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.
What categories of stocks are doing best lately? That is a question with multiple answers, some easier to understand than others. Saying US stocks are beating Europe and Asia is intuitive. So is saying Tech and Communication Services are among the best sectors. But when the conversation shifts to growth beating value, many investors’ brows inevitably furrow. We are here to help with that, as we think the value and growth distinction is especially important to returns in 2021. Understanding what makes a stock growth versus value can help investors understand why certain categories have led since lockdowns—and will probably keep doing so for the rest of this bull market, in our view.
Through Wednesday’s close, global stocks have more than doubled since last year’s March 23 bear market low. But doing that well—or better—required emphasizing the right kind of companies. Since this young bull market began, global value stocks have risen 85.7%, while global growth is leading the charge at 115.5%.[i] Lest you think owning only growth stocks and ignoring value would have been an easy path to big returns, however, there have been several countertrends along the way where value led—testing investors’ mettle. The most notable countertrend occurred late last year and early this year, tied to enthusiasm over COVID vaccines and widespread expectations of swift reopenings kicking off a new “Roaring Twenties” of lasting, hot economic growth. By Q1’s end, pundits globally claimed value would lead for a long while, and investors left and right wanted to jump on the bandwagon. Yet from mid-May onward, growth crushed value 16.9% to 2.4%, and we think it is likely to stay in the driver’s seat for the rest of this bull market.[ii]
To understand why, it helps to understand what growth and value entail and when each category usually does best. Value stocks, as the name implies, are generally valued more cheaply relative to their underlying assets and earnings potential than growth stocks (which we will get to shortly). They typically have lower valuations (price-to-earnings, price-to-book, price-to-sales, etc.) and return more of their earnings to shareholders via dividends and stock buybacks, investing less in long-term endeavors. Their profits are highly sensitive to economic trends. Overall, they tend to have lower credit quality and borrow primarily from banks, not capital markets. As a result, they often get hit hard during bear markets, as inverted yield curves lead banks to rein in credit, starving these companies of capital at the precise time their sales are tanking. Investors, cognizant of value’s heightened bankruptcy risk and fueled by bear market panic, normally punish the category indiscriminately. Inevitably the panic overshoots, creating a huge gap between reality and expectations. Accordingly, value usually rises disproportionately in a bull market’s initial rebound. This is also when value companies’ earnings growth is usually strongest, as all the cost cuts they made to stay afloat during the recession turn modest revenue growth into easy profits.
In recent days, a new presumption has quietly gained steam: Rising stock markets, pundits warn, are increasingly detached from a faltering economic recovery. Sure, most flagship economic indicators are still doing well, but slowing real-time data (e.g., restaurant bookings), supply shortages and the ever-present Delta variant have forecasters on edge. The implication: Euphoric markets are ignoring bad news and in for a rocky road once they wise up. In our view, this misunderstands how markets work, and even if the recovery does take a breather for whatever reason, it doesn’t render all-time-high markets irrational.
For one, to presume stocks should do X if near-term indicators do Y misunderstands how markets work. Economic data, no matter how timely, are backward-looking. They reflect what happened last week, month or quarter, depending on the statistic. Markets, however, are forward-looking. They generally look about 3 – 30 months out. Their focus within that span isn’t the precise economic trajectory, but whether the economic and political landscape in general look likely to keep corporate profits generally better or worse than expected. If economic data in the here and now wobble a bit, that could very well rein in expectations, making it easier for reality to beat—and fueling stocks.
It is true, of course, bear markets often begin when euphoric investors overlook deteriorating economic conditions. But that is generally about forward-looking economic indicators, not coincident and lagging data. For instance, if stocks were notching new highs while the US and other major yield curves were inverted, the Leading Economic Index was dropping and the new orders components of Purchasing Managers’ Indexes were contracting, that would be a strong signal that it is time for investors to take a cold, hard look around them. It wouldn’t be a call to immediate action, as getting out of the market is perhaps the biggest risk you can take if you need stock-like returns to reach your goals. That is why we generally think it is beneficial to wait at least three months after a peak to take action, lest you move hastily and miss more bull market if you are incorrect. But that sort of disconnect is something we would think it wise to watch very, very closely during that three month window.
Tuesday afternoon, the Social Security and Medicare Boards of Trustees released their delayed annual report on the state of their respective trust funds. The Social Security report in particular always generates a ton of headlines for its grim projections about when the trust will run out, allegedly chopping retirement benefits overnight. True to form, this year’s report spurred headlines coast to coast, all focused on COVID’s impact, which amounted to moving the depletion date up one year from 2034 to 2033. As always, we think investors mapping out their far-future retirement cash flow needs should take the projections and the handwringing with many grains of salt, as nothing here is etched in stone.
Practically, it matters little whether the trust fund is scheduled to run out in 2033 or 2034, as this is mostly a political deadline—Congress can always act as needed to ensure the trust fund’s ongoing viability. Options include raising the retirement age, tweaking the way benefits are calculated, adjusting the cap on earnings subject to payroll taxes and more. Congress has used all of these tricks before. They just haven’t done so since the early 1980s, which happens to be the last time the fund appeared to be stumbling toward insolvency. Necessity is the mother of legislation, and if we know politicians at all, we know they will delay action as long as possible before finally tweaking the system for fear of being seen as hurting people who paid into the system. But eventually they will act, and they will likely try sparing current and soon-to-be beneficiaries from being hit, as that would be bad politics. Yes, that is a somewhat cynical view, but we also think it is pretty realistic. So, a few years from now, if (more likely, when) they raise the retirement age for people born from around 1980 onward and bump the cap on earnings subject to the payroll tax at around $200,000 annually, remember you heard it here first.[i]
With that said, it is far from guaranteed that 2033 is the actual deadline, as these projections are chock full of guesswork and uncertainty—especially the pandemic-related parts. Taking their cues from the trustees’ commentary, pundits largely pinned the accelerated shortfall on COVID. As one outlet put it: “The Covid-19 pandemic and economic recession are to blame for moving up the depletion rate by a year, driven by the big drop in employment and resulting decline in revenue from payroll taxes.”[ii] In their accompanying letter, the trustees wrote, “The finances of [Social Security and Medicare] have been significantly affected by the pandemic and the recession of 2020.”
In late April and again in early July, we showed you that markets have been relatively calm in 2021, despite an ocean of fearful headlines. That relative calm has continued through today. Now, that long quiet period doesn’t mean stocks’ smooth stretch is about to be shattered. Volatility can strike or vanish at any time for any or no reason. But we do think getting acquainted with this year’s lack of volatility relative to the norm can help you mentally prepare for whenever markets do hit turbulence.
So far in 2021, the S&P 500 has had no pullbacks—declines from a prior high—exceeding -5%.[i] Although there is great variance among bull markets, as Exhibit 1 shows, the 12 postwar bull markets (before the current one) have averaged about 8 sizeable declines each. By magnitude, there are typically a handful of -5% to -10% pullbacks and a couple of -10% to -20% corrections. There are always outliers, but as the current bull market wears on, it would be unusual not to see more volatility and pullbacks.
Exhibit 1: Frequency of Pullbacks Exceeding -5%
Source: Global Financial Data, Inc. and FactSet, as of 9/1/2021. S&P 500 price index, 4/28/1942 – 8/31/2021. *Not including the current bull market.
August—that interminable slow financial news month—is finally ending, and economic record keepers globally decided to go out with a bang. Tuesday brought an avalanche of data, running the gamut from Chilean unemployment (improving to 8.9% in July) to Slovenian GDP (accelerating from 1.7% y/y to 16.3% in Q2).[i] There were also some interesting nuggets from larger nations, so let us bring you the two we found most interesting.
Is Germany causing a eurozone inflation headache?
The eurozone released preliminary August inflation today, and headlines globally described the acceleration from 2.2% y/y to 3.0% (versus expectations for 2.7%) a “shock.”[ii] Shouldering much of the blame was Germany, which announced yesterday that inflation hit 3.4% y/y when using the standard EU calculation and 3.9% using the Federal Statistics Office’s standard approach.[iii] Analysts pointed to the country’s well-documented supply chain issues, which are starting to hamper manufacturing output—driving prices higher as customers compete for a limited supply of goods. With no end to these issues in sight, they argue, it is no longer fair to call higher inflation “transitory.”
Fed Chair Jerome Powell virtually delivered his much-anticipated speech at the Kansas City Fed’s annual Jackson Hole central banker-fest Friday. As expected, he pretty overtly hinted the Fed is heading towards slowing quantitative easing (QE) bond purchases—i.e., “tapering”—this year. Loads of pundits see QE as crucial to stocks and the economy, and many have hyped this proclamation as a watershed moment. But, no shock to us, the news didn’t seem to faze markets one bit. In our view, this is further evidence pundits’ Fed focus is overdone. Central banks simply aren’t as powerful as many believe—worth remembering amid calls to give them even more responsibilities.
In past communications, the Fed has tied changes to monetary policy to the state of the economic recovery. Powell often referred to the need for “substantial further progress” before even considering any adjustments. His speech today implies that hazy distinction has been hit, with most coverage focusing on this particular section:
My view is that the ‘substantial further progress’ test has been met for inflation. There has also been clear progress toward maximum employment. At the FOMC's recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year.[i]
Fun and financial reporting are rarely two things that go together (outside of MarketMinder, that is), but Ann Carrns at The New York Times gave readers a tasty treat on Friday: a delightful look at some of the apps teaching kids, teens and young adults about finance and investing. This wasn’t yet another dismal treatise on the dangers of the “gamification” of investing, whatever that even means. Nope, it was full of encouragement and cheerleading about private companies doing what many schools haven’t for the past few decades and making it fun in the process. To which I say, hear, hear! The more young people know about compound interest, saving, budgeting and the tradeoffs between risk and return, the better they can navigate markets, find and capitalize on opportunities and get a head start on their long-term financial goals.
Back when I was a youngster,[i] schools attempted to teach a few core financial concepts. I remember lessons on compound interest and how to write a check when I was in fifth grade, along with a stereotypical stock-picking contest the next year. The compound interest lesson resonated, and I immediately started tallying how many baseball cards I could buy in 20 years if I kept all my money in a bank account yielding 5%.[ii]
The stock-picking contest, however, did nothing but encourage speculation, heat chasing and other behavioral errors. The teacher divided the class into groups of four and handed each group copies of the San Jose Mercury News’s Business section from the past week. I suppose many of you had the same experience. With that and that alone at our finger tips, we were to pick a stock to pretend to buy—just one stock—and the group with the highest return at the end of the month would win. Most groups picked stocks they knew, like Disney. Mine picked CBS, solely because it was up 10 points the previous day, which seemed promising. I don’t remember who won, but suffice it to say, we did not learn the difference between speculating and investing. Nor did we learn how to research companies. Or diversify. Or manage risk. Or or or.
For the past week, analysts have pored over the Fed’s July meeting minutes for clues about the Federal Open Market Committee’s (FOMC) thinking—particularly as it pertains to tapering quantitative easing (QE). That has many speculating about what Fed Chair Jerome Powell will say this Friday at the Kansas City Fed’s annual economic symposium at Jackson Hole, Wyoming. We suggest investors tune out the noise. Central banker chatter, regardless of the forum, doesn’t have a predetermined market reaction, and concerns about a taper are overwrought.
The July FOMC meeting minutes added more fodder to a much-speculated topic: When will the Fed taper its monthly asset purchases? The minutes revealed mixed perspectives. “Various participants” thought a taper would make sense in the “coming months,” but “several others” thought early next year was appropriate.[i] Though the minutes keep comments anonymous, officials’ statements in the subsequent days have led many to conclude tapering will start this year. Now many observers look to Powell at Jackson Hole for clarity.
The way pundits portray it, Jackson Hole isn’t just any conference, nor is it just the town’s famous antler arches and the Million Dollar Cowboy Bar that draw attention. No, they paint it as the place where things happen, making it one of the most-watched events on the financial calendar. The gathering’s reputation stems from former Fed head Ben Bernanke’s speeches from 2007 – 2012, particularly when he hinted at new QE programs in 2010 and 2012.[ii] Former ECB Chief Mario Draghi laid the groundwork for his QE program in 2014 at the mountain resort, while Powell introduced the Fed’s new monetary policy framework at last year’s virtual shindig. Hence, every late-August day this year seemingly brings a new round of What Will Jay Say?
Amid all the gut-wrenching images and stories emerging from Afghanistan, stocks globally have held steady—a testament to markets’ seemingly coldhearted ability to see through local tragedies and continue pricing in the world’s economic future. Encouragingly, we haven’t seen pundits argue the country’s destabilization and Taliban control of American weapons and war materiel are directly negative for markets. But several now claim there is an indirect impact that looms over the future, courtesy of the heightened risk of terror attacks in the West now that the Islamic State and Al Qaeda have safe quarter. They point to the US stock market’s severe reaction to 9/11 and warn of repeats. To be clear, the risk of terrorism is real and omnipresent, and attacks can destroy lives and property on an unfathomable scale. But for stocks, the calculus is different, and the past 20 years have shown terrorism doesn’t cause lasting declines.
Perhaps counterintuitively, 9/11 both demonstrates this and explains why it is so. As Exhibit 1 shows, the S&P 500 plunged -11.6% between market close on September 10 and September 21, the post-attack low.[i] An attack of that scale on the World Trade Center and Pentagon was unprecedented and unexpected, a shocking tragedy that cut America deeply. This plus the associated uncertainty understandably sent markets reeling. But then the rout stopped, and in retrospect, it is easy to see why. People in lower Manhattan went back to work. Society pulled together and got on with it. It soon became clear that the economic effects weren’t huge—utterly disproportionate with the impact on thousands of families and the national psyche. Business continued. Markets callously accepted the reality that terrorism was part of our lives, and moved on. Just 19 trading days after 9/11, markets regained September 10 levels. The S&P 500 finished the year higher than its pre-attack level. The bear market that had begun back in March 2000 would last until October 2002 as investors continued dealing with the dot-com bubble’s implosion and fallout from the Sarbanes-Oxley Act’s problematic consequences, but 9/11’s negativity was a small pocket.
Exhibit 1: US Stocks and 9/11
With Afghanistan and Delta still hogging most headlines in the US Tuesday, there was little new for investors to mull over. Enter Germany, which delivered a one-two punch of news: more details on Q2 GDP and the latest election polling, which put outgoing Chancellor Angela Merkel’s Christian Democratic Union (CDU) a hair behind its main opposition (and current coalition partner), the Social Democratic Party (SPD), for the first time in 15 years. That development isn’t mere trivia, as Germans go to the polls in five weeks. Some argue the election could have big economic consequences, as Germany’s main parties have disparate views on public spending. But overall, in our view, the status quo likely continues economically and politically, which is just fine for German stocks.
To understand the election’s alleged fiscal implications, it likely helps to dive into GDP first. German Q2 GDP grew 1.6% q/q (6.7% annualized), a whisker above the initial estimate of 1.5% q/q.[i] In most countries, GDP revisions aren’t terribly newsworthy, but Germany is one of a handful that doesn’t release a detailed breakdown until the second estimate. Those details, which showed consumer spending leading the charge with a 3.4% q/q rise, confirmed the Federal Statistics Office’s earlier observations that services did the heavy lifting while global supply chain chaos hampered manufacturers.[ii] Yet in heavy industry, it wasn’t all bad news. Business investment in capital equipment eked out 0.3% q/q growth, and exports rose half a percent.[iii] So, following the pattern in other developed nations, supply shortages and shipping delays remained a surmountable obstacle in the quarter.
The lone category to contract was collective government consumption, which refers to spending in broad areas like defense and public safety (versus spending on individual services, including education, housing and health care). Total government spending still grew, but the -1.5% q/q drop in collective spending dragged down the federal government’s broader contribution. That might not ordinarily be major news, but collective government consumption is the category where Germany’s big COVID relief spending showed up in GDP in Q1 and Q2 2020. It fell in Q3 2020 as the economy reopened and private businesses resumed driving economic activity, but as new restrictions emerged and lingered in late 2020 and early 2021, the government amped up its response again. Now, with the country reopening once more, it appears officials are once again stepping back.