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.


Into Perspective: Renewed Fears of an EM Currency and Debt Crisis

The global bear market beginning in February left few asset classes unscathed. But the heightened risk aversion hit many Emerging Markets (EMs) particularly hard, with a surge in capital outflows and material currency weakness reigniting debt fears. This is a common narrative during times of stress—EMs have been plagued by multiple crises over the past 30 years, and memories of the late-1990s currency crisis loom large. But too often, pundits focus on fragile positions in a few countries, then extrapolate those fears to the broader category. A similar phenomenon is occurring today, with headlines dwelling on IMF bailouts and defaults. Yet most EMs are in relatively healthy shape, and the probability of a new currency and debt crisis remains low.

Fears surrounding debt tend to focus on absolute levels—think of the US national debt clock, currently over $25 trillion at the time of this writing. EMs as a whole owe even more—a massive $71 trillion.[i] Big numbers scare people, and there isn’t a person on Earth who thinks trillions of anything is a small figure. Overall debt levels have indeed risen globally in the past decade—but so has the size of the global economy and countries’ institutional defenses against financial trouble. In our opinion, it is more instructive for investors to focus on debt sustainability, which means scaling borrowings and better understanding their composition.

Historically, EM debt crises generally arise from currency crises. This is because EMs find it more difficult to raise funds domestically, so they lean heavily on financing abroad in foreign currency. The Asian Financial Crisis in 1997 – 1998—the last true debt crisis to ripple through EM—is a textbook case of what can go wrong. At that time, many countries pegged their currency to the US dollar to piggy back on its relative stability. They then heavily borrowed in dollar-denominated debt to finance booming economic growth, keeping few currency reserves to fend off speculators. When their currencies fell under pressure, they quickly ran out of firepower to defend the pegs and were forced to devalue. In doing so, their debt levels and service costs in local currency terms skyrocketed—and crisis ensued.

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Stocks and Unemployment’s Relationship Hasn’t Changed

Last week, we highlighted stocks’ strong tendency to move before unemployment data—falling before unemployment starts rising during a recession and rising before the unemployment rate peaks post-recession. This bear market and economic contraction, thus far, have been hyper-compressed. Stocks’ decline preceded data putting numbers on stay-at-home orders’ economic impact, including weekly jobless claims. The rally since March has been similarly fast and ahead of economic data, which is normal at the end of a bear market. Should it hold, the rise preceding the unemployment peak, though also hyper-compressed, would be quite typical.

One article that caught our eye on Monday presented the S&P 500 Index and unemployment rate in a visual way we hadn’t encountered before. It took the last 10 years of S&P 500 price index levels (the full history available for free public use at the St. Louis Fed’s FRED database) and unemployment rate and made a scatterplot—unemployment on the Y-axis (vertical) and stocks on the X-axis (horizontal). It then connected all the dots in chronological order. The result, which we have recreated, looked like this (although the data labels here are ours):

Exhibit 1: A Creative Look at Stocks and Unemployment

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What Recovery Pessimism Means for Stocks

With countries gradually reopening from COVID-19 lockdowns, investors’ focus seems to be shifting from the economic contraction’s depth to its duration. Where at first hopes seemed high that reopening would mean a swift return to normalcy, pessimism seems to be growing. A number of outlets now argue that even if lockdowns end swiftly, it won’t be a magic economic elixir—dooming the economic recovery to look more like an “L” than a “V.” In our view, the recovery’s eventual speed and trajectory aren’t knowable now, as they rest on a number of unpredictable variables. But from an investment standpoint, more pessimistic expectations widen the range of outcomes that could generate positive surprise.

As most states and countries are opening gradually, we have only a very limited look at how businesses and consumers will respond. In the US, about half the states have started phased reopening processes, with Georgia the first locked-down state to lift restrictions and Texas the largest so far. Overseas, the UK announced slightly eased restrictions, while Germany, Italy and Spain are a couple weeks into reopening.

Economists are creating models tracking activity to gauge states’ and countries’ progress. Georgia selectively opened gyms, salons and tattoo parlors on April 24. Dine-in restaurants and movie theaters followed a few days later, with stay-at-home orders expiring April 30. But some models now suggest the state’s reopening hasn’t meant much for consumer spending thus far.[i] This finding has many now extrapolating Georgia’s experience to other states—and America as a whole. They say people’s individual decisions trump government decrees. With uncertainty still running high—about viral contamination and personal finances—ending official lockdowns allegedly won’t buoy economic activity.

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How to Think About Health Care Stocks Now

Amid a global pandemic that has dominated world news, the Health Care sector is unsurprisingly front-of-mind for many equity investors. Many see it as an innovation hub offering profitable crisis solutions. Others see it as a stodgy, defensive haven. But in reality, Health Care is a diverse sector with a huge array of industries responding to different drivers. Here is a primer on how we think investors should approach the sector—both generally and in light of recent developments.

COVID-19 has put the Health Care sector under a spotlight, particularly as the race for treatments and vaccines heats up. Headlines frequently highlight individual Health Care firms’ apparent progress and speculate about winners. Health Care stocks also garner attention for their superior recent performance. Since global stocks peaked on February 12, the MSCI World Index is down -17.1%, while Health Care leads all sectors at -4.3%.[i] This leadership has burnished its reputation as a defensive sector. Many presume it is less economically sensitive and therefore likely to hold up better in a recession. Even in downturns, the logic goes, people will still consume healthcare products and services. While that has aspects of truth, we think it is an oversimplification. Digging deeper reveals more nuances.

First, here is a look at the various industries comprising Health Care.

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April’s Astounding Employment Report Confirms What We All Expected

Friday morning, the US Bureau of Labor Statistics’ much-watched Employment Situation Report confirmed what we all expected: an unprecedented spike in the unemployment rate. In April, the rate surged from March’s 4.4% to 14.7%, underpinned by a 19.52 million decline in private-sector payrolls.[i] State and local governments cut another 980,000 jobs, bringing the total drop in non-farm payrolls to an astounding 20.5 million.[ii] This—plus each week’s lofty-and-previously-unheard-of millions of new unemployment insurance claims—has many fretting weak consumer demand forestalling an economic recovery, dooming stocks to more downside ahead. While we can’t know if March 23 was this bear market’s low, we are quite confident employment issues won’t impede the next bull market—and economic recovery—from starting.

The massive hit business shutdowns have caused the labor market is unmistakable. To put its scope in some sort of perspective (to the extent that is possible), the BLS has published the unemployment rate in its current format monthly since 1948. Prior to April, the biggest single monthly increase in the unemployment rate was October 1949’s 1.3 percentage points.[iii] That rate rose by 10.3 percentage points in April. The biggest single monthly decline in private-sector payrolls? 1.766 million in September 1945, a clear effect of World War II ending. More than 10 times as many lost jobs in April. Those are all just statistics, but make no mistake: Joblessness is a personal tragedy. These highlight the macroeconomic scope of the issue, but they don’t speak to what individuals are going through. If you or a family member have been affected, you are in our thoughts.

Now, there are reasons to think looking at the headline unemployment rate (what the BLS’s statisticians call the U-3 rate) understates reality. As many likely recall from the last recession, the unemployment rate isn’t calculated by dividing the number of unemployed by the population. The numerator is the number of unemployed who sought work in the last four weeks divided by the labor force (the number who worked or sought work in the last four weeks). Laid-off workers who don’t seek a job because they don’t think they can find one (so-called discouraged workers) fall out of the calculation. To see them—and people working part-time for economic reasons—you must look to the U-6 rate, the broadest BLS measure of unemployment. The U-6 rate ticked up from 7.0% in February to 8.7% in March.[iv] Last month, it spiked to 22.8%.[v] This is of course the largest monthly increase to U-6’s highest level ever, dating to its 1994 inception.

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COVID-19 Highlights the Perils of Relying on Dividends for Cash Flow

Editors’ note: MarketMinder doesn’t make individual security recommendations; those mentioned here are part of a broader theme we wish to highlight.

With COVID-19 responses squelching sales, many companies are looking to build up cash reserves to help get through lean times. For some, that puts dividend payouts in the crosshairs. In our view, this is a timely, albeit tough, reminder for investors about the limitations of relying on dividend-paying stocks alone for cash flow.

As COVID-related restrictions disrupt normal business, companies are seeking myriad ways to stay afloat. One easy target: dividend payouts. Per one research outfit’s analysis, more US firms have suspended or canceled dividends this year than in the past 10 years combined. On April 30 Royal Dutch Shell, one of the UK’s most well-known dividend stocks, cut its payment for the first time since World War II.

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Stocks for the Long Run?

US Treasury yields have plunged this year, lifting most bond prices during stocks’ bear market. One byproduct: Various bonds’ total returns now outpace US stocks’ since 2000’s start. For example, 10-year Treasurys have returned 213.7% compared to the S&P 500’s 187.1%.[i] We have noticed some news commentators seizing on this, arguing it means stocks no longer compensate investors for their higher volatility via higher returns. In our view, though, bonds’ outperformance over the last two decades doesn’t alter stocks’ superiority for investors needing long-term growth.

It seems popular among articles touting bonds’ 20-year edge to note that long-term US government bonds have outperformed in 26% of 20-year rolling periods ending in 2000 or later.[ii] This is a fair point to a limited extent, but we see a problem: It uses monthly rolling periods. Since bonds’ historical stretches of outperformance tend to cluster around bear markets, any figure using monthly rolling calculations could easily be double counting (or more)—overstating the phenomenon’s frequency. We think it is clearer to use rolling annual returns, which better isolate bonds’ leadership stretches.

On that basis, there have been two previous annual 20-year stretches of 10-year Treasury outperformance—1929 – 1948 and 1989 – 2008.[iii] As Exhibit 1 highlights, neither prevented big subsequent stock market gains. In the latter case, the most recent bull market—history’s longest—kicked off the following year. Investors who concluded stocks’ historically higher returns wouldn’t resume might have missed out. Cumulative US stock returns have also far outpaced 10-year Treasurys from 2009 onwards, current bear market included—299.4% to 52.2%.[iv]

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Why Falling Prices Don't Mean Falling Stocks Ahead

In the depths of the global financial crisis in late 2008 and early 2009, an odd thing happened: People simultaneously feared runaway inflation and depressionary deflation. In the past couple weeks, we have started seeing this phenomenon once again. The former we addressed last week. Lately, deflation seems to be gaining primacy, with the OECD’s announcement Tuesday that global inflation fell by the most since the financial crisis in March, making this a good time for us to weigh in. In short, while investors have myriad risks to grapple with right now, deflation shouldn’t be one of them, in our view. 

The popular deflation narrative holds that growing economies and rising inflation are sympatico, with gradually rising prices helping spur demand, while crises like the present destroy demand, driving retailers and service providers to slash prices. That supposedly creates a vicious circle in which consumers perpetually hold out for a better deal while sellers repeatedly discount, and before you know it, we are Japan during its lost decade or the US in the early 1930s.

In our view, the problem with this theory is that it flat out ignores what drives prices. Inflation, as Milton Friedman summed it up, is a monetary phenomenon of too much money chasing too few goods. Deflation, then, is the opposite—not enough money chasing too many goods. In either scenario, the key variable is money supply. In the early 1930s, a series of Fed errors caused money supply to plunge, as Friedman and Anna Schwartz documented in their classic work, A Monetary History of the United States, 1867 – 1960.[i] The modern money supply measure most analogous to what they displayed is M1, which the Fed describes as including bank notes, coins, bank reserves and checkable deposits. As policymakers sucked money out of the system, capital dried up, wrecking investment and consumption. Deflation was a symptom of this destruction, not the cause.

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Q1 GDP: More Hint Than Revelation

Q1 US GDP came out Wednesday, giving investors their first glimpse at how well economists have accounted for COVID-19 business disruptions in their projections. In The Wall Street Journal’s most recent survey, estimates ranged from 1.5% annualized growth to an -8.1% contraction. The actual result: a -4.8% annualized decline. That is in the mid-low end of the range and below the general consensus’s average. However, due to the way the Commerce Department’s statisticians calculate the preliminary GDP estimate, it still doesn’t provide a great look at how much social distancing restrictions have hit economic activity. So our advice for investors is: Don’t draw firm conclusions, for better or worse, and remember stocks look forward.

Exhibit 1 shows a more detailed breakdown of GDP’s major components. Note, all of the figures here are seasonally adjusted annualized growth rates. So not only are they manipulated a bit to smooth out seasonal skew (e.g., holidays and weather), but they show the rate GDP would grow or contract in the full year if the quarterly growth rate persisted. In other words, GDP did not shrink by nearly 5% in one quarter. The quarter-over-quarter contraction rate was -1.2%.[i] We point this out because European nations, which will soon begin reporting, use the quarter-over-quarter numbers. So to compare them to the US’s result, you will have to compound them by converting them to decimals (i.e., 1.2% becomes 0.012), adding one, taking them to the fourth power, and then subtracting one.[ii] And here endeth the math detour.

Exhibit 1: GDP and Its Main Components

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Why the COVID Response Likely Won’t Ignite Inflation

With the Fed responding to the COVID-19 lockdown’s economic damage with trillions of dollars’ worth of lending and liquidity, it was only a matter of time before people started fearing a massive money supply increase fueling runaway inflation. Based on a slew of articles we have seen recently, that time seems to have arrived. Some of the jitters stem from unlimited quantitative easing (QE) bond purchases and the related increases in bank reserves. Others take the recent jumps in various money supply measures, extrapolate them, and warn an uncontainable genie has left the bottle. We don’t think either case for turbocharged inflation withstands scrutiny, much as similar fears during and after 2008’s global financial crisis didn’t pan out.

The current crop of inflation fears do get one thing right: the focus on money supply. As Milton Friedman summed it up decades ago, inflation is a monetary phenomenon. Too much money chasing too few goods. Hence, major money supply gauges’ double-digit surges amid a sudden halt in economic activity raise the specter of mountains of money chasing a very small pool of goods and services, making prices surge.

Trouble is, this ignores the larger factors at play. In an economic crisis, one of the biggest risks is money drying up, forcing businesses under. The hints of that happening this time were fairly obvious, including the sudden stop in businesses’ sales and a temporarily frozen high-yield corporate bond market. Central bankers have learned a lot since 1929, when Fed policy following the stock market crash reduced money supply and forced a grueling, years-long recession and bear market accompanied by deep deflation. That is what policymakers sought to stave off this time around. Rather than model out the 24.8% y/y rise in M1 (mostly notes, coins, bank reserves and checkable deposits) or 15.9% y/y rise in M2 (M1 plus savings deposits, money market funds and CDs), we think it is more logical to interpret the increase as a sign the Fed isn’t repeating the early 1930s’ errors.[i] Whatever else happens, we quite likely aren’t staring down a prolonged deflationary decline.

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