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.
With all that is going on in the world this week, it might seem trivial to zero in on one cog in the global economy. Yet even little nuggets of falling uncertainty matter, and there is one that investors shouldn’t overlook: Even as recession chatter mounts, global supply chain pressures are easing. While they aren’t fast inflation’s only cause, they have been a contributing factor, due primarily to dislocations from lockdowns and reopening. But in recent weeks, things have started settling down a bit, albeit to little fanfare, which should help gradually ease one of the fears in this year’s cocktail of scary stories.
Consider Exhibit 1. Since we featured the New York Fed’s Global Supply Chain Pressure Index (GSCPI) last month, it has fallen further. The GSCPI mashes together various global shipping and transportation costs plus other supply chain indicators including delivery times, backlogs and inventory levels. June’s reading was still elevated relative to the index’s history, but it was noticeably down from December’s peak. This doesn’t mean disruptions won’t flare again—see 2021 after 2020’s spike—but absent further severe lockdowns (like China’s) affecting global supply chains, companies appear to be working through bottlenecks.
Exhibit 1: Global Supply Chain Pressures Elevated, but Easing
Source: Federal Reserve Bank of New York, as of 7/7/2022. Global Supply Chain Pressure Index, January 1998 – June 2022.
Of all the economic indicators out there, the most entertainingly named has to be the JOLTS report—shorthand for the job openings and labor turnover survey. This supplemental employment release from the Labor Department has a trove of data missing in the monthly Employment Situation Report, including details on the number of job openings and how many people are resigning from their jobs versus getting pink slips. We always enjoy this report and think some of its nuggets are useful, but we are flummoxed by headlines’ reaction to the latest release, which showed job openings falling a bit but staying near record highs. One big crowd argues this is surefire evidence a recession isn’t here. The other cites the falling number of openings as a sign labor markets are cooling. We don’t think either interpretation carries much weight and urge you, dear readers, not to factor these data into your economic or market outlook.
The bullish school says the 11.3 million job openings in May—miles above the 7 million openings on the 2020 lockdowns’ eve—shows a red-hot labor market at odds with recession chatter.[i] The more pessimistic bunch points out that there were nearly 11.9 million openings in March, arguing the downtick shows businesses are cooling their jets in response to Fed rate hikes.[ii] In our view, both claims are at odds with how labor markets typically function as an economic indicator. For one, employment tends to follow economic growth, not lead it. Hiring is a big up-front investment, so businesses tend to delay it until they have reached the limit of what they can produce with current headcount—and tend to avoid layoffs until there is no other alternative, as that renders prior investment in employees a sunk cost. So you typically don’t see employment start to fall until after a recession has begun—and it usually won’t start recovering until after the ensuing economic bounce is underway. Two, the Fed started hiking in March, and most research estimates monetary policy changes take around 6 – 18 months to start bearing fruit in the real economy, making it unrealistic to think the Fed’s moves are already affecting hiring.
Most importantly, the JOLTS report’s very limited history doesn’t suggest job openings are predictive. Exhibit 1 shows the entire data set, which begins in December 2000, with recessions shaded. As you will see, it is normal for job openings to drift sideways or lower during a broader economic expansion. They also roll over so far in advance of a recession that they are utterly useless from a timing perspective.
They don’t always, but bear markets often precede recessions. So US stocks’ breaching -20% on June 13 poured gasoline on already hot recession fears. Given that backdrop, it shouldn’t surprise you that the Atlanta Federal Reserve’s GDPNow—a statistical model designed to estimate the quarter’s GDP based on incoming data and forecasts—falling to -2.1% annualized for Q2 on July 1 further fanned fears. While we don’t dismiss the possibility of a Q2 contraction, which would technically be the second-straight quarterly decline, we think there are reasons to be skeptical this outcome is assured. Or that it means America would be in recession.
The Atlanta Fed’s tool is one of several like it that aggregate incoming data, math it up and try to predict the eventual GDP release. It mashes together Fed forecasts and actual data releases, evolving throughout the quarter as data arrive. It also, the Atlanta Fed wants you to know, isn’t the bank’s official forecast. It is a research exercise above all else, based largely on ideas cooked up in the private sector.
As you might imagine, the earlier in the quarter one looks at GDPNow, the less accurate the “nowcast” tends to be. But even at quarter end, when most data are in, tracking error exists. And it is up since the pandemic. That doesn’t mean GDPNow is wrong or useless. It just means handle with caution because, like all economic data, it is far from perfect—especially given the oddity of 2020’s lockdown-driven downturn. Exhibit 1 shows GDPNow’s historical tracking error on the day before the US Bureau of Economic Analysis published the relevant quarter’s advance GDP estimate. (This quarter, that would be on July 27.)
Editors’ Note: MarketMinder favors no political party nor any politician. We assess political developments for their potential economic and market impact only.
UK Prime Minister Boris Johnson is under fire. Again. This time, cabinet ministers, backbench Members of Parliament (MPs) and the general public are revolted by revelations that Johnson had given an MP a senior government position despite knowing of outstanding allegations of abuse against him—and then claimed to have no prior knowledge of said allegations once they became public. As always, we will stay above the socio-political fray, as we are here to discuss only how politics intersect with markets and the economy—and this latest scandal looks increasingly likely to force Johnson out of office. Moreover, whether he stays or goes, it looks like the Conservative Party’s recent economic policy suite may get an overhaul. That is placing a hefty dose of political uncertainty over UK stocks, which could roil sentiment for the time being—but creates room for falling uncertainty to be a tailwind as this situation resolves.
Last time Johnson was at risk of an ouster, he won a confidence vote from his party’s committee of backbench MPs, known as the 1922 Committee. Under the committee’s current rules, MPs aren’t allowed to bring another no-confidence motion against him for a year. But that was then. Now, more than 40 MPs (and counting) have resigned from Johnson’s government since Tuesday, including Chancellor Rishi Sunak and Health Secretary Sajid Javid. Home Secretary Priti Patel reportedly joined the rebellion Tuesday night and told Johnson to step down, but as we write, it is unclear whether she formally resigned. Former Brexit ally Michael Gove, who had been serving as Secretary of State for Levelling Up—basically the guy in charge of European-style industrial policy—got fired before he could resign, and a parade of MPs and ministers filed through 10 Downing Street urging Johnson to stand down. But by 10 PM, only Larry the Cat had made an appearance on the steps, and Downing Street staff told reporters their boss had no plans to go.
Stocks had another tough day Thursday, officially closing out the past six months as the S&P 500’s worst start to the year since 1962.[i] That, and all of its associated pain and frustration, is the bad news. But there is a modest silver lining: Despite what you may have seen in the numerous pieces on this topic, that factoid means exactly nothing for returns over the next six months and beyond. Stocks aren’t serially correlated, and past performance doesn’t predict future returns.
To show you this, we crunched first- and second-half returns for every year from 1926 through 2021. That is a data set of 96 years—a pretty significant sample size. In this stretch, the correlation between first-half and second-half returns is -0.099.[ii] For those who are a little rusty on statistics, the correlation coefficient measures the relationship between two variables. It ranges from 1.0 to -1.0, with 1.0 signaling they move in the same direction always, 0 meaning no relationship, and -1.0 meaning they always move in opposite directions. So, the -0.099 (or if you prefer to round, -0.1) correlation between first- and second-half returns means they have a very, very slight tendency to move in opposite directions—but it is a relationship so slight that it is functionally meaningless.
Now, that figure includes the 51 years where the S&P 500 rose in both the first and second half—years that are less relevant to the situation today. It also includes the 13 years when the S&P 500 rose in the first half and fell in the second. So let us zoom in on the remaining 32 years when stocks fell in the first half. The second half was positive 17 times and negative 15. That makes the probability of a positive second half roughly a coin flip (maybe a little better).
Last Friday was moving day for dozens of stocks as FTSE Russell undertook its annual index reconstitutions. Some companies moved between the small, medium and large-cap categories—all reflecting market movement in the 12 months through early May and its impact on companies’ market capitalization. There were also shifts within the growth and value world, with several famous growth stocks entering the value index thanks to their falling valuations. For some it was a clean break, while others now live in both indexes. In our view, this presents a timely reminder: Growth and value are often judgment calls, and understanding their qualitative characteristics as well as the more objective criteria can help you delineate between the two investing styles. That will be a critical task moving forward, as we think growth stocks are likely to lead the rebound whenever this year’s bear market ends.
Traditionally, growth stocks represent companies whose returns come from long-term, well, growth—while value stocks’ gains tend to come from investors’ finding and bidding up discounted or undervalued firms. FTSE Russell delineates between the two based on price-to-book ratio, earnings forecasts for the next two years, and a projection of sales growth based on the past five years.[i] The first of those three seeks to measure value, while the latter two measure growth—which is how a company can straddle both styles. MSCI uses the same general approach but with more metrics. On the value side, MSCI adds 12-month forward price-to-earnings ratios and dividend yields, while other growth characteristics include short- and long-term forward earnings growth estimates, the long-term historical earnings growth trend and the current internal growth rate, which is an estimate of how much the company could grow by reinvesting earnings and not seeking additional finances.[ii]
Here, too, these criteria—while sound—can create significant growth and value overlap. Currently, the MSCI World Value Index has 940 constituents, while the MSCI World Growth Index has 805.[iii] Yet a whopping 231 constituents are in both indexes, usually weighted as a blend of say, 65% growth and 35% value, 50% each or what have you.[iv] Objectively, they have growth and value characteristics.
Stocks had a rough day Tuesday, and the alleged culprit is one we have seen with increasing frequency lately: A raft of good-looking economic data supposedly raises the likelihood of more big Fed rate hikes to come. This is part and parcel of a sentiment phenomenon we call the “pessimism of disbelief”—investors’ tendency to see any good news through a negative lens. It is a hallmark of late downturns and early recoveries, and its prevalence today is a big reason we think this downturn’s end is likely close by. When people dismiss good news as bad, it shows a big gap between sentiment and reality—substantial room for positive surprise. What did people overlook in the latest data? Read on!
Durable Goods Orders Look Pretty Durable
The week started with May’s advance durable goods report, released Monday. It showed total orders for goods designed to last three years or more rising 0.7% m/m, beating expectations for no change and accelerating from April’s 0.4% climb.[i] Core capital goods orders (non-defense ex. aircraft), which are widely considered a proxy for business investment, grew 0.5% m/m—their third straight rise and an acceleration from April’s 0.3%.[ii] Now, this corresponds only to the equipment portion of business investment, which is only about 40% of the total—commercial real estate and intellectual property products (e.g., research & development and software) hold big sway, too.[iii] And these figures aren’t inflation-adjusted, which is an important caveat. But the resilience of a major category is still noteworthy, as it occurred against the backdrop of rising rates—a factor people have worried would derail investment for months.
Another month, another round of flash purchasing managers’ indexes (PMIs) giving an early read into major economies’ business activity. Though they mostly ticked down in June, prompting more recessionary chatter, their levels still indicate overall expansion. It may not be gangbusters, but stocks don’t need perfection to mount a recovery from this year’s downturn—just for reality to beat dreary expectations.
PMIs are surveys that aim to measure growth’s breadth. Readings above 50 indicate the majority of surveyed firms reported expanding business activity, with growth (and contraction) theoretically accelerating the further readings drift from that marker. PMIs don’t say anything about how much their businesses grew (or shrank), only that they did, so they are a timely but loose estimate of economic activity at best. Among the various readings, the composite PMI combines services and manufacturing, but it is a narrower measure of their “output” that focuses only on production. The services and manufacturing PMIs are broader, including new orders, backlogs, suppliers’ delivery times and employment. That is why, for example, the composites for June’s US, UK and eurozone PMIs can be below each of their services and manufacturing PMIs.
Exhibit 1 shows major economies’ PMIs remain above 50—though they are down from the spring, implying deceleration (Japan excepted). The US and eurozone’s June flash composites, released with only 85% – 90% of responses in, fell to the low 50s, continuing a generally slower trend. This includes both services, which comprise the bulk of developed market economies, and manufacturing. But while low-50s PMIs aren’t historically robust, they generally coincide with pedestrian growth.
Another week, and another flurry of news in European energy markets—much of it bad. Between warnings of power rationing and plans to restart idled coal-fired plants, the landscape is changing rapidly. Yet developments outside Europe just might help cushion the blow a bit, potentially helping things go at least a tad better than feared later this year. Not that European businesses and households will have an easy time of it, but stocks don’t need them to. Rather, when markets are pricing in worst-case scenarios, reality proving to be modestly less bad than feared can be a big relief. In our view, the surprise potential here skews more to the upside than the downside.
The latest trouble started brewing last week, when it became evident that Russia was throttling natural gas flows to the EU through the Nordstream 1 pipeline. Russian state-run Energy giant Gazprom, which operates the pipeline, cited maintenance issues for the cutbacks. The company claims sanctions are preventing it from importing needed components from Canada. EU leaders say that is hogwash, arguing the move was more retaliation against their developing plans to curb their dependence on Russian oil and gas. But apportioning blame doesn’t change the fact that summer is when EU nations traditionally fill their gas reserves ahead of the winter heating season, and Gazprom’s move ratchets up the risk of winter shortages. EU officials believe Russia could cut supply outright when cold weather hits, using the risk of blackouts in frigid weather to strong-arm the EU into backing off its economic response to Vladimir Putin’s war in Ukraine.
That is the backdrop for a flurry of emergency warnings throughout Europe this week. The Dutch government declared an “early warning” of a natural gas crisis, which clears the way for utilities to fire up coal power plants in order to curb demand for gas. Germany took similar steps by activating “phase 2” of its emergency response plan, which enables more coal use and is a step toward permitting utilities to pass increased wholesale costs to consumers. The hope there is that higher prices will better regulate demand, abating the need for “phase 3,” which would entail formal rationing. Austria, too, reverted to coal. Ideally, these nations would be able to import some nuclear energy from France to help fill the shortfall, but deferred maintenance at several nuclear plants has caused energy shortfalls there, too, risking rolling blackouts this winter if state-backed power provider EDF can’t fix the problems.
Central banks worldwide are raising interest rates fast and furious, with even the Swiss National Bank getting in on the action. Yet there is one major outlier: Japan, where the Bank of Japan (BoJ) remains wedded to negative interest rates and its yield-curve control (YCC) program even as the weak yen creates big headaches for businesses and politicians alike. Meanwhile, Japan isn’t really playing its traditional defensive role during global stocks’ bear market, and we think the BoJ’s misadventures go a long way toward explaining why. Let us discuss.
The BoJ implemented YCC—which sets targets for 10-year Japanese Government Bond (JGB) yields—in September 2016. Then, the BoJ targeted a 0% 10-year yield, though most thought officials allowed fluctuations within a bandwidth of +/- 0.1 percentage point (10 basis points, or bps). The BoJ pursued this strategy in part because Japanese banks complained the BoJ’s quantitative easing (QE) and negative policy rate—which pulled 10-year yields below zero—made it all but impossible to lend profitably. At the time, we called the BoJ’s policy update a “stealth taper” since it required the bank to let 10-year yields rise, implying fewer bond purchases. Since its implementation, the BoJ has widened its target trading bandwidth twice: in July 2018 (up to +/- 20 bps) and March 2021 (up to +/- 25 bps).
This target is effectively an interest rate peg, which is inherently unstable. Pegs work as long as the targeted rate isn’t far off what the market-driven rate would be. Once markets start moving, though, it takes extraordinary intervention to preserve the fixed value—and that is happening now. As bond yields globally climbed this year, 10-year JGB yields followed, reaching the BoJ’s 0.25% ceiling. Market forces have tried to push Japanese yields even higher, prompting the BoJ to announce in late March that it would buy an unlimited amount of 10-year JGBs to keep yields at or below 0.25%. Without that extraordinary intervention, 10-year JGB yields would likely be far higher than where they are today.