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.
Q3 earnings season is drawing to a close. With over 91% of S&P 500 companies reporting through Monday, profits are up 39.2% from Q3 2020, shattering expectations for a 23.5% rise.[i] Big growth isn’t shocking, considering earnings fell -5.8% y/y a year ago, meaning today’s figures look back to a depressed base.[ii] But the big divergence from expectations is noteworthy, particularly for what it reveals about how companies are adapting to the supply chain crunch, labor shortage and rising costs allegedly hobbling global commerce.
All sectors enjoyed growing earnings in Q3, with growth rates ranging from 3.7% y/y (Utilities) to irrational (Energy, whose net income rose from a -$1.5 billion loss in Q3 2020 to a $24.8 billion gain).[iii] The other top sectors, Materials (90.1% y/y) and Industrials (69.2%), received a clear reopening boost and benefited from easy year-over-year comparisons. But the same cannot be said of two sectors that were close on their heels: Tech (36.3%) and Communication Services (35.0%), which is home to several Tech-like giants.[iv] Both sectors were resilient during lockdowns, with minimal damage in Q2 2020 and modest growth in Q3 2020. Their ability to generate fast growth off relatively difficult year-over-year benchmarks speaks to just how strong their fundamentals are now, in our view.
Exhibit 1 offers one way to see this: gross profit margins. That is, sales minus cost of goods, divided by cost of goods. This is a quick and dirty measure of a company’s core profitability before adjustments for taxes, debt service and other accounting items. Companies with slim margins generally have to get outside financing to fund expansion (think: bank loans or bond issuance) and have a hard time swallowing rising costs. Those with fat margins are much more self-sufficient. They can plow profits back into the business, self-financing future growth. They also have more bandwidth to weather cost pressures. Tech and Communication Services have the fattest gross margins in the S&P 500, which may not shock. But you might be surprised to see both have overall improved margins this year.
Editors’ Note: MarketMinder is politically agnostic. We favor no political party nor any politician and assess developments for their potential market and economic impact only.
Late Friday evening, a rare celestial phenomenon occurred: The House of Representatives actually passed a bill of substance. Specifically, they passed the Senate’s nominally bipartisan infrastructure bill, with 13 Republican reps providing the votes to get it past the finish line as 6 progressive Democrats voted no. Pundits largely spent their weekend speculating on the legislation’s economic impact, touching on everything from the deficit to inflation to the potential winners and losers at both a state and industry level. In our view, a lot of it misses the big picture: This money trickles out over more than five years, and much of it may not get spent at all. We doubt this legislation moves the needle for stocks or the economy for good or ill.
Most headlines describe the bill as a $1 trillion infrastructure package, which is technically correct but also incomplete. While that is the total amount of federal funds the bill will deploy (provided the next Congress doesn’t change course), only about $550 billion of this is new spending—meaning, spending on top of what Congress had already penciled in. That $550 billion primarily features:
Good news! The US economy added 531,000 nonfarm jobs in October, inching the unemployment rate down from 4.8% to 4.6% as people found work across the services sector.[i] Strong wage growth also helped pull new workers into the labor force, which increased by 104,000. Those are the highlights—and pretty strong numbers! As always, though, none of this means anything for stocks, as labor market data are late-lagging indicators. But we did glean two fun nuggets for you—let us dive in.
1. Job gains and losses aren’t good real-time economic snapshots.
People often look to the Employment Situation Report—the technical title of each month’s payroll and unemployment report—as a real-time barometer, and we can sort of see why. It comes out the first Friday after month-end, making it one of the fastest releases. But as this report shows, haste makes waste: These data are subject to revision, often to a very large degree.
Welp, after Bank of England (BoE) Governor Andrew Bailey seemingly went to great pains to signal the BoE would hike rates Thursday, it didn’t. This is exactly the kind of action that led one member of Parliament to dub Bailey’s predecessor, Governor Mark Carney, an “unreliable boyfriend.” Similar chatter to that abounded during Bailey’s post-non-hike presser. For investors, we think this illustrates why you shouldn’t take central bankers at their word.
While Bailey said the BoE’s decision to keep its Bank Rate on hold at 0.1% was a “very close call,” the Monetary Policy Committee’s (MPC) 7 – 2 vote belies that. The MPC also voted 6 – 3 to stick with the previously announced December end to increasing its gilt holdings under quantitative easing (QE), eschewing some analysts’ calls for a quicker cessation.
Normally, policy meetings with no changes are a snoozefest. But this one left many shaking their heads. Less than a month ago, Bailey warned that the BoE needed to prevent higher inflation expectations from becoming entrenched as energy prices spiked. As he put it, “That’s why we, at the Bank of England have signaled, and this is another signal, that we will have to act. But of course that action comes in our monetary policy meetings.”
Just about two months from now, many will “celebrate” Brexit’s two-year anniversary. We used those scare quotes because some remain convinced Brexit is disastrous for the UK to this day, arguing the additional paperwork and associated higher costs have squashed UK businesses that depend on frictionless shipping across the English Channel. We agree Brexit has likely had some effects, but the degree to which Brexit is responsible for weak UK trade data is debatable in light of global developments. That so many UK observers seem to emphasize Brexit over extant global issues shows how this event, now long since behind markets, has become a near-permanent feature of background chatter in the UK.
Brexit has indeed distorted UK trade data since June 2016’s vote to leave the EU. The initial Brexit day was set for March 29, 2019. After agreeing on a short-term extension days before the scheduled exit, on April 10 the UK and EU delayed the date to October 31, 2019 in order to avoid a messy no-deal Brexit. That, too, was delayed at the last minute on October 28, pushing the final Brexit date to January 31, 2020 with a one-year transition period in which the UK would stay in the EU’s single market and customs union. That final tie severed, as scheduled, on January 31, 2020.
As Exhibit 1 shows, trade with the EU spiked leading up to March and October 2019 as businesses raced to front-load exports and stockpile ahead of potential no-deal Brexits, which pundits warned ad nauseam risked bringing draconian tariffs and customs barriers overnight. We saw a repeat as businesses pulled activity forward late last year before the transition period ended and customs checks and the Irish protocol took effect. In our view, trade was always likely to drop after those initial bursts of activity—somewhat significantly—and take some time to revert to longer-term trends. The deadlines simply pulled some demand forward, leaving it weak in their wake.
Happy Day Before Friday, and what means of celebrating could be great-a than data? (Sorry.) Economic record-keepers globally were busy bees today, releasing a smorgasbord of stats for investors to mull over. As always, they are all backward-looking, and stocks generally care about what happens over the next 3 – 30 months, not what happened a few weeks ago. But we did find some nuggets of interest, so let us share.
The record-high trade deficit is not the real story.
The US imported $80.9 billion worth of goods and services more than it exported in September, prompting the usual flurry of headlines hyping the record-high gap.[i] We will leave them to stew over that meaningless statistic, which has no bearing on the country’s economic health. After all, imports represent domestic demand, and foreign investment inflows offset the trade deficit. It is an accounting factoid. Nothing more.
Editors’ Note: MarketMinder favors no politician nor any political party, assessing developments and trends solely for their potential market and economic impacts.
This week marked a year from the contentious 2020 US presidential election. Along the course, we have endured 12 months of hot, shrill rhetoric over contested outcomes and recounts, twin Georgia Senate runoff votes, a riot at the Capitol, lots and lots of talk about big legislation and so much more. Regardless of which side of the aisle you favor, there was something to trigger your emotions. Now 2022’s midterms are coming into focus, which could roil emotions again. In our view, that makes now an apropos time to remember: Mixing political bias into your investment strategy is dangerous.
Last year at this time, many on America’s political right warned President Joe Biden’s winning would spell big trouble for stocks. They doubled down on this argument when it became clear both Georgia Senate seats would be up for grabs on January 5. That raised the possibility of the Democratic Party controlling the White House and both chambers of Congress, which many presumed meant huge legislative activity was coming, drawing some investors’ hope—and many others’ ire.
Pop quiz: When is fast wage growth bad news? Common sense says the answer is “never,” as making more money is always a good thing for those on the receiving end of higher paychecks. But that viewpoint wasn’t too prominent when data released last week showed US wages rising 4.2% y/y in Q3, the fastest rise in over 30 years.[i] Far from representing a nice improvement in living standards, because they followed months of above-average inflation, rising wages are allegedly signs of a potentially brewing wage-price spiral, according to some pundits. Meaning, a vicious cycle in which businesses raise wages to attract workers when inflation is high, then raise prices to preserve margins, fueling more inflation, necessitating even higher wages and more price increases, lather, rinse, repeat. As logical as this might sound, however, it has little bearing in reality, and we think investors can cross it off their list of worries.
The wage-price spiral was all the rage in the 1960s, when an economist named A.W. Phillips created a model showing a link between the unemployment rate and inflation. This model, now known as the Phillips Curve, has underpinned Fed policy for decades. It posited that when unemployment is high, businesses don’t need to raise wages to attract workers, which keeps inflation low. But when unemployment is low, according to the model, wages and inflation rise. Some Phillips Curve models use unemployment and wages, while others use unemployment and inflation. All hinge on wage-price spiral theory.
Nobel laureate economist Milton Friedman took this on in a 1968 speech entitled, “The Role of Monetary Policy,” which he delivered as an address to the American Economic Association. In it, he posited that the Phillips Curve was flawed because it focused on nominal wages, not “real” or inflation-adjusted wages. That essentially led to a model that argued inflation drives inflation, which is fatally circular. We explained this in detail a few years back in a piece that is plenty relevant today, so rather than rehash that argument, we offer you a link.
The Fed officially tapered its quantitative easing (QE) bond purchases today, and far from triggering a tantrum, it ended up being a giant snooze. Instead of being rocked by the news, the S&P 500 flipped from slightly negative on the day before the announcement to close up 0.7%.[i] The 10-year US Treasury yield rose all of 4 basis points on the day, from 1.55% to 1.59%.[ii] Most commentary on the move was laced with sleep aid, with the notion of a “taper tantrum”—prevalent mere months ago—largely disappearing down George Orwell’s famous memory hole. About all pundits could conjure up in the way of angst were questions about when the Fed would hike rates. Let this be a lesson: Markets pre-price widely expected events, including monetary policy decisions, which don’t have a preset market impact.
We don’t often give central bankers kudos, but we would like to start by presenting Fed head Jerome Powell and friends the (ironically named) Mark Carney Award for Acting in Accordance with Forward Guidance, rather than saying A but doing B at the last minute.[iii] The minutes from the Fed’s July meeting revealed monetary policymakers “judged that it could be appropriate to start reducing the pace of asset purchases this year.”[iv] In his late-August (virtual) address at the (virtual) Jackson Hole central banker confab, Powell reiterated that stance and said he believed inflation had made enough “substantial further progress” to warrant tapering. Minutes from September’s meeting teed up this month as Taper Decision Day and outlined a potential path for “monthly reductions in the pace of asset purchases, by $10 billion in the case of Treasury securities and $5 billion in the case of agency mortgage-backed securities (MBS).”[v] That is precisely what the Fed announced today, with the reduction beginning this month. The policy statement left some wiggle room to change course in the future if economic data veer unexpectedly,[vi] but otherwise, QE is set to conclude in June.
And that was that! No fireworks. No big market swings. The tantrum pundits wrote about repeatedly over the summer just hasn’t happened. The S&P 500 is now up 5.1% since those July meeting minutes were released in mid-August.[vii] 10-year Treasury yields are up 33 basis points.[viii] That is even smaller than its move during 2013’s taper talk, which we view as the alleged tantrum that wasn’t. In our view, this echoes the general non-reactions to the Bank of England’s (BoE’s) decision to halt QE outright, the European Central Bank’s taper that chief Christine Lagarde swore wasn’t a taper, the Bank of Canada’s quiet tapering for most of this year, and the Reserve Bank of Australia’s abandonment of its “yield curve control” policy, which set official targets for 3-year yields. None of these moves caused a big ruckus in stocks.
Fresh on the US’s heels, the eurozone and several member-states released Q3 GDP Friday—and tossed in October inflation as a bonus. In our view, all largely follow the course the US charted when it reopened earlier, and none of the results likely surprised stocks for good or ill. Reopening drove swift growth, while energy prices fueled faster inflation. Both developments were widely expected, and both are likely (shhhhh) transitory—which should prove fine for markets, in our view. Let us take each in turn.
Behold, the Reopening Boom!
Q3 GDP results for the eurozone and three of its four biggest member-states all accelerated from Q2, with the outlier—Italy—still notching double-digit annualized growth.