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.
Last Friday was 401(k) Day in the US, a day dedicated to retirement planning. We think 401(k) plans are great—a useful tool for those traveling along the most reliable road to riches: saving and investing well over the longer term. The occasion is also an opportunity to revisit some timeless lessons we think are particularly useful during a challenging year for investors.
Lesson One: Fathom the Power of Compounding
The max contribution to a 401(k) plan in 2022 is $20,500 (plus a catch-up contribution of $6,500 for those 50 and over), which doesn’t include any employer-matching funds. Of course, one contribution of $20,500 won’t provide for retirement. Moreover, not everyone can necessarily save that sum year in, year out. However, to the extent you are able, the combination of time and saving is critical to unleashing the power of compounding. Consider what a yearly contribution of $20,500 invested the instant the market opens on the first trading day of every year combined with an 8% annual return—a little below stocks’ historical average—can turn into over 30 years. (Exhibit 1)
Stocks’ rocky 2022 certainly continued Tuesday, as the S&P 500 fell -4.3%—with most blaming disappointing inflation data.[i] But in our view, the large drop extends this year’s one constant: Sentiment seems detached from reality. While we don’t deny the pain of higher prices and interest rates—and negativity like Tuesday’s can sting—investors’ moods and reactions to incoming information seem overall too dour relative to the observable facts on the ground. In our view, Tuesday’s August US Consumer Price Index (CPI) report provides a timely example. Headline CPI decelerated, albeit less than expected, but an acceleration in “core” CPI, which excludes food and energy, triggered more handwringing over a potential 75 basis-point Fed rate hike later this month. Even though investors have been penciling in that large of a Fed rate hike for several weeks now. When stocks sink on emotional flashpoints rather than a materially negative shift in incoming information, we think it is a strong signal that staying cool remains the wisest move.
The CPI report itself held few new or surprising insights. The headline reading slowed from 8.5% y/y in July to 8.3%, missing expectations for 8.1%.[ii] The 0.1% month-over-month increase sped from August’s flat reading but remains below the long-term monthly average.[iii] Yet, extending August’s trend, falling gasoline prices drove much of the deceleration, masking continued price increases elsewhere. Those were more apparent in core CPI, which accelerated from 5.9% y/y to 6.3%, with the month-over-month change speeding from 0.3% to 0.6%.[iv] That may seem sharp, but the month-over-month figures have been quite volatile throughout this high-inflation stretch, and extrapolating any of them forward—whether they were faster or slower—would have been an error. Such is the nature of monthly data.
Much of today’s coverage tried to dig deeper, leading to conclusions that August’s results show inflation is stickier than first expected—hence all the talk of big Fed rate hikes to come. In our view, this is a philosophical error. You can’t look to current price moves to predict future price moves. Looking at CPI’s various subcategories can help identify trends, but these are generally backward-looking. For instance: It is probably fair to conclude that, with core services and core goods measures accelerating, higher energy and petrochemical feedstock costs are starting to bleed through into consumer prices … to some extent. That delayed reaction isn’t surprising, given producers will hedge these costs and try everything possible to avoid passing them to customers, lest they lose market share by reacting to temporary surges in commodity prices. (And it seems like a stretch to connect those theories to shelter, which was the single largest contributing category to the monthly rise, beyond the fact that many rental agreements include utilities.) But this isn’t guaranteed to continue indefinitely, especially with most US energy prices trickling downward more recently. Said differently: Just because core prices tend to be overall less volatile than headline prices doesn’t mean every move is part and parcel of a long-term trend.
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.