permanently, crippling the world economy indefinitely. Others argue fear of infection could keep people in self-induced lockdown even when governments let businesses reopen. Or reopening could happen too gradually to kickstart a recovery. The ongoing civil unrest in several metro areas has prompted many to speculate that these impromptu mass gatherings could be the catalyst for a COVID second wave—and another round of lockdowns. Others focus on the economic impact of looting and property damage, warning it could be a devastating second sucker punch. Even under a rosier scenario, where businesses reopen quickly, some warn prolonged mass unemployment could permanently alter people’s shopping habits. Compounding that, many suspect extra Federal unemployment benefits could incentivize furloughed employees to stay out of work, adding an economic headwind. We have seen many a headline warning a lack of international travel could kill airlines and tourism-reliant economies. Elsewhere in the “reopening is no elixir” category, we hear millions of small businesses could close permanently, cementing an L-shaped recovery. Or a wave of bankruptcies could slow the recovery and wreck corporate bond markets. Last but not least, at least one headline daily warns the economic damage could last for years without additional financial assistance from the government.

To be fair, there are also some positive coulds. With pharmaceutical researchers fast at work, some suggest we could have a working vaccine by autumn. Even if that doesn’t happen, some medical researchers think COVID could fade away like SARS (also a coronavirus) did and never return—a prominent British virologist made this very argument in a Telegraph op-ed published Monday evening, explaining why models based on the 1918 influenza outbreak’s second wave may not be the most scientifically sound. He isn’t the only one claiming COVID could fail to resurge with a properly executed reopening. Multiple researchers also claim the fatality rate could wind up being very low. We have also seen people theorize that Sweden’s less-intrusive lockdown strategy could prove correct and serve as a template for the future.

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From the Mailbag

Earlier this week, a couple of our regular readers pinged us with some follow-up questions on two of last week’s articles, and we suspected our broader audience might share their curiosity. So without further ado, we present you with a brief mailbag recap!

Regarding last week’s article on the UK’s new tariff schedule and free-trade talks with the EU: How much does the UK trade annually with the EU versus the rest of the world?

Alas, this question isn’t as simple as you might think, as the UK doesn’t report a geographic breakdown of its trade in services, which represented about 30.7% of total imports in 2019 and 46.7% of total exports. However, the UK does report more granular data on trade in goods, which is most relevant when it comes to tariffs. In 2019, 45.8% of UK goods exports went to the EU, with 54.2% going to the rest of the world. On the import side, 52.9% of imported goods in 2019 came from the EU, and 47.1% came from everywhere else. These numbers are all from the ONS’s March 2020 UK trade report, which you can find here if you are really into that sort of thing.

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Be Averse to Mean Reversion Arguments

Just over two months from the stock market’s lowest point (at least thus far) this year in late-March, a number of pundits are wondering whether its growth-led rally has legs to continue into the year’s second half. Many answer this question with variations of “no.” Some see more downside ahead, pointing to the bear market’s short duration. Others claim that whichever way broad markets head, growth’s huge outperformance this year means a reversal looms. Both theories seemingly hinge on mean reversion—a common investing flaw, in our view, since markets are never “due” to reverse course tied to the gravitational pull of an average or norm.  

Mean reversion is another way to refer to the “law of averages.” The thinking goes, if an extreme event occurs, the opposite will inevitably transpire to preserve the historical average. Variations of this argument arise often in markets. As the last bull market went on to become history’s longest, folks frequently fretted that its longer-than-average length meant imminent trouble. Similarly, many spent much of the last bull market worrying far-lower-than-average interest rates would revert, dooming a “bond bubble.”

But now, such theories are mushrooming tied to various aspects of stocks’ recent swings. For example, some argue stocks can’t be in a new bull market yet because bear markets have averaged 14 months in length since 1950.[i] A few compare the COVID bear market to some of history’s biggest—most of which lasted 18 months and required more than five-and-a-half years to regain all-time highs.[ii] Their conclusion: Stocks won’t return to pre-lockdown highs until 2025. Beyond the duration debate, other observers have pondered whether a style leadership shift is afoot. Growth has led value for years, leading many to speculate a reversal is “due.” Yet it didn’t happen. Now, with growth stocks leading value by 26.5 percentage points in the trailing 12 months—the widest gap in decades—proponents argue that long-awaited rotation must be at hand.[iii] 

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What Trump’s Order Reviewing Social Media Legal Protection Means for Markets

Editors’ Note: Our political commentary is intentionally nonpartisan, favoring no party or politician as political bias blinds, which invites investing mistakes. We assess political developments only for their market impact—or lack thereof.

Are social media’s liability protections now gone with a stroke of a pen? Two days after Twitter added fact-check labels to a pair of his tweets on mail-in voting, President Trump signed an executive order last Thursday directing the Federal Communications Commission (FCC) to examine how it implements the 1996 Communications Decency Act’s Section 230 regulations, citing unfair bias in the outlet’s policing of content. Section 230 is the legal provision that grants Internet companies broad legal protection from content their users post. This has sparked fears regulatory change could disrupt many Tech and Tech-like companies’ business models. Like most executive orders though, it likely doesn’t amount to much for stocks and the economy.

Many believe Section 230 is critical for social media sites to function without being sued into oblivion. The law limits content platforms’ liability for user-generated content so long as they make a sufficient effort to remove objectionable material. Some think taking away this shield risks imposing onerous costs on companies because they would be liable for all activity taking place on their sites. Imagine reviewing every post put up by over a billion users for anything that might include accuracy issues, misstatements or other problems. Besides the cost, some also argue heavy-handed policing alienates users vital to attracting advertisers, which are social media platforms’ primary revenue source.

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On the EU’s Allegedly Landmark Budget

Last week, the EU announced a coronavirus relief proposal including jointly issued debt—an expansion of the one France and Germany mooted earlier—as part of its €1.85 trillion 2021 – 2027 budget. Pundits treated it as a watershed moment. But in our view, this reaction looks overstated and hasty. The budget likely faces a long, uncertain road to passage, with a lot of compromise along the way. Moreover, it doesn’t look much like stimulus to us—and we don’t think its passage or rejection should materially affect the pace of Europe’s economic recovery or the length of the bear market.

The budget’s key plank—and the piece that drew so many headlines—is a proposed €500 billion in grants and €250 billion in loans for EU member-state governments. They would target those (especially Italy and Spain) with less-sound finances and larger COVID outbreaks. Ideally, by easing perceived fiscal pressure, they would bolster and encourage national coronavirus response efforts.

The purportedly groundbreaking part is the financing. EU revenues currently come from member-states’ required contributions, import duties and a portion of each member’s value-added tax. Initially, funding for this far more expansive budget would come from €750 billion in newly issued (and new, period) common EU debt. The EU hopes an array of new taxes flowing directly to EU coffers would help pay off this debt down the road. These include a tax on companies the EU classifies as significant beneficiaries of access to the EU single market—most likely multinational companies based outside the EU; a digital transactions tax on companies with a “significant digital presence,” in the event ongoing OECD efforts to develop a global digital tax fall short; and a “carbon border adjustment tax” on imports from countries with less strict emissions controls than the EU. [i]

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Inside the Debate Over the Fed’s Extralegal Mandate Expansion

Earlier this month, Fed head Jerome Powell did what central bank chiefs usually do in a crisis: He went on 60 Minutes. His comments on the recovery’s potential length took most headlines, but economic policy wonks zeroed in on something different: a de facto admission that the Fed’s extraordinary actions in March and April exceeded the central bank’s mandate and expanded its original function well beyond anything in legislation. That has spurred a wave of think pieces on the wisdom and potential long-term consequences of these decisions, and in our view, they raise some valid points. These issues are worth weighing, and they could indeed have long-term ramifications. Yet we also think it is important for investors to distinguish long-term academic debates from issues that can affect markets in the here and now, and we think the case of the Fed’s mandate breach falls squarely in the former category. Projecting how this all ends amounts to sheer speculation and isn’t productive for investors to get hung up on today, in our view.

Since the 1970s, the Fed has had two main roles: adjusting monetary conditions to foster maximum employment with stable inflation (the famous dual mandate) and, the one it was created for in 1913, serving as lender of last resort during a crisis. That second part is traditionally limited to banks. In normal times, banks meet short-term obligations by borrowing from each other—a way for banks to keep the financial system liquid and stable while earning a very small return on spare cash. But when the system gets stressed, those short-term funds can dry up. When this happens, the Fed steps in, providing short-term loans to carry solvent-but-illiquid banks through a rough patch. It is a bridge to better times, not a bailout—a move designed to mitigate the broad economic impact of vast bank runs and panics that characterized 19th century America.

This time around, banks were in overall fine shape. The COVID crisis didn’t destroy their balance sheets or cause funding markets to freeze. Instead, as Powell pointed out, it was the “real economy” that saw funding disappear. That is pundit-speak for normal households and businesses small and large. Furloughed workers weren’t receiving paychecks. Businesses forced to close weren’t bringing in revenues. Larger companies that would ordinarily tap bond markets saw demand for new issuances dry up as investors fretted credit rating cuts and the potential for longer-than-expected closures to raise bankruptcy and default risk. Small businesses without significant collateral faced high hurdles to obtaining bank loans. State and local governments faced tax revenue shortfalls, raising fears of big deficits and troubles in muni bond markets. So, identifying those myriad trouble spots, the Fed chose to intervene as lender of last resort—not to banks, but to businesses, households and municipal governments. Or, if you prefer, to Main Street.

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What May’s Flash PMIs Say About the Global Economy

Slightly less awful than April. That is our primary takeaway from last week’s release of May’s IHS Markit preliminary—or “flash”—purchasing managers’ indexes (PMIs) for many major world economies. PMIs tally the breadth of economic activity, and while more companies are now reporting an uptick, the results still show most businesses are contracting. This, despite gradual reopening, likely contributes to what seems to be an increasingly common view: that any economic recovery will be slow and drawn out. How fast that economic revival moves from here probably depends on further reopening progress. But for stocks, we think what matters most is how the economic trajectory squares with expectations.

May’s flash PMIs broadly rose versus April’s extremely low levels. But all remained well under 50, indicating contraction—just not as widespread as last month’s. (Exhibit 1) Services activity—the lion’s share of developed world GDP—saw the biggest jump off of April’s depressed levels, leading the increase in composite PMIs. Yet services’ readings remained worse than manufacturing’s across the board.

Exhibit 1: Major Economy PMIs

Source: IHS Markit and FactSet, as of 5/21/2020.

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The UK’s Post-Brexit Plan Undercuts Protectionism Fears

In non-COVID news, last week the UK announced its post-Brexit trade policy—both within the nation and with the rest of the world—chipping away at no-deal Brexit dread. EU trade deal or none, the country looks open for business, countering long-running fears that Brexit is a protectionist nightmare.

Last Tuesday, the government unveiled a tariff regime—the UK Global Tariff (UKGT)—that shows what a Brexit on World Trade Organization (WTO) terms would look like. As an EU member, the UK had to apply the tariffs Brussels set for EU trade with the rest of the world. Post-Brexit, the UK can set its own terms based on its most-favored-nation status at the WTO. UKGT fleshes out those terms, which will apply to all nations the UK doesn’t have a separate free-trade agreement with.

The result, contrary to widespread fears, is broadly freer trade with simpler terms than the EU’s. The plan eliminates all “nuisance” tariffs presently set at 2% or lower and reduces most others. It also reduces the percentage of imported products subject to tariffs from 53% to 40%. In value terms, 60% of imports will be tariff-free. But there are still carve-outs to “protect” pet industries. For instance, the plan cuts tariffs on car parts and other strategic manufacturers’ components, but levies will apply to competing final goods—such as assembled cars, as well as agricultural and fishing products.

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Will the EU Bond Over Coronabonds?

For several weeks now, France and several southern European nations have argued the only way to fund the EU’s fiscal response to COVID-19 without sending Italy and others into a debt crisis is to issue so-called coronabonds—joint bond issuance by all 27 EU member-states. Germany, Austria, the Netherlands and most of northern Europe have long opposed this concept, seeing it as a wealth transfer from fiscally responsible to spendthrift nations. Until Monday, that is, when Chancellor Angela Merkel and French President Emmanuel Macron announced their joint support for a €500 billion coronabond issuance, sending cheers throughout European markets. But the enthusiasm was short-lived, as the deal’s many caveats and a raft of opposition emerged on Tuesday. The debate probably won’t resolve soon, and even if the deal goes through, the proceeds won’t be an immediate benefit. Regardless of the outcome, however, an EU economic recovery likely doesn’t hinge on coronabonds.

Though the name “coronabonds” is new, the concept of pooled EU or eurozone debt isn’t. Member-states considered the concept but rejected it when the euro was born, preferring to have a monetary union without a fiscal transfer union—a unique arrangement that led many to see the eurozone as incomplete. After all, most areas that share a currency and monetary policy also share fiscal policy, including transfers from wealthier nations to weaker states. That is how it works in the US, with federal tax revenue and bond proceeds redistributed across all 50 states, as well as the UK, which redistributes revenue from England to Wales, Scotland and Northern Ireland. The EU, by contrast, has always had a limited budget funded by pre-set contributions from member-states, and that budget is mostly for operational and development purposes, not transferring funds to national budgets. Some eurozone member-states sought to change that during the 2011 – 2013 sovereign debt crisis, viewing it as an opportunity to “complete” the currency union, but opposition from several northern European nations rendered the idea of “eurobonds” dead on arrival. Asking their voters to underwrite what many viewed as irresponsible spending on the periphery was a non-starter.

And then came COVID-19, which hit Italy and Spain particularly hard both medically and economically. That naturally heightened calls for a fast, huge fiscal response. But with Italy’s debt finishing 2019 at 135% of GDP and Spain’s at 96%, most presume neither has the bandwidth to borrow a few hundred billion extra euros this year without causing a new debt crisis that could risk splintering the euro.[i] It seems the tragedy of COVID was enough to convince Merkel she could sell this to voters as a sacrifice necessitated by events out of everyone’s control, rather than a bailout of profligate spenders.

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