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.
Global stocks keep clocking new highs as the summer rolls on, but one sector is notably absent from the party: Energy, which also happened to be the best-performing sector in 2021’s first half. That hot start fanned widespread expectations that vaccines, reopening, resurgent travel and a new Roaring Twenties would stoke vast demand for fuel, making oil-related stocks surefire winners for a long while. At the time, we thought that seemed rather far-fetched, and now Energy has returned to earth somewhat. We don’t think dismal times are in store for the sector, but its recent travails do show the danger in extrapolating hot performance forward.
As Exhibit 1 shows, Energy’s 38.2% return through mid-June far outpaced the MSCI World Index’s 13.0%.[i] Propelling this move: oil prices, Energy’s main driver. Brent crude oil climbed from about $50 a barrel at 2021’s start to over $75 in July.[ii] Then, pundits claimed countries’ reopenings and rebounding travel would send demand soaring. Coupled with American shale drillers’ and OPEC’s newfound production discipline, limited supply would supposedly keep oil prices elevated to usher in the Roaring Twenties.
In our view, this all sounded a bit overstated. Sure, easing lockdown restrictions should raise demand, but only back to a pre-pandemic normal. After an initial pop, extrapolating accelerating growth forevermore didn’t appear wise. Then, too, in markets—especially commodity markets—higher prices invite greater production. Maybe at a lag, but with the Middle East’s abundant proven reserves and America’s ready supply of drilled but uncompleted wells, global production rising before too long never seemed in question, likely keeping a lid on oil prices—and Energy stocks, whose earnings are sensitive to prices rather than production volumes.
One year ago, Fed head Jerome Powell unveiled a change to the Fed’s inflation targeting objectives, culminating a multi-year strategy review process. That review stemmed from the Fed’s chronic failure to hit its 2% y/y inflation target, installed in 2012, with price increases throughout the 2010s deemed too low. The solution Fed people cooked up: Instead of targeting 2% inflation in every given month, they would now target “inflation that averages 2% over time.” They didn’t unveil a precise formula or define “over time,” leaving the world to believe the Fed would tolerate a spell of relatively hot inflation if the long-term average over some arbitrary period was 2%. There was some cheering at the time, but that was before CPI inflation spiked over 5% y/y and the Fed’s targeted gauge, the PCE price index, hit 4%.[i] Now pundits are calling for the Fed to change tack again, either going back to the old targeting system or clarifying precise boundaries. In our view, this all misses the point greatly, as there is little the Fed can do about the issues driving prices now—a key point for investors to understand.
Inflation, defined as a broad, consistent increase in prices across the entire economy, is a monetary phenomenon—too much money chasing too few goods. This, the Fed can theoretically influence with short-term interest rates, which it can raise or lower to flatten or steepen the yield curve, respectively. In a modern system like the US, banks create most new money by holding only a fraction of every new loan in reserves, so fast lending generally speeds money supply growth (and vice versa). When yield curves are steep, with long rates comfortably above short rates, banks’ core business model—borrowing at short-term rates and lending at long-term rates—becomes more profitable. That makes lending more attractive for banks, so they do more of it, and money supply grows swiftly. When the yield curve is flat or even inverted, aggressive lending becomes much less profitable. Banks tighten their belts. That slows or, in some cases, reverses money supply growth. Eventually, those money supply changes feed through to prices.
It is probably tempting to look at last year’s money supply spike and think that was the trigger for today’s high inflation rates. But money supply isn’t the only monetary variable. Velocity—the rate at which money changes hands—also matters a great deal. If supply is up while velocity is down, they can offset each other. We think that is mostly what happened last year. Velocity tumbled as lockdowns blocked sales and hit incomes. The Fed’s big money supply increase mostly offset that plunge.
Over the past month, Chinese stocks have gotten a lot of media attention—a subject that mostly centered on a handful of firms and got very company-specific. As such, we chose not to delve into it on these pages, as we don’t make individual security recommendations and will touch on specific companies only when they represent a broader theme worth highlighting. But last Friday, the tenor of global media coverage changed considerably, focusing on the bear markets that materialized first in the MSCI China Index, then in Hong Kong’s Hang Seng Index, which includes several mainland Chinese listings. So we think it is time to take a broad look at what has been going on, whether the downturn stems from sentiment or deep negative fundamentals, and explore where long-term investors with Chinese exposure go from here.
Most of the developments and volatility preoccupying investors have occurred over the past month, stoked either directly or indirectly by regulatory announcements from various Chinese officials. Since July 22, the day before rumors first broke that regulators were about to drop tough new rules on online private tutoring companies (rumors that soon came true), the MSCI China is down -15.6%.[i] But the downturn actually started back in mid-February, in the wake of some very high-profile cheer about Chinese IPOs. To us, that environment seemed a tad frothy, but market fundamentals appeared overall strong. China’s economy was growing swiftly, buoyed by the domestic and international recoveries from lockdowns alike. When COVID flared in cities now and then, renewed restrictions didn’t appear to have much broader economic impact. Accordingly, the -18.5% drop from February 17 through March 25 seemed to us like a classic correction: sharp, sudden and sentiment-fueled.[ii]
Throughout the spring and first half of summer, Chinese stocks bounced overall sideways. Not the classic V-shaped bounce that usually follows corrections, but also not a continued freefall. A brief dip into bear market territory in mid-May reversed quickly. But then came the regulatory ruckus in July and August, leaving the MSCI China Index down -32.2% from its peak as of Friday’s close.[iii] A bear market in magnitude.
Fifty years ago this month, then-President Richard Nixon did you a favor: He rendered the US trade deficit utterly meaningless. That, in my view, is one of the biggest after-effects of the Nixon gold shock, and it is largely absent from the flood of retrospectives dotting the financial news world this week, which preferred to focus on the 1970s’ inflation, seemingly playing off today’s fears. So let us take a short stroll down memory lane to see how Nixon’s fateful announcement played a small role in helping the US prosper alongside an ever-increasing trade deficit.
A lot of this week’s commentary called Nixon’s announcement the end of the gold standard, which isn’t technically true. The US actually went off the gold standard in the 1930s, when FDR pulled the plug after the Great Depression’s deep monetary contraction. But under the post-WWII Bretton Woods international monetary system, which pegged major currencies to the dollar, the US agreed to redeem all overseas dollars for gold at a fixed rate. This convertibility is what Nixon ended.
Before then, other nations’ dollar reserves had the potential to be a ticking time bomb for the US Treasury, as governments could theoretically cash in at any time. Officials began viewing that as problematic in the mid-1960s, when foreign dollar reserves grew larger than the US’s gold stockpile. One important counterbalance at the time? The US’s consistent small trade surplus. When US firms import goods from foreign companies, they pay in dollars. When the exporting companies convert those dollars into their local currency, they generally end up at their central bank as foreign exchange reserves.
From the tragic circumstances in Afghanistan and Haiti to COVID’s persistence, headlines have no shortage of bad news these days. The Delta variant in particular has dominated coverage, and it is weighing on the collective mood if the latest sentiment surveys are any indication. US consumers are feeling their bluest in nearly a decade, and the atmosphere seems similarly dour on the Continent. But for investors, sentiment surveys are at best a snapshot of feelings in the present—a coincident indicator. They won’t tell you where the economy or markets are headed next.
Several widely watched surveys highlighted the world’s case of the summertime blues. The University of Michigan’s US Consumer Sentiment Index (CSI) fell -13.5% m/m to 70.2 in August, well below expectations of 81.0.[i] That was the third-largest monthly decline on record—behind only April 2020 and October 2008. The ZEW – Leibniz Centre for European Economic Research’s Indicator of Economic Sentiment for Germany fell 22.9 points to 40.4—a third-straight monthly contraction after May’s 20-year high.[ii] A Wall Street Journal/Vistage small-business confidence survey reported only 39% of small-business owners expect US economic conditions to improve in the next 12 months—nearly 30 percentage points below March’s 67%.[iii] The overwhelming (and unsurprising) factor weighing on sentiment: the Delta variant. As an economist summarized in U-Michigan’s press release, “Consumers have correctly reasoned that the economy’s performance will be diminished over the next several months, but the extraordinary surge in negative economic assessments also reflects an emotional response, mainly from dashed hopes that the pandemic would soon end.”[iv]
We can certainly empathize. Yet it is also important to keep perspective, as sentiment surveys don’t predict future market returns. Take the U-Michigan survey, which last plumbed similar lows in December 2011 and spent much of that year below today’s level. That year coincidentally[v] illustrates how sentiment surveys are, at best, coincident indicators—and can be influenced heavily by recent stock market movements and fearful headlines. Several big stories weighed on sentiment in 2011. In the US, a debt ceiling fight—and potential credit rating downgrade (which eventually happened)—led coverage. Across the Atlantic, the eurozone’s debt crisis stirred concerns about a potential euro collapse. Global stocks suffered twin corrections (sharp, sentiment-fueled drops of -10% to -20%) that year, further shattering investors’ nerves. However, as Exhibit 1 shows, Americans’ mood didn’t predict lasting market malaise. Nor did it do a good job predicting volatility—mostly, it just mirrored market wobbles.
Editors’ Note: MarketMinder is politically agnostic, preferring no politician nor any political party. We assess political developments for their potential market impact only.
September’s political calendar, which already included general elections in Norway and Germany, got busier over the weekend when Canadian Prime Minister Justin Trudeau called a snap election. Canadians will vote on September 20, when Trudeau hopes his center-left Liberal Party will win an outright majority, improving on their current minority government. If that were to happen, it risks ending the gridlock that Canadian stocks have enjoyed since 2019, making this a vote worth watching. However, even with the Liberals’ wide polling lead, that majority isn’t a given, and we don’t think knee-jerk investment reactions are wise.
Trudeau’s logic is easy to see. Since 2019’s election, when the Liberals lost their majority in the wake of some high-profile scandals, he has had to rely on support from smaller parties to pass legislation. That has stymied most major initiatives aside from COVID relief, as even when rivals like the leftist New Democratic Party (NDP) agree on some of the broad brush strokes, politicking often gets in the way. Meanwhile, despite Canada’s long-lasting lockdowns, Trudeau and the Liberals have gained popularity with voters due to the country’s successful vaccine campaign and fiscal response. Those gains came as the opposition Conservative Party’s (aka the Tories) new leader, Erin O’Toole, has struggled to gain a foothold within his party and with voters at large. Strong polling, plus a seemingly disorganized opposition, appears to have Trudeau believing a majority is there for the taking, enabling the Liberals to accomplish much more of their agenda.
Continuing a big week in economic data, the US took its turn in the spotlight Tuesday with July retail sales and industrial production. The former stole most headlines, with retail sales’ -1.1% m/m drop in July blamed widely for Tuesday’s market volatility.[i] Pundits portrayed July’s weakness as a portent of worse to come in August, given the Delta variant’s escalation and renewed mask mandates since the calendar flipped. We wouldn’t read that much into either weak retail sales or industrial production’s 0.9% m/m climb, which beat expectations and contained some encouraging nuggets under the hood. Whether good or bad, one month’s economic data don’t make a trend, and we think stocks are looking well beyond summertime results.
To put it bluntly, retail sales’ slide—which missed expectations for a -0.4% drop—wasn’t great. The two main positives were gas stations and restaurants, neither of which is a terribly convincing plus. Gas station sales tend to rise and fall with gas prices, which are up, so that 2.4% rise probably stole demand from other categories.[ii] Restaurant sales’ 1.7% increase (on the heels of June’s 2.4% rise) should be an encouraging sign of services’ continued recovery, but with mask mandates returning in several major metro areas in August, the boomlet could be short-lived.[iii]
But context matters for the other categories, too. Exhibit A: Sales of autos and auto parts, which fell -3.9% m/m, extending their ongoing decline.[iv] Auto sales are weak not because of low demand, but because of low supply tied to the ongoing semiconductor shortage. Excluding that category, retail sales fell just -0.4% m/m, which is a little better than May’s print.[v] That, you might recall, was not a sign of terrible things to come. Elsewhere in the report, it is hard to see the results as anything other than normal data variability. Clothing stores’ -2.6% drop followed June’s 3.7% rise, which was inflated by office reopenings and workers’ need to update their professional wardrobes after a year and a half of remote work.[vi] Home improvement and garden store sales have been weak for a few months, tied to the DIY boom fizzling as lockdowns ended.
Was it Delta, flooding or a deeper economic problem? That is the question pundits scrambled to answer Monday, when China’s July economic data missed expectations. Retail sales and industrial production grew at what the rest of the world would consider a fine clip (8.5% y/y and 6.4% y/y, respectively), but both slowed sharply from June.[i] So did exports and imports, released earlier this month. Most coverage arrived at the conclusion that the escalating battle with the Delta variant and flooding in central China had only a modest impact on July’s results, with deeper troubles explaining the rest. We agree the tragic floods and Delta alone likely don’t explain the disappointing data, but we don’t agree with the implication that a faltering China is about to impede the global recovery from the pandemic.
For a few months now, the general consensus has held that China’s economic recovery rests on heavy industry, with consumers and services struggling. That allegedly points to weak domestic demand, as factory activity continues getting a boost from the developed world. In our view, that explanation is too simple and ignores all of the distortions at play within China and globally right now.
Central flooding and the Delta variant are two of those distortions, of course. Zhengzhou, the capital of flood-ravaged Henan province, is one of the country’s major manufacturing hubs, which likely partly explains industrial production’s slowdown. Flooding also complicated the city’s efforts to curtail a Delta outbreak, but other major cities (e.g., Nanjing, Wuhan, Yangzhou and Zhuzhou) have all reportedly entered partial lockdowns in recent weeks, curbing economic activity.[ii] Outbreaks also closed multiple ports this summer, hampering trade. Then, of course, there is also the global shortage of several raw materials, which has hit manufacturers in China and the developed world alike.
Technology stocks act like growth stocks. Materials firms behave like value. That sectors tend to overlap heavily with investment styles is relatively common knowledge. Yet those simple observations don’t tell you everything you need to know: They show what happens, but not why—and the latter is crucial to understanding and assessing which categories and areas may lead markets. Growth stocks’ uncharacteristic leadership since this bull market began last March is a prime example, as applying surface-level observations of value’s traditional early leadership would have set investors behind. But sectors’ and countries’ behavior can also change over time. The Real Estate sector appears to be undergoing such a shift today.
It isn’t unprecedented for sectors to undergo style shifts. One classic example is Consumer Staples. Widely considered a value-heavy sector today, it acted much more growth-like in the 1960s and 1970s, when many Staples were part of the “Nifty Fifty.” (Hence, the Nifty Fifty’s slogan: “Growth at any price.”) Back then, Staples firms benefited from expansion into new international markets and wildly popular product development. Procter & Gamble introduced household mainstays like Pampers disposable diapers, Head and Shoulders shampoo, Crest toothpaste and Downy detergent (along with memorable ad campaigns). Coca-Cola took diet soda mainstream with Tab, and Gillette made shaving less painful with the first silicone-coated razors. This innovation provided Staples product differentiation, driving profitability relative to the market and making the sector act much more growthy than it does today. But over the ensuing decades, the Consumer Staples sector matured, changing as products became more commoditized and international market penetration increased.
A similar shift may be occurring today in the Real Estate sector, as new sub-industries have more growthy characteristics. First, understand: All REITs aren’t created equal. While both publicly traded and non-traded REITs offer diversification beyond what most investors can achieve through direct investment in physical real estate, non-traded REITs tend to have much higher fees and a lot less liquidity than their publicly traded counterparts. Non-traded REITs often lock in investors until specified redemption windows, whereas listed REITs trade much like stocks, only with the requirement to pass through 90% of earnings to investors via dividends to maintain their exemption from corporate taxes.
Editors’ note: MarketMinder is nonpartisan. In our view, political bias blinds and leads to investing errors. As such, we never favor any party or politician. Our political analysis aims solely to assess developments’ potential market impact.
Thursday, the Census Bureau released its delayed, once-per-decade congressional redistricting data, sending political wonks scrambling to crunch the numbers, redraw House electoral maps and assess what it all means for next year’s midterm elections. For investors, we think the takeaway is more high level: The redistricting process likely adds to the political gridlock stocks enjoy in the here and now.
April’s state-level Census data reapportioned House seats among states for the next 10 years, but the granular, local data for them to draw new districts still weren’t available. As with most things lately, COVID delayed collection, analysis and publication of the data originally due in March. Hence, for the past four months, states knew if they would gain and lose seats, but not which districts would change, as that depends on population changes at the city and county levels. For example, California is one of a handful of blue states losing a seat. But without the data on local population changes, it was impossible to know whether the vanishing seat would leave a Republican or Democratic incumbent out in the cold. The long process of parsing this granular data to determine the final district boundaries can now begin.