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.


The Puzzle in UK GDP

UK GDP came out Friday morning, and here are the facts: Output fell -0.1% q/q in Q2, according to the Office for National Statistics’ (ONS) first estimate, with the bulk of the decline seemingly coming from June’s -0.6% m/m drop.[i] Ordinarily, the logical interpretation would be that the flattish quarterly reading obscures a late-quarter slide, implying the economy has weakened significantly since spring and signaling bad times ahead. However, due to some calendar quirks that the ONS warned skewed monthly data pretty heavily, in this case we think the quarterly figure is probably more telling. It isn’t predictive, and stocks are likely looking ahead to the next 3 – 30 months rather than what happened in April through June, but we think putting these data in context can help investors better weigh the UK’s economic fundamentals overall.

The calendar quirk in question is the Queen’s Platinum Jubilee, which pulled one bank holiday from May into June and added another to the calendar. This resulted in two fewer working days in June and an extra one in May, which the ONS warns threw off their seasonal adjustments. The official monthly GDP release states plainly that there will be a visible effect on both May and June data and concludes: “Caution should be taken when interpreting the seasonally adjusted movements involving May and June 2022.”[ii]

In our view, this should provide some relief about the fact that all major categories—services, heavy industry and construction—declined month-over-month. Most of that drop stems from having fewer working days in June than May. Similarly, the jump in entertainment services and restaurant spending probably stems from people having two additional days of leisure—days with big celebrations up and down the country to celebrate the Queen’s 70 years on the throne. We don’t view this boom as any more representative of the country’s underlying economic health than the drops in other categories of services and the manufacturing industry. We aren’t saying there is no core weakness. Businesses reported higher energy and input prices as headwinds in June, which probably contributed to falling output in the categories that rely on petrochemical feedstock. But with so much one-time skew, it is impossible to disentangle the two. With July data likely to benefit from an easy comparison with June, we probably won’t get a clearer read until August figures hit the wires—which won’t happen until mid-October.

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Q2 Earnings in Focus

Q2 earnings season is winding down, with the vast majority of S&P 500 companies having reported. The results? Three-fourths of those reporting so far beat expectations, and revenues did much of the heavy lifting. Yet while Energy earnings soared, profits in the other 10 sectors overall fell, echoing the split among sector returns during the bear market. We think this is a good reminder that stocks look forward.

As Exhibit 1 shows, sector returns from their early peak this year through the year’s low point to date on June 16 mostly previewed how earnings turned out. While S&P 500 earnings overall rose 6.7% y/y, much of that came from Energy earnings soaring 299.2%. Excluding Energy, they fell -3.7%.[i] So while headline earnings growth was near its 7.1% annualized average historically, it masks some underlying weakness.[ii] Yet first-half sector returns largely captured the earnings dynamic below the surface, with only Energy positive through Q2. Markets anticipated high oil prices’ impact on Energy earnings well in advance of official reports.

Exhibit 1: S&P 500 Sector Returns, 1/3/2022 – 6/16/2022

Source: FactSet, as of 8/11/2022. S&P 500 sector total returns, 1/3/2022 – 6/16/2022.

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An Overlooked Reason Behind July’s Slowing Inflation

Editors’ Note: Inflation remains a hot political topic, so please understand that our commentary is intentionally non-partisan and focused on the potential market implications only.

In all the coverage of July’s inflation report, we have seen numerous explanations for why the inflation rate decelerated from June’s 9.1% y/y to 8.5% y/y. There is much chatter about falling gasoline prices. Some argue the Fed’s recent moves are starting to bear fruit. We see an alternative, widely overlooked explanation, and we think understanding it can help investors better navigate inflation’s wiggles over the period ahead.

That explanation: the base effect, which we have long eyed as a likely disinflationary force this year. The inflation rate, as a year-over-year calculation, measures the percentage change between prices in one month and that same month a year prior. The “base” is that year-ago price level, which is the denominator in the calculation. As we all learned in grade school fraction lessons, a higher denominator can result in a smaller quotient—and vice versa. That is what happened in July.

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A Word on the Inflation Reduction Act’s Climate Spending

Editors’ Note: MarketMinder is politically agnostic. We don’t prefer any politician, political party or policy proposal and assess political developments for their potential economic and market impact only.

As investors continue digesting the Inflation Reduction Act (IRA), which is now heading from the Senate to the House of Representatives, the conversation seems to be shifting from its tax changes to its spending provisions—in an optimistic sense. We have seen numerous articles arguing the tax breaks and subsidies for wind, solar, electric vehicles and other similar technologies will bring big gains for investors who try to ride those waves. Sounds nice, but in our view, this is a manifestation of a basic behavioral error: Stocks are probably too efficient for Congress’s plans to be a meaningful market driver from here.

In our coverage of the tax provisions, we pointed out that nothing in the bill was a surprise. Its contents were pulled over from the old Build Back Better budget reconciliation bill, which bounced around Congress throughout 2021 and early 2022. That bill was a hodge-podge of the Biden administration and several high-profile congresspeople’s campaign pledges, placing these initiatives in headlines way back in 2020. In our view, that history—and all the speculation, forecasts, opinion pieces and other chatter it generated—sapped the tax changes’ surprise power, which is the primary source of most legislation’s market impact. What is true for taxes must logically be true for the subsidies and tax breaks headed “green” energy’s way.

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What to Make of the Disbelief Towards July’s Jobs Numbers

Amid the dog days of summer, we received some good economic news late last week: a strong July jobs report. A handful of observers cheered the month's figures, saying they suggested recession isn’t underway after all. However, most experts worried the unexpectedly robust numbers would motivate the Fed to keep hiking interest rates—increasing the risk of an economic hard landing. In our view, the largely dour reaction to overall positive, if backward-looking, data says more about the state of sentiment today than anything about the US economy going forward.

Widely watched jobs measures showcase the labor market’s recovery from the pandemic-driven downturn. July nonfarm payrolls rose by 528,000, better than expectations of 250,000, and bringing total payrolls to 152.54 million—a tick higher than February 2020’s pre-pandemic reading of 152.50 million. (Exhibit 1) The unemployment rate ticked down to 3.5% from June’s 3.6%, returning to February 2020’s level. (Exhibit 2) The one laggard is the labor force participation rate: It slipped to 62.1% from June’s 62.2% and has been drifting further away from February 2020’s 63.4% for months. (Exhibit 3)

Exhibit 1: Nonfarm Payrolls, July 2019 – July 2022

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Sinema Speaks, Delivering Inflation Reduction Act Tweaks

Editors’ Note: MarketMinder favors no politician nor any political party. Our commentary is intentionally nonpartisan and seeks only to identify the probable market and economic impacts of developments.

Alas, we have reached August—the notoriously slow news month when most governments are in recess and people worldwide are trying to squeeze in one final vacation before the kiddos go back to school. That doesn’t mean nothing happens, of course. But we do think it kind of explains why even slight changes to draft legislation can get heaps of attention. So it went Friday with the artist formerly known as Build Back Better (BBB) and now titled the “Inflation Reduction Act” (IRA[i]), which received centrist Senator Kyrsten Sinema’s (D-AZ) backing after a few tweaks to the package of tax changes, climate and healthcare spending that moderate Joe Manchin (D-WV) hashed out with Majority Leader Chuck Schumer last week. As we write, most observers expect swift passage, perhaps as soon as late Sunday or early Monday. That could prove a touch optimistic, but regardless: Given the outsized attention and chatter about their potential impact on stocks, the bill’s main tax provisions seem worth a look.

To pass, the bill will first need the Senate Parliamentarian’s approval to enter the reconciliation process, which would enable it to pass on a simple-majority, party-line vote. That remains up in the air. Senate Parliamentarian Elizabeth MacDonough remains holed up in her office reviewing the draft legislation, and Congressional aides from both sides of the aisle are reportedly parading through to lobby her. (We have the utmost sympathy for her current ordeal.) For spending measures to qualify, they must be strictly budgetary, not policy changes dressed up as budget items, and some observers suspect pieces of the climate and healthcare provisions won’t qualify. If the bill clears that hurdle, then it needs unanimous support from Democratic Senators, which doesn’t seem certain yet. Manchin hasn’t yet weighed in on the changes Sinema drove, which remove one tax provision he wanted (eliminating the carried-interest provision) and add one he seemingly nixed several months ago (an excise tax on stock buybacks). This could be an unsolvable impasse. Even if it isn’t and the bill clears the Senate, its path in the House isn’t clear. The IRA is far removed from the version of BBB that passed in the House late last year, and it could be too watered down for some lawmakers’ tastes. It also doesn’t remove the cap on state and local tax deduction, which several Democratic lawmakers have demanded. Maybe this sails through, but we aren’t sure it will be so easy.

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On the BoE’s Dreary Forecast

The Bank of England (BoE) announced its biggest rate hike since 1995 on Thursday, raising the Bank Rate from 1.25% to 1.75%—but that wasn’t the day’s biggest news. Paired with that rate hike was the BoE’s August Monetary Policy Report, which included the bank’s updated economic forecasts. That forecast: inflation reaching 13% y/y when the household energy price cap resets higher in October and recession starting that quarter and lasting all of 2023. Looming over all of this is a fierce political debate on the BoE’s mandate and independence, which has featured in this summer’s Conservative Party leadership contest. We see some medium-term risks for UK stocks here, but not the ones you might think. Let us discuss.

When last we left the BoE in May, its top-line forecast was for inflation at 11% y/y and a -0.25% GDP contraction in 2023. Now it thinks the most probable scenario is CPI hitting 13% this autumn and GDP falling -1.25% in 2023. Our May coverage discussed the BoE’s methodology and inputs at length, so we won’t rehash that here, but suffice it to say they mostly extrapolate recent conditions forward, which is a big reason why forecasts often don’t pan out. (Which, in turn, is part of the reason for the political kerfuffle over the BoE’s status, which we will turn to momentarily.)

The BoE could prove correct. Wage growth, while strong in nominal terms, has lagged inflation, and the patchwork quilt of tax credits and rebates hasn’t offset the headwinds of this spring’s tax hikes and spiking household energy costs. We could see a scenario where GDP grows steadily in nominal terms but shows as contraction once the inflation adjustment kicks in. That would represent a fall in living standards and, yes, recession. Plus, the yield curve spent the past two weeks ever-so-slightly inverted, and as we write, it is just barely positive. Couple that with slight falls in broad lending and money supply in June, and there is some indication conditions are tightening.

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Mixed Messages in America’s Services Surveys

Right in time for the increasingly politicized is this a recession debate, July services purchasing managers’ indexes (PMIs) for the US rolled in with some mixed messages Wednesday. Behind Door Number One: the Institute for Supply Management’s (ISM) Services PMI, which accelerated to 56.7 from June’s 55.3.[i] Considering readings over 50 indicate expansion, this implies the US’s vast services sector accelerated last month. But behind Door Number Two, we have S&P Global’s Services PMI, which fell to 47.3 from June’s 52.3.[ii] While this split doesn’t do much to un-muddy the economic waters, we also don’t totally think it needs to. The “recession” debate is largely political, and whatever you call it, we think it is clear stocks have been pricing in economic weakness. What matters from here is how the landscape develops over the next 3 – 30 months, and recession labels won’t tell you anything about this.

Between the locked Wikipedia entry for “recession” and politicians’ seemingly newfound obsession with the National Bureau of Economic Research (NBER)—not to mention the debate’s partisan nature—we feel compelled to lead with a bit of MarketMinder history. We have never used “two sequential GDP contractions” to determine a US recession and have always deferred to the fine folks at NBER’s definition: “a significant decline in economic activity that is spread across the economy and lasts more than a few months.”[iii] We will occasionally note that some people choose to define a US recession as two consecutive quarterly contractions, but calling that a “technical recession,” is a stretch, in our view. Besides, sticking to the two consecutive contractions definition would cause you to omit the very real recessions that occurred in 1960 and 2001. It would also lead you to miss two-fifths of 1970’s recession and the first year of 1973 – 1975’s.

But also, what is really the point of putting a label on this? One could argue that the present situation is a repeat of Q2 and Q3 1947. Then, like now, GDP fell twice in a row, due largely to an inventory drawdown, but consumer spending stayed strong. NBER doesn’t call that a recession, which seems defensible. But that didn’t keep stocks from suffering a long bear market due to the fallout of extended rationing and interest rate controls after WWII. Recession label or no, it was a bad time economically and in the stock market. Similarly, even if the present period doesn’t go down in history as a recession, we have dealt with a stock bear market, and households globally are swallowing inflation-adjusted pay cuts. Tough times are tough times whatever NBER’s Business Cycle Dating Committee decides to call them. Most importantly, whatever the label, it becomes clear far too late in the game to be of any use to investors. Stocks are leading indicators. They fall ahead of recessions, not after them. So if this is a recession, we could very well be long into a new bull market before the label becomes official.

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Delineating the US Government’s Two Inflation-Linked Investment Options

With inflation at 40-year highs, investors seem to have many questions about “inflation-protected” options. Two seem to continually come up: inflation-indexed US savings bonds (known as I Bonds) and Treasury Inflation-Protected Securities (TIPS), with many investors seemingly confusing and conflating the two. Now, we don’t think the current environment necessarily calls for either. But if you are considering these assets, it behooves you to understand the vast differences between them.

What are they?

I Bonds are US savings bonds that earn interest based on a fixed rate plus an inflation rate (based on US Consumer Price Index, or CPI).

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Our Perspective on the Midsummer Rally

We aren’t superstitious, so here is a statement we are comfortable making: The S&P 500 closed Monday up 12.5% from its June 16 low and the MSCI World Index isn’t far behind at 10.7% since its low the following day.[i] It is impossible to know whether this is the initial upturn of a new bull market or a short-lived false dawn. But the past few weeks have much in common with a typical rebound, which we see as reason for encouragement.

No, neither index’s bounce is a symmetrical “V” off the low. The S&P 500’s closing level Monday is roughly in line with its level on June 6, a whopping seven trading days before the low. It has taken about six weeks to retrace that journey. But it is also quite a swift rise—far from an L-shaped languishing around the bottom. Tech, which got hit disproportionately on the way down, is now leading. The upturn thus far also pairs with a hefty dose of pessimism. We have seen oodles of warnings that it is a bear market rally—a temporary respite presaging deeper declines later. Seasonality chatter is returning, with some arguing the S&P 500’s weak average returns in the past 25 Augusts and Septembers point to tough times ahead. Others argue that stocks aren’t really cheap, despite the drop in P/E ratios, because earnings have much further to fall. This, they claim, points to stocks falling alongside earnings from here in order to reach truly cheap levels. And looming over everything is the constant drumbeat of recession doom.

We can’t and don’t rule out renewed declines from here. But this type of sentiment is a hallmark of young bull markets. Fisher Investments’ founder and Executive Chair Ken Fisher calls it “the pessimism of disbelief”—the tendency to ignore good news or see positives as fleeting or soon to morph into something bad. You have no doubt seen this with any good economic data that hit the wires over the past six weeks. Most coverage couches expansionary data as sure to trigger additional Fed rate hikes, implying more trouble ahead. Falling oil and gas prices hit headlines not as a relief, but as a symptom of weak demand—a dawning recession. Big eurozone economies’ Q2 GDP growth? A last gasp before natural gas shortages wreck output, according to the popular take last week.

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