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.
As the world mourned the passing of Her Majesty Queen Elizabeth II Thursday, markets did what they always do at such times: got on with the job. In a way, it is a fitting tribute to the steadfast woman who exemplified this attitude during her remarkable 70 years on the throne. Yet a stiff upper lip doesn’t quite describe the way headlines reacted to the day’s biggest financial news: the European Central Bank’s (ECB’s) decision to raise its benchmark interest rate by 75 basis points (0.75 percentage point) from zero to 0.75%. There was much chatter about the tricky position the bank finds itself in as the eurozone economy seemingly teeters on the brink of recession as inflation accelerates. Most agreed rate hikes won’t do much on the inflation front and raised the likelihood of an economic downturn. Perhaps both of those prove true—and perhaps not. We have written at length about what rate hikes can and can’t do in this environment, and there is mounting evidence that inflationary forces outside central banks’ control are starting to turn, albeit to varying degrees in various regions. And, crucially, there is also evidence the broader fallacy underlying these fears—a mantra known as Don’t Fight the Fed—is as off-target now as ever.
Don’t Fight the Fed—which may as well be Don’t Fight Central Banks[i]—holds that stocks should generally party when monetary policymakers are cutting rates and struggle when central banks are hiking. This year, it might even seem to hold true, given central banks have tightened during a bear market, which is typically a prolonged decline of -20% or worse with a fundamental cause. To us, this bear market seems much more sentiment-driven, with about eight different issues weighing on investors’ minds. Rate hikes are one of those, so from that standpoint we will concede they bear some blame. But that doesn’t mean rate hikes—even big ones—are negative from a fundamental standpoint.
We generally don’t like looking to short-term returns to prove a point, as they are myopic and happen for any or no reason. Yet we also think it is fair to presume that if rate hikes were fundamentally bad for the economy or stocks—the bear market’s trigger—we would see a consistent pattern of negative returns in their wake. Thing is, we haven’t.
The western United States may be enduring an epic heatwave right now, but winter is front and center on many investors’ minds—specifically the European winter, now that Russian gas provider Gazprom has ceased supplying the EU through the Nord Stream 1 pipeline. European Commission President Ursula von der Leyen laid out a potential response plan ahead of an emergency summit to tackle the issue Friday, but her package of windfall taxes, price caps and mandatory conservation left most observers underwhelmed. In our view, that dour reaction is probably a good thing. Rationing, of course, adds to widespread worries of a forthcoming European recession. If this becomes the baseline expectation, which doesn’t seem too distant, then it should help stocks price the economic impact quickly and move on.
The European Commission doesn’t get the final say-so on the EU’s collective response. That honor goes to the European Council, which is composed of heads of state and government from every EU member state. Its decisions are typically unanimous, and they usually include exemptions for some nations in order to win approval. So von der Leyen’s statement—and the policy proposals leaked to The Guardian Wednesday—isn’t necessarily a blueprint of what EU leaders will agree to. But as the likely starting point for talks, it is worth a look.
The provision gaining the most attention: a revenue cap on electricity providers that use low-carbon power sources, including wind, solar and nuclear. EU energy regulations tie electricity prices not to input costs, but to the price of the most expensive source. Right now, that is natural gas, delivering a big revenue windfall to providers that use cheaper inputs. While she didn’t specify a cap, The Guardian reported the European Commission will propose a ceiling of €200 per megawatt hour for low-carbon sources, which their research claims is what the market price of electricity would be absent sanctions and supply hiccups, with a windfall tax running parallel.[i] There is also a proposed windfall tax for oil and gas companies, mandatory energy reduction of 5% during peak hours and a cap on Russian gas prices and measures to support the functioning of energy derivatives markets. Proceeds of the windfall tax would go to member states to help households and businesses cope with energy costs.
With stocks tumbling again, we have seen a notable shift in financial commentary: an abundance of chatter about winners and losers, both in this current bear market and in recessions historically. The implication? Shifting into what has done well—and what usually holds up better during recessions—will help limit portfolio downside from here. This prospect, coupled with the emotional relief some investors feel when “selling the losers,” seems enticing to many. Yet we think it is one of the least beneficial things anyone seeking long-term growth could do right now.
Selling stocks that have suffered this year may seem appealing from a stop the bleeding standpoint.[i] But in investing, emotional appeal and wisdom rarely intersect. So it is with selling stocks that are down right now, in our view. For one, it amounts to selling a company because of what it has done, not what it will do. Two, overall and on average, the categories that get pounded the hardest during a bear market (generally a prolonged decline of -20% or worse with a fundamental cause) typically have the biggest, fastest bounce off the bottom. So if the bounce is close by, you likely limit your potential to capitalize on it if you sell the stocks most likely to drive it.
Then too, selling losers risks impeding diversification. The popular view of this bear market holds that Tech and Tech-like stocks in Consumer Discretionary and Interactive Media & Services (within the Communication Services sector) are primarily responsible for stocks’ trip below -20%. And to an extent, that is true, considering these categories have been hit the hardest. Yet the vast majority of stocks are down this year (Exhibit 1), and nearly half of MSCI World Index constituents are currently in bear market territory (Exhibit 2). If you were to sell all the down stocks, you would be selling over 80% of the global market’s constituents. Selling only those that are down big would take 749 of 1,510 MSCI World Constituents off the table. Ditching all of those and piling into what has held up well basically means taking concentrated positions in Energy, Utilities and Consumer Staples.
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.