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.
Coming into Friday’s US employment situation report, fear abounded. But, perhaps counterintuitively, the fear wasn’t that the data would support widespread recession narratives. No, most onlookers feared the opposite: that data would show a big payroll gain, suggesting labor markets remain tight—in turn, fostering more Fed hikes. There are myriad presumptions that underlie this good-data-are-bad-news theory, but above all, we think the inconsolable mood illustrates the “Pessimism of Disbelief” (PoD) in action—a sign sentiment is too low relative to reality.
Ahead of the release, we saw many headlines say signs of strong economic growth entail further Fed tightening. Those Fed hikes, proponents argue, will surely pummel stocks even more. As the thinking goes, ongoing labor shortages and supply constraints mean any growth in payrolls is inflationary. To fight inflation, the Fed has to crush job growth and induce recession if need be to bring prices to heel. Under these conditions, pundits argue the outlook for earnings isn’t great. Hence, good news is really bad news.
That was the general zeitgeist entering the release. Never mind that the link between jobs and inflation is tenuous at best. Never mind that rate hikes aren’t automatically bearish and that markets are very well aware the Fed is trying to tighten policy, limiting surprise power. Never mind that the Fed isn’t as powerful as many think.
Editors’ Note: MarketMinder’s political commentary is intentionally nonpartisan, favoring no party nor any politician, assessing developments solely for their potential market and economic effects.
The UK has a new prime minister, and pundits globally are predictably fretting, focusing on a top politician’s personality and all manner of sociological issues. We will leave that to them, as stocks don’t tend to sweat such matters, focusing instead on policies. And on that front, we see plenty of room for the reality of new Prime Minister Liz Truss’s administration to deliver positive surprise. Several commentators have argued that Truss’s economic policies amount to even faster inflation, potentially followed by a debt crisis, which a politicized Bank of England will be unable to fix. We mostly see a new prime minister with a big agenda that is about to run into gridlock. In other words, the status quo, which should bring falling uncertainty and a positive surprise for fearful commentators.
At first blush, Truss seems to be making a break with the policies of her predecessor, Boris Johnson, and Rishi Sunak—Johnson’s Chancellor of the Exchequer and Truss’s leadership rival. After all, Johnson and Sunak raised the tax that funds Britain’s National Health Service, an unusual stroke for Conservative Party leaders—as was their decision to schedule a corporate tax increase for 2023. Truss has pledged to undo both and generally did her best Margaret Thatcher impression on the campaign trail. But look beyond the past two years, and the picture changes. To us, Truss mostly channels Johnson’s economic policy rhetoric when he took office before COVID, when he and Sunak were all about boosting economic competitiveness and tackling the alleged regulatory and administrative bloat that arose from decades of EU membership. Johnson and Sunak don’t seem to have acted on this much, which many saw as a break with the Conservative Party’s 2019 election manifesto. Between her policy brief and cabinet appointments, Truss seems to be posturing her premiership as a return to those election commitments, which we reckon is hardly a radical or unprecedented move from markets’ perspective.
Editors’ Note: MarketMinder doesn’t make individual security recommendations. The below merely represent a broader theme we wish to highlight.
Whenever long-term interest rates rise, it isn’t long before the focus turns to debt—national debt. It already seemingly has in Britain, with 10-year Gilt yields set to close August at their highest since early 2014—2.8%.[i] That level isn’t high by global or historical standards. Nor does it tie to concerns about the UK’s creditworthiness—rather, we think it is part of a global, sentiment-fueled wiggle as investors continue overthinking central bank rate hikes. We doubt it sticks for long. Yet it is raising some eyebrows across the pond because a big chunk of the UK’s outstanding debt has inflation-linked interest rates, making Britain’s debt service costs more sensitive to consumer price levels than America’s. Even with this factored in, however, we don’t think UK debt is a ticking time bomb likely to hit the economy or markets in the foreseeable future.
The raw numbers here might seem alarming. UK net debt (which excludes intra-government holdings) outstanding tops £2 trillion and finished fiscal 2021/2022 at 98.2% of GDP.[ii] According to the official figures, 30% of the total Gilt pile is inflation-linked, and due to some quirks in British national statistics and official policy, that linkage is to the antiquated Retail Price Index (RPI), which runs higher than the Consumer Price Index.[iii] That rate hit 12.3% y/y in July, creating the specter of a rapidly rising interest rate bill.[iv]
Lately, economic data have been coming out a bit better than expected. While a backward-looking glance won’t dictate where markets are headed, it does help lay down the baseline reality from which to gauge sentiment. Have a look.
July’s personal consumption expenditures (PCE) release last Friday showed inflation-adjusted consumption rising at Q3’s start and inflation moderating. Real PCE—aka consumer spending—rose 0.2% m/m. (Exhibit 1) That isn’t gangbusters, but it is right on its monthly average rate since 2002. Underlying demand is holding up despite inflation.
Exhibit 1: Consumer Spending Growth Slow, but Still Upward
Source: Federal Reserve Bank of St. Louis, as of 8/31/2022. Real PCE and its goods and services components, January 2002 – July 2022.
Inflation, Europe’s energy blues, China’s slowdown—just when you thought markets had reached scary-story saturation, another bogeyman nears: the calendar. September’s approach always brings the usual annual warnings that stocks “fall in the fall”—but this year’s early weakness has seasonality adherents convinced an extra-awful autumn awaits. Don’t buy it. Whatever the autumn months bring, it won’t be because of the calendar. September swoon and “season of crashes” myths are long on legend but short on logic.
September doomsayers argue the month historically has been bad for stocks—and that several world-shaking crashes have come in September and October. There is some truth to that. Since good data begin in 1925, September is the only month to average negative returns, at -0.65%.[i] October? It ranks ninth out of all months, averaging 0.67%.[ii] Some of history’s scariest crashes have indeed come as summer flips to fall, too. In 1929, the market plunged -19.7% in October, sticking a fork in Roaring Twenties euphoria. Two years later in September, US stocks had their worst month in modern history: a -29.6% drubbing amid Dust Bowl and Great Depression devastation. October 1987 brought the “Black Monday” meltdown—which by itself represented most of stocks’ -21.5% decline for the month. Then in 2008, Lehman Brothers’ September collapse accelerated that month’s -8.9% selloff, which rolled into a -16.8% October nosedive.[iii]
But while those bludgeonings stain memories, September’s and October’s full stories are far more nuanced—providing no hints for investors. While a few big outliers have flipped September’s average return negative and weighed on October’s average, both months actually feature positive returns more often than not. Again since 1925, 52.1% of Septembers and 61.5% of Octobers have been up.[iv] Both months’ median returns—the midpoint of all observations—are positive, too, showing the negative average results from outliers.[v] That means investors shunning stocks in September and October usually sidestep gains, not losses.
After a 17.7% rise between June 16 and August 16, the S&P 500 is now down -7.3% since then after Tuesday’s drop.[i] Is the resumed negativity a brief blip along the way to recovery? The start of a W-shaped bear market (typically a prolonged decline worse than -20% with a fundamental cause) low instead of the V-shaped variety? Or the resumption of a longer bear market following a temporary rally? Unfortunately, the answer is probably the last thing you want to hear: “unknowable.” Short-term movements are always unpredictable, regardless of direction—and regardless of whether they occur during a bull or bear market. In our view, the best thing investors can do right now is focus on their long-term goals and avoid the temptation to react to day-to-day swings.
As last Thursday’s commentary discussed, whether the summertime rally was the recovery’s start or a bear market correction is impossible to glean from patterns and comparisons with historical market movement. For example, we have seen much discussion of the fact that the 17.7% rise erased over half of the bear market’s decline, as if getting past the halfway point eliminates the possibility of retracement. We have seen this rally overlaid with the “typical” bear market recovery, as if visual resemblance is enough to declare it for-real. Problem is, it is also common for a bear market rally—or bear market correction, if that term is more intuitive for you—to recoup over half the decline from the prior bull market’s peak to the rally’s starting point, only for the relief to prove temporary as stocks eventually sink to new, worse lows. Patterns are no help.
Fundamental analysis is more meaningful, in our view, and while it won’t confirm whether the upturn is a new bull market, we think it points to a recovery being close. Stocks move on the gap between sentiment and reality, and sentiment hasn’t much improved since June. People still dwell on rate hikes, dissecting every Fed person’s comments and every inflation report for hints at how monetary policy will evolve. Europe’s energy woes continue fueling recession fears. US economic sentiment continues hovering around its summertime lows, and good economic news continues attracting “yah, but” objections. China’s rolling blackouts, COVID restrictions and property woes continue generating fearful headlines globally. Food and fertilizer shortages spark talk of global hunger. Surveys of fund managers and individual investors alike give little indication that expectations rose alongside stocks over the summer. While fund flows don’t show huge capitulation, we wouldn’t necessarily expect them to in this environment, considering there isn’t exactly anywhere for investors to go—not when bonds are also down, inflation is eating cash alive, crypto is crashing and gold is sinking. There is nowhere for fearful investors to flee—all the alternatives would be equally scary-looking.
Inflation wasn’t the only hot topic hovering over last week’s annual central bankers’
summer retreat holiday gathering in Jackson Hole, Wyoming. With the event happening days before the results of the UK’s Conservative Party leadership are set to be announced—and with frontrunner Liz Truss having pledged to review the Bank of England’s (BoE) mandate and perhaps even its autonomy—central bank independence seemed to occupy many pundits’ minds. There have been several long think pieces on this topic, all arguing independence is sacrosanct and must be protected against all threats. That is a fine enough argument in theory, I guess, but central banks aren’t as independent as we all have been led to believe—nor has the present system always delivered great policy. I am not advocating for policy changes or anything, but this debate seems more of a distraction than a market or economic driver.
Truss isn’t the only frontline politician considering shaking things up. Australia has just launched a formal review of the Reserve Bank of Australia’s (RBA) performance after it seemed to dither over hiking rates as inflation accelerated, leading RBA Governor Philip Lowe to call his bank’s forecasts “embarrassing.” Current BoE Governor Andrew Bailey has issued a similarly scathing self-assessment. Some US congresspeople argue the Fed is straying too far from its remit by focusing on sociological concerns, and there is chatter about new legislation to curb it. One candidate in Canada’s Conservative Party leadership race has pledged to fire Bank of Canada (BoC) Governor Tiff Macklem if he becomes prime minister.
It is axiomatic in the finance world that independent central banks are holy and anything less than full autonomy would run the risk of the Fed et al turning into the Central Bank of the Republic of Turkey (CBRT), which largely does President Recep Tayyip Erdogan’s bidding. Erdogan subscribes to the unorthodox view that high interest rates cause high inflation and has routinely installed governors who will comply and cut rates, then fire them once they start showing some independent thought. The result, predictably, is the Turkish consumer price index (CPI) inflation rate of 79.6% y/y in July 2022, a debased currency and plunging foreign exchange reserves.[i] This is an extreme example, but most observers argue that if central banks lose independence, governments will force them to cut interest rates at politically opportune times—regardless of what economic conditions warrant—and therefore risk creating big economic problems.
Investors have faced many challenges this year. The latest test: After rallying over the past two months, stocks dipped this week and closed on a big down note, with many fretting about Fed Chair Jerome Powell’s keynote address at Jackson Hole, Wyoming’s big central banker symposium. Powell’s speech was just 1301 words, yet financial headlines spewed oodles of pixels trying to make sense of it all—some blaming him for Friday’s selloff. That is possible, as daily volatility can happen for any (or no apparent) reason. But looking more broadly, Powell didn’t say anything noteworthy. Most of those parsing Powell’s words make much out of very little, and we suggest investors refrain from doing the same.
Powell’s eight-minute speech focused on inflation, the Fed’s commitment to price stability (mentioned nine times!) and a historical review of past monetary policy. As the Fed head noted, “Restoring price stability will likely require maintaining a restrictive policy stance for some time,” and he concluded with this headline grabber: “We will keep at it until we are confident the job is done.”[i] Unsurprisingly, central bank observers did their best English major impression reading into Powell’s words. His callback to past Fed Chairman Paul Volcker? Clearly this Fed will attack inflation with gusto. Acknowledgement that higher interest rates may hurt households and companies? Get ready for even more rate hikes. A commitment to not stopping prematurely when tackling inflation? Prepare for a long stretch of restrictive monetary policy. The upshot: Many believe the Fed is willing to whack the economy to tame prices, so brace for trouble now.
Yet from our reading, Powell didn’t share anything new. Rather, he reiterated long-discussed stances. Go back to March 2022, a week after the Fed hiked rates for the first time since 2018. At a speech for the National Association for Business Economics, Powell observed, “… inflation is much too high. We have the necessary tools, and we will use them to restore price stability.”[ii] He sang a similar tune to Congress in June. The Jackson Hole speech conveyed more of the same, including what will influence the Fed’s decision-making. Powell noted, “Our decision at the September meeting will depend on the totality of the incoming data and the evolving outlook. At some point, as the stance of monetary policy tightens further, it will likely become appropriate to slow the pace of increases.”[iii] (Boldface emphasis ours.) In our view, that is a version of saying monetary policy remains “data-dependent”—a squishy, ambiguous approach popularized by Fed officials years ago.
Is the stock market rally since mid-June the real deal? That question has been on many minds lately, particularly amid this week’s renewed negativity (Thursday’s positivity notwithstanding). In an effort to deliver the answer, many analysts are comparing how the past two and a half months stack up with past rebounds. That is an understandable impulse, but we think it stems from a flawed place. Inflection points are only ever clear in hindsight, and stressing over them can lead to myopic behavior.
That logic doesn’t stop the financial community from trying, though. Analysts are busy drawing myriad conclusions about the summertime rally. One found “bear market rallies rarely claw back more than 50pc of the previous loss. When they go beyond this point, it is usually a sign that the rally is the real deal.”[i] Some are less optimistic, arguing technical indicators don’t support more gains.[ii] Others have tallied up similar two-month jumps over the past 65 years to glean something about today’s upturn, though their takeaways are inconclusive.[iii]
We agree looking to history is a useful practice. Past rebounds can provide a sense of what is probable and help investors set expectations. From June 16 to August 16, the S&P 500 rose 17.4% in price returns—in line with the postwar average two months into past new bull markets.[iv] (Exhibit 1)
If ever we needed evidence that August is a slow news month, we got it Thursday when the second estimate of Q2 US GDP stole many headlines. It wasn’t just the slight upward revision to a -0.6% annualized contraction that grabbed the world’s attention, but the sharp divergence with gross domestic income (GDI), which rose 1.4% annualized—theoretically an odd development considering GDP and GDI are technically opposite sides of a ledger that should balance (but rarely ever actually do). We don’t really get the hype, though, considering GDP and GDI have different data inputs and accounting adjustments, which can have greater variability when inflation is high. More interesting to us: Corporate profits, which accelerated and, when compared to yet another measure of gross output, suggested profit margins are widening. It is backward-looking, and the Bureau of Economic Analysis’s (BEA’s) corporate profit measure includes more than publicly traded companies, but we think it shows the gap between sentiment and reality remains in stocks’ favor.
The BEA offers a few corporate profit measures, and all accelerated bigtime from Q1. The topline measure, which adds some accounting maneuvers, flipped from Q1’s -2.2% annualized decline to 6.1% growth, while the after-tax version erased Q1’s -4.9% drop with 9.1% growth.[i] Or, if you prefer, the after-tax measure with no accounting adjustments shot from 1.0% annualized growth in Q1 to 10.4%.[ii] Now, none of these measures are inflation-adjusted, but that is sort of the point, as inflation jacks up businesses’ costs and revenues. Given profits slowed to a crawl in Q4 and dropped in Q1, it appears businesses at first tried to swallow price pain without cranking up customers’ costs. That changed in Q2, as firm demand gave them pricing power across the board, letting them recoup Q1’s pain and then some. If you are reading this as a normal American trying to make ends meet at the supermarket, this isn’t good news—we don’t dismiss that. But for business owners? Companies large and small trying to weather the storm? Rebounding profits show resilience in the face of high inflation. If you own stocks, you own shares in this.
A quick-and-dirty calculation of profit margins provides another way to see this. Non-financial corporate businesses’ after-tax profits before accounting adjustments improved to 15.5% of their gross value added (GVA), which is basically a company’s sales revenues minus the cost of goods sold—in other words, the value it adds at its stage in the supply chain.[iii] GVA doesn’t reflect pure profits, however, as it doesn’t back out labor and other costs. After-tax profits do, so the ratio is basically the percent of net revenues that is pure profit. Obviously, the math isn’t as clear or simple as single-company gross operating profit margins, which are revenues minus cost of goods sold divided by revenues. But as an analogue for broad Corporate America, it is an ok metric, and one analysts occasionally look to. And it is significant: That 15.5% ratio, as Bloomberg pointed out, is the highest since 1950. Let us repeat: The biggest non-financial corporate profit margins in over 70 years happened as consumer price inflation hit a 40-year high. They also happened as producer prices, which represent companies’ input costs, rose at a much faster rate than consumer prices, which represent their revenues. If there is a better sign of businesses’ ability to overcome today’s economic pressures, we are hard pressed to think of it.