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.

Q2 GDPs Were Historically Awful, but Not a Surprise

Q2 GDP results for the first two major developed nations to report emerged today, and in a word, they are … ugly. The US and Germany each notched record-fast declines, and they probably won’t be the last to do so. As these awful Q2 numbers hit the wires, we think it is worth remembering stocks spent February and March reckoning with the lost activity that is now registering in GDP—and markets are now looking far, far beyond what happened between April and June.

Perhaps the most surprising development is that US GDP didn’t fall quite as much as German. US output fell -32.9% annualized, which translates to -9.5% q/q.[i] German GDP fell -10.1% q/q, which simple math translates to -34.7% annualized.[ii] We did this math because the US’s Bureau of Economic Analysis’s headline figure is the annualized rate, which is the rate GDP would fall over an entire year if the quarter-over-quarter rate persisted for four quarters. But Germany, like the rest of Europe, uses the quarter-over-quarter figure. The math makes it easier to do a comparison.

Considering Germany began reopening from the COVID lockdowns before most of the US, it would be reasonable to expect German GDP to fall less than the US’s. Analysts certainly did. According to FactSet’s most recent surveys, consensus estimates were for German GDP to drop -9.0% q/q, beating the US, which analysts estimated at -10.1% q/q (based on consensus estimates of a -34.6% annualized drop).[iii] Germany’s initial release doesn’t include a detailed breakdown, though the presser noted a “massive slump” in trade and private demand, with only government spending increasing. The US breakdown showed much the same. But we won’t know for a few weeks whether the US’s edge over Germany stemmed from a slightly less bad private sector decline or relatively higher government spending—presuming that edge isn’t revised away in future releases.

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Will a Jobless Recovery Hinder Stocks?

As the latest business surveys showed improving economic output across the developed world, headlines trumpeted a new concern: a potential “jobless recovery.” Though businesses reported increased activity overall, they were also still cutting headcount, and recent US initial jobless claims reports showed layoffs are rising for the first time since March. Many worry budding economic green shoots will wither if millions remain out of work. But this development isn’t unique: Most recoveries are “jobless” early on. While the magnitude may be large, nothing in the latest reports is a unique or different risk to stocks than in most historical bull markets.

IHS Markit’s July flash purchasing managers’ indexes (PMIs) showed ongoing economic improvement in the US, UK and eurozone. All composite readings (services plus manufacturing) were at or above 50, indicating a broad return to expansion for the first time since COVID went global.

Exhibit 1: IHS Markit Composite PMI

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On Banks, Bigger Doesn’t Mean Badder

Editors' note: MarketMinder doesn’t make individual security recommendations. The companies mentioned here serve only to highlight a broader trend we think is worth noticing.

As big banks kicked off earnings season last week, headlines focused most on their moves to bolster loan loss provisions and management’s uncertain outlook for lending, defaults and more. But another, less-discussed aspect of the biggest US banks’ Q2 results grabbed our interest more, as they reiterate one largely unacknowledged lesson of the financial crisis. Many see megabanks’ size and diverse lines of business as a threat—a source of instability. In our view, the experience in 2008 says otherwise—and Q2 2020 results add more evidence.

After 2008’s financial crisis, many thought big, diversified banks—which some refer to as “supermarkets”—were riskier in part because they mixed multiple business lines. They thought banks that provided financial services for everything from investment banking to mortgage lending were unwieldy and hard to manage, injecting extra risk into institutions backed by federal deposit insurance. These concerns motivated aspects of 2010’s Dodd-Frank financial regulation, which imposed additional oversight and capital buffers for banks—which are helpful enough, we guess, as that extra capital has shored up the industry to an extent. It also included the so-called Volcker Rule. When implemented in 2015, it sought to restrict banks’ proprietary trading using depositors’ money. While there is little to no evidence trading played any significant role in causing the financial crisis, many argued it was a potential source of instability. Since deposits are FDIC insured, the thinking went, banks shouldn’t have a free hand to trade their own account, capturing the upside, while putting a big part of the risk of failure on taxpayers. But proprietary trading was always hard to define, as few wanted to ban hedging and other risk management trades. Hence, the rule that took effect bore little resemblance to the strict ban many regulators envisioned early on and didn’t prevent all proprietary trading at big banks—a fact some still see as a risk to the financial system.

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Considering the CARES Act ‘Cliffs’

Despite budding signs of a nascent US economic recovery, fears of renewed weakness persist. The latest: Many pundits worry Congress might fail to extend various CARES Act programs. In a throwback to 2012, they argue these benefits’ expiry sets up “fiscal cliffs” the recovery could plunge off of and deepen the recession. While this may make for tense political theater, we don’t believe this bull market’s future hinges on whether or not Congress extends certain programs. These fears seem mostly like common early bull market worries that stimulus alone is keeping stocks afloat.

Here are some of the prominent programs set to expire soon.

Exhibit 1: Upcoming Fiscal Cliffs

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Unpacking the EU’s New COVID Fiscal Response

Well that was fast. It took just one summit and five days for EU leaders to settle various disagreements and agree on a €1.8 trillion budget, including €750 billion in grants and low-cost loans for countries needing assistance with the recovery from COVID lockdowns’ economic fallout. If this plan receives national parliaments’ approval, funding for that assistance would come from bonds issued by the European Commission (EC), and repayment would be a line item in the EC’s budget for the next 38 years. As for the new spending money, troubled countries would receive it gradually in 2021, 2022 and 2023, which is predictably driving chatter that the assistance is too little, too late. In our view, this is just one more example of the Pessimism of Disbelief—the perpetual search for bad news that accompanies new bull markets. Europe doesn’t need some massive fiscal stimulus or other quasi-governmental crutch to recover from the recession that began in Q1. Continuing the reopening process, no matter how gradually, should suffice. With expectations still so dreary, it shouldn’t take much for results to positively surprise.

One big talking point that isn’t so relevant for markets, in our view, is whether the new bonds would qualify as collectively issued EU debt. In our view, they wouldn't—an assessment most pundits seemingly share. They wouldn't be issued, serviced and guaranteed jointly by EU states. Rather, the issuer would be a supranational organization—a bureaucratic institution—with its own budget. Funding for that budget comes from EU nations, with each paying a share relative to its size. So these bonds wouldn't really be a statement of collective creditworthiness, and they wouldn’t replace member-states’ national bonds. In other words, this plan doesn’t aim to turn the EU into a federalized fiscal transfer union like the US. Whether or not this is a good thing is a long-term academic issue that many have debated for years, not anything for markets to deal with in the here and now. This deal simply means that academic debate can continue. How enjoyable.

As for the more immediate implications, on the one hand, it does seem to shore up sentiment toward Spanish and Italian debt. Every euro in help these nations get from the European Commission is a euro they don’t have to borrow on open markets, which seems to be easing concern that either will encounter funding issues and default. Mind you, we always thought that possibility was exceedingly remote, considering their low long-term sovereign yields and reasonable debt service costs. But to the extent the assistance eases these fears, so much the better.

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What to Make of China’s Q2 GDP Rebound

In a bit of good global economic news, China’s Q2 GDP rose 3.2% y/y after Q1’s historic -6.8% contraction, topping expectations for 2.5% growth.[i] Though the report beat expectations, the broad reaction was largely skeptical—indicative of the dour sentiment prevalent today. 

Of course, the rebound doesn’t reverse the drop in total. For the first half of 2020, Chinese GDP is down -1.6% y/y from 2019’s first half.[ii] Looking under the hood reveals industrial production has recovered more quickly than personal consumption—a trend supported by recent monthly data. For example, in June, industrial production rose 4.8% y/y, accelerating from May’s 4.4%, while retail sales’ decline slowed by a percentage point but remained in negative territory (-1.8% y/y in June versus May’s -2.8%).[iii]

Exhibit 1: China’s GDP, Retail Sales and Industrial Production

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Gold Climbs, Still Isn’t a Good Long-Term Investment

Gold is having a moment right now. Prices, up 19.3% this year, sit near all-time highs set in 2011.[i] Inflows into gold-linked funds in the year’s first half surpassed the prior annual record. Why all this interest? Among the many narratives that are likely contributing, gold allegedly hedges against equity market declines. With many fearing a second shoe is about to drop and send stocks back towards March 23’s bear market low, a haven may seem alluring. In our view, though, gold is a fatally flawed long-term investment—and one that would require remarkable timing to do well with near term. Hence, we think it is tough to make the case for a material allocation to gold in the vast majority of investors’ portfolios. 

Gold’s recent jump higher—and its year-to-date outperformance versus stocks—is, well, historically atypical. Since US investors could legally own investment gold in the mid-1970s, it has posted a cumulative 868% gain.[ii] Sound shiny? Consider Exhibit 1, which shows stocks have crushed gold over this span. Even government bonds’ total returns are far, far ahead of gold.

Exhibit 1: Gold Returns Lags Stocks’ and Bonds’

Source: Global Financial Data, Inc. as of 7/9/2020. Growth of $1 invested in the US 10-Year Government Bond Index, S&P 500 Total Return Index and gold prices, 12/31/1974 - 6/30/2020.

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How Campaign Pledges Help Election Uncertainty Fall

Editors’ note: MarketMinder is nonpartisan and favors no party or politician, as we believe political bias blinds and leads to investing mistakes. Our political commentary serves only to assess elections’ potential economic and market impacts—or lack thereof.

In one sign 2020 is slowly returning to normal, the presidential campaign has moved to more traditional ground in recent days: Former Vice President and presumptive Democratic nominee Joe Biden has begun unveiling sweeping economic proposals, previewing the tack he will likely take on the campaign trail. Pundits have accordingly been crunching the numbers in his tax package, $700+ billion “Buy American” economic plan and $2 trillion in proposed energy infrastructure spending, commencing the typical election year speculation about proposals’ impact on the deficit, taxes, the economy and markets. In our view, this is all quite premature. It is far too early to assess not just the presidential winner, but also the Congressional races and the likelihood any sweeping proposal from any party can become law. For now, campaign pledges are merely a way of drumming up election support. In the process, they help markets slowly get clarity on how the political backdrop may look post-vote.

Given the scope of Biden’s proposals—which is not at all unique for any candidate in any party—and his large polling lead, it is natural for investors to try to discern some market impact. Last week’s plan featured $400 billion to buy American goods, $300 billion in research and development and $50 billion in worker training. Tuesday, Biden announced a $2 trillion, four-year infrastructure plan attempting to spur an energy transition to carbon-neutral electrical generation by 2035. Biden’s previously announced tax plan aims to pay for at least some of these efforts by reverting individual tax rates for those earning over $400,000 to 39.6% from 37% and corporate tax rates to 28% from 21%. Elsewhere on the tax front, Biden proposed raising Social Security payroll taxes. Currently, earnings above $137,700 aren’t subject to Social Security taxes. Biden would keep this but re-impose the tax on incomes exceeding $400,000, creating a barbell structure.

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The UK’s Limited Reopening Limited May GDP

The UK released monthly GDP for May today, giving the first official look at how the broader British economy benefited from the gradual reopening that began in the month. The results—1.8% month-over-month growth—missed expectations for 5.5%, generating disappointment and worries that renewed lockdowns will derail an already feeble recovery.[i] Our perspective is rather different. For one, given this unprecedented situation, analysts’ expectations were always guesswork—you can see that in the widely varied US Q2 GDP expectations we discussed a couple of weeks ago. Two, if you look at the details underlying the headline results, modest GDP growth seems consistent with May’s limited reopening.

As in the US, the UK’s reopening wasn’t universal or all at once. The government’s reopening plans covered only England—the other three constituent countries (Scotland, Wales and Northern Ireland) set their own policies and generally reopened more slowly. Even within England, May’s reopenings largely covered factories and offices. Among retailers, only garden centers reopened in May, and that happened mid-month. All other non-essential retailers didn’t get the green light until mid-June, and most personal services and restaurants weren’t allowed to reopen until early July. Some, namely estheticians and other beauty providers, still aren’t open. Considering UK GDP is about 80% services, a recovery was always going to depend on a more complete High Street reopening.[ii]

GDP’s categorical breakdown vets this out. The heavy industry component, which includes manufacturing and mining (primarily oil drilling), grew 6.0% m/m.[iii] Further under the hood, manufacturing output jumped 8.4%, while mining notched a 5.0% rise.[iv] That meshes well with factories’ May reopening. But services grew just 0.9% m/m, which is more stabilization at a low level than actual growth, in our view.[v] It also seems about what one should expect given the very limited scope of reopened businesses. Even those who returned to office life had very limited options to shop or dine after hours.

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On the Re-Entry Debate

What do you do now if you exited stocks during this year’s bear market? The New York Times ran a piece yesterday attempting to answer that question:

Once You’re Out of the Market, It’s Tricky Getting Back In
Brian J. O’Connor, The New York Times

This is a relevant topic worth highlighting, but we found the article itself a mixed bag. Several of the interviewed experts provide sensible, if cliché, advice (e.g., buy low and sell high), but they primarily focus on how to re-enter the market: tactics or strategies like dollar-cost averaging or waiting until a COVID-19 vaccine is available. The questionable wisdom of that advice aside, the article overlooks a simple but critical question all long-term investors must answer:

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