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.


What Follows Truss’s 44 Days?

Editors’ Note: MarketMinder prefers no politician nor any party. We assess developments for their potential economic and market impact only.

Forty-four (and a half) days. That is how long Liz Truss served as UK Prime Minister (PM) before announcing her resignation today, capping a madcap week in Parliament. Now the Conservative Party must hold another leadership contest to determine who will be this year’s third PM. A lot of names are flying around, as is talk of a snap election, with much chatter about who is and isn’t good for markets. In our view, this is the wrong way to think about it. While recent volatility may seem to imply otherwise, stocks don’t care about political personalities or the ideology of who is in charge. Remember this as the circus rolls on.

Mercifully, the replacement process should be short, unlike the months-long contest that determined ousted PM Boris Johnson’s immediate replacement. That race, with many runners and riders, went through multiple rounds of voting among Conservative Members of Parliament (MPs) before winnowing down to Truss—the grassroots’ preferred choice—and former Chancellor of the Exchequer Rishi Sunak, whom more MPs backed. Both spent the summer wooing party members, and Truss emerged victorious. But although the Conservative public at large remains largely favorable to Truss’s platform of tax cuts and deregulation, many Conservative MPs blame her ideology for their recent polling declines. So in what looks like an effort to keep Truss’s ideological bedfellows off the final shortlist, the party will require all leadership hopefuls to get the backing of at least 100 MPs in order to make the ballot. That would mean a maximum of three. In that event, MPs would vote Monday, then put the top two finishers to an online vote of all party members, which would run from Tuesday through Friday. But it is also possible that only one candidate attracts the necessary number of backers, which would negate the need for a vote. Either way, the matter will be settled by the end of next week.

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A Counterpoint to Dour Economic Forecasts

Recession forecasts have dominated financial headlines this year. That is understandable given the global economy’s soft patches (e.g., Europe’s energy situation), and today’s economic headwinds heighten the prospect of recession in certain regions. That said, expectations of a severe global downturn seem overstated, in our view. Fundamental drivers—key among them bank lending—suggest reality isn’t as poor as many anticipate and underpin the recovery we think is coming.

Many prominent outlets and voices think things are going to get worse before they get better. A recent Wall Street Journal survey found a majority of polled economists expect the US will enter recession in the next 12 months. World Bank President David Malpass warned of a “real danger” of a worldwide contraction next year. The International Energy Agency lowered its global oil demand growth forecast because “major institutions” downgraded their latest global GDP estimates.

But the kicker: Last week the IMF’s “World Economic Outlook” (WEO) cranked headlines’ recession warnings into overdrive. Interestingly (and unsurprisingly), most coverage focused on one line in the WEO’s foreword: “In short, the worst is yet to come, and for many people 2023 will feel like a recession.” (boldface ours) We don’t dismiss people’s emotions or hardships, but feelings don’t predict people’s actions. Looking a bit deeper, the IMF isn’t even forecasting a global GDP contraction next year—it is predicting annual growth of 2.7%, 0.2 percentage point below its July WEO estimate. Yes, that is slower growth—but it is still growth.

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What to Make of Heightened Volatility

All year, volatility—swings in both directions, even intraday—has been elevated, contributing to many feeling like markets are on a roller coaster in 2022. The swings may be uncomfortable. But how people react can often be more problematic than that: Wild gyrations are potentially unhelpful, leading many to think momentous events—and perhaps turning points—are afoot. They see the swings as a call to action as a result. We suggest tuning out the noise.

If it seems like 2022 is more volatile than in recent years, it is. Consider intraday data. As Exhibit 1 shows, this year has seen the biggest S&P 500 intraday moves since 2009, with a 1.9% average difference between days’ lows and highs. Volatility normally is elevated, unfortunately, in a bear market. Also see the mid-1970s, early-1980s and early-2000s. And, of course, there is the Great Depression, history’s most volatile period.

Exhibit 1: S&P 500 Bouncier in 2022 Than Most Years, but not Abnormally So

Source: Global Financial Data, Inc., as of 10/19/2022. S&P 500 price index annual average percent change between daily intraday lows and intraday highs, 1/2/1930 – 10/18/2022. 2022’s average is year to date. Note: Intraday prices aren’t available during WWII and the Korean War.

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As Britain’s Mini-Budget U-Turns…

Editors’ Note: MarketMinder is politically agnostic. We prefer no politician nor any party and assess developments for their potential economic and market impact only.

UK politics keep moving at warp speed, continuing bond markets’ wild ride. When last we left you Friday evening, Prime Minister Liz Truss had replaced Chancellor of the Exchequer Kwasi Kwarteng with Jeremy Hunt and U-turned on her prior plans to cancel the corporate tax hike scheduled for April. At the time, Hunt was due to unveil the government’s new economic plans on Halloween, and Truss had seemingly managed to shore up her position a wee bit. But after a weekend of leaks and rumors about an intraparty coup, Hunt unveiled the new economic plans two weeks early and U-turned on the vast majority of Truss and Kwarteng’s prior proposals, leaving most Westminster insiders speculating that her days are numbered. The UK’s 10-year Gilt yield fell over 41 basis points to 3.97% in response, mid-to-longer-term European 10-year yields fell modestly in sympathy and medium-term US Treasury yields inched lower, while the S&P 500 jumped 2.6% on the day.[i] We see all of this as a sentiment reaction—much ado about a lot of political wrangling and very little actual change. Moving on from this saga, however it resolves, probably reduces uncertainty and gives markets one less thing to stew over.

Hunt’s new package keeps a handful of Truss and Kwarteng’s earlier proposals. The reversal of April’s 1.25 percentage point (ppt) increase to the tax that funds Britain’s National Health Service, which has already begun its journey through Parliament, will go forward. So will the low-tax “investment zones” and the increased threshold for “stamp duty” on home purchase, which will rise from £125,000 to £250,000. The cap on bankers’ bonuses will still be scrapped, and households will still get relief from higher energy prices … with a catch. Where the original plan ran through the next two winters, Hunt’s version will end in April, and he hinted that it would be means-tested.

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The Latest Twists in Westminster

Editors’ Note: MarketMinder prefers no party nor any politician. We are politically agnostic and assess developments for their potential economic and market impact only.

What a difference a day makes. Twenty-four hours ago, Jeremy Hunt was a backbench Member of Parliament (MP) in the UK with two failed Conservative Party leadership bids and no Cabinet position in three years. Now he is Chancellor of the Exchequer, responsible for executing the economic vision of Prime Minister Liz Truss. That is a bit awkward considering he supported her leadership opponent and economic policy foil, former Chancellor Rishi Sunak, in the final stage of this summer’s leadership contest. Out, just days into his tenure, is now-former Chancellor Kwasi Kwarteng, who has endured the insult of getting sacked by Truss simply for trying to fulfill her campaign proposals. Yes, UK politics are getting messy. Again. Breeding immediate policy uncertainty. Again. But the dust shouldn’t take long to settle, which should reveal the country’s deep gridlock and help investors get past today’s jitters.

When last we left Truss and Kwarteng, they were dealing with the fallout from their “mini-budget,” which they tried to sell as a growth-boosting suite of tax cuts and help for households dealing with sky-high energy costs and a cost-of living crisis. When they unveiled the measures, the majority of global think tank/political-types labeled them an irresponsible pile of debt-fueling “unfunded tax cuts.” We didn’t—and don’t—think either viewpoint is right. As we wrote at the time, the plan merely undid one very small, six-month-old rise in the tax that funds Britain’s National Health Service; reduced the basic income tax rate to partly offset tax bands’ not rising with inflation; removed the top 45% tax rate on incomes over £150,000 (leaving the top rate at 40% on income over £100,000); and canceled a corporate tax hike from 19% to 25% scheduled to take effect next year. All in, these changes would have reduced some, but not all, of the stealth tax hike Brits endured this year.

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Addressing the Latest on Rising US Debt

Editors’ Note: MarketMinder’s commentary is intentionally nonpartisan. We favor no party nor any politician and assess developments solely for their potential market and economic effects.

Last week, the US Treasury announced gross national debt exceeded $31 trillion for the first time and, predictably, the huge number spurred myriad concerns. Chief among them: Rising interest rates mean higher borrowing costs—so does that mean America’s finances are in trouble? We don’t think so.

As a lot of coverage noted, the $31 trillion figure refers to gross debt—i.e., total debt outstanding, which includes debt owned by the Federal Reserve, private investors and intragovernmental agencies. We think it is more accurate to focus on net public debt (i.e., debt held by investors and the Fed), which is $24.3 trillion—and not because the figure is smaller.[i] Rather, net public debt excludes the money the government owes itself, which effectively cancels. (You can read more about that here.)

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Our Perspective on Markets’ Rollercoaster Reaction to September Inflation Data

September’s Consumer Price Index report hit the wires today, and once again, inflation data sent Fed watchers into a tizzy. While the headline rate slowed from 8.3% y/y to 8.2%, the “core” rate, which excludes food and energy, accelerated to 6.6%—a fresh multi-decade high.[i] Unsurprisingly, rate hike expectations jumped, with most market participants now seeing the fed-funds target range topping 4.5% by 2023’s end—and a growing minority now envisioning rates topping 5% by then.[ii] That is a big change from yesterday’s expectations, and it was initially enough of a jolt to send market sharply lower. The S&P 500 opened down around -1.6% from Wednesday’s close, and 10-year US Treasury yields jumped from 3.91% to a high of 4.22%.[iii] But as the day progressed, the moves reversed. The S&P 500 closed up 2.6% on the day and the 10-year yield flipped to finish at 3.94%.[iv] While we hesitate to read much into a wobbly day, we see a couple of interesting lessons to draw here, and we think they provide reason for optimism.

Why is always harder to know than what, but we doubt 10-year yields’ reversal stems much from Fed predictions, which remain high. Best as we can tell, the bigger development is the rampant chatter about the UK government plotting another U-turn on its recent “mini-budget” and will soon announce it doesn’t plan to cancel next year’s corporate tax hike after all. This seems to have radically shifted sentiment toward UK Gilts: British 10-year yields are down almost -33 basis points on the day as we write. Their decline has helped pull rates down globally, and if you look at an intraday chart of the US 10-year yield, you will see an initial decline that paralleled Europe, then a sharp spike as the inflation data came out, followed by a renewed decline—which in turn parallels stocks’ rise.

So, we would venture that the inflation report—and its impact on rate hike expectations—caused a fleeting sentiment jolt global factors soon overrode. This is unprovable, as most explanations for daily market movement are, but we think it is useful as a working hypothesis. Now, ordinarily we wouldn’t dwell on such things, but stock returns and bond yields have been very negatively correlated lately, which is rather unusual. Since 2000, the rolling 3-month correlation between weekly S&P 500 price returns and the weekly change in 10-year Treasury yields has been more negative than it is today on only four occasions.[v] To us, this is a strong indication that bond market freakouts are spilling over into stocks right now. So when rate hike expectations and UK Gilt volatility took Treasurys on a wild ride Thursday, stocks rode shotgun.

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RMD Tips for a Down Market

Of all the investing maxims we have seen, we can’t recall any that included “sell low” as timeless advice. More often, it is a thing people do out of panic, then regret later as a market recovery leaves them behind. But what if you have no choice? That is the situation retirees may be facing if they haven’t yet taken their annual mandatory minimum withdrawals from their traditional 401(k)s and IRAs this year. The prospect of reducing stock exposure at levels well below early-year highs—thereby reducing exposure to the eventual rebound—is far from attractive. Thankfully, there are ways to lessen the blow.

Yes, those who turned 72 this year and older with tax-deferred retirement savings accounts must take required minimum distributions (RMDs) or risk facing a stiff 50% penalty on the amount not withdrawn. What is your RMD? Divide last year’s ending balance for your tax-deferred plan(s) by your—and perhaps your spouse’s—remaining-year life expectancy, which the IRS helpfully estimates (Uniform, Single, Joint). Or, ask your financial professional to tabulate it for you. This is the minimum amount you must withdraw this year—which is then subject to taxes. It is how Uncle Sam ensures he gets his slice of those long tax-deferred monies.

Federal law mandates retirees withdraw these funds. But they don’t mandate what you must do with them, which gives people some flexibility. If you don’t need the money straight away and can cover the taxes, you might find it beneficial to withdraw your RMD amount in-kind—simply transferring securities into a taxable brokerage account in the amount required. You still have to pay taxes on the withdrawal, but this lets you stay invested. Then, you are able to sell at your discretion when you need to raise cash for living expenses or other purposes.

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Needed Context for the BoE’s Poor Word Choice

Contagion. That is the word many pundits latched onto Monday, when the Bank of England (BoE) announced new support measures for pensions forced to sell Gilts to meet sudden margin calls. When the trouble first erupted two weeks ago, a vicious circle of rising interest rates and forced selling prompted the BoE to offer to step in as Gilt buyer of last resort for pensions to stop this technical issue from roiling broader markets. That stemmed the tide for a while, but another 10-year yield spike Monday to a fresh closing high of 4.55% accompanied more intervention to “reduce risks from contagion.”[i] There is a lot more to that sentence, as we will discuss, but much of the coverage buried the context, and the hunt for the next shoe to drop began. We aren’t dismissing the UK bond market ructions, but we don’t think this is a 2008-scale financial crisis in waiting.

For simplicity, we will avoid rehashing the political backdrop other than to say yields initially spiked when the market overreacted to the new government’s “mini-budget” that attempted to offset a stealth tax increase with tiny tax rate cuts. For our purposes today, it simply matters that when long rates jumped, it triggered some problems in a corner of the UK pensions market called Liability-Driven Investing (LDI), which—as the name implies—is a tactic pensions will use to match their investments with their future liabilities. In practice, this is easier said than done, as some active pensions have unfunded liabilities, meaning they are still accepting new participants, don’t know what their actual benefits payments will be and still need to earn a long-term return to be able to pay benefits to all participants. As a result, many funds will invest in stocks and other securities as well as bonds, which earns the needed return over time but also subjects the pension’s total value to market volatility in the interim. Enter LDI, which uses interest rate swaps and other derivatives to hedge against market movement in order to keep a portfolio’s market value (and funding ratio) more stable when volatility strikes.

We won’t get into the technicalities of all these contracts, as that too is beside the general point. All you need to know is that a lot of funds used LDI to get leveraged exposure to fixed income in order to increase returns when yields were low. The derivative contracts were designed to rise in value when interest rates fall, but when rates rise and values fall, it requires pensions to post more collateral to meet their margin requirements.

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The Trouble With Projecting Fed Policy From September’s Jobs Data

After a strong start, stocks retreated to close the week, with the S&P 500 down -2.4% as we type early Friday morning.[i] The culprit for the day’s selloff, according to most accounts, was September’s US employment situation report, which showed an unexpected dip in the unemployment rate and nonfarm payrolls rising by 263,000.[ii] A few outlets noted that the pace of hiring has continued to slow—from 315,000 in August and 537,000 in July, and an average of 493,000 in the 12 months prior to Friday’s report. Yet given jobs growth remains quick, most outlets quickly dismissed that: Yeah but the Fed still needs to do more was the common theme, implying we will eventually get to a point where the Fed must kneecap the economy in order to tame the inflation beast, lest it risk allowing a hot job market to fuel a wage-price spiral. We don’t buy this thesis, and we think investors would do well to understand why.

Conventional wisdom—and the Fed’s dual mandate of seeking maximum employment with stable, low inflation—hold that the job market drives wage growth, which drives inflation. Ergo, the Fed should raise interest rates to cool hiring in an inflationary environment like the present and cut them to spur hiring when unemployment is up. Nobel laureate Milton Friedman shattered this myth decades ago, and simple logic does the same today. He showed inflation drives wage growth, not the other way around. Think about it from a worker’s perspective: When are you most apt to hound the boss for a raise? When your rent hasn’t gone up for years, food prices are stable and gas is reasonable? Or when you are suddenly faced with a 10% premium to renew your lease, a newly astronomical grocery bill and much higher fuel prices? Employers understand this too and factor recent inflation into their wage and salary offers. If it were the other way around—if companies randomly raised wages, then prices, then wages, then prices—then inflation would be a merry-go-round that never stops and would start for basically no reason. Money supply growth, supply chain issues and all of the things that have actually driven inflation this year wouldn’t matter.

Secondly, there just isn’t much the Fed can do right now, in a practical sense, to affect hiring noticeably. Traditionally, it would try to control money supply growth by using its benchmark interest rate to influence the yield curve—Fed controlling the short end, market controlling the long end. The gap between the two (long rates minus short) would influence banks’ net interest margins on new loans, as banks generally borrow at short rates and lend at long rates. Banks aren’t charities, so the potential profit margins would influence their willingness to lend at borrowers’ varying degrees of creditworthiness. For good measure, the Fed would also raise or lower reserve requirements to give banks a shorter or longer leash. In a fractional reserve banking system like ours, banks create a large share of new money through lending, so enabling more lending would boost the money supply, which in turn would driver faster growth and more hiring. Disabling lending would slow money supply growth, cooling the economy and tamping down job growth. The relationship between the quantity of money and the amount of goods and services available for it to chase would determine inflation.

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