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.
Editors’ note: MarketMinder is nonpartisan, preferring no party nor any politician. Our analysis aims solely to assess political developments’ potential market impact.
It was supposedly a double whammy for Italian bond markets Thursday after (now caretaker) Prime Minister Mario Draghi resigned and the ECB hiked rates half a percentage point (ppt). Italy’s 10-year yield rose 0.22 ppt on the day to 3.58%—its highest since summer 2020, when credit spreads spiked during initial pandemic lockdowns, before falling back Friday. (Exhibit 1) Pundits now say a financial crisis is brewing, but we don’t think one looks any more likely than last month.
Exhibit 1: The 10-Year Italian-US Credit Spread Widened Some
Source: FactSet, as of 7/25/2022. 10-year Italian BTP yield minus 10-year US Treasury yield, 1/1/2010 – 7/25/2022.
The next Fed meeting is less than a week away, and most analysts are penciling in another steep rate hike. Almost no one expects this to do anything about inflation, given the Fed can’t refine petroleum into gasoline, increase the grain harvest, staff airlines or unload container ships, all of which have fueled accelerating inflation even as money supply has started rolling over. But there is mounting fear that even one more big rate hike could be overshooting and kneecapping the economy, especially given how much the yield curve has flattened in recent weeks. In our view, there is some risk of the yield curve inverting, but it isn’t a given—and even a mild inversion isn’t an automatic recession trigger.
Now, when we look at the yield curve, we don’t use the 2-to-10 year segment that gets most pundits’ attention of late. We think the yield curve’s importance comes from its relationship with banks’ funding costs (short-term rates) and loan revenues (long-term rates), with the spread between them influencing banks’ potential profit margins on new loans—which drives loan growth. Generally, a wide spread means big profits and aggressive lending, while a deeply negative spread can signal a credit crunch. Banks don’t get much funding through 2-year CDs. They fund primarily through retail deposits and interbank markets, which are much shorter-term. We think the 3-month Treasury yield is a better approximation, so we use the 3-month to 10-year yield spread. That spread, as Exhibit 1 shows, has narrowed sharply since early May, from over two full percentage points (a multiyear high) to roughly half a point as of Tuesday’s close.
Exhibit 1: The Rapidly Shrinking Yield Curve Spread
The doctor is in—Doctor Copper, that is. The metaphorical Economics PhD with an allegedly uncanny forecasting ability is back in headlines this month, as many argue copper prices’ recent slide signals a nasty recession looms. Yet as leading indicators go, copper’s record is pretty spotty. We don’t recommend relying on it to determine what the economy is up to.
The case for copper’s prescience might seem intuitive. Conventional wisdom says that a humming economy will have widespread construction of homes, offices, factories, warehouses and stores—driving demand for copper, which is a key construction component. Therefore, if copper prices drop, it signals falling demand, which means construction is down, which means the economy is sagging.
But this logic doesn’t really hold up in developed-world economies, where services are much more important to growth than construction and physical goods. Many decades ago, when heavy industry and infrastructure had larger economic roles, it made sense to view copper as a leading indicator. When pioneering the Leading Economic Index (LEI) in 1938, economists Wesley C. Mitchell (founder of the National Bureau of Economic Research, which dates US business cycles) and Arthur Burns included copper on their initial list of the most telling components. But by the time LEI was reconfigured in 1950, copper was out. The more growth came from services and intellectual property, the less of a role copper played.
With seemingly everyone on recession watch nowadays, many extrapolate any monthly data dip—like US industrial production’s (IP) last week—as evidence. On the flip side, some see the eurozone’s surprising IP growth as a sign recession worries are overblown. But we think there are a couple considerations to note here. First, manufacturing isn’t a huge slice of developed world economies. Then too, although IP (which also includes mining and utilities output) can offer clues on the state of global growth, it is backward looking. Current IP data neither confirm nor deny a recession is underway.
Exhibit 1 shows US June IP dipped -0.2% m/m. That small dip, it is worth noting, was IP’s first decline this year. We always think you shouldn’t overrate a single data point, but this has sparked worry regardless, especially with manufacturing—IP’s largest component—down -0.5% m/m for a second consecutive month.[i]
Exhibit 1: Industrial Production Doesn’t Dictate Economic Activity
Source: Federal Reserve Bank of St. Louis, as of 7/15/2022. US industrial production, January 2007 – June 2022. Recession shading based on NBER business cycle dates.
China released Q2 GDP data Friday, and—please stay with us—the data were arguably the least interesting thing about it. No, we aren’t dismissing the sharp slowdown to 0.4% y/y, which missed expectations and reflected the economic damage from this spring’s COVID restrictions.[i] Nor are we glossing over continued real estate weakness, which remains a challenge. But the press release itself was a tour de force in political messaging that, when you understand the context, augurs well for economic policy—and growth—over the rest of this year. That, in turn, argues for economic fundamentals continuing to support Chinese stocks’ rebound off March’s lows. Let us discuss.
In countries with strong institutions and independent statistical agencies, economic releases are usually pretty dry. Most won’t even reference government officials, never mind sing their praises. But China is different. So the official release for Q2’s economic data begins not with a dry summary of the results, but a rather poetic statement: “Faced with extreme complexities and difficulties, under the strong leadership of the Central Committee of the Communist Party of China (CPC) with Comrade Xi Jinping at its core, all regions and departments deeply implemented the decisions and arrangements made by the CPC Central Committee and the State Council, responded to COVID-19 and pursued economic and social development in a well-coordinated manner, stepped up macro policy adjustments, and fully implemented a package of pro-stability policies and measures. As a result, the resurgence of the pandemic was effectively contained, the national economy registered a stable recovery, production and demands saw improving margins, market prices were generally stable, people’s livelihood was protected sufficiently with robust steps, the momentum of high-quality development was sustained and the overall social stability was maintained.”[ii]
It is entirely unsurprising to us to see such a statement now, as this autumn’s National Party Congress approaches. Xi, reportedly, is seeking an unprecedented third term as party leader, which would effectively cement him as president for life. Simple logic suggests that is easier said than done when the government’s zero-COVID policy and its many everyday-life and commercial disruptions complicate everyday life. That creates two urgent tasks: easing COVID frustration and helping the economy rebound as quickly as possible without storing up debt problems later. We read this press release as a preliminary declaration of success. The official message seems to be that lockdowns, while difficult, were successful and therefore worth it, and the payoff of a swift economic rebound is here—aided by fiscal stimulus, under Xi’s watchful eye and careful guidance.
Inflation hitting successive 40-plus-year highs to finish June at 9.1% y/y.[i] A bear market. Sliding bonds. Recession worries. War in Ukraine—and fear of war spreading. If ever there was a backdrop longstanding myths say should favor gold, this difficult environment is it. The long-rumored “safe haven” is supposed to provide protection from rising prices, falling stocks, recession and chaos generally. But let us explore how those theories look now, amid an environment allegedly super favorable to the shiny yellow metal.
In the year’s first month, when world stocks fell -5.2%, gold traded largely sideways—falling just -0.6%.[ii] In February, amid heightening war tensions—that ultimately culminated in Russian President Vladimir Putin’s vile invasion of Ukraine on February 24—gold’s gains accelerated. On March 8, while war and inflation fears raged, gold hit 12.9% on the year alongside bigger gains in less flashy commodities like industrial metals and grains.[iii] At the time, world stocks were down -13.2%, making the precious hedge look like it was working.[iv]
By that time, commentary dotted the financial press touting gold and commodities as a hedge—a surefire investment for these times. ETFs launched, offering retail investors exposure. As Bloomberg reported, Bank of America’s April Global Fund Manager Survey—published early that month—showed respondents were “… now the most net overweight ever for commodities.”[v]
A curious thing happened on the way to the UK’s allegedly surefire recession Wednesday: Some of the data that supposedly confirmed its existence were revised away. Not only did monthly GDP grow in May, but April’s contraction was milder than initially reported, and March’s slide flipped to a slight gain. Now, parsing the numbers here won’t give you much insight into whether a recession is or isn’t underway—the jury remains out, as it always does when pockets of weakness and relative strength abound. But the revised wobbles show why getting bogged down in headline data isn’t too productive. Stocks look forward, not at backward-looking numbers that won’t be final until long after the fact.
Exhibit 1 shows how this year’s results evolved between April and May. Overall, the changes aren’t terribly significant, but they shifted GDP growth expectations pretty radically. Entering this week, most everyone had penciled in a Q2 decline. Now, with April falling less than expected and May up, some commentators argue that will be enough to offset the impact the extra bank holiday during the Queen’s Platinum Jubilee will have on June’s data, making Q2 GDP flat or even slightly positive. Moreover, the data no longer show GDP falling two straight months after a flat February, which had caused people to extrapolate declines forward. In our view, a Q2 GDP contraction was always more if than inevitable, and we guess the data now just make that a bit clearer (notwithstanding the potential for further revisions, of course).
Exhibit 1: The Ever-Changing UK GDP Data
Editors’ Note: Inflation has become a hot political topic, and we aren’t commenting on it from that standpoint. We are looking at the investment-related implications only.
9.1%. That is the latest multi-decade high the US’s Consumer Price Index (CPI) year-over-year inflation rate hit in June.[i] When headlines weren’t stewing over what the acceleration from May’s 8.6% means for the Fed’s decision making at its next meeting in two weeks, they were looking for some signs—any signs—that the pain will soon end.[ii] We understand the impulse: The more prices rise, the more it creates hardship for many and forces people to forego things. Inflation has also sent political rancor to the boiling point, which is never pleasant. But from an investing standpoint, pinpointing inflation’s peak isn’t necessary. Stocks don’t need prices to ease—inflation is just one of seven or eight (at least) items weighing on sentiment right now. The key to recovery isn’t fundamental improvement, but gradually easing uncertainty on a multitude of fronts.
The main source of uncertainty underlying inflation right now is the main contributor: energy prices. Those rose 34.6% y/y, which included a 48.7% rise in gas prices.[iii] (Ugh.) That led to a sharp divergence between headline and core inflation, which excludes food and energy prices—not because they are meaningless (they aren’t), but because they are quite volatile and can occasionally mask underlying trends. Core CPI actually ticked a wee bit slower, from 6.0% y/y in May to 5.9%. That doesn’t mean inflation is for sure slowing from here, but it does cut against the notion that all prices are accelerating rapidly.
The June jobs report came out last Friday, and most analysis covered a well-tread topic: How will the latest employment data influence the Fed? Speculating about this isn’t helpful for investors, as central bankers’ actions aren’t predictable, in our view. However, we think digging deeper into the jobs numbers sheds light on another development: Pandemic dislocations continue evening out, a sign the return toward normal is ongoing—a small, but overlooked, positive, in our view.
The most widely watched jobs measures didn’t deviate much from their recent trends in June. Nonfarm payrolls rose 372,000, more or less in line with the average monthly gain of 383,000 over the past 3 months, while the unemployment rate registered its fourth straight month at 3.6%.[i] The labor force participation rate ticked down from May’s 62.3% to 62.2% as the numerator—the labor force (the sum of employed and unemployed persons)—fell by 353,000. A decline in the number of employed government workers underpinned the drop—the number of employed private-sector workers actually rose in June.
While the headline figures didn’t reveal much new insight, we found some interesting nuggets that run against recent popular headline themes. For example, many have worried about hiring freezes and layoffs among some (particularly small) Tech firms and startups—and the potential implications for the broader sector. However, jobs in the “computer systems design & related services” field rose by 10,000 in June, and the industry hasn’t suffered monthly net job losses on a seasonally adjusted basis since July 2020.[ii] Now, the Bureau of Labor Statistics has acknowledged the pandemic’s challenges to its seasonal adjustment methodology, especially in 2020 data, though the agency’s adjustments may have mitigated COVID’s effects.[iii] We also don’t dismiss the fact some Tech firms are laying people off or letting their headcount shrink through attrition. But in our view, they aren’t exactly of a huge magnitude at this point from a macroeconomic perspective. This could well be a case of hard data telling a different story than headline anecdotes—and why it is important to consider both, not just one or the other in isolation.
Editors’ Note: MarketMinder favors no politician nor any party. We assess political developments for their potential economic and market impact only.
The world continued digesting last week’s major political earthquakes Monday, with the fallout from UK Prime Minister Boris Johnson’s resignation and the tragic assassination of former Japanese Prime Minister Shinzo Abe just two days before Sunday’s upper house’s election. We have seen a ton of speculation as to how these events will potentially affect economic policy in the months to come, and while it might feel trivial to focus on this aspect—particularly in Japan—rather than the gravity of the events, markets are pretty laser focused on policy, not the social and human angles. So let us look at the latest happenings through that lens.
The Race to Replace Johnson Takes Shape