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.


What to Make of Recent Chinese Defaults?

For years, a conundrum has confronted investors and Chinese officials alike: How do you move to a more market-oriented system if it means state-owned enterprises (SOEs) lose their implicit government guarantee and are allowed to default, fanning fears of a debt crisis?

That problem took center stage again lately following over a dozen defaults by SOEs this year alone. One striking example occurred a little over a month ago, when local SOE Yongcheng Coal & Electricity defaulted on a $150 million AAA-rated issue—a credit rating that clearly stemmed from the perception of government backing. Interestingly, Yongcheng appeared to have enough cash to cover the note, but it transferred major assets to other SOEs without compensation a week prior, ostensibly to hide them from creditors. Thus, the events suggested SOEs could dictate default on their terms, making it more difficult for markets to assess credit risk, which runs counter to the purpose of allowing default. That compounds questions about local governments’ blanket support of local SOEs. With local SOE bonds accounting for 60% of China’s onshore market, the circumstances understandably spooked investors and aggravated long-standing fears of a debt crisis. However, while there are important takeaways from the development, the response from Beijing, its policy priorities and the relatively small scale suggests systemic risks remain minimal. 

There are two primary risks related to broader credit events. The first, and most immediate, surrounds liquidity: Do banks have access to funds on a short-term basis to roll over their obligations? In the days after the default, one-year interbank rates jumped to nearly twice that of earlier this year.[i] In response, the People’s Bank of China quickly intervened to calm nerves, injecting $30 billion in one-year loans with the promise it would conduct another medium-term lending operation on December 15 to roll over maturing loans for the month. In the weeks since, liquidity measures have stabilized.

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Ratings Agencies Meet Realism in 2020

If misery indeed loves company, then what follows should be a heartwarming tale. For, you see, all of us normal people aren’t the only ones who have had an awful 2020. Credit ratings agencies have taken it on the chin, too. First they downgraded Canada and the UK and … few noticed. Then they downgraded two Australian states and pundits responded by rhetorically downgrading the agencies in noting just how feckless these ratings have become. Not that we are reveling in anyone getting kicked in the pants, but we think it is noteworthy that the world is catching on to the meaninglessness of ratings changes—illustrating how much the world has moved on since S&P downgraded the US nearly a decade ago and giving investors one less thing to fear.

Once upon a time, conventional wisdom held that if one of the three Nationally Recognized Statistical Ratings Agencies (NRSROs) downgraded a government’s credit rating, it would trigger mass selling of that issuer’s bond, sending interest rates soaring as investors fled the allegedly heightened credit risk. That was the raging fear when S&P downgraded the US’s credit rating from AAA to AA+ on August 5, 2011. At the time, the 10-year US Treasury yield sat at a benign 2.58%.[i] But the world did not end. Pension funds and overseas governments (cough, China) didn’t dump their holdings en masse. Yields did not soar. Instead, they fell. One month later, the 10-year was down to 1.98%.[ii] A year after the downgrade? 1.59%.[iii] And now, of course, they are all the way down to 0.9%.[iv] In the interim the US has had no debt crisis and no trouble finding buyers for new debt, despite quite a bit of new issuance. Other nations receiving downgrades in this era, including France, the UK and a host of other stalwarts, could tell similar tales.

None of the downgrade chatter since 2011 has matched the panicky hyperbole we saw then, but we have still seen a fair amount of fear—particularly when the UK faced another round of downgrades after the Brexit vote. This year, however, downgrade fear seems largely absent, and in our view, for good reason. It has always been clear to us that the NRSROs—S&P, Moody’s and Fitch—based their decisions on backward-looking information. That would be the same information that markets previously digested. In 2011, S&P’s stated downgrade rationale was the protracted debt ceiling battle, which had ended three days prior.[v] Investors had spent months dealing with panicky headlines and shouting politicians. Markets, which deal efficiently with widely known information, reflected all of it—including the many rumors of S&P’s impending decision. The announcement merely tied a bow on everything, adding S&P’s official opinion to the many, many, many opinions yields had already priced in. Investors then seemingly decided they were perfectly capable of weighing risks on their own and acting accordingly, and they continued buying, sending yields lower.

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Why Bonds Still Make Sense in a Low-Yield World

No matter where you look or how you cut it, bond yields are historically low. That has many asking: Why hold them at all? In our view, bonds’ primary purpose is to dampen portfolio volatility to mitigate swings for those needing to draw cash flow. Yes, yields today are miniscule, but we think bonds’ ability to cushion against short-term volatility endures—and makes a compelling case for them, should your goals and needs make smaller swings optimal.

On August 4, 10-year Treasury rates dropped to a record-low 0.5%, and they have hovered below 1% since.[i] Meanwhile, investment-grade corporate bond yields have fallen below 2% for the first time.[ii] Both are well below their averages during the 2009 – 2020 economic expansion (2.4% for 10-year US Treasurys, 3.5% for corporates), when people were also complaining about yields being too low.[iii] Yet even then, investors could assume a bit more credit risk, buy corporate bonds with still-low default probabilities and earn positive inflation-adjusted returns. Not hugely so, of course, but still positive. Now, this refuge is dwindling.

Contrary to what many yield-focused investors may think, record-low rates don’t mean bonds play no role in portfolios today for those who need cash flow. They tend to fluctuate less than stocks in the short term—a vitally important point for these investors to weigh. If your long-term financial goals require a relatively high rate of cash flow, a blend of stocks and bonds can be very beneficial. Yes, portfolio income—bond interest or dividends—can help fund withdrawals. But as we have written, selling slices of securities is often a better, more reliable means. With this in mind, the combination of price movement and income—total return—is what matters most.

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A Look at Three Bitcoin Myths

Bitcoin is front-page news again after topping its December 2017 record high and thereby unleashing an array of speculation about how far it could climb. But as with any hot-sounding, headline-grabbing investment, we suggest folks look past the hype over highs and coolly assess the common arguments people cite for owning bitcoin. Here is a breakdown of some, showing they are little more than myths—beware buying into bitcoin based on them alone.

Myth: Bitcoin is a safe haven asset.

In theory, a “safe haven” asset is one you buy when you want to shield it from severe problems in the stock market. The goal isn’t to own something that zooms when stocks sink, but rather, something stable—a fluffy cushion. It shouldn’t have high expected volatility, it definitely shouldn’t swing similarly to stocks, and generally the goal is for a cash-like return over a short period. US Treasury bonds, UK gilts and German bunds are classic examples of assets with this reputation. Ditto the Japanese yen and Swiss franc.

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Today in Brexit, Day 1,628

Editors’ Note: As always, MarketMinder is politically agnostic. We favor no politician or political party and have no position for or against Brexit or similar geopolitical developments. We assess this and all political issues solely for their potential economic and stock market impact.

They say good news comes in waves, so is it really any surprise that Brits began receiving the COVID-19 vaccine on the same day the UK and EU finally solved one of the most contentious pieces of Brexit? No, not fishing rights. But they did agree on how to implement last year’s agreement on the Irish border, prompting the British government to remove the bits of its highly contentious Brexit legislation critics argued violated international law. Tuesday’s developments don’t take a no-deal Brexit off the table, but they do remove some uncertainty over what that outcome would look like and what the UK’s international standing would be—an incremental positive for stocks, in our view, although we never thought a no-deal Brexit would be disastrous to begin with.

This agreement ends the saga that began in September, when the UK released legislation called the Internal Market Bill. That lengthy tome set out the legal framework for post-Brexit trade in the event the EU and UK couldn’t strike a trade deal—a fallback position. The bill aimed to strike the tricky balance between maintaining frictionless cross-border transactions between Northern Ireland and Great Britain as well as the UK and Ireland. That is despite the fact Brexit turned the UK/Irish border into an EU border. In the months that followed the Withdrawal Agreement’s finalization, it seems the UK government realized this was easier said than done. Hence, the Internal Market Bill contained some provisions that aimed to preserve free commerce between Northern Ireland and the rest of the country, preventing a de facto border running up and down the Irish Sea. Many argued these provisions violated the Withdrawal Agreement and broke international law. That touched off a diplomatic firestorm, with several prominent people warning it would hurt the UK’s ability to sign free trade deals. Of course, mere days later, the UK finalized a deal with Japan, suggesting the initial reaction was overblown. Several other deals have followed or are in the works now.

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Next Year in Global Politics

Editors’ note: MarketMinder is politically agnostic, favoring no party or politician in any country. We assess political developments solely for their potential market impact.

After a hectic and harried 2020 on the political front—keyed by America’s election and Brexit—2021 seems set for a refreshing calm. Brexit’s likely conclusion at yearend, American gridlock and a sparse calendar on the electoral front beyond our borders should mean markets get some relief from 2020’s tension, without big hurdles from politics next year. Here is a look at what to expect politically in the developed world and why it shouldn’t raise much risk for stocks, in our view.

New Year, new Senate. Georgians will vote in two Senate runoffs on January 5, and whatever the outcome, gridlock likely results. With Republicans’ current 50 – 48 edge, their winning just 1 seat means normal partisan gridlock prevails. If Democrats take both, Vice President-elect Kamala Harris would break ties. That gives them control on paper, but intraparty gridlock would then erupt, in our view, echoing President Donald Trump’s first two years. For example, when the Tax Cut and Jobs Act passed in December 2017, Republicans had a 52 – 48 Senate majority and a 239 – 193 House advantage. Narrow margins plus infighting watered down the final bill from initial proposals.

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The Not-So Curious Case of Britain’s ‘Missing’ Cash

Quick, alert Miss Marple! There is a grand mystery afoot: $67 billion (£50 billion) of cash is missing in the UK! That, at least, is the headline finding from a parliamentary report getting wide attention from headlines and politicians alike. But before you start hunting for Britain’s DB Cooper, consider the details. According to the British Parliament’s Public Accounts Committee (PAC), around three-fourths of the UK’s paper money supply isn’t being spent regularly. Politicians are up in arms over the Bank of England’s alleged failure to trace this “missing” cash. The PAC warns it could be out of the country, stuffed in British couch cushions or lining gangsters’ pockets, and politicians are demanding that the BoE do something to find these so-called undeclared savings. The BoE’s response was a delight: “Members of the public do not have to explain to the Bank why they wish to hold bank notes. This means that bank notes are not missing.” They are out in the wild, being bank notes, and that is that. However annoying to politicians this might be, it seems like the most beneficial response to me, as recent history shows problems arise when politicians try to tackle this problem.

First off, here is a partial solution to the mystery. When I left Heathrow a few years ago in the pre-COVID era, I didn’t feel like dealing with currency exchange fees and decided just to hold £85 in bills for the next time. (The ECB, Swiss National Bank and People’s Bank of China might appreciate knowing there is also a handful of euros, francs and yuan in my piggy bank as well.) I’m sure this isn’t unique to me. Many international travelers keep foreign cash for a future trip or give it to relatives as souvenirs. This is normal, non-nefarious behavior.

So is keeping emergency cash on hand at home, however unwise it may be. With all the sour sentiment toward banks and talk of negative interest rates, is it really so weird that people would feel more secure having a hidden cash trove in their personal castle, where it is immune to bank runs, account fees and potential erosion from a negative interest rate, if the BoE enacts one? Perhaps it isn’t the most logical or beneficial response, and not just because it doesn’t consider catastrophes like fire or robbery. But the mindset is understandable, and not just because I have watched my fair share of Doomsday Preppers.

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The Details Debunk Fears of Chinese Stocks’ Delisting

If you are seeking a heartwarming display of holiday togetherness, we suspect Capitol Hill is not the first place you would look. But the season of goodwill does seem to have affected our hugely polarized congresspeople, as the House voted unanimously on Tuesday to pass a bill requiring foreign companies to submit their financial audits to US regulators within three years in order to retain their listings on US stock exchanges. With the Senate unanimously passing a near-identical bill earlier this year, it now goes to President Trump, who seems likely to sign it given he has championed the effort. Most companies domiciled outside the US already comply with this requirement, but there is one notable exception: China. Considering China presently bars mainland firms from complying with this requirement, investors fear delisting is a foregone conclusion—and deeply negative—for Chinese companies. We think that conclusion is too hasty. Even if these firms must delist eventually, it shouldn’t mean much for investors or these companies’ returns in practice.

The rule in this week’s legislation has technically been on the books for several years, but neither exchanges nor regulators have enforced it. US and Chinese regulators have also been haggling over access to audits for years. Chinese law doesn’t permit auditors to send their reports abroad, on the grounds that it could expose confidential information. However, in 2013, they reached an agreement to send certain companies’ records to the US’s Public Company Accounting Oversight Board (PCAOB). That seemed like a major breakthrough until they provided exactly … zero reports. The compromise still barred auditing firms from sending records directly to the US. Instead, the PCAOB had to request them from Chinese regulators, and those requests evidently went nowhere—yet companies continued listing on US exchanges, raising money from US investors and giving Americans access to mainland stocks. This was a win for investors seeking to diversify in China, but it came at the expense of transparency, and some argue it created an uneven playing field favoring Chinese firms. Hence, Congress’s moves to tighten the rules.

Nothing in this legislation means Chinese companies will be forced to de-list. The SEC has been working separately on a similar rule for months as well, and as part of this, it has reopened negotiations with China. They are reportedly nearing a compromise that would allow Chinese companies to remain on US exchanges—and keep the reports by their Chinese auditors confidential—if they agree to a secondary review by an international auditor that already reports to the PCAOB. If this happens, we would consider it a win for all involved. Companies would get to stay on US exchanges, and investors would get more disclosure and transparency. It may also force companies to up their accounting game if they don’t already follow international standards (which overlap heavily with Chinese standards), and it removes many questions about the veracity of Chinese audits.

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The Persistent Partisan Divide in Consumers’ Economic Expectations

Editors’ Note: MarketMinder is intentionally non-partisan. We favor neither party nor any candidate and consider political bias blinding and a frequent source of investment error.

Wednesday morning, The University of Michigan released its November US Survey of Consumers—an index compiling responses to various underlying questions in an effort to gauge how people feel about current and expected economic conditions. Now, we don’t think this gauge tells you much about what consumers will do in the period ahead. There is little to no sign it predicts spending behavior. But there are some ways this is useful for investors. One we think is relevant right now: It serves as a stark reminder not to let partisan political views infect your economic or stock market outlook.

We base the preceding statement on a series of survey questions that assess consumers’ feelings about current and future economic conditions based on their political leanings (Republican, Democrat or Independent[i]). UMich hasn’t always done so—the history of this survey question is spotty until mid-2016. Even then, researchers didn’t ask monthly until February 2017. Still, we think the findings are telling: Many people base their economic expectations on whether the party they favor holds the presidency, as Exhibit 1 clearly shows.

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The Real Lesson From Britain’s ‘Austerity’ Error

Is the UK government about to repeat a terrible mistake? That question is stealing quite a few headlines in Britain as focus shifts from cushioning lockdowns’ economic impact to reining in 2020’s massive public deficit. Some pundits are lamenting the prospect of a capital gains tax hike, which one government commission recommended. But the vast majority are preoccupied with the potential for spending cuts, which they see as a repeat of the 2010s’ “austerity.” Conventional wisdom says big spending cuts under former Prime Minister David Cameron and his Chancellor, George Osborne—which continued under Osborne’s successor, Phillip Hammond—doomed the UK economy to a decade of lackluster growth. Cutting spending now, they argue, would repeat this error and cause the rest of the world to leave the UK in the dust after the pandemic fades. We don’t think it is worthwhile trying to predict what the government will do or how it will affect the UK economy, as there are just too many unknowns and human inputs. But a brief look at recent history might offer investors some helpful perspective.

It is true that Osborne and Hammond stressed deficit reduction while in office, and they used the word “austerity” a lot. But as Exhibit 1 shows, their actions didn’t amount to austerity as most of the world would recognize it. There were no draconian spending cuts. Heck, annual spending fell in just one calendar year, 2013, and by only £7.6 billion from the year before—a -0.9% drop.[i] What actually happened is that Osborne edited his predecessor, Alistair Darling’s, plans and reduced the projected rate of public spending increases. Spending still rose, just not by as much as the prior government intended. We guess you could argue these fit under the loose definition of “budget cuts,” but editing a forecast isn’t a spending cut if actual spending doesn’t drop.

Exhibit 1: The UK’s Not-So-Austere Decade

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