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.
We have a decision! After holding the country in suspense for weeks, President Joe Biden announced on Monday that he has tapped Fed head Jerome Powell for another term. Fed Governor Lael Brainard, whom some observers had tipped as a potential replacement, got tapped as Vice Chair, while Powell will continue steering monetary policy. Naturally, pundits are now speculating at what the latest news means for monetary policy—an endeavor we think is fruitless and pointless. Yet the news does reduce uncertainty over Fed personnel—uncertainty that will likely fall further in the coming weeks, as Biden signaled he will soon fill the Fed’s open (and soon-to-open) seats. But we think it is a stretch to glean much impact beyond that.
Powell’s reappointment extends the status quo, and not just of the last four years. For the most part, Powell’s Fed was an extension of former Chair Janet Yellen’s Fed, which mostly extended the policy of her predecessor, Ben Bernanke. All three were cut from the same technocratic cloth, and all three have headed committees of economists and academics. All have followed the same quantitative easing (QE) playbook and left the Fed’s traditional toolkit mostly untouched. We don’t think this has been terribly beneficial, but it is an approach markets are quite familiar with, and stocks have been largely fine with it.
Some argue Powell’s reappointment changes the calculus a bit. The logic goes like this: Powell was holding off on rate hikes or other supposedly major moves in order to raise the likelihood of being reappointed, and now that his job is safe, the coast is clear to tighten monetary policy. Brainard, meanwhile, allegedly would have been more likely to keep rates lower for longer. We think this errs on multiple fronts. One, had Brainard gotten the job, her resume wouldn’t have helped predict her actions, as Fed heads often defy their own past writings and experience. When asked about this, former Fed head William McChesney Martin quipped that when you become head of the Fed, they make you take a little pill that makes you forget everything you once knew, and it lasts as long as you are in the job. When questioned about his own unorthodox decisions, Martin’s successor and rival, Arthur Burns, joked he took “Martin’s little pill.” We think plenty of other Fed heads have also fallen prey, making predictions useless.
Have you heard the one about stocks being really expensive? We sure have, with most of the chatter centering on the S&P 500’s above-average price-to-earnings (P/E) ratio. Some pundits argue this sets up a weak 2022. The Fed got in on the action this week, warning in its semiannual Financial Stability Report that high valuations make stocks “vulnerable to significant declines should investor risk sentiment deteriorate, progress on containing the virus disappoint, or the economic recovery stall.”[i] While the Fed’s analysis was measured, some pundits took the headline and ran, taking it on faith that surging valuations pose a risk. So it might interest you to know that valuations are, well, down over the past year-plus. Mind you, we don’t think valuations are predictive, but we think this is a shining example of pundits ignoring the denominator—earnings—and drawing off-base conclusions as a result.
Exhibit 1 shows the S&P 500’s trailing P/E—that is, price divided by the past 12 months’ earnings—since the end of 2018. In our view, this metric is inherently backward-looking, as stocks move on expectations for profits and fundamentals over the next 3 – 30 months. Markets today are pricing in next year’s profitability, not last year’s. Yet trailing P/Es are oft cited as evidence of stocks’ being overvalued, so let us take a look.
Exhibit 1: Checking In on Trailing P/Es
Editors’ Note: MarketMinder does not make individual security recommendations. Those mentioned below merely illustrate a broader theme we wish to highlight.
Here is something of a sign of the times: Today’s biggest financial news story, by far and away, was a rate cut and currency slide in Turkey. A country that is just 0.3% of the MSCI Emerging Markets (EM) Index’s market cap.[i] This is part of a recent trend we have noticed, in which events of little fundamental significance to global markets get bigtime attention simply because they are new and different. The flipside of this? There is actually precious little in the way of news right now, which we have long found to be a nice backdrop for stocks. In our view, no news is usually good news, giving the market plenty of latitude to do its daily work of pricing in longer-term fundamentals.
We aren’t denying that Turkey’s news is interesting. Today’s cut lowered the benchmark rate from 16.0% to 15.0% despite Turkish inflation clocking in at 19.9% y/y last month.[ii] Calling the move unorthodox is an understatement. But it also caps President Recep Tayyip Erdogan’s long history of meddling with monetary policy, including firing prior central bank governors who didn’t share his belief that high interest rates cause, rather than tame, inflation. He fired prior central bank governor Naci Agbal in March after a series of rate hikes, replacing him with Sahap Kavcioglu—a former newspaper columnist who espoused monetary views similar to Erdogan’s. Kavcioglu’s move today followed cuts from 19.0% to 18.0% in September and to 16.0% last month, likely keeping the boss happy, yet the lira is now down to historic lows versus the dollar, driving Turkish people to switch their bank accounts to more stable currencies.[iii] Some analysts suspect this could finally break Erdogan’s political grip, teeing up some political uncertainty as chatter about early elections escalates.
The Fed released industrial production for October today, and the results smashed expectations. Total industrial output rose 1.6% m/m, more than double analysts’ consensus expectations for 0.75%.[i] Manufacturing’s 1.3% m/m rise also more than doubled estimates, adding to the good news.[ii] For stocks, this is all backward-looking. Markets today are looking to the next 3 – 30 months, not back to October. Still, the report contained some encouraging news related to some of today’s biggest headline fears—namely the energy and supply chain crunches. Let us take a look.
First up: energy. Even as oil prices rose this year, US output was slow to recover as smaller shale producers opted to pay down debt instead of invest in new production. Now, the tide is shifting. Oil and gas well drilling jumped 9.3% m/m, bringing the cumulative recovery in activity to 93% since July 2020’s low.[iii] As Exhibit 1 shows, there is still a lot of ground left to make up, but oil’s hovering around $80 per barrel makes drilling quite profitable. In the Permian Basin, which is increasingly the locus of US shale production, drillers’ breakeven prices are below $40 per barrel—among the lowest in the country.[iv] Basic economics teach us that high potential profit margins incentivize new production, which points to continued drilling and pumping from here. The latest industry looks from the US Energy Information Administration and International Energy Agency see this activity helping boost output in the very near future. The latter’s latest report, released today, showed global output rising 1.4 million barrels per day (bpd) as US output recovered post-Hurricane Ida.[v] It eyes a further rise of 1.5 million bpd over the rest of this year and continued increases in 2022.[vi] Time will tell if that comes true, but the big jump in drilling activity augurs well.
Exhibit 1: US Oil & Gas Drilling Continues Recovering
Buckle up. Satellite images show Russian troops are amassing along the border with Ukraine, and the US has reportedly warned European allies that an invasion is possible. NATO announced its solidarity with Ukraine Monday, raising the perceived risk of Western nations getting dragged into the conflict despite Ukraine not being a NATO member. We have already seen a few articles warning an invasion and conflict would bring terrible consequences for the global economy and stocks, and if tensions ratchet up, those warnings will probably get louder and more widespread. Steel yourself against the associated fear now: Market history overwhelmingly shows regional conflict is highly unlikely to cause a bear market (typically a deep, lasting decline of -20% or worse with an identifiable fundamental cause). So while fighting is tragic, and potentially a cause for near-term volatility, we think it is a mistake to overrate the threat to stocks.
Now, of course, we aren’t in the intelligence community and have no access to “President” Vladimir Putin’s plans. This may be all a bluff. It may be yet another move designed to goad the EU into approving the Nord Stream 2 gas pipeline that bypasses Ukraine. But in the event Russia does invade Ukraine, remember: Markets have sadly dealt with a number of regional conflicts and potential conflicts in recent years. The list is long. The first Gulf War and Bosnian War in the 1990s. US-led intervention in Afghanistan and Iraq and the Hezbollah/Israel dust-up in the 2000s. Libya and Syria in the 2010s. Russia and Ukraine in 2014 over the former’s annexation of Crimea and meddling in eastern Ukraine—and a host of others. In general, if stocks registered the strife at all, they followed the same general trajectory: negativity as tensions escalated and armed conflict became an increasingly realistic possibility, then a recovery as the endgame became clear.
In cases where the endgame was armed conflict, that recovery typically arrived as or just after the fighting broke out. Not because regional war is bullish, but because the fighting ended the uncertainty over whether saber-rattling would spiral into military action. It ceased the will-they-or-won’t-they and let investors weigh the conflict’s reach. In all these cases, even when major powers were involved, the conflict occurred on a very small swath of the global economy, with no impact on commerce in the developed world or major Emerging Markets. That clarity enabled markets to move on quickly. Exhibits 1 and 2 detail two examples.
Midway through November, a month and a half after September’s end, Q3 economic data like the UK’s GDP report (released late last week) are rather backward looking. Yet new GDP releases let pundits make comparisons, and the verdict among them seems to be that Britain is falling behind. You see, on a quarterly basis, UK GDP remains -2.1% below its Q4 2019 pre-pandemic peak, lagging other major developed world economies.[i] Fair enough, to an extent. For markets though, this is trivia. While economic growth supports stocks, it isn’t a race, and stocks don’t move in lockstep with GDP.
Pundits point to the UK’s slowing growth, which decelerated to 1.3% q/q in Q3 from Q2’s 5.5%, saying this means Britain’s recovery is faltering under the weight of post-Brexit supply disruptions and labor shortages.[ii] While those may be crimping growth at the margin, they aren’t unique to the UK. We doubt Brexit is the primary, or even a major, cause. For example, exports fell -1.9% q/q led by a -5.8% drop in goods exports.[iii] But the quarterly decline was driven by non-EU exports. Meanwhile, UK services exports rose, driven by financial services. Imports rose 2.5% q/q, mostly from non-EU fuel imports.[iv] Not everything is about Brexit. Also notable: Services imports rose, too, as easing travel restrictions allowed more Britons to vacation abroad.
Beyond trade, manufacturing and construction fell -0.3% q/q and -1.5%, respectively, due mainly to ongoing chip shortages for cars and building supply delivery delays.[v] But services, by far the UK’s biggest economic driver at close to 80% of GDP, rose 1.6% q/q, with accommodation and food services jumping 30.0% and recreation services up 19.6% in Q3.[vi] Services overall still slowed from Q2’s 6.5% q/q growth, but it is now just -0.7% below its Q4 2019 level. In our view, growth was always likely to slow as output approached pre-pandemic highs and the burst from easing restrictions faded.
Editors’ Note: MarketMinder favors no political party or any politician. We assess political and legislative developments solely for their potential effect on markets and the economy.
After the House passed the infrastructure bill and sent it to President Joe Biden to sign last Friday, most coverage—including ours—focused on the spending side of the ledger. The bill’s tax provisions didn’t get much attention, which we find both sensible and telling. Sensible because the tax changes are minor and probably won’t dent corporate earnings a ton or discourage new investments. Telling because people often ignore top-line income and corporate tax changes, presuming something so niche won’t have broad reach. Yet as we all know, nothing in life is certain but death and taxes—and corporations’ knack for passing on taxes to consumers. Understanding how this works now can help reduce surprise power when you inevitably start noticing the (likely small) impact. More broadly, assessing second- and third-order consequences is one of the most beneficial things investors can do when assessing policies’ impact, and we are happy to show how this is done.
On the surface, the bill’s tax changes appear to have limited reach. One seeks to curb tax evasion by requiring brokers to report all of their customers’ cryptocurrency transactions, with the definition of “broker” expanded to include cryptocurrency exchanges. If you don’t own crypto, that has nothing to do with you. The other change is the reinstatement and modification of Superfund excise taxes on a range of petrochemicals—taxes that were born in the 1980s and lapsed in the mid-1990s. This would tax production and importation of a broad range of chemicals. Perhaps that still sounds distant, as many of which are feedstock for plastics and a host of everyday goods from shoe soles to household cleaners. The list also includes nickel and cobalt, which feature in rechargeable batteries. Also, zinc—used in all of your home’s brass and bronze fixtures (as well as galvanized steel and iron).
Where is the economy headed next? That is a tough question to answer even during “normal” times, and considering supply bottlenecks and the pandemic, the task looks even harder now. It seems to have many experts turning over lots of stones, with some convinced certain economic indicators are bellwethers. But we caution investors against reading too much into any one data series—they all have their limitations, regardless of the economic environment.
Economic bellwethers are supposedly the canary in the coalmine—as they go, so goes the economy. Copper prices are one popular example. Since copper has a wide range of uses, from plumbing to electric cars, many view prices as a proxy for broad economic growth. Rising prices imply demand for goods is purportedly strong. Falling prices suggest the opposite, leading some to believe it shows the economy will soon slow, too. Some think auto sales reflect consumers’ willingness to spend on big-ticket items, so weak sales portend broad weakness. Others zero in on home sales, which they see as a sign of household formation and a key consumption driver. In today’s environment, analysts have explored alternative indicators to divine the economy’s health. For example, some study hospitality hiring trends to determine whether the pandemic’s economic impact is waxing or waning. While the rationale behind some of today’s bellwethers seems logical, we think it is important to dive deeper.
Take the semiconductor industry. A recent Bloomberg article noted that despite the widespread shortage of memory chips, prices have fallen over the past couple months. With several semiconductor companies reporting slowing customer orders and reduced economic outlooks, the concern seems to be that hardware producers see weaker demand for laptops, mobile phones and the like. Since chips feature in a vast array of consumer products, many argue falling chip demand may be a harbinger of a broader slowdown outside the world of gadgets, too.
Breathe. Yes, the US Consumer Price Index (CPI) inflation rate hit a 30-year high, 6.2% y/y, in October.[i] Yes, this is a big jump from September’s 5.4%.[ii] But no, it doesn’t mean that dogged, persistent inflation is here to stay. It doesn’t mean a wall of easy money has thrown the economy out of balance. Rather, it is a symptom of a reality we have all lived through the past 20 months: It is far, far easier for a government to suddenly stop economic activity via lockdown than for businesses to restart it once regulations permit. Stocks have long understood this, even if it is only just starting to dawn on the world at large.
The sudden halt and choppy restart of the global economy explains much of prices’ trajectory since early 2020, in our view. First lockdowns shattered production and demand, sending prices tumbling. That created a low year-over-year comparison point this spring, when vaccines’ rollout enabled broader reopening, juicing demand. That added skew to the year-over-year inflation rate, making the month-over-month rate a better place to look when assessing inflation’s drivers. The biggest contributors to month-over-month rates this spring and summer were categories tied most to reopening, including hotels, airlines and used cars—which were in short supply after rental car companies rebuilt their fleets in a hurry.
But as summer rolled into autumn, some reopening-related pressures faded, as Exhibit 1 shows, and new pressures appeared in their wake. Many stemmed from supply shortages, which in turn stemmed from labor shortages and global shipping hangups. These are perhaps most visible in accelerating food and vehicle prices. Owners’ equivalent rent is another recent driver—an imaginary cost that no one pays, as it is the hypothetical amount a homeowner would pay to rent their own house. It rises alongside home prices, making it useless even as a proxy for households’ mortgage payments, the vast majority of which are fixed. The other recent big contributor is energy prices—namely oil and gas prices—which jumped when global demand surged as coal and natural gas prices spiked and utilities needed an alternate power source in a hurry. In October, energy alone accounted for over one-third of CPI’s 0.9% m/m rise.[iii]
Editors’ Note: MarketMinder does not make individual security recommendations. The below merely represent a broader theme we wish to highlight.
One year ago Tuesday, Pfizer and BioNTech announced that their COVID vaccine candidate had shown promising results in phase 3 trials, and value bulls got a shot in the arm. Value stocks normally lead early in a bull market, but growth had led since stocks bottomed late the prior March. The vaccine announcement led value bulls to argue they weren’t wrong, just early—value had lagged because lingering lockdowns were crimping demand, they claimed, and vaccinations would get the party started for real. A year later, that hasn’t exactly worked out as they anticipated.
True, value has led cumulatively since Pfizer’s momentous press release. But as Exhibit 1 shows, the margin is small. Moreover, value’s leadership occurred in two short bursts: one last November, and one this January and February. Since value’s returns relative to growth peaked on May 13, growth is up 20.1%.[i] Value? Just 5.0%.[ii] Moreover, since the bull market began on March 23, 2020, growth is beating value by a whopping 31 percentage points—121.4% to 90.4%.[iii]