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.
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).
Editors’ Note: MarketMinder doesn’t make individual securities recommendations. Those mentioned herein merely represent a broader theme we wish to highlight.
Chatter over regulation is a near-constant in the commentariat. But still, there seems to be an awful lot of chatter about regulatory risk right now. New UK Prime Minister Liz Truss has pledged to review the Bank of England’s mandate and overhaul the financial regulatory system, stirring fear. On our shores, the Securities and Exchange Commission has proposed broadening the definition of a securities dealer in a way that could ensnare entities investing their own money. And who can forget the ongoing global tussle over the definitions of “green” investing? Crypto regulation talk continues to simmer in much of the world. Some people favor these initiatives. Others oppose them, warning of decades-long economic and market consequences. This article isn’t about which sides are right. Rather, a simple point: Regulatory changes that bring big downstream consequences can have strong near-term effects. But it is a mistake to project or think they will have a very long-term market impact. Rather, their second, third and fourth-order side effects typically fade into the backdrop.
To see this, consider a US regulatory overhaul that turned 20 this summer: The Public Company Accounting Reform and Investor Protection Act, better known as the Sarbanes-Oxley Act of 2002. Or SarbOx, for short. Congress conceived it in February 2002 as a response to the accounting scandals at Enron, Tyco International, WorldCom and others, and after a short debate—including waffling back and forth between versions—a more extreme House version passed in overwhelmingly bipartisan fashion that summer, before receiving then-President George W. Bush’s signature at July’s end. Accounting fraud, of course, was already illegal, but lawmakers determined that its seemingly widespread nature rendered the extant rules insufficient—it needed to be illegal-er. So Congress added a bespoke public accounting regulator, cracked down on auditors’ conflicts of interests, made CEOs and CFOs criminally liable for inaccurate reports and ratcheted up public companies’ reporting requirements.
By some measures, bonds have entered a bear market (typically a prolonged fundamentally driven decline exceeding -20%) this year along with stocks. In blended portfolios, bonds are usually supposed to provide asset-class diversification, cushioning against equity volatility for those whose goals, needs and comfort with volatility make that desirable. But given this year’s environment, you may ask: If bonds don’t mitigate portfolio swings, why own them at all? In our view, although bonds may disappoint temporarily, they still provide adequate cushion over investors’ required time horizons.
First, let us explore the so-called “bond bear market” headlines have touted recently. One widely watched bond benchmark, the Bloomberg Global Aggregate Bond Index, has fallen -21.2% from its January 4, 2021 peak on a total return basis.[i] But it includes non-US dollar-denominated investment-grade debt from 24 markets abroad. Given the US dollar’s strength over the last year, a big chunk of the Global Aggregate’s decline stems from currency translation.
In our view, most long-term investors whose portfolios include fixed income are probably better served investing in their own nations’ bonds. Unlike stocks, in our view, a bond allocation’s purpose is to dampen expected volatility versus an all-equity portfolio. Adding currency risk cuts against that objective. So for US investors, we think it is better to look at domestic bond indexes. The same goes for UK, Australian and Canadian investors, to name a few.
Last July, someone in Illinois won the $1.3 billion Mega Millions prize—the third-largest lottery jackpot in US history—though no one has claimed it yet, despite a payment option deadline looming.[i] This is the very Mega Millions jackpot your neighbors likely dreamt of. It is easy to imagine the benefits of a tremendous windfall, like paying off debt, erasing your family’s financial stress or purchasing a home. However, it is even easier to overlook the surprising possible downsides—which aren’t exclusive to lottery winners. Inheritors can also experience sudden wealth’s psychological effects. In my view, preparing to give or receive an inheritance can help mitigate these potential negatives.
Sudden wealth syndrome,” coined and described by the MMC Institute, can manifest in lottery winners and inheritors alike.[ii] As the MMCI’s research documents, feelings of guilt and paranoia may arise—along with anxiety, sleeplessness and thoughts like, “I don’t deserve this,” or “will this money disappear equally fast?” Furthermore, per the MMCI, guilt associated with newfound wealth may lead to self-defeating behaviors—such as an individual attempting to reconcile their past and present financial realities by spending (i.e., getting rid of) this new money as quickly as possible, consciously or not. This can include spending sprees, gambling or giving impulsively.
Identity crises and social isolation can also crop up. A sudden influx of wealth can force individuals to reassess their life goals and daily purpose. For example, an individual might suddenly question the purpose of their job—even if they enjoy it—when money is seemingly no longer relevant. They may need to redefine entirely what success looks like in their new reality. This can dovetail with social isolation. Without a sense of purpose or identity, suddenly wealthy individuals may self-isolate from friends and family. Familial resentment and requests for money—real or imagined—can drive isolation further. Meanwhile, the reality of one’s peers being comparatively financially limited means life plans may diverge. Friends might not be able to join on that big vacation or relate to new life goals. Financial mismanagement is yet another potential issue. As I touched on above, guilt can drive overspending and impulsivity—as can overconfidence. Conversely, an individual may fear financial missteps—leading to decision paralysis.
Amid a quite volatile week for stocks, investors continue hunting for hints at which way stocks will go. In the very short term, this is—of course—unknowable: Volatility cuts both ways, and it both starts and stops for any or no apparent reason. But over more meaningful periods, as stocks weigh fundamentals, they move on the gap between expectations and reality over the next 3 – 30 months. As bull markets begin, those expectations are colored by a phenomenon we call the pessimism of disbelief: investors’ tendency to emphasize bad news and hunt for negatives in news that would otherwise be good. While we can’t know now whether stocks’ latest rocky spell is merely a brief interruption of a nascent recovery or another leg down to a more W-shaped bear market low, that pessimism abounds today. The coverage of Thursday’s US retail sales is a prime example, in our view.
Retail sales resumed growing in August, following July’s (downwardly revised) -0.4% month-over-month slide with a 0.3% rise.[i] That rise was subject to big positive skew from autos and big negative skew from gas stations—both influenced mainly by price movements. But those canceled each other out, as retail sales excluding autos and gas stations also rose 0.3% m/m.[ii] Headline retail sales also rose 9.1% y/y, which—as many noted—outpaced August’s year-over-year inflation rate, implying sales continue to eke out some growth on an inflation-adjusted basis.[iii] Mind you, that is overly simplistic considering properly deflating retail sales would require squaring up the month-over-month sales growth and inflation rates in dozens of small categories, but the observation is interesting all the same.
Not because it was a cheerful observation—rather, in typical pessimism-of-disbelief fashion, most of Thursday’s commentary didn’t offer positive reasons why inflation wouldn’t be eroding spending on goods and food service. Articles didn’t tout strong demand, nor did they express relief that falling gas prices are freeing up more of people’s money for discretionary spending. Rather, much of the coverage centered on timing: Not only is August back-to-school month, which boosts sales of clothing and school supplies, but it is also typically when stores will slash prices in order to make room for holiday season inventory. Accordingly, pundits credited deep discounting for sales’ seeming resilience, implying that the only reason consumers are buying more is that they are raiding clearance sales in order to pinch pennies.