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.
Editors’ Note: Inflation has become a hot political topic, and we aren’t commenting on it from that standpoint. We are looking at the investment-related implications only.
9.1%. That is the latest multi-decade high the US’s Consumer Price Index (CPI) year-over-year inflation rate hit in June.[i] When headlines weren’t stewing over what the acceleration from May’s 8.6% means for the Fed’s decision making at its next meeting in two weeks, they were looking for some signs—any signs—that the pain will soon end.[ii] We understand the impulse: The more prices rise, the more it creates hardship for many and forces people to forego things. Inflation has also sent political rancor to the boiling point, which is never pleasant. But from an investing standpoint, pinpointing inflation’s peak isn’t necessary. Stocks don’t need prices to ease—inflation is just one of seven or eight (at least) items weighing on sentiment right now. The key to recovery isn’t fundamental improvement, but gradually easing uncertainty on a multitude of fronts.
The main source of uncertainty underlying inflation right now is the main contributor: energy prices. Those rose 34.6% y/y, which included a 48.7% rise in gas prices.[iii] (Ugh.) That led to a sharp divergence between headline and core inflation, which excludes food and energy prices—not because they are meaningless (they aren’t), but because they are quite volatile and can occasionally mask underlying trends. Core CPI actually ticked a wee bit slower, from 6.0% y/y in May to 5.9%. That doesn’t mean inflation is for sure slowing from here, but it does cut against the notion that all prices are accelerating rapidly.
The June jobs report came out last Friday, and most analysis covered a well-tread topic: How will the latest employment data influence the Fed? Speculating about this isn’t helpful for investors, as central bankers’ actions aren’t predictable, in our view. However, we think digging deeper into the jobs numbers sheds light on another development: Pandemic dislocations continue evening out, a sign the return toward normal is ongoing—a small, but overlooked, positive, in our view.
The most widely watched jobs measures didn’t deviate much from their recent trends in June. Nonfarm payrolls rose 372,000, more or less in line with the average monthly gain of 383,000 over the past 3 months, while the unemployment rate registered its fourth straight month at 3.6%.[i] The labor force participation rate ticked down from May’s 62.3% to 62.2% as the numerator—the labor force (the sum of employed and unemployed persons)—fell by 353,000. A decline in the number of employed government workers underpinned the drop—the number of employed private-sector workers actually rose in June.
While the headline figures didn’t reveal much new insight, we found some interesting nuggets that run against recent popular headline themes. For example, many have worried about hiring freezes and layoffs among some (particularly small) Tech firms and startups—and the potential implications for the broader sector. However, jobs in the “computer systems design & related services” field rose by 10,000 in June, and the industry hasn’t suffered monthly net job losses on a seasonally adjusted basis since July 2020.[ii] Now, the Bureau of Labor Statistics has acknowledged the pandemic’s challenges to its seasonal adjustment methodology, especially in 2020 data, though the agency’s adjustments may have mitigated COVID’s effects.[iii] We also don’t dismiss the fact some Tech firms are laying people off or letting their headcount shrink through attrition. But in our view, they aren’t exactly of a huge magnitude at this point from a macroeconomic perspective. This could well be a case of hard data telling a different story than headline anecdotes—and why it is important to consider both, not just one or the other in isolation.
Editors’ Note: MarketMinder favors no politician nor any party. We assess political developments for their potential economic and market impact only.
The world continued digesting last week’s major political earthquakes Monday, with the fallout from UK Prime Minister Boris Johnson’s resignation and the tragic assassination of former Japanese Prime Minister Shinzo Abe just two days before Sunday’s upper house’s election. We have seen a ton of speculation as to how these events will potentially affect economic policy in the months to come, and while it might feel trivial to focus on this aspect—particularly in Japan—rather than the gravity of the events, markets are pretty laser focused on policy, not the social and human angles. So let us look at the latest happenings through that lens.
The Race to Replace Johnson Takes Shape
With all that is going on in the world this week, it might seem trivial to zero in on one cog in the global economy. Yet even little nuggets of falling uncertainty matter, and there is one that investors shouldn’t overlook: Even as recession chatter mounts, global supply chain pressures are easing. While they aren’t fast inflation’s only cause, they have been a contributing factor, due primarily to dislocations from lockdowns and reopening. But in recent weeks, things have started settling down a bit, albeit to little fanfare, which should help gradually ease one of the fears in this year’s cocktail of scary stories.
Consider Exhibit 1. Since we featured the New York Fed’s Global Supply Chain Pressure Index (GSCPI) last month, it has fallen further. The GSCPI mashes together various global shipping and transportation costs plus other supply chain indicators including delivery times, backlogs and inventory levels. June’s reading was still elevated relative to the index’s history, but it was noticeably down from December’s peak. This doesn’t mean disruptions won’t flare again—see 2021 after 2020’s spike—but absent further severe lockdowns (like China’s) affecting global supply chains, companies appear to be working through bottlenecks.
Exhibit 1: Global Supply Chain Pressures Elevated, but Easing
Source: Federal Reserve Bank of New York, as of 7/7/2022. Global Supply Chain Pressure Index, January 1998 – June 2022.
Of all the economic indicators out there, the most entertainingly named has to be the JOLTS report—shorthand for the job openings and labor turnover survey. This supplemental employment release from the Labor Department has a trove of data missing in the monthly Employment Situation Report, including details on the number of job openings and how many people are resigning from their jobs versus getting pink slips. We always enjoy this report and think some of its nuggets are useful, but we are flummoxed by headlines’ reaction to the latest release, which showed job openings falling a bit but staying near record highs. One big crowd argues this is surefire evidence a recession isn’t here. The other cites the falling number of openings as a sign labor markets are cooling. We don’t think either interpretation carries much weight and urge you, dear readers, not to factor these data into your economic or market outlook.
The bullish school says the 11.3 million job openings in May—miles above the 7 million openings on the 2020 lockdowns’ eve—shows a red-hot labor market at odds with recession chatter.[i] The more pessimistic bunch points out that there were nearly 11.9 million openings in March, arguing the downtick shows businesses are cooling their jets in response to Fed rate hikes.[ii] In our view, both claims are at odds with how labor markets typically function as an economic indicator. For one, employment tends to follow economic growth, not lead it. Hiring is a big up-front investment, so businesses tend to delay it until they have reached the limit of what they can produce with current headcount—and tend to avoid layoffs until there is no other alternative, as that renders prior investment in employees a sunk cost. So you typically don’t see employment start to fall until after a recession has begun—and it usually won’t start recovering until after the ensuing economic bounce is underway. Two, the Fed started hiking in March, and most research estimates monetary policy changes take around 6 – 18 months to start bearing fruit in the real economy, making it unrealistic to think the Fed’s moves are already affecting hiring.
Most importantly, the JOLTS report’s very limited history doesn’t suggest job openings are predictive. Exhibit 1 shows the entire data set, which begins in December 2000, with recessions shaded. As you will see, it is normal for job openings to drift sideways or lower during a broader economic expansion. They also roll over so far in advance of a recession that they are utterly useless from a timing perspective.
They don’t always, but bear markets often precede recessions. So US stocks’ breaching -20% on June 13 poured gasoline on already hot recession fears. Given that backdrop, it shouldn’t surprise you that the Atlanta Federal Reserve’s GDPNow—a statistical model designed to estimate the quarter’s GDP based on incoming data and forecasts—falling to -2.1% annualized for Q2 on July 1 further fanned fears. While we don’t dismiss the possibility of a Q2 contraction, which would technically be the second-straight quarterly decline, we think there are reasons to be skeptical this outcome is assured. Or that it means America would be in recession.
The Atlanta Fed’s tool is one of several like it that aggregate incoming data, math it up and try to predict the eventual GDP release. It mashes together Fed forecasts and actual data releases, evolving throughout the quarter as data arrive. It also, the Atlanta Fed wants you to know, isn’t the bank’s official forecast. It is a research exercise above all else, based largely on ideas cooked up in the private sector.
As you might imagine, the earlier in the quarter one looks at GDPNow, the less accurate the “nowcast” tends to be. But even at quarter end, when most data are in, tracking error exists. And it is up since the pandemic. That doesn’t mean GDPNow is wrong or useless. It just means handle with caution because, like all economic data, it is far from perfect—especially given the oddity of 2020’s lockdown-driven downturn. Exhibit 1 shows GDPNow’s historical tracking error on the day before the US Bureau of Economic Analysis published the relevant quarter’s advance GDP estimate. (This quarter, that would be on July 27.)
Editors’ Note: MarketMinder favors no political party nor any politician. We assess political developments for their potential economic and market impact only.
UK Prime Minister Boris Johnson is under fire. Again. This time, cabinet ministers, backbench Members of Parliament (MPs) and the general public are revolted by revelations that Johnson had given an MP a senior government position despite knowing of outstanding allegations of abuse against him—and then claimed to have no prior knowledge of said allegations once they became public. As always, we will stay above the socio-political fray, as we are here to discuss only how politics intersect with markets and the economy—and this latest scandal looks increasingly likely to force Johnson out of office. Moreover, whether he stays or goes, it looks like the Conservative Party’s recent economic policy suite may get an overhaul. That is placing a hefty dose of political uncertainty over UK stocks, which could roil sentiment for the time being—but creates room for falling uncertainty to be a tailwind as this situation resolves.
Last time Johnson was at risk of an ouster, he won a confidence vote from his party’s committee of backbench MPs, known as the 1922 Committee. Under the committee’s current rules, MPs aren’t allowed to bring another no-confidence motion against him for a year. But that was then. Now, more than 40 MPs (and counting) have resigned from Johnson’s government since Tuesday, including Chancellor Rishi Sunak and Health Secretary Sajid Javid. Home Secretary Priti Patel reportedly joined the rebellion Tuesday night and told Johnson to step down, but as we write, it is unclear whether she formally resigned. Former Brexit ally Michael Gove, who had been serving as Secretary of State for Levelling Up—basically the guy in charge of European-style industrial policy—got fired before he could resign, and a parade of MPs and ministers filed through 10 Downing Street urging Johnson to stand down. But by 10 PM, only Larry the Cat had made an appearance on the steps, and Downing Street staff told reporters their boss had no plans to go.
Stocks had another tough day Thursday, officially closing out the past six months as the S&P 500’s worst start to the year since 1962.[i] That, and all of its associated pain and frustration, is the bad news. But there is a modest silver lining: Despite what you may have seen in the numerous pieces on this topic, that factoid means exactly nothing for returns over the next six months and beyond. Stocks aren’t serially correlated, and past performance doesn’t predict future returns.
To show you this, we crunched first- and second-half returns for every year from 1926 through 2021. That is a data set of 96 years—a pretty significant sample size. In this stretch, the correlation between first-half and second-half returns is -0.099.[ii] For those who are a little rusty on statistics, the correlation coefficient measures the relationship between two variables. It ranges from 1.0 to -1.0, with 1.0 signaling they move in the same direction always, 0 meaning no relationship, and -1.0 meaning they always move in opposite directions. So, the -0.099 (or if you prefer to round, -0.1) correlation between first- and second-half returns means they have a very, very slight tendency to move in opposite directions—but it is a relationship so slight that it is functionally meaningless.
Now, that figure includes the 51 years where the S&P 500 rose in both the first and second half—years that are less relevant to the situation today. It also includes the 13 years when the S&P 500 rose in the first half and fell in the second. So let us zoom in on the remaining 32 years when stocks fell in the first half. The second half was positive 17 times and negative 15. That makes the probability of a positive second half roughly a coin flip (maybe a little better).
Last Friday was moving day for dozens of stocks as FTSE Russell undertook its annual index reconstitutions. Some companies moved between the small, medium and large-cap categories—all reflecting market movement in the 12 months through early May and its impact on companies’ market capitalization. There were also shifts within the growth and value world, with several famous growth stocks entering the value index thanks to their falling valuations. For some it was a clean break, while others now live in both indexes. In our view, this presents a timely reminder: Growth and value are often judgment calls, and understanding their qualitative characteristics as well as the more objective criteria can help you delineate between the two investing styles. That will be a critical task moving forward, as we think growth stocks are likely to lead the rebound whenever this year’s bear market ends.
Traditionally, growth stocks represent companies whose returns come from long-term, well, growth—while value stocks’ gains tend to come from investors’ finding and bidding up discounted or undervalued firms. FTSE Russell delineates between the two based on price-to-book ratio, earnings forecasts for the next two years, and a projection of sales growth based on the past five years.[i] The first of those three seeks to measure value, while the latter two measure growth—which is how a company can straddle both styles. MSCI uses the same general approach but with more metrics. On the value side, MSCI adds 12-month forward price-to-earnings ratios and dividend yields, while other growth characteristics include short- and long-term forward earnings growth estimates, the long-term historical earnings growth trend and the current internal growth rate, which is an estimate of how much the company could grow by reinvesting earnings and not seeking additional finances.[ii]
Here, too, these criteria—while sound—can create significant growth and value overlap. Currently, the MSCI World Value Index has 940 constituents, while the MSCI World Growth Index has 805.[iii] Yet a whopping 231 constituents are in both indexes, usually weighted as a blend of say, 65% growth and 35% value, 50% each or what have you.[iv] Objectively, they have growth and value characteristics.
Stocks had a rough day Tuesday, and the alleged culprit is one we have seen with increasing frequency lately: A raft of good-looking economic data supposedly raises the likelihood of more big Fed rate hikes to come. This is part and parcel of a sentiment phenomenon we call the “pessimism of disbelief”—investors’ tendency to see any good news through a negative lens. It is a hallmark of late downturns and early recoveries, and its prevalence today is a big reason we think this downturn’s end is likely close by. When people dismiss good news as bad, it shows a big gap between sentiment and reality—substantial room for positive surprise. What did people overlook in the latest data? Read on!
Durable Goods Orders Look Pretty Durable
The week started with May’s advance durable goods report, released Monday. It showed total orders for goods designed to last three years or more rising 0.7% m/m, beating expectations for no change and accelerating from April’s 0.4% climb.[i] Core capital goods orders (non-defense ex. aircraft), which are widely considered a proxy for business investment, grew 0.5% m/m—their third straight rise and an acceleration from April’s 0.3%.[ii] Now, this corresponds only to the equipment portion of business investment, which is only about 40% of the total—commercial real estate and intellectual property products (e.g., research & development and software) hold big sway, too.[iii] And these figures aren’t inflation-adjusted, which is an important caveat. But the resilience of a major category is still noteworthy, as it occurred against the backdrop of rising rates—a factor people have worried would derail investment for months.