Market Analysis

Random Musings on Markets XI: Museraker

This week’s potpourri includes a lesson in incentives, a funky investment vehicle, yet another look back at the financial crisis and more.

This week, we are sad to report we did not run into Kanye West as he roamed through Hillsdale Mall in San Mateo. We did, however, overcome our sadness to bring you another non-weekly smorgasbord. Read on for the tales of a bizarre way people are investing in FANG stocks, the latest Bank of England hiring news, iffy income calculators and more!

Annuities and Incentives

People respond to incentives. Reduce taxes, and avoidance typically falls. Pay people to install solar panels, voila, solar panels! Raise sales taxes on cigarettes, and cigarette consumption falls. So it will be unsurprising—yet still noteworthy to us—if selling annuities to IRA owners becomes less common now that one major firm that rhymes with Cheryl Pinch has banned commissions on the practice.

To back up a wee bit, selling annuities to IRA owners is a practice the SEC has long frowned on, considering it duplicates tax deferral. Basically, the SEC mandates that the sales broker/agent gets the buyer to sign a notice saying they are buying this product for reasons other than tax deferral. (Which is usually worded in a less-than-fully transparent fashion.) Cheryl banned commissions on all product sales to IRA holders after the DoL proposed its fiduciary rule a couple years ago. However, they recently reversed that move after the DoL rule died in court. The one exception: annuity sales. Cheryl Pinch will allow only sales of “fee-based annuities”—those expressly designed for sale to clients in fee-based relationships—in these accounts. We guess they realized brokers are people who, again, respond to incentives. Big commissions on annuities are a heck of an incentive to sell them, even to IRA holders.

Kudos to Cheryl Pinch on this move, which we consider a teensy step in the right direction. Yet moves like this aren’t enough to fix problems with annuities in general. Variable annuities’ internal fees and complexity mean they are, in our view, oversold. Fixed annuities are a more restrictive product with high teaser rates and CD-like returns. Indexed annuities carry few fees, but their structure caps returns—making the return far from the equity-like rates advertised. So yep, sell ‘em less to IRA owners. That is a plus. But maybe reconsider the structure overall?

FANGless FANGs, Take Two?

A few weeks ago we mused about the FANG ETF that didn’t include one of the companies in the titular acronym. We will admit we thought that might be the extent of our commentary on creative ways people try to invest in the FANG stocks without buying the actual stocks. We were wrong! This week, The Wall Street Journal blew the lid off a tool some investors are using in an attempt to “reap the gains of highflying technology stocks while avoiding the risk.”

The security in question is called an “auto-callable note.” For those who don’t speak Jargonese, it is basically a security that carries a given interest rate but may not exist long enough to pay the advertised rate because the issuer will automatically redeem it early under certain conditions. In the case of many notes linked to FANG stocks, they offered large returns, but the conditions in which investors could actually receive those returns were quite narrow. They paid out only if the stock’s price traded within a given range on the monthly “observation date,” with the price at issuance typically the ceiling. If the price fell below the lower bound, investors wouldn’t get paid. If it rose above the issuance price, the note would get called, and investors would get their principal back but lose future interest payments. Of the FANG-linked notes tracked by the Journal’s study, nearly three-fourth of those issued in Q1 2018 had been called by August’s end, paying just 3.2% on average—which pales in comparison to what US stocks returned in 2018’s first 8 months. It also happened to trail the average cost of these securities, which the Journal estimated based on the products’ disclosures.

We will leave it to others to opine on the merits of these securities—our interest lies with the mentality of folks who purchase them. If your goal is to invest in a “highflying” stock while minimizing downside risk, we struggle to see the logic in buying a security that is designed to pay out when said stock sags a bit—and provides the desired return only if the stock then flatlines for the rest of the security’s lifespan. That seems like a weird thing to do if you consider a stock a high flyer? Moreover, there is a philosophical problem here: the quest for risk-free return. This, folks, is the yeti of finance. The Loch Ness Monster of the investing world.[i] It simply doesn’t exist. To earn any sort of return above cash (which carries its own risks thanks to inflation), you must accept some risk of loss. We encourage everyone to remember this whenever they encounter a product boasting very large payouts and very low risk. If it sounds too good to be true, it probably is.

The UK Has One Less Job Opening

If you are one of the many wondering who would helm the Bank of England (BoE) after Mark Carney stepped away next summer, wonder no more: The Canadian gent has agreed to stay an extra seven months, through January 2020. We would now make a quip about how the man once dubbed an “unreliable boyfriend” by an MP frustrated with the bank’s inconsistent forward guidance has now twice changed his mind about his departure date, but we read recently that Carney feels the same way about this moniker as Wil Wheaton does about “Shut Up, Wesley” memes, so we will be kind and refrain.

Most commentators cheered the move, giving a thumbs-up to the prospect of stable monetary policy during the Brexit transition (the official Brexit date remains late March 2019). We will cheerfully concede the benefits for investor sentiment of having a known quantity in place for a while longer, but we suspect the broad “huzzah!” is another example of people overrating any one central banker’s impact. As BoE Governor, Carney chairs meetings but is one of just nine votes on the Monetary Policy Committee, which sets interest rates and administers the currently dormant quantitative easing program. Like the Fed, the BoE operates by consensus, not fiat. We doubt having a new person in the big chair would usher in radically different monetary policy immediately, just as Carney didn’t shake up policy after taking over for Mervyn King in 2013. And just as new Fed head Jay Powell didn’t do a 180 from Janet Yellen, who merely extended Ben Bernanke’s policies, who kept right on with Alan Greenspan’s rate hikes.

Peak Oil … Demand? And More Incentives

Could Oil Demand Peak in Just Five Years?” is a provocative headline in The Wall Street Journal, kicking off an article arguing Americans reaching peak consumption would be mega-awful for oil stocks. Now, as worded, this title isn’t as jarring as it seems. “Could” implies possibility, not probability. Therefore, by definition, the answer is yes, it could peak in five years. However, that doesn’t mean oil demand will peak in five years, is even likely to peak in five years or anything of the sort. The article, when you get beyond the headline, makes this point crystal clear—although perhaps inadvertently.

The article offers, as evidence, the following bullet points, sourced to company reports:

  • Carbon Tracker: fossil fuel demand to peak in 2023
  • DNV: 2023
  • IEA: demand continues to grow out to 2040
  • Equinor: around 2030
  • Shell: as soon as 2025, as late as 2040
  • BP: 2035-40
  • Exxon: demand continues to grow out to 2040
  • Chevron: no peak in the near or intermediate future
  • Wood Mackenzie: mid-2030s

So the first two are estimates projecting a peak in five years, but … none of the rest are. All are long-term forecasts! A folly!

Want to better grasp the folly of these projections? Consider: As recently as 2010, the common forecast was for peak oil supply. That proved false because folks didn’t foresee the shale revolution and human creativity in problem solving when incentives (high prices bringing profitable oil drilling) came into play. The same applies, in reverse, here. Incentives like lower prices, which can stem from rising production, mean folks are likely to consume more fuel.

Oil demand could indeed peak in 5 years—or 15, 30 or whatever. But that will hinge on the economics of alternatives to internal combustion engines, as well as the infrastructure to support these vehicles. Finally, before presuming this is awful for oil stocks’ future, consider: Just because demand peaks doesn’t mean it craters shortly thereafter.

On the Perils of Calculators

We have long been fascinated by the cognitive dissonance surrounding America’s middle class: It is supposedly shrinking, yet between 70% and 90% Americans self-identify as middle class, depending on the survey. So we were intrigued (and skeptical) when a new income calculator purported to settle the issue once and for all. And of course, we had to play around with it.

The calculator collects four datapoints: your state, metro area, pre-tax household income, and number of people in your household. If your household is large, it adjusts your income down. If your household is small, it adjusts your income up. So we tried it out on a hypothetical Bay Area Tech Worker making $200,000 a year, whom we have nicknamed Suzie Coder. The survey says our single, childless programmer is upper-income. Which, maybe, but she probably also either has two roommates or lives in an apartment the size of a postage stamp.

Where this gets nuts is when we ratchet up household size. Bizarrely, this calculator says Suzie Coder would be “middle income” even if her household size was 10, which could entail her being a single mom with 9 kids. This is … laughable? According to, a five-bedroom house in the area (about the minimum needed to prevent World War III starting in her household) goes for $3 million—generating a monthly payment of $16,211, according to their calculator. This translates to 97.3% of her pre-tax annual pay. A three-bedroom apartment would be more affordable, ranging from $3,000 to $7,000 per month—still expensive, and the kiddos would have no personal space. Then there is the cost of feeding nine growing humans, not to mention clothing and giving them a well-rounded childhood. Oh, and childcare!

This is an extreme example, but highlights to the broader issues surrounding financial calculators. They are only as good as their inputs. We suspect this calculator would be more useful if, in addition to adjusting for household size, it also adjusted for cost of living in each metro area (they collect this information only so you can see how your neighbors stack up). If Suzie Coder were living in Houston, where a nice five-bedroom house costs as little as $225,000—with a monthly payment of just $1,557—the situation would be much different. She would probably feel a lot more “middle income” than she would in the Bay Area.

So if you use calculators to track your retirement readiness and the like, make sure you pick one with sufficient inputs that doesn’t make unrealistic assumptions. (DISCLOSURE: You can always try some of the calculators linked at the top of this page!)

Then and Now

Earlier this week, one of our colleagues remarked on the media’s quest to wring every last story out of comments made by a comedian who hasn’t much been in the spotlight since leaving Saturday Night Live 20 years ago, calling it the epitome of a slow news cycle—and as we had just been trying to round up meaningful financial news stories for the “Headlines” section, we couldn’t agree more. And then we got to wondering: How do today’s top stories compare with 10 years ago, on the eve of Lehman’s death? So we hopped in the Wayback Machine, which is the actual name of the Internet Archive’s portal, and pulled up homepages from The New York Times on September 13, 2008 and The Wall Street Journal on the 14th.

Then, as now, the top story was a devastating hurricane bearing down on a heavily populated coast: Ike then, Florence now. But that is about where the overlap ends. Just below Ike, the Journal had six stories on Lehman brothers, a train accident, one more Lehman article and a smattering of pieces on the increasingly heated presidential race, a diplomatic spat with Hugo Chavez, Russia’s adventures in Georgia, an update on Fannie Mae and Freddie Mac and the death of David Foster Wallace. And now? As we look at the Journal’s homepage below Florence, we see more theatrics over Supreme Court nominee Brett Kavanaugh, Serena Williams’ US Open outburst, Facebook fact-checking memes, glee over the prospect of 5G wireless technology, the lira recovering after Turkey’s rate hike, progress on avoiding a government shutdown, Jeff Bezos’ philanthropy and Treasury Secretary Steven Mnuchin trying to sell his Manhattan home for $32.5 million. Any stories about a financial crisis are 10-years-ago retrospectives. In other words, life is a little calmer now.

Same goes with the Times. 10 years ago, it was banks’ woes, the heated campaign, the train crash, struggling Americans buying lottery tickets, op-eds on bank regulation, all things Sarah Palin, Lehman, homeowners’ mortgage woes, a personal finance piece encouraging investors to stay strong, and more on Russia and Venezuela. Overall, a more broad survey of news than the typically finance-oriented Journal, but still with a heavy focus on market mayhem. And today? We have the usual analysis of all things President Trump, a colorful New York police scandal, midterms, an article about the joys of fried fish, Spain’s government voting to move Franco’s remains and the discovery of the oldest-known human drawing. The business headlines previewed toward the bottom of the page include the stronger Turkish lira, special counsel Robert Mueller’s new PR strategy and the return of Wall Street’s martini-filled power lunches. Here as well, things are a lot fluffier than 10 years ago.

None of this is predictive for stocks, but it is telling about sentiment. When the biggest business stories amount to political gossip and martini lunches, things are probably pretty good overall, and investors are probably feeling pretty breezy. Perhaps this is a sign of animal spirits stirring?

Let’s Go to the Mall!

In non-Kanye mall news this week, the long-running fascination with dead malls took a new turn with a Wall Street Journal report on how some local governments are buying the empty, hulking behemoths in order to shepherd their redevelopment. This follows a long stretch of pieces bemoaning malls’ decline, highlighting creative attempts to repurpose them and—our favorite—profiling the daredevil photographers who break in to long-shuttered malls to turn their decay into art.[ii]

We are not casting aspersions on any of this, as we miss 1980s mall culture, pine for the Sherman Oaks Galleria and love the Dead Mall Series on YouTube. But we sort of wonder: Why malls? They are far from the only abandoned buildings in any given town. Why do the carcasses of old factories, apartments, office buildings, grocery stores, hotels and urban tenement dwellings not inspire the same attention? Cupertino’s mostly dead Vallco Mall has earned far more headlines over the last decade than Redwood City’s dead Century Park 12 movie theatre. Pardon the tautology, but fallow property is fallow property. Unused space is unused space. We guess some would say “eyesores are eyesores,” but we would never insult architecture like that.

Is it because most dead malls are on suburban thoroughfares and impossible to ignore, not hiding among other offices, warehouses or gentrified tenements? Is it because a shuttered, crumbling commercial cathedral is more symbolic than the weed-ridden remains of a roadside HoJo? Is it the emotional pang of losing the setting for childhood memories?

Or maybe, this: Time passes, and documenting a changing retail landscape is one way to chronicle history as it unfolds. If you google vintage Safeway storefronts, you will see the evolution of 20th century commerce from neighborhood markets to strip mall behemoths. The shift to suburbia. The automobile’s mass adoption giving rise to the park-and-shop. And, more recently, the shift back toward denser, more walkable neighborhoods. If you can trace all the tenants of a retail structure built in the 1940s, you probably have America’s economic history in a nutshell. In a way, knowing Steins beer garden in downtown Mountain View is in a structure built by a grocery store named Purity in the 1940s is like having a real-life version of Virginia Lee Burton’s The Little House in your proverbial back yard.

Enjoy your weekend! And to all our readers and their families (including ours) in Florence’s path, stay safe!

[i] We would say it is a unicorn, but that term is already taken by startups with $1 billion valuations, which are things that exist, unlike actual unicorns, destroying the metaphor.

[ii] Disclosure: Elisabeth may own a coffee table book of this.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.