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.
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.
Last week, the National Association of Home Builders’ August survey suggested its members’ sales conditions are starting to deteriorate as mortgage rates have doubled from last year, leading it to declare a “housing recession” is underway. Besides ongoing supply chain problems hiking construction costs, builders noted cancellations are spiking. With inventories rising, housing starts slowing and reports of sellers slashing prices to attract balking buyers, alarm over a potential residential real estate collapse is growing. Many fear such a downturn could hit the economy hard—and send stocks slumping anew. But although the housing market may be weakening, we don’t expect stocks to mind much.
The housing market has indeed hit a rough patch. Home sales have dropped sharply.
Exhibit 1: Home Sales Sinking
Source: FactSet, as of 8/24/2022. Census Bureau new privately owned houses sold and National Association of Realtors existing homes sold, January 2000 – July 2022.
Every couple weeks, news breaks that yet another global energy producer is ramping up oil and natural gas exports to the EU. Israel is the latest example, with its energy ministry announcing natural gas production is up bigtime year to date amid plans to beef up exports to the EU. We have seen many such anecdotes involving non-Russian suppliers, including Azerbaijan, Qatar, the US and others, but data on how all of this is panning out has been a bit thin. Germany publishes monthly crude oil imports by country but not natural gas. The Netherlands publishes both, but the data are values, not volumes, subjecting them to big skew from commodity price swings. So you can imagine our excitement on Wednesday, when the UK’s Office for National Statistics (ONS) posted a report detailing how the country has adapted to Russian sanctions. It is but one example, but knowing how it has replaced Russian commodity imports can help investors get a better sense of how supply chains are readjusting, perhaps easing uncertainty as we head into the winter.
The UK’s main commodity sanctions included a pledge to phase out all Russian crude oil imports by yearend, cease natural gas imports as soon after that as possible, and ban all iron and steel products. As the ONS notes, Russia accounted for 24.1% of the UK’s refined oil imports in 2021, 5.9% of its crude oil imports and 4.9% of its natural gas imports.[i] Now, the UK also produces its own crude oil, refined petroleum and natural gas, so these percentages don’t represent Russia’s share of UK consumption, which was more like 8% of total oil and oil products, according to Business Secretary Kwasi Kwarteng’s March estimates. Much of its natural gas imports are also re-exported to Continental Europe. But refined petroleum imports in particular play a key role in the UK, making Russia’s impending absence an important hole to fill. Unsurprisingly, businesses haven’t waited for the bans to take effect: Russian fuel imports fell to zero in June. Meanwhile, the UK imported more refined oil from the UAE, Saudi Arabia, Belgium, the Netherlands and India.
That last one is perhaps most of interest, given India hasn’t ceased buying Russian crude—actually, it has ramped up Russian imports bigtime and is reportedly refining Russian oil into gasoline and diesel shipped globally. It is entirely possible that the UK is now simply buying Russian crude that was refined in India, underscoring an important point about energy markets: They are fully global, and total global production is what ultimately matters most. Even if Russian petroleum products are taking a more circuitous route than usual, they are still contributing to global supply, which we think goes a long way toward explaining oil prices’ fall from their March peak.
Has the global recession begun? That question was back at the fore Tuesday after S&P Global’s flash Purchasing Managers’ Indexes (PMIs) for August showed declining output in most major economies. In our view, that makes today ripe for a timely reminder: Regardless of what the global economy is doing this month, stocks generally look about 3 – 30 months out and have likely already digested whatever business surveys and output metrics will eventually confirm happened.
PMIs, unlike “hard” data like retail sales and industrial production, aim to use survey responses to determine the economy’s general direction. They ask participants how business evolved across a range of categories including output, new business, employment, inventories, supplier deliveries, prices and others, then mash the responses into a number. Readings over 50 indicate expansion, with growth broader the farther above 50 it is. Similarly, under 50 means contraction, with lower readings implying widespread declines.
Exhibit 1 shows the flash results for August, which S&P says include about 85% of expected responses. The Manufacturing and Services columns show headline indexes—the aforementioned mashups. The Composite column aggregates Manufacturing and Services output only, hence its apparent divergence.
Remember checkbooks? Back in the day, I learned how to balance one (by hand, trudging miles uphill barefoot through the snow, etc.) in my high school’s personal finance class given by one of our PE teachers. It was an elective, but not one many kids took—perhaps understandably. The subject matter wasn’t exactly scintillating. Also, I can’t say it was very useful, either, especially nowadays, what with banking on your phone and all. Still, financial literacy is vital and under-taught in America today. However, it may be making a comeback in high school, as more state legislatures are requiring a personal finance class to graduate. Georgia and Michigan became the 13th and 14th states in April and June, respectively, and now more than a third of US students have to take such courses as back-to-school season gets in full swing.[i] I doubt the curriculum features checkbook balancing, but that got me to thinking: What would be some good topics to cover? Here are a few I think kids—of any age—might appreciate.
If there is one lesson to impress on young (and young-at-heart) folks, it is the magic of compound growth—earning a return on returns. In my view, finding ways to let your money compound is the surest of the roads to riches humanity has discovered (although decidedly not the quickest). Stock-picking contests like many experienced in school may be exciting, but instilling an appreciation of compounding’s power is way more impactful, not to mention practical.
The last two weeks have been chock full of US economic data, much of it conflicting. The latest example: The New York Fed’s Empire State Manufacturing Index sank into deeply negative territory in July, suggesting a steep contraction in Northeastern factory activity … but the Philadelphia Fed’s counterpart jumped into positive territory, suggesting factory activity expanded on the eastern seaboard. This follows a short run of conflicting manufacturing output (negative) and Institute for Supply Management (ISM) Manufacturing Purchasing Managers’ Indexes, or PMIs (positive). Monthly inventory data, which isn’t adjusted for inflation, is high and rising—but quarterly inventories, which are inflation-adjusted, continue detracting from GDP. We see a broad, important takeaway for investors to keep in mind here: Economic data remain quite volatile post-COVID, making it unwise to read into any one metric, or even a small gathering of metrics.
Exhibits 1 – 6 show an array of monthly data from January 2017 through the latest reading available. As you will see, from PMIs to retail sales to factory orders and beyond, most of these are far more volatile since January 2020. Not just during the initial lockdowns, but afterward, with one exception, the month-to-month moves are bigger across the board.
Exhibit 1: Regional Manufacturing PMIs
Europe’s energy crisis has dominated headlines for nearly a year, with many fearing shortages will lead to recession. The Continent’s hot and dry summer has further stoked energy supply concerns, as droughts impact increasingly in-demand electricity. We don’t dismiss the economic pain for households and businesses, but our focus is on the market impact. In our view, the widespread discussion of an energy-driven recession across the pond reveals how dour moods are—a sign of the low bar reality must clear to positively surprise.
Of course, moods are dour for a reason. Natural gas prices are surging in Europe, with hot weather boosting demand and Russia throttling supply in response to EU sanctions. Russian gas flows through the Nord Stream 1 pipeline have been around 20% of contracted volumes since late July, straining Europe’s ability to generate power while filling storage for the winter.[i] Beyond this, the summer heat has impacted other energy sources: In France, high river water temperatures are interfering with nuclear reactor cooling. In the UK, energy regulator Ofgem will announce October’s energy price cap (which resets semiannually) on August 26, and some anticipate the new cap will double today’s record levels—worsening UK households’ burden.
Politicians have responded in myriad ways. The EU has asked member states to reduce gas demand voluntarily. Some governments have imposed new taxes, from the UK’s windfall tax on energy firms, which passed last month, to Germany’s levy on households to help utilities. Pols have also sought to provide relief. Italy approved a €17 billion aid package while the Netherlands cut energy taxes for 8 million households. The contenders in the UK Conservative Party leadership contest are each reportedly preparing household assistance packages to introduce once they take office next month. France plans to re-nationalize power operator EDF—in which it already owns an 84% stake—in order to sell electricity below cost without getting pushback from minority shareholders. An example of that resistance: The government ordered EDF to sell nuclear power to its rivals at below-market prices, and EDF is now suing for having to take a loss.
Good news! Gas prices are down, and economic data are starting to show the fruit. Exhibit A: July retail sales, which were flat overall as sales excluding gas stations rose. That largely confirms the latest U-Michigan Consumer Sentiment Index, which inched higher in July and August as consumers expressed relief about the easing pain at the pump. We don’t see this as a big economic change, but it should help shore up sentiment—part of the late-2022 wave of falling uncertainty we expect.
Unlike the full consumer spending report, retail sales aren’t adjusted for inflation. Accordingly, sharp price swings can skew the data. That happened with gas station sales in July: They fell -1.8% m/m, heavily influenced by falling prices.[i] The national average price of regular unleaded is now down -21.4% from its mid-June peak, which appears to have freed up some money for more discretionary spending last month.[ii] Excluding gas stations, retail sales rose 0.2% m/m. Excluding motor vehicles and parts as well (given their falls stemmed more from shortages than weak demand), sales jumped 0.7% m/m.[iii] This comparison isn’t apples-to-apples, but to illustrate a practice we see in publications often: That far exceeds the monthly change in both headline and core (ex. food and energy) prices in the month, implying growth stemmed from higher demand, not inflation.
We won’t go so far as to call this some big economic positive or a sign the US is set to avoid a recession, as some outlets did Wednesday. Spending on gasoline is still spending—it adds to GDP. Changes in gas prices tend to shift where people spend without significantly altering how much they spend. Nor do we think this is a sign that Consumer Discretionary stocks’ earnings are about to categorically turn the corner after some high-profile Q2 disappointments. Sales at clothing stores and general merchandise stores (e.g., department stores) fell in July, and as of June (the latest data available) both had big inventory piles to work through.[iv] There may yet be more earnings weakness ahead as some firms continue clearing stockpiles and reorienting toward consumers’ post-pandemic preferences. Mind you, we think stocks are looking well past this, but it is a reminder to keep realistic expectations for—and not get hung up on—near-term earnings data.