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.


Will a ‘Housing Recession’ Spur Wider Economic Contraction?

Last week, the National Association of Home Builders’ August survey suggested its members’ sales conditions are starting to deteriorate as mortgage rates have doubled from last year, leading it to declare a “housing recession” is underway. Besides ongoing supply chain problems hiking construction costs, builders noted cancellations are spiking. With inventories rising, housing starts slowing and reports of sellers slashing prices to attract balking buyers, alarm over a potential residential real estate collapse is growing. Many fear such a downturn could hit the economy hard—and send stocks slumping anew. But although the housing market may be weakening, we don’t expect stocks to mind much.

The housing market has indeed hit a rough patch. Home sales have dropped sharply.

Exhibit 1: Home Sales Sinking

Source: FactSet, as of 8/24/2022. Census Bureau new privately owned houses sold and National Association of Realtors existing homes sold, January 2000 – July 2022.

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The UK’s Commodity Supply Chain Adapts

Every couple weeks, news breaks that yet another global energy producer is ramping up oil and natural gas exports to the EU. Israel is the latest example, with its energy ministry announcing natural gas production is up bigtime year to date amid plans to beef up exports to the EU. We have seen many such anecdotes involving non-Russian suppliers, including Azerbaijan, Qatar, the US and others, but data on how all of this is panning out has been a bit thin. Germany publishes monthly crude oil imports by country but not natural gas. The Netherlands publishes both, but the data are values, not volumes, subjecting them to big skew from commodity price swings. So you can imagine our excitement on Wednesday, when the UK’s Office for National Statistics (ONS) posted a report detailing how the country has adapted to Russian sanctions. It is but one example, but knowing how it has replaced Russian commodity imports can help investors get a better sense of how supply chains are readjusting, perhaps easing uncertainty as we head into the winter.

The UK’s main commodity sanctions included a pledge to phase out all Russian crude oil imports by yearend, cease natural gas imports as soon after that as possible, and ban all iron and steel products. As the ONS notes, Russia accounted for 24.1% of the UK’s refined oil imports in 2021, 5.9% of its crude oil imports and 4.9% of its natural gas imports.[i] Now, the UK also produces its own crude oil, refined petroleum and natural gas, so these percentages don’t represent Russia’s share of UK consumption, which was more like 8% of total oil and oil products, according to Business Secretary Kwasi Kwarteng’s March estimates. Much of its natural gas imports are also re-exported to Continental Europe. But refined petroleum imports in particular play a key role in the UK, making Russia’s impending absence an important hole to fill. Unsurprisingly, businesses haven’t waited for the bans to take effect: Russian fuel imports fell to zero in June. Meanwhile, the UK imported more refined oil from the UAE, Saudi Arabia, Belgium, the Netherlands and India.

That last one is perhaps most of interest, given India hasn’t ceased buying Russian crude—actually, it has ramped up Russian imports bigtime and is reportedly refining Russian oil into gasoline and diesel shipped globally. It is entirely possible that the UK is now simply buying Russian crude that was refined in India, underscoring an important point about energy markets: They are fully global, and total global production is what ultimately matters most. Even if Russian petroleum products are taking a more circuitous route than usual, they are still contributing to global supply, which we think goes a long way toward explaining oil prices’ fall from their March peak.

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What to Consider in August's Purchasing Managers' Indexes

Has the global recession begun? That question was back at the fore Tuesday after S&P Global’s flash Purchasing Managers’ Indexes (PMIs) for August showed declining output in most major economies. In our view, that makes today ripe for a timely reminder: Regardless of what the global economy is doing this month, stocks generally look about 3 – 30 months out and have likely already digested whatever business surveys and output metrics will eventually confirm happened.

PMIs, unlike “hard” data like retail sales and industrial production, aim to use survey responses to determine the economy’s general direction. They ask participants how business evolved across a range of categories including output, new business, employment, inventories, supplier deliveries, prices and others, then mash the responses into a number. Readings over 50 indicate expansion, with growth broader the farther above 50 it is. Similarly, under 50 means contraction, with lower readings implying widespread declines.

Exhibit 1 shows the flash results for August, which S&P says include about 85% of expected responses. The Manufacturing and Services columns show headline indexes—the aforementioned mashups. The Composite column aggregates Manufacturing and Services output only, hence its apparent divergence.

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Personal Finance: It Isn’t an Elective Anymore

Remember checkbooks? Back in the day, I learned how to balance one (by hand, trudging miles uphill barefoot through the snow, etc.) in my high school’s personal finance class given by one of our PE teachers. It was an elective, but not one many kids took—perhaps understandably. The subject matter wasn’t exactly scintillating. Also, I can’t say it was very useful, either, especially nowadays, what with banking on your phone and all. Still, financial literacy is vital and under-taught in America today. However, it may be making a comeback in high school, as more state legislatures are requiring a personal finance class to graduate. Georgia and Michigan became the 13th and 14th states in April and June, respectively, and now more than a third of US students have to take such courses as back-to-school season gets in full swing.[i] I doubt the curriculum features checkbook balancing, but that got me to thinking: What would be some good topics to cover? Here are a few I think kids—of any age—might appreciate.

First: Compounding!

If there is one lesson to impress on young (and young-at-heart) folks, it is the magic of compound growth—earning a return on returns. In my view, finding ways to let your money compound is the surest of the roads to riches humanity has discovered (although decidedly not the quickest). Stock-picking contests like many experienced in school may be exciting, but instilling an appreciation of compounding’s power is way more impactful, not to mention practical.

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Eight Ways to See America’s Volatile, Mixed Economic Data

The last two weeks have been chock full of US economic data, much of it conflicting. The latest example: The New York Fed’s Empire State Manufacturing Index sank into deeply negative territory in July, suggesting a steep contraction in Northeastern factory activity … but the Philadelphia Fed’s counterpart jumped into positive territory, suggesting factory activity expanded on the eastern seaboard. This follows a short run of conflicting manufacturing output (negative) and Institute for Supply Management (ISM) Manufacturing Purchasing Managers’ Indexes, or PMIs (positive). Monthly inventory data, which isn’t adjusted for inflation, is high and rising—but quarterly inventories, which are inflation-adjusted, continue detracting from GDP. We see a broad, important takeaway for investors to keep in mind here: Economic data remain quite volatile post-COVID, making it unwise to read into any one metric, or even a small gathering of metrics.

Exhibits 1 – 6 show an array of monthly data from January 2017 through the latest reading available. As you will see, from PMIs to retail sales to factory orders and beyond, most of these are far more volatile since January 2020. Not just during the initial lockdowns, but afterward, with one exception, the month-to-month moves are bigger across the board.

Exhibit 1: Regional Manufacturing PMIs

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On Europe and the UK’s Energy Pain

Europe’s energy crisis has dominated headlines for nearly a year, with many fearing shortages will lead to recession. The Continent’s hot and dry summer has further stoked energy supply concerns, as droughts impact increasingly in-demand electricity. We don’t dismiss the economic pain for households and businesses, but our focus is on the market impact. In our view, the widespread discussion of an energy-driven recession across the pond reveals how dour moods are—a sign of the low bar reality must clear to positively surprise.

Of course, moods are dour for a reason. Natural gas prices are surging in Europe, with hot weather boosting demand and Russia throttling supply in response to EU sanctions. Russian gas flows through the Nord Stream 1 pipeline have been around 20% of contracted volumes since late July, straining Europe’s ability to generate power while filling storage for the winter.[i] Beyond this, the summer heat has impacted other energy sources: In France, high river water temperatures are interfering with nuclear reactor cooling. In the UK, energy regulator Ofgem will announce October’s energy price cap (which resets semiannually) on August 26, and some anticipate the new cap will double today’s record levels—worsening UK households’ burden.

Politicians have responded in myriad ways. The EU has asked member states to reduce gas demand voluntarily. Some governments have imposed new taxes, from the UK’s windfall tax on energy firms, which passed last month, to Germany’s levy on households to help utilities. Pols have also sought to provide relief. Italy approved a €17 billion aid package while the Netherlands cut energy taxes for 8 million households. The contenders in the UK Conservative Party leadership contest are each reportedly preparing household assistance packages to introduce once they take office next month. France plans to re-nationalize power operator EDF—in which it already owns an 84% stake—in order to sell electricity below cost without getting pushback from minority shareholders. An example of that resistance: The government ordered EDF to sell nuclear power to its rivals at below-market prices, and EDF is now suing for having to take a loss.

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Retail Sentiment and Gas Prices

Good news! Gas prices are down, and economic data are starting to show the fruit. Exhibit A: July retail sales, which were flat overall as sales excluding gas stations rose. That largely confirms the latest U-Michigan Consumer Sentiment Index, which inched higher in July and August as consumers expressed relief about the easing pain at the pump. We don’t see this as a big economic change, but it should help shore up sentiment—part of the late-2022 wave of falling uncertainty we expect.

Unlike the full consumer spending report, retail sales aren’t adjusted for inflation. Accordingly, sharp price swings can skew the data. That happened with gas station sales in July: They fell -1.8% m/m, heavily influenced by falling prices.[i] The national average price of regular unleaded is now down -21.4% from its mid-June peak, which appears to have freed up some money for more discretionary spending last month.[ii] Excluding gas stations, retail sales rose 0.2% m/m. Excluding motor vehicles and parts as well (given their falls stemmed more from shortages than weak demand), sales jumped 0.7% m/m.[iii] This comparison isn’t apples-to-apples, but to illustrate a practice we see in publications often: That far exceeds the monthly change in both headline and core (ex. food and energy) prices in the month, implying growth stemmed from higher demand, not inflation.

We won’t go so far as to call this some big economic positive or a sign the US is set to avoid a recession, as some outlets did Wednesday. Spending on gasoline is still spending—it adds to GDP. Changes in gas prices tend to shift where people spend without significantly altering how much they spend. Nor do we think this is a sign that Consumer Discretionary stocks’ earnings are about to categorically turn the corner after some high-profile Q2 disappointments. Sales at clothing stores and general merchandise stores (e.g., department stores) fell in July, and as of June (the latest data available) both had big inventory piles to work through.[iv] There may yet be more earnings weakness ahead as some firms continue clearing stockpiles and reorienting toward consumers’ post-pandemic preferences. Mind you, we think stocks are looking well past this, but it is a reminder to keep realistic expectations for—and not get hung up on—near-term earnings data.

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Britain’s Sky-High Inflation Fosters Low Expectations

The UK notched a dubious milestone in July, becoming the first major country to record double-digit inflation this year. The Consumer Price Index’s 10.1% y/y rate is the fastest since 1982, and the Office for National Statistics estimates it is just the fourth trip over 10% in 70 years.[i] This is obviously not good news, not least because essential goods and services—food, gasoline, household energy—fueled much of the rise. But even excluding food and energy, “core” inflation accelerated to 6.2% y/y, driving worries of entrenched price hikes hitting consumer spending hard—and giving UK stocks a nasty recession to price in.[ii] In our view, a UK recession is possible and could already be underway. But we see reasons to think reality has a higher likelihood of going better than feared, not worse.

With that said, inflation is quite likely to accelerate from here due to the way household energy costs factor in. Millions of households are on what is known as the default tariff, which is not a barrier to international trade in this case, but rather the official term for the standard electricity pricing for households that don’t secure a fixed-term rate by switching providers. Parliament capped this rate in 2019, but it isn’t a hard, permanent ceiling. Every six months, regulators announce a new maximum for the default tariff, typically based on how wholesale prices have evolved over the prior half year. When wholesale prices rise, power suppliers tend to treat the price cap as a target to mitigate the likelihood of future losses. Hence, Brits endured huge stair-step increases to household energy costs last October and this April. Yet dozens of suppliers have failed anyway after being forced to take steep losses when wholesale power prices spiked, limiting competition and probably pushing prices even higher.

Later this month, the UK’s energy regulator will announce the new price cap that will take effect in October. Some researchers anticipate it will double the current ceiling in order to reduce the risk of more suppliers going bust if power is in short supply this winter. The Bank of England projects the cap increase will cause inflation to pass 13% y/y in October—a forecast some warn is too optimistic. Labor market data released earlier this week showed real wages falling at the fastest rate in the dataset’s short history over the three months ending in June (-3.0% y/y), a figure that doesn’t account for either the forthcoming price cap hike or the fact that tax brackets aren’t indexed to inflation. So we can understand why people think the consumer spending outlook is bleak.

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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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