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.
Stocks had another big day Tuesday, but it hasn’t done much to help sentiment as headlines continue stewing over the latest fear: the strong dollar. Some warn it is a negative for the US itself, as a strong dollar hits US-based multinationals’ overseas revenues (never mind that it also reduces their overseas costs and most international earnings don’t get repatriated and converted to dollars). Others focus on international stocks, warning their weak currencies are a headwind and are causing them to import even faster inflation. Add in actual currency market intervention in Japan plus talk of the same in South Korea and China, and currency chaos is top of mind. In our view, this is more a sign of sentiment than an actual negative for stocks, as we will show.
Re-read the prior paragraph carefully, and you may notice a weird inconsistency: the concerns about the US directly contradict the concerns about Europe and Asia. If the strong dollar is supposedly bad for the US, then that implies a weaker dollar would be better. Yet we are also told a weaker currency is a massive headwind in Europe and Asia, implying they would benefit from the stronger currency that is supposedly a massive risk on our shores. Absent some mythical Goldilocks exchange rates, which we have never seen theorized ever, there is no way to make it make sense.
If theoretical arguments aren’t your thing, then consider Exhibit 1. It shows a smattering of major developed and Emerging Markets’ currency moves year to date, along with their year-to-date stock returns in their home currencies and US dollars, their highest inflation rate in 2022 thus far and their most recent inflation reading. As you will see, there isn’t much evidentiary support for today’s prevailing fears. The US, which has the largest currency appreciation, is in a bear market. Brazil, which has the second-best currency of this bunch, has positive year-to-date returns in its home currency. Yet Mexico, whose currency is also up this year, is down double digits in pesos. As for the eurozone’s four largest economies, Germany is down over twice as much as Spain, and the corresponding inflation rates are all over the map. The UK has the second-weakest currency but is down just single-digits, albeit with double-digit inflation. Yet Japan, where the yen is down more than -20% on the dollar, has the second-lowest inflation rate.
The good kind of volatility returned Monday as the S&P 500 jumped 2.6% to start Q4.[i] But stocks weren’t the only thing that rose. Crude oil prices also jumped, tied largely to rumors that OPEC and its partners are considering reducing their production target by a million barrels per day (bpd) at this week’s meeting. Cue fears of a big cut fueling (sorry) another spike in oil prices, exacerbating this year’s inflation and compounding extant economic headwinds. This is understandable from a sentiment perspective and right in line with the fears driving this year’s bear market. Yet we also think it is quite out of step with oil supply and demand, not to mention how oil prices have behaved since spiking as Vladimir Putin invaded Ukraine.
Exhibit 1 shows global oil prices this year to date. As you will see, crude rose in the run-up to the invasion and spiked just afterward, reaching its year-to-date high on March 8. That, you might recall, is the day the UK announced its decision to ban Russian oil imports, heightening fears of a sudden supply crunch. But since summer, oil has declined steadily as it became apparent that Russian oil was finding buyers and global supply was resilient. Oil prices now sit right around pre-Ukraine war levels.
Exhibit 1: Brent Crude Oil in 2022
Stocks’ jarring week continued Thursday as the S&P 500 dropped -2.1%, closing a whisker below Tuesday’s low and bringing the bear market’s magnitude to -23.2%.[i] While that isn’t large by historical standards, retesting the lows after a summertime rally has understandably weighed on investors. Yet the mood seems to be one of frustrated resignation than outright panic, and we have a hunch why—and in a perhaps counterintuitive way, we think it argues for the recovery lying closer than many seem to expect now.
Last week, we looked at stock and bond mutual fund flows and considered the possibility that the panic selling known as capitulation was occurring more in bonds than stocks. That wasn’t a short-term market forecast, mind you, but an attempt to explore why investors’ behavior wasn’t quite typical for a late-stage stock bear market. This week’s bond market volatility seemingly underscores this hypothesis, judging from the sharp moves, reports of forced selling as pension funds scrambled to raise collateral, and the widespread presumption that much, much worse is in store for fixed income. That all suggests investors are taking their frustration out on bonds more than stocks right now.
Yet it isn’t just bonds that are down alongside stocks this year, and while it may be cold comfort, stocks are in the middle of the pack relative to other categories. Exhibit 1 shows year-to-date returns in US; World; Europe, Asia and Far East (EAFE); Emerging Markets and Japanese stocks (which we include due to Japan’s reputation as a safe haven), as well as two broad US bond indexes and the two flagship cryptocurrencies. Returns are as of Wednesday’s close, since Thursday’s tallies aren’t in across the board as we write, but one day won’t change the overall picture much. And that picture shows that if you are looking for an alternative to stocks, there really isn’t anywhere to go. Even the bond declines don’t quite capture the full picture, as fixed income’s grueling decline began before 2022. Supposedly defensive Japan is underperforming the US and global stocks. Crypto has crashed hardest of all.
Global stocks hit new lows this week as the bear market persists—extending a disappointing year. Naturally, many investors are frustrated, which is understandable. But frustration often gives rise to the urge to act—doing something, anything, can feel like taking back some control in an uncomfortable situation. However, this long into a bear market, such urges can easily be dangerously counterproductive. As challenging as this year has been, reacting to the past is arguably the biggest risk investors can take right now, in our view.
If the past two weeks feel like a bad case of déjà vu, your intuition isn’t far off base. This year has been a rollercoaster for global stocks. After a rocky spring, world stocks first crossed -20%—the threshold for bear markets (typically prolonged and fundamentally driven declines)—on June 13. Days later, on June 17, the MSCI World began a rebound. But after two months, the summertime rally faded and early this week, world stocks hit a new low—down -15.3% since August 16 and -25.1% since the January 4 peak.[i]
Exhibit 1: A Challenging Period for Global Stocks
Days after the Fed ratcheted rates higher again last Wednesday, chatter over policy moves continues, as stocks hover near new bear market lows. But most talk now isn’t about the hike itself—that wasn’t exactly a shock. Rather, consternation about where policy is heading has many fearing much more tightening to come, roiling sentiment. As evidence, they point to the Federal Open Market Committee (FOMC)—the Fed’s monetary policy decision-making body—boosting its dot-plot projections for rates’ “appropriate policy path” this year and next. But, in our view, while future policy moves could spur volatility, they don’t dictate market direction—and today’s dot plot doesn’t determine tomorrow’s hikes.
As expected, the Fed raised its fed-funds rate target range 0.75 percentage point for the third straight time to 3.0% – 3.25%. But this was mostly a forgone conclusion, with interest rates largely pre-pricing the move ahead of time. So instead, most observers focused on the unanswerable question: How high does the Fed think rates need to go to break inflation’s back? To suss that out, interested parties pored over reams of Fed prognostications released with its rate announcement—the quarterly Summary of Economic Projections (SEP). Bundled within it: a dot plot showing what FOMC participants think rates’ path should look like over the coming years. The midpoint of members’ latest guesstimates for this year jumped to 4.4% from the prior SEP’s 3.4% in June.[i] Next year, supposedly, the fed-funds rate will hit 4.6%, up from June’s thinking it would be 3.8%. So it might seem at least another percentage point of rate hikes are baked in.
But slow down. The dot plot’s evolution over the past year proves you can’t take these forecasts as gospel. In December 2021, the SEP’s dot-plot midpoint had rates ending 2022 at 0.9%.[ii] They were collectively expecting to barely lift rates at all this year. Three months later, March’s dot plot put the fed-funds rate’s 2022 close at 1.9%. Now it has more than doubled. We don’t see these projections as forward guidance in any useful sense. All they do is show the FOMC members’ evolving opinions. They underscore that even Fed officials can’t forecast what policy they think will be appropriate. And they decide the rates. If they can’t foretell future policy decisions, what chance do outsiders have?
Editors’ Note: MarketMinder favors no party nor any politician and doesn’t advocate policy proposals. We review political developments solely for their potential market impact.
Global stocks sold off again Friday, capping another trying week for investors with a decline that has world and US markets hovering around their June lows. Many attributed the drop to the newly installed British government’s “Growth Plan” announcement, which includes tax cuts, the reversal of planned tax hikes, select deregulatory moves and relatively large subsidies designed to offset rising energy prices. UK stocks sold off, Gilt yields rose and the pound fell sharply, briefly touching record lows against the dollar before rebounding on Monday. Prime Minister Liz Truss and Chancellor of the Exchequer Kwasi Kwarteng argue this plan, which we will highlight below, will boost long-term UK GDP growth to 2.5% annually, up from the 1.8% average in the 20 years before the pandemic. Yet many fear the plans will fail to spur growth, risk stoking further inflation and, worse still, put the UK’s public finances on an unsustainable path. Theatrically, some claimed it puts the UK on a path to become an unstable Emerging Market.[i] While the plan may not deliver the faster growth targeted—if it becomes law later this autumn—fears tied to it are far overstated, in our view.
The motivation for the plan is straightforward enough, and at root, it seems largely like a traditional economic proposal from Truss’s Conservative Party. It lays much of the blame for the growth slowdown in the 20 years pre-pandemic on lower private investment than many peer nations. These are well-known factoids that have circulated in many hifalutin discussions of “structural challenges” facing the UK economy for years and years. They aren’t new.
As stocks continued retracing their summertime rally last week, pundits offered no shortage of reasons more pain must be in store—rising rates, Fed moves, Europe’s energy crisis, weakening earnings estimates and high-ish valuations barely scratch the surface. Lurking underneath all of this is the assumption that complacent investors haven’t factored these in, with the primary evidence being that they have yet to capitulate. That is, investors haven’t thrown in the towel en masse and fled from stocks. That observation is true enough, yet we think it is a stretch to argue capitulation is a precondition for a recovery. That investors historically have often capitulated near market lows doesn’t mean they must or always do so. And we see a big reason why a mass exodus from stocks is unlikely this time around.
Simply: If you leave stocks, where do you go? Inflation looks set to eat cash alive. Gold is down far more than stocks since March. Commodities broadly are down, too, after fears of the war in Ukraine causing big shortages proved overstated. Crashing crypto is hardly the stereotypical safe haven fearful stock investors would flee to. Even the most traditional “safe” alternative, bonds, are down double digits since peaking in early January 2021. We aren’t saying these assets won’t recover, and we happen to think bonds’ decline is sentiment-fueled and out of touch with the bond market’s longer-term supply and demand fundamentals. But fear arguably reigns there, making it an unattractive destination for people tempted to react emotionally to stocks’ declines.
Lest you think our point is merely theoretical, we made some charts of stock and bond fund flows. Exhibit 1 shows weekly year-to-date flows for both, with US stock and bond returns overlaid. As you will see, investors have pulled much more money from bonds than stocks, much more consistently, this year. That isn’t shocking when you consider how fund flows work: They tend to follow returns. Bonds’ decline, though shallower than stocks’, has been relatively steadier and lasted longer, seemingly leading to a steady stream of outflows. Stocks’ decline, by contrast, concentrates in short bursts followed by seemingly fast rebounds. Flows have escalated at relative lows, but not to an astounding degree.
As the latest surveys revealed, folks are feeling dour stateside and overseas. The bleakness is understandable given this year’s myriad negative stories. Yet many forecast worse times ahead as the global economy contends with high prices and the prospect of recession. That is possible. But a roundup of the latest data out of the world’s largest economies continue showing a mixed picture—worth keeping in mind when comparing reality to such dark expectations and sentiment.
Reviewing the Latest Out of China
China released several widely watched data series for August last Friday, and they beat expectations. Industrial production rose 4.2% y/y, ahead of expectations of 3.9%, while retail sales were up 5.4%, 2 percentage points better than consensus estimates.[i] Fixed asset investment’s 5.8% growth on a year to date, year-over-year basis was also a few ticks higher than expectations of 5.5%.[ii]
Nine months into stocks’ slump, the latest downdraft has many on edge—and expecting the worst. That is understandable given the disappointing and difficult year. But, although it can be hard to appreciate in the moment, history shows bull markets are born on pessimism—and recent surveys suggest bearishness is at an extreme. This doesn’t pinpoint when a recovery will begin or whether it is already underway—nothing does—but we see widespread pessimism as a reason for optimism.
Bank of America’s (BofA) widely watched global fund manager survey showed broad bearishness in September. The latest reading indicated the majority of respondents are underweight equities for the first time on record.[i] Now, records start in 2002, so it isn’t an especially long history, but it does include 2007 – 2009’s bear market (typically a prolonged and fundamentally driven decline exceeding -20%) and early-2020’s brief downturn for comparison. Similarly, 62% of managers are overweight cash—a reading that has never been above 60% in two decades. Also notable: 72% expect the global economy to weaken in the next year, with 68% seeing recession likely.[ii] Both rates are near all-time highs, exceeded by only March 2009 and April 2020. The earnings outlook is even glummer with 92% expecting a profits downturn.
BofA’s survey reflects professional investors’ attitudes—what large money managers are thinking and (presumably) doing. But the American Association of Individual Investors’ (AAII) polling suggests individual investor sentiment is similar. AAII surveys its members weekly about their portfolio positioning: bullish, bearish or neutral. Combining them, AAII subtracts the bearish from the bullish, resulting in its net bull-bear percentage. This bull-bear spread can be very noisy week to week, so to smooth it out a bit, Exhibit 1 shows the four-week moving average. Although off its summer trough that coincided with the S&P 500’s June 16 year-to-date low, it remains below nearly all points in its 35-year history. While it isn’t so surprising individual investors are feeling dour, the extent is rather remarkable.
In a week with monetary policy meetings scheduled in Norway, Switzerland, Sweden, Japan, the UK—oh, and the US—it was perhaps inevitable interest rates would feature prominently in financial commentary. Then, on Monday, the US 10-year Treasury yield hit 3.489%, its highest close since April 2011, triggering even more headlines. Many presume the rise in long-term yields is poison for stocks, and fear of rising rates seemingly has played a role in this year’s market decline. We don’t dismiss how challenging this market environment has been, as interest rate concerns have been one of at least eight stories weighing on sentiment over the past nine months. Yet in our view, it is an error to extrapolate forward this effect—chiefly a sentiment function—and presume rates simply must fall for a new bull market to begin.
Arguments positing the upturn in long rates undercuts stocks generally go like this: Low yields in the not-so-distant past presumably buoyed stocks. Proponents of this take said, “there is no alternative” (aka, TINA) to stocks providing a reasonable return. So, they argue, low rates lured more people out of bonds and into stocks. Still others carry this a bit further into theoretical territory, noting that, because rising interest rates reduce the current value of future revenues and profits, higher yields now weigh on stocks’ appeal.
Today, with most people projecting rates’ rise this year into ever-higher yields to come, many conclude there is more trouble ahead for stocks. There is an alternative now, they say, even if yields at 3.5% are far below inflation and further rises in yields would hit bond prices (which move inversely to yields).