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.


Our Snap, Preliminary, Too Early Take on America’s Midterms

Editors’ Note: MarketMinder favors no party nor any politician, assessing developments solely for their potential market and economic implications.

Two days after the votes were due, much remains unclear about America’s midterm elections. Votes are still being tallied in the Arizona and Nevada Senate races, Georgia is headed for (another!) Senate runoff election on December 6, and quite a few House races are undecided. The party that takes two of those three Senate races will control the body and, although the House seems to be heading for Republican control—which would usher in the bullish gridlock markets typically celebrate after midterms—even that isn’t assured yet. All this is keeping uncertainty high right now, but it should start falling fast before long.

There are really only a couple definitive things one can say now. One, this election went off without much protesting or squabbling over improprieties. Two, it was a very close election—in the House, there was no “red wave.” That is basically what we expected. As Fisher Investments founder and Executive Chairman Ken Fisher explained in his August LinkedIn column, the House’s structure made a wave election highly unlikely:

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October’s CPI and the Inflation Wall of Worry

Throughout this year’s maddening inflation, we have held the basic premise that sentiment surrounding inflation, rather than the fast-rising prices themselves, is the primary drag on stocks. This is always a hard thing to prove, but every now and then a powerful piece of evidence arises. We think Thursday’s market reaction to October’s US Consumer Price Index (CPI) report is one such piece. If you dig into the details, there is little fundamental reason the news should spur the S&P 500 to jump 5.5% on the day.[i] Yet jump it did, which we think speaks to how sour inflation-related sentiment is. If a modest deceleration for quirky reasons could spur such a big relief rally, the inflation wall of worry—which stocks legendarily climb—must be very high indeed.

To be clear, the CPI data were encouraging. The headline year-over-year inflation rate slowed to 7.7%, which is high—but below consensus expectations for 8.0% and significantly slower than September’s 8.2% rate and well off June’s 9.1% high.[ii] Core CPI, which excludes volatile food and energy prices, also slowed, from 6.6% y/y to 6.3%.[iii] On a month-over-month basis, headline CPI matched September’s 0.4% rise, while core slowed to 0.3% from 0.6%.[iv] But under the hood, things were mixed. Energy flipped from September’s -2.1% m/m drop to a 1.8% rise as falling household natural gas utility prices couldn’t offset a 4.4% jump in oil-based fuels.[v] Core goods prices fell -0.4% m/m, which seems promising at first blush, but that stemmed primarily from used cars (down -2.4%) and apparel (down -0.7%).[vi] Recreational goods, most personal care products, new cars and a broad spectrum of household products all endured another month of rising prices. Meanwhile, services’ deceleration from 0.8% m/m to 0.4% stems primarily from a -4.0% drop in health insurance costs, which is mostly an imaginary figure.[vii] The measurement of Health Insurance CPI is bizarre, reflecting health insurance firms’ retained earnings rather than actual health insurance prices.

Will inflation continue to slow from here? We can’t say with certainty, but we don’t expect inflation to stay super high. There are many signs it is likely to slow, including falling commodity prices. Home prices are also rolling over, which should feed through into the shelter component of CPI in the months ahead. Ditto slowing money supply growth and easing supply chain conditions. All are down from the red-hot levels that fed into CPI earlier this year, and prices are slowly digesting all these changes. So to us the outlook is positive. But we think it is premature to argue October’s CPI report confirms this.

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Checking In on US Household Financial Health

Whenever a negative or perceived negative arises, you can count on investors hunting far and wide for signs of real trouble. So it has gone this year with inflation and household finances. Undoubtedly, inflation has been a burden for many, stretching budgets and forcing some people and families to make tough decisions. Yet on the macroeconomic front, there isn’t much sign of major trouble yet. Consumer spending is still growing, even adjusted for inflation, albeit slowly. Wages are rising, maybe not as much as inflation, but they are up. Hence, the hunt for the signs of deeper trouble finally arriving. This week, the hunt centered on consumer debt—specifically credit card debt, which the latest reports estimate could hit $1 trillion by yearend. This allegedly signals that cash-strapped households are borrowing to make ends meet, storing up trouble for later. However, when we take a broader look at household balance sheets, we think this observation falls flat as an economic risk.

One of the most common pitfalls in assessing data is viewing debt in absolute terms—the amount outstanding—and getting hung up on the big numbers. Those numbers are usually meaningless, as debt is just one part of a balance sheet. Think about a middle-American household with a car loan and a mortgage. This hypothetical family may have $400,000 in debt. But they also have assets: the house, car, savings accounts, retirement accounts and investment accounts. And they don’t have to repay the debt all at once. Income, perhaps combined with assets, enables these folks to handle the debt.

So rather than looking at credit card debt in a vacuum, we think it makes more sense to view it as one ingredient of households’ broader finances. One way to do that: compare it to total financial assets. Exhibit 1 does this, using the Fed’s quarterly data since 1995, when granular data on household credit card debt begins. As you will see, while credit card debt is up lately, it has more than halved since the 1990s and finished Q2 below 1.0% of total assets—and even this overstates matters a bit, as it compares the combined credit card debt of households and nonprofits, which is the most granular measure available, to the total financial assets of households only. Even if you add in the roughly $40 billion in credit card debt that separate Fed data show the country has taken on this year, it isn’t enough to move the needle. If the US economy and consumer spending could grow just fine at higher credit card debt ratios in the past, we doubt the present uptick is problematic. 

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Keep a Narrow Focus on October Jobs

Like many economic reports lately, experts searched for clues in last Friday’s US jobs numbers for whether the Fed’s rate hikes are cooling the economy—a fallacious practice, in our view. We suggest tuning out that noise and speculation and instead viewing the data in their own context. To us, doing so helps show the October jobs report simply confirms the labor market’s ongoing post-pandemic trend. We don’t suggest ascribing anything more to the data than that. 

From the headline level, October’s jobs report was generally growthy. Nonfarm payrolls rose 261,000 after September’s revised 315,000 gain, beating expectations of a 200,000 increase. However, the unemployment rate ticked up to 3.7% from September’s 3.5%—higher than analysts’ expected 3.6% rate. The unemployment rate reflects the number of unemployed as a percentage of the labor force. Since the former rose in October while the latter fell a bit, a larger number of unemployed folks divided by a smaller labor force resulted in a higher percentage. While this might appear to contradict a jump in payrolls, a deeper dive into the Bureau of Labor Statistics’ (BLS) criteria reveals a more nuanced reality: The hiring data and unemployment rate stem from different surveys. The former is from the employer or “establishment” survey—the latter, the household survey. Since they reflect different data sources (about 131,000 businesses and government agencies versus about 60,000 households), it isn’t unusual for them to send seemingly conflicting signals.

One reason for this is that the BLS has specific definitions for what constitutes “unemployed”: Persons that aren’t employed—but available to work and have sought a job in the four-week period ending with the survey reference week (or were temporarily laid off and are expected to be recalled). Abnormal seasonal, industry and/or one-off (e.g., natural disasters) developments can impact who gets classified as “unemployed,” which can lead to volatile monthly readings—a reason we caution investors against painting broad brushstrokes based on one data point.

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The Fed Is In the Red. And It Doesn’t Matter.

Are central banks about to take losses—even go insolvent? That question, or forms of it, appear to be popping up with increased frequency lately, paired with varying degrees of alarm. Some coverage focuses on unrealized losses in the Fed and other central banks’ bond portfolios tied to rising interest rates, as if this has implications for capital as it would for a commercial bank. Others dwell on negative net interest income, warning central banks’ operating in the red stores up trouble. We think all of the chatter misses some key points about how central banks function. Namely, it is impossible for central banks to go bankrupt, and their purported losses are not a financial crisis in the making, in our view.

Yes, it is true that the Fed, Bank of England (BoE), European Central Bank (ECB), Bank of Japan (BoJ) and others own a lot of bonds. And yes, it is true that bond prices are down this year, as they move inversely with interest rates. Hence, the market value of some of these central banks’ holdings is likely well below the purchase price. The Swiss National Bank (SNB) and others who own stocks as well as bonds are also sitting on declines, with the SNB’s year-to-date paper losses topping 20% of Swiss GDP.[i] Other researchers estimate the Fed has racked up about $1 trillion of unrealized declines this year.[ii] That is a lot of red ink for entities that supposedly underpin the financial system.

Yet it is also mostly imaginary red ink. Central banks aren’t like commercial banks. They don’t have regulatory capital requirements. They may report their assets at fair value, but they aren’t actually subject to mark-to-market accounting rules. They would take a loss if they were to sell assets for less than they paid for them, but only the BoE is presently selling bonds—and its holdings are in an account indemnified against losses by His Majesty’s Treasury. The Fed, meanwhile, is passively letting maturing securities roll off its balance sheet—no sales, no realized losses, except to the extent it may have bought bonds at a premium to par value years ago.

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What Investors Should Make of Windfall Taxes and Export Bans

Editors’ Note: MarketMinder favors no politician nor any political party, assessing politics and policy ideas solely for their potential market and economic impact.

Crude oil and gasoline prices may be down from this year’s highs, but households worldwide continue dealing with high home energy costs, spurring governments to consider taking action. On our shores, the Biden administration is jawboning about an Energy sector windfall profits tax and banning oil and gas exports. Britain is mulling an extension of its own temporary windfall tax, and Australia is considering an export ban and capping natural gas prices. Now, this is obviously a politically sensitive topic, so please understand that we aren’t trying to take sides or wade into the political aspect—especially on the eve of America’s midterm elections. But considering policies’ impact is an important task from an investing standpoint. In this case, while we don’t think any of these initiatives would likely be a net benefit, we doubt their imposition would be a huge new negative for stocks.

Take windfall profits taxes. The argument for them seems simple: Oil and gas companies have enjoyed bumper profits due to prices that rose for reasons outside their control this year—a happy accident, according to our politicians—while consumers have suffered. Therefore, it is only fair to tax this temporary windfall and use the proceeds to help households and businesses having trouble making ends meet. Problem is, a windfall tax discourages new investment, which is what is ultimately needed to bring prices down. Why would companies invest in future production now when governments are signaling they could raid any profits that brings? It also ignores recent history as well as the Energy sector’s cyclicality. In general, oil prices rise as demand exceeds supply. Eventually high prices incentivize new investment, which boosts production and brings supply in balance with demand. Inevitably, oil companies overshoot, creating a supply glut that pulls prices down. When that happens, they cut costs to stay afloat, which eventually reduces supply as new wells don’t come online to replace spent ones. That leads to supply shortages, pushing prices higher and starting the whole cycle anew.

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Putting America’s Diesel Situation Into Perspective

Steep oil prices have stolen headlines all year, enflamed by supply concerns after Russia’s invasion of Ukraine. Now, it seems US diesel prices are getting their turn after major US diesel supplier Mansfield Energy warned of a potential shortage earlier this week—particularly for the East Coast.[i] While it is possible such a shortage rekindles some near-term supply chain issues, we think the evidence suggests any pain would likely be short-lived. More importantly for investors, fears of potential diesel shortages have been widely discussed since March, suggesting negative surprise power for stocks is likely minimal.

 

Diesel—heavily used in transport, trucking, farming, manufacturing and heating—is a hot commodity presently. Many fear a potential shortage would worsen supply-chain issues, push inflation higher and increase the likelihood of recession. There is little data on diesel itself. However, it, jet fuel and heating oil are primary distillate fuels—industry lingo for petroleum products made from vapors emitted by heating crude oil. US distillate inventories are currently about 20% below their five-year seasonal average, amounting to roughly 25 days of reserves.[ii] (Exhibit 1) This has pushed diesel prices up about 45% y/y.[iii] Supplies are particularly low—about -60% under typical levels at this time of year—in the Northeast, where heating demand is higher. (Exhibit 2)

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Zoom Out to Gain More Perspective on Traders’ Reactions to the Fed

S&P 500 falls -2.5% on Fed rate hike.[i] That is how most coverage sums up stocks’ volatility on the day the Fed announced it will raise the fed-funds target range by another 0.75 percentage point (or 75 basis points) to 3.75 – 4.0%. Deeper analysis delves into the intraday wiggles, tying every twist and turn to the Fed’s words—and drawing big, forward-looking conclusions. We urge you not to try. There is simply too much noise in ultra short-term moves, which typically have little to do with how markets actually view the foreseeable future.

Initially, when the Fed’s release came out, markets jumped. Live blogs tied that to the following sentence in the Federal Open Market Committee’s (FOMC’s) statement: “In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” Those who parse these things for a living interpreted this to mean the Fed might soon slow its pace of hikes, rendering expectations for the fed-funds rate to top 4.6% next year overwrought. Since many think stocks have paid close attention to terminal rate expectations lately, this was allegedly good news.

But then Fed head Jay Powell launched into his press conference and made numerous statements countering this view, and the more he talked the more markets fell. He warned “the ultimate level of interest rates will be higher than previously expected.” He implied he doesn’t think there is much lag between monetary policy moves and economic activity and claimed “there’s no sense that inflation is coming down” despite what he views as tightening financial conditions, leading him to conclude the Fed has “a ways to go.” The more stocks fell, the more commentators concluded that markets interpreted this forward guidance as a very bad sign indeed.

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Q3 Earnings Take Shape

With about two-thirds of S&P 500 companies reporting Q3 results, what can investors glean from them? While there were without doubt high-profile beats and misses that sent some companies’ stock prices soaring and reeling, more meaningful on a forward-looking basis, in our view, are the broader trends and what they reveal about how Corporate America is weathering this year’s storms. Scratch the surface of the overall mixed headline results, and there are strong indications that inflation, supply chain issues and other headwinds are working their way through the system. That doesn’t predict stocks, but it adds color to what markets have spent this year pricing in and suggests to us fears of much greater pain from here will likely miss the mark.

As analysts point out, earnings that exclude the Energy sector are down—not terribly much, but perhaps consistent with what this year’s mild bear market hinted at in advance. While the S&P 500’s Q3 earnings are up 3.0% y/y (combining actual results and remaining estimates), Energy’s 137.4% haul is swelling the figure.[i] Excluding Energy, they fell -4.4% y/y, the second-straight decline after Q2’s -4.0%.

The weakest sectors were Communication Services, Financials and Materials, which are facing year-over-year earnings declines of -19.2%, -17.5% and -15.7%, respectively. Declining ad revenue appears to be Communication Services biggest detractor, while Financials’ decline is partially an accounting construct—banks’ loan loss provisioning is contributing to their earnings weakness, especially after releasing reserves last year. Commodity prices’ steep drop from a year ago seems mostly behind Materials’ profit slide. All this is backward looking, which doesn’t affect forward-looking stocks fundamentally. So we wouldn’t read into any of it as signs of worse to come for the sectors in question or the S&P 500 overall (notwithstanding base effects over the next couple of quarters). Nor do we think Energy’s jump is some massively bullish feature looking forward—it is an artefact of higher oil and gas prices.

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From the Mailbag: Some Considerations About Those ‘Real’ Returns

Here is a question we have seen a few times in our mailbag this year: Shouldn’t you adjust stock market returns for inflation—i.e., discuss “real” returns? The sentiment is understandable, given the backdrop in 2022. And, lately, this has given rise to another question: Shouldn’t earnings be adjusted for inflation? But in our view, there are some pretty big drawbacks we think anyone considering these practices ought to weigh.

To start with, investors earn nominal (meaning, unadjusted) returns. Like a worker’s paycheck, that is what shows up on statements and in brokerage accounts, making them the most meaningful. Furthermore, corporate earnings and fundamentals are also nominal, so adjusting stock returns would compare apples and squirrels, since a stock is a share in a company’s future earnings.

But that is just the tip of the iceberg. When statisticians adjust economic data for inflation, the goal is to remove skew caused by rising prices. Consider UK retail sales: For much of this year, growth in sales values was quite strong. But was that because prices rose, or because Brits bought more stuff? Enter the inflation-adjusted measure, sales volumes. It fell in seven of the nine months for which we have data so far. Similarly, nominal US GDP grew 6.6% annualized in Q1, 8.5% in Q2 and 6.7% in Q3.[i] Without the inflation-adjusted dataset, we would never know whether this stemmed from rising prices or an actual increase in economic activity. Deflating the figures lets everyone zero in on what actually happened.

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