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.

No, the Fed’s Balance Sheet Doesn’t Explain Stocks’ Moves

Every now and then, a chart goes viral and freaks people out. In early 2014, it was a graph that used manipulated y-axes to make the Dow Jones Industrial Average’s path since July 2012 look identical to the run-up to 1929’s crash—with look out below being the general implication. In early 2016, folks tortured data to make the Fed’s balance sheet look identical to the S&P 500’s rise since 2008, implying tough times once the Fed started shrinking its portfolio. Now they are at it again! Last week, Fed meeting minutes revealed plans to start letting the balance sheet shrink at a fast clip in May. Queue another fast-circulating chart claiming the Fed’s balance sheet and stocks are highly correlated, setting stocks up to fall once the Fed starts shedding assets. Please let us dismantle this.

Today, as in 2014 and 2016, the viral chart seems to hinge on a long-running error: It employs two series on separate y-axes that feature a range and scale that makes them look identical. We like using separate y-axes now and then when we think it provides more clarity than indexing everything to 100 and keeping it on one axis. We will also truncate y-axes to improve visibility when necessary. But we do our best to keep it clean—especially when we are trying to argue two things are closely related.

That, however, is what the offending charts fail to do. Exhibit 1 shows our recreation of 2016’s version. As you will see, we started the Fed axis at $800 billion and ended it at $5.2 trillion. That is how we were able to make it look exactly like a raw graph of the S&P 500 price index, with the two lines starting and ending in roughly the same place. If we hadn’t chopped off that $800 billion and arbitrarily selected an endpoint, it wouldn’t work.

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March Inflation Through Markets’ Eyes

Editors’ Note: MarketMinder is nonpartisan, favoring no politician nor any political party. We assess developments and policy prescriptions solely for their potential market or economic impact (or lack thereof).

US inflation hit another 40-plus year high in March, this time with the Consumer Price Index (CPI) rate clocking in at 8.5% y/y.[i] In a rather novel twist, most of the coverage parsed the underlying details in search of signs prices are peaking—and hit on encouraging nuggets like the deceleration in month-over-month core CPI, which excludes food and energy. While we think the nascent sentiment shift is noteworthy, the overall exercise seems largely beside the point. For stocks, the question remains: Is elevated inflation a big enough negative to knock the economy into recession? We don’t think so.

Not that fast inflation is good—it isn’t. For households keeping to strict budgets, it is cold comfort that prices outside food and energy rose just 0.3% m/m compared to headline CPI’s 1.2% jump.[ii] Inflation has become increasingly political, too, turbocharging the emotional response (and leading to some rather unusual “solutions,” which we will discuss momentarily). There are hardships and difficulties all around, and we don’t dismiss that. But stocks don’t move on whether any development is good or bad in a vacuum. Rather: Is the totality of the economic—and corporate earnings—picture likely to develop better or worse than expected over the next 3 – 30 months? Whether inflation is a big enough negative to offset all the positive forces is what really counts, in our view.

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How Predictive Is Dow Theory?

Does the Dow Jones Transportation Average (DJTA) know something broader markets don’t? If you have paid attention to some pundits’ claims, you might think it holds special magic, foretelling future broad market moves. But as we have written, there is nothing special about transport-based gauges. Stocks are stocks, and none are smarter than another set.

The DJTA consists of 20 stocks and, like its more famous 30-stock sibling, the Dow Jones Industrial Average (DJIA), is price-weighted. That alone should give you pause, never mind its narrow sliver of the broader stock market. Price weighting means a member’s share price determines its weight in the index. But this is arbitrary. In a price-weighted index, stock ABC worth $100 with only 2 shares outstanding would have 10 times the influence of $10 stock XYZ with 200 shares outstanding, even though the latter’s market cap is 10 times bigger. Weighting stocks by alphabetical order makes about as much sense. The only good (historical) reason to price weight is easier calculation, but with the advent of computers, that ship sailed long ago. Still, Dow Averages’ quirky legacy carries on.

The same goes for transportation’s market relevance. Early in the Industrial Age, when railroad tycoons strode the earth, its economic might wasn’t questioned. Transportation (and logistical) infrastructure is still important today—food and energy are, too; some of our favorite things! But as a percentage of the MSCI World Index’s market cap, for example, Transportation is 2%—there are much more economically important sectors nowadays.[i] Despite the Dow Transports’ aura of historical importance, it is a mistake to overrate it, much less the alleged signals it sends about the economy and stocks generally.

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A Minute to Discuss the Fed’s Meeting and Plans

The Fed released minutes from its March meeting Wednesday, and normally, we don’t much rate these things. If you have ever tried reading Fed minutes, you know they are a sleep-inducing, jargon-laden slog that reveals precious little. But every now and then they stir up sentiment and stoke volatility. Such was the case yesterday, when the minutes allegedly revealed the Fed plans to tighten monetary policy even more than expected. Unsurprisingly, pundits blamed the announcement for the S&P 500’s Wednesday drop (which the index partially reversed Thursday). We don’t see anything negative in the Fed’s plans, though. Don’t get us wrong, we are always watching for Fed error, and we never underestimate central banks’ ability to foul things up. But in this case, their plans don’t seem likely to knock the economy or stocks any time soon.

Headlines focused on two nuggets in the meeting minutes—some members’ belief that a 0.5 percentage point (as opposed to the usual 0.25 ppt) rate hike may be necessary, and the revelation that the bank will start letting assets run off its balance sheet at a $95 billion maximum monthly rate starting in May, which echoed remarks from Fed Governor Lael Brainard earlier the same day. The general perception: The Fed let inflation get away from it and now has to tighten the screws hard to fix it. Some pundits already warned of impending recession because their favorite segment of the yield curve—the 2-year/10-year chunk—inverted, and now they reckon aggressive tightening makes this a foregone conclusion.

To which we say: Hold your horses. Rate hikes may be tightening, but in our view, shrinking the balance sheet is not. As long as the Fed continues reinvesting all proceeds from maturing bonds, it exerts downward pressure on long-term rates. Pressing long rates down while raising short rates would flatten—and risk inverting—the yield curve. But, if the Fed’s minutes are to be believed, letting assets roll off its balance sheet—at about twice the pace it did in 2017 – 2019—takes that artificial dampener off long rates, which should help keep a decent margin between short and long rates. In our view, this could very well help preserve the yield curve’s recent steepening for a while.

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How to Think About Bonds’ Rocky Q1

In Q1, the S&P US Aggregate Bond Index fell -5.6%—exceeding the S&P 500’s -4.6% decline.[i] Seeing this, some investors with blended fixed-income and equity asset allocations may question the logic of owning bonds. If they fall more than stocks in a volatile market, what is the point? But in our view, this conflates volatility and negativity, which aren’t synonymous. We don’t think occasional wobbles should make you ditch your bond allocation, which can still dampen portfolio swings.

Bonds may dip (or spike), but they typically do so to a smaller degree than stocks. Take the current situation. Without context, bonds’ adding to stocks’ Q1 negativity may look less than beneficial. But consider a more granular view. While bonds didn’t move opposite stocks in Q1, that isn’t unusual—the two aren’t really negatively correlated in any meaningful way. The degree of movement is telling, though. During the quarter, stocks fell as much as -12.3% on March 8.[ii] On that day, bonds were down only -3.9% quarter to date.[iii] At their worst in Q1, March 25, bonds were off -6.5%—half stocks’ worst.[iv] That means the margin of swings is smaller—potentially beneficial if you are drawing cash flow.

Look at this another way. Exhibit 1 shows stocks’ and bonds’ best, worst and median one-day, one-week and one-month returns last quarter. For example, stocks’ (in green) best one-day return last quarter was 2.6% and their worst was -2.9%, with a median one-day decline of -0.1%, which you can see if you squint. Bonds’ (yellow) best one-day return was 0.6% and their worst -1.1%, with a median rounding to 0%. So investors whose goals, time horizon and cash flow needs are commensurate with a blended allocation are still seeing smaller gyrations.

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Don’t Let the Politicking on Gas Prices Fool You

Editors’ Note: As always, our commentary is intentionally non-partisan. We favor no politician nor any party and assess political developments for their potential economic and market impact only.

Congress indulged one of its favorite pastimes Wednesday: a public roasting of energy executives. Lately, politicians, mostly Democratic ones, have accused the industry of price gouging, and a couple of Senators have proposed windfall profits taxes. Wednesday’s hearing appeared aimed at building momentum for this effort, with members of the House Energy and Commerce Committee demanding to know why gas prices have risen more (in percentage terms) than oil and not eased alongside crude in recent weeks. For their part, Republican politicians seem mostly to rely on the same talking points we recently discussed here. Experience, economics and simple logic tell me that anything Congress does to “fix” this situation will probably do more harm than good, so it is a blessing for stocks that gridlock will likely block any bills Wednesday’s hearing spawns. Let us explore why that is the case.

The allegations at the hearings are similarly more politics than substance. For one, gas prices have ticked down slightly for three straight weeks.[i] This hasn’t fully reversed the spike, of course. But then again, oil prices haven’t fully reversed the war-fear-fueled jump. WTI crude oil—the US benchmark—is down from $123.64 on March 8, but at $96.23 as of Wednesday’s close, it is still above pre-invasion levels.[ii] Now, gas prices tend to follow oil at a lag, so gas’s failure to match oil’s rate of decline over the past four weeks isn’t a shock. But politicians rarely let facts get in the way of a good rant, so the House committee made a fun chart. It showed gas prices staying high and mostly level for the past week while oil bounced lower—but for fun and maximum shouting, it had oil and gas on separate y-axes and skewed the axis intervals so that gas prices looked higher than oil. As you would expect, they gestured to this chart a lot.

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A Broad Update on Energy Markets

There is a lot happening in the Energy space this week, as politicians globally react to both the horrors in Bucha and their constituents’ ire over high gas prices. Is a full EU embargo of Russian energy in the offing? Will coordinated oil reserve releases ease the pain at the pump?

We will dive into both of these—from a pure market and economic standpoint. These are hot political topics, and oil and gas prices have become an increasingly partisan issue in the run-up to November’s midterms. But we favor no party nor any politician, and markets don’t have political preferences either. Their focus, like ours, is on policies, not personalities. So please take a moment to turn off your political biases. … Ready? Ok!

The EU Cracks Down?

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Unemployment Won’t Push Prices Higher

The US March jobs report came out last Friday, and it was chock full of goodies. Nonfarm payrolls rose 431,000—the 11th straight month of job gains over 400,000—while the unemployment rate dipped 0.2 percentage point to 3.6%.[i] Many say March’s figures confirm a full recovery is underway, but some still worry rising wages in a tight job market may keep inflation high. However, unemployment and inflation aren’t linked—worth keeping in mind given myriad worries about today’s elevated prices.

The purported connection between unemployment and inflation originates from the Phillips Curve. According to this theory, low unemployment leads to higher wage growth due to higher competition for workers. That forces employers to pass on higher labor costs to consumers, driving broadly rising prices, which drives wages higher, which drives prices higher, lather, rinse, repeat. Economists refer to this phenomenon as a wage-price spiral, and some think one may be forming based on the latest data. Everyone is aware of high inflation rates both here and abroad, and wage growth has been accelerating since April 2021, rising 5.6% y/y in March. (Exhibit 1)

Exhibit 1: Accelerating Wage Growth

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The BoJ Tries Even More of the Same, Expects Different Outcome

Amid all the flurry of central bank activity in recent weeks, one bank has been relatively absent from headlines … until now. Yes, our old friends at the Bank of Japan (BoJ) are back at their creative monetary policy, this time buying up “unlimited” quantities of Japanese Government Bonds (JGBs) in order to force 10-year yields to stay between 0% and 0.25%. While you might think their success at holding this interest rate peg, known as “yield curve control” (YCC), is earning them a gold star, it is also contributing to a sharp slide in the yen as money flows toward higher-yielding assets. That presents a clear headwind for a nation that imports most of its energy, leading people to suspect the BoJ will have to raise its 10-year yield target by half a percentage point at least. If you have ever wondered why we say central banks are rate followers more than rate setters, this is why.

The BoJ, which invented quantitative easing (QE) over 20 years ago, started targeting 10-year yields last decade in an effort to keep the yield curve ever-so-slightly positively sloped at a time when markets were pulling long rates globally into negative territory. At the time, it functioned as a stealth tapering of QE. These days, the opposite is happening. Long rates across the developed world have shot up, and 10-year JGB yields are trying really, really hard to join them. That shouldn’t shock: Long rates globally tend to be highly correlated.

Hence, in order to keep them below 0.25%, the BoJ has conducted unlimited purchases since Monday. Thursday, the bank announced it would up its purchases for the next three months from a target of ¥1.7 trillion per month to ¥2.0 trillion.

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Our Perspective on Stubbornly High Global Inflation Rates

There is a lot of inflation data out this week, and as you might have seen, it isn’t good. Grabbing most eyeballs on our shores, February’s Personal Consumption Expenditures (PCE) price index—the Fed’s preferred inflation measure—accelerated to 6.4% y/y, another multi-decade high.[i] Meanwhile, preliminary March numbers in the eurozone suggest more pain is in store: the French Consumer Price Index (CPI) sped to 5.1% y/y, and Germany’s jumped to an eye-popping 7.2%.[ii] Last week, Britain reported February CPI rose 5.5% y/y, up from 4.9% in January.[iii] Another uptick seems likely when March data hit. The extended surge of fast inflation is a hardship for many and painful for all. Yet for stocks, “painful” often isn’t part of the calculus. Rather, are the ongoing disruptions forcing prices higher big enough to offset all the underappreciated positive drivers out there? We don’t think so.

Now, please note: Inflation is an increasingly partisan issue in many parts of the world. We favor no party nor any politician. Our comments on inflation are limited to the economics in question, viewed through a market-oriented lens. With that out of the way, we suspect it is worth noting inflation probably will peak higher—and stay elevated for longer—than we thought likely last summer. There is a simple reason for this: Russian “President” Vladimir Putin’s invasion of Ukraine, which rippled through oil, natural gas and other commodity markets, as well as complicating shipping routes. We have all felt this at the gas pump and when paying our electricity bills. Soon, fertilizer shortages may show up in food prices. So, too, might the potential shortages of wheat. Pricier petrochemical feedstocks will drive up costs for plastic and a range of consumer goods.

This is all happening at a time when the forces that drove prices higher throughout 2021 should be starting to wane. Last spring and summer—which might feel like an eternity ago—prices jumped off a depressed base as businesses reopened from lockdowns. Many businesses weren’t prepared for the sudden demand influx, sending prices higher throughout travel and leisure. Car prices also surged, in part because rental company activity was skewing the market. Those fast increases, with 2020’s lockdown-deflated prices as the denominator in the year-over-year calculation, were primarily responsible for inflation as 2021 progressed, with supply chain issues adding dislocations later in the year.

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