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.

Index Changes Don’t Charge Up Stock Returns

Editors’ Note: MarketMinder doesn’t make individual security recommendations. All references to specific stocks included herein are made exclusively to illustrate a broader point.

Monday, index provider S&P Dow Jones made waves, announcing electric car manufacturer Tesla would join America’s flagship stock index, the S&P 500. This move has been widely anticipated for months, particularly as the firm gradually met more and more of the index’s requirements. Tesla met the final one, turning a positive profit in the trailing four quarters, in Q3 2020—driving[i] the index provider’s decision. The stock celebrated this move with a three-day surge on Tuesday, Wednesday and Thursday, rekindling a long-running theme among pundits: That index changes are super bullish, with many guessing at which stocks are next. To us, this doesn’t hold water. While anything can happen with Tesla, the car maker stock that doesn’t trade like a car maker, gaming index changes isn’t likely to generate repeat wins.

The theory seems logical enough. Adding a stock or set of stocks to an index should boost demand for the shares. After all, the change would force passive managers to buy. Many active managers would likely also follow suit, given they may want to reflect a change to the benchmark (depending on how notable this is). S&P Dow Jones estimates there is over $4.6 trillion in passive money mirroring the S&P 500 and another $6.6 trillion in active money benchmarked to it.[ii] That sounds like a lot of money chasing new additions—plenty of demand to drive outperformance.

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Earnings Reality Is Beating Expectations—by a Lot

With 92% of S&P 500 companies reporting Q3 earnings, the results are not only much better than what analysts anticipated at midyear—during the lockdowns’ depths—but even better than expectations set as the world reopened somewhat in the fall.[i] While mostly backward looking, the yawning gap between reality and expectations suggests stocks still have plenty of room to keep climbing the wall of worry.

Entering earnings season, analysts expected a bloodbath. But the results weren’t nearly as awful as expected. At their worst—halfway through 2020—analysts expected Q3 earnings to plunge -25.4% y/y and sales to drop -5.6%.[ii] As Q3 closed, they had revised those estimates up a smidge to -21.1% y/y and -3.6%, respectively.[iii] But now, with most results in, companies are smashing those initial projections. Q3 earnings are on track to fall just -7.1% y/y, with revenues only -1.6% below Q3 2019.[iv]

Better-than-expected results are widespread and historically above average. Of the companies that have reported so far, 84% surprised positively—a record high and well above the 73% five-year average.[v] Further, Q3 earnings have topped estimates by a whopping 19.4%—second only to Q2’s 23.1% and way above the 5.6% five-year average.[vi] In short, last quarter’s earnings reveal a big reality-expectations gap.

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Lockdowns, Slowdowns and the Adaptive, Efficient Market

October US retail sales missed expectations this week, rising just 0.3% m/m—a big slowdown from September’s 1.6% jump.[i] While a slowdown from this summer’s torrid growth rates was always inevitable once society reaped that low-hanging fruit—and retail sales are a narrow slice of consumer spending and often volatile—pundits had a darker view. According to the popular interpretation, this wasn’t just consumers returning to more normal spending patterns after a severe interruption. It was a foretaste of worse things to come as more businesses shut down again this autumn and the lockdown Grinch steals Christmas. Stocks, they say, will then fall to earth as vaccine euphoria wears off and reality sets in. We don’t buy it. Markets are forward-looking, and we suspect that even some contractionary data wouldn’t shock markets. Exhibit A: Europe. Despite some negative economic readings, markets have overall continued rising. In our view, that shows you markets are looking far beyond the next several weeks—as they normally do in a young bull market.

On Monday, eurozone stocks finally closed at new highs, passing their pre-pandemic peak in US dollars.[ii] This month alone, they are up a whopping 18.1% in dollars through Tuesday’s close.[iii] (They are up 15.8% in euros, so that huge rally isn’t just a figment of currency translations.) Over these 17 days, much of the region has dealt with new COVID restrictions, many of which began in October. Those restrictions’ effects have now begun showing up in economic data. It started on November 4 with contractionary October services PMIs in the eurozone and its four biggest economies: France, Germany, Italy and Spain. The next day, September retail sales hit the wires. They fell -2.0% m/m, hobbled by the new restrictions taking effect in several major cities that month.[iv] The following week brought September’s French industrial production (-5.6% m/m), eurozone industrial production (-0.4%) and a handful of deeply negative sentiment surveys.[v] All of these reports received widespread attention. Stocks soared anyway.

In our view, this demonstrates a lot about how markets work. They efficiently discount widely known or anticipated factors. For months, many have anticipated an autumn COVID resurgence triggering lockdowns. Virtually everyone knows lockdowns interrupt business. Markets likely reflected this long before those factors became a reality, part of the steep decline back in February and March, as they reckoned with lockdowns’ deep economic impact before any data showed it. That is a textbook example of markets’ efficiency. Once stocks fathomed the recession’s likely depth and duration, they were able to begin pricing in the recovery. For markets to react now would likely take restrictions that meet or exceed the spring’s stringency, with fallout much deeper and more lasting than looks likely today.

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Don’t Chase the Vaccine Hunt

Editors’ Note: MarketMinder doesn’t make individual security recommendations. The below merely represent a broader theme we wish to highlight.

With two companies now reporting positive advanced trial results for a COVID vaccine—with big share price booms accompanying their announcements—investors’ interest in vaccine candidates is at fever pitch. The thesis: If you can just pick the winner(s) in the vaccine race, quick riches will follow. Appealing, but in our view, wrong. This heat chasing ignores markets’ efficiency and fundamental considerations, and we think investors are best off not speculating in this arena (or at all).

Nine months (or so) into the pandemic, we have lost count of the number of articles hyping Pharmaceuticals and Biotech stocks as surefire winners, all because they anticipate sky-high demand for COVID treatments and vaccines being stock price rocket fuel. Any investing thesis this long-lived and widespread must already be discounted in share prices, to some extent. To say there is material surprise power left is to argue markets aren’t efficient. That doesn’t negate the possibility for short-term boomlets as vaccine news comes out, as we saw with Pfizer and Moderna this month, but that is mostly sentiment—fleeting and unpredictable. Plus, investors seeking longer-term growth need a lot more than a one-day price pop. To us, that longer-term growth comes from a steady drip of positive surprise.

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The All-Time High Bad News Couldn't Block

The S&P 500 price index hit a new all-time closing high Friday, capping nearly two and a half months of volatility. While record highs are a dime a dozen in bull markets, we think this one demonstrates a crucial point: Stocks are forward-looking and always price in widely expected events—even if that includes bad news.

Think back to September 2, the S&P 500’s prior all-time high. Pundits preached that the summer’s big rally was a fluke. They said stocks had come too far, too fast, and would sink when COVID’s inevitable autumn resurgence triggered new restrictions. A messy election with delayed results would deliver another sucker punch, and stocks would erase most of their recovery since late March. That, at least, was the popular theory.

For much of September and October, volatility might have had you thinking this thesis was correct. The S&P 500 endured twin pullbacks, twice coming very near to correction territory (down -10% from the prior high). COVID indeed flared up again, stalling reopening in much of the country. Some cities (most notably Newark, Chicago and Denver) added new restrictions. Across the pond, much of Western Europe re-entered lockdowns, to varying extents. By Halloween, with the election looming, the mood in markets and headlines alike was very grim.

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Slowing Jobs Growth Won’t Derail a Recovery

As the US economic recovery continues, some worry the latest jobs data signal trouble ahead. October’s jobs report showed ongoing hiring, but improvement in more timely weekly jobless claims has slowed. Others fret over the ramifications of rising long-term unemployment. These developments renew concerns of a “jobless recovery,” in which high unemployment tramples economic green shoots. However, we don’t think these are a sign investors should start bracing for problems. Jobs data aren’t only backward-looking, but today’s much ballyhooed trends aren’t out of line with history—important perspective for investors to keep in mind, in our view. 

According to October’s Employment Situation Report, employers added 638,000 jobs—the sixth straight positive month. The private sector filled 968,000 jobs—offsetting the 268,000 drop in the public sector (largely related to the release of temporary census workers). The unemployment rate improved by a percentage point, from 7.9% to 6.9%—and down from April’s peak of 14.7%. While analysts acknowledged the ongoing improvement, plenty of concerns persist. With unemployment still high, worries about a “K-shaped” recovery—in which some workers recover while others struggle—are gaining ground, especially with the long-term unemployment rate soaring the past three months. Some argue more recent data—e.g., weekly jobless claims—show problems afoot. Though continuing jobless claims (which represent people who have already filed an initial claim) have improved for seven straight weeks, some argue this doesn’t tell the whole story, as people are simply migrating to other unemployment programs (e.g., the Pandemic Emergency Employment Assistance) after maxing out traditional benefits.

We aren’t saying the numbers are stellar, and we are empathetic to the personal hardships they reflect. But positive hiring cuts against the notion that falling continuing claims broadly signals folks falling through the cracks. This is also consistent with recent history. As the past two economic recoveries show, positive hiring and falling continuing claims aren’t perfectly aligned, but they roughly track each other. (Exhibits 1- 2)

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From the Mailbag: The 4% Rule, RMDs and You

Last month, we explored popular criticisms of the so-called “4% rule” and whether it is reasonable to expect to withdraw 4% of your starting portfolio value annually, adjusted for inflation, without running out of money too soon. Many pundits argue this math no longer holds up because of today’s low interest rates. But as we explained, that objection falls apart when you stop conflating portfolio income (e.g., bond interest and stock dividends) with cash flow (money you withdraw). Instead, we think you should focus on total return (price appreciation plus dividends and interest) and building an asset allocation targeting the long-term return you need over time to sustain withdrawals should suffice (provided your needs aren’t excessive). One reader responded with a question we reckon many of you share: What about required minimum distributions (RMDs) from an IRA? What if all my savings are in qualified retirement accounts and the IRS forces me to withdraw funds above and beyond both the 4% rule and my living expenses? How do I avoid depleting it too soon?

First, before we go any further, we should be clear: RMDs are suspended for 2020. So nothing we say here needs to apply to this calendar year—it is more about what follows, assuming RMDs return in 2021 (which seems likely to us).

In our view, there is a way around this. If your RMDs exceed your living expenses (and for those older folks with decent-sized IRAs, that isn’t uncommon), you can keep any excess invested. The IRS mandates only that you take the RMD out of the tax-deferred environment so they get their slice in the form of ordinary income taxes. They don’t tell you what to do with it. So if you don’t already have a plain old taxable brokerage account (e.g., an individual or joint account), you can open one at your custodian of choice and move any unneeded RMD funds there.

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The Case Against the BoE’s Bond Buying

As England re-enters lockdown, policymakers are trying their darnedest to stave off the worst economic effects. For Her Majesty’s Treasury, that means extending the furlough scheme, which replaces a chunk of workers’ lost wages, and other support programs. For the Bank of England (BoE), it means unleashing a fresh wave of quantitative easing (QE). Although well intended, we now have about a decade of evidence QE hurts economies more than it helps and isn’t stock market rocket fuel. We don’t think more QE will prevent a UK recovery or derail the nascent bull market, but in our view, it is a headwind against banks and value stocks, making it unlikely UK stocks meaningfully outperform any time soon.

QE’s goal is to stimulate lending by reducing household and business borrowing costs and giving banks more liquidity. As implied by the BoE’s name for QE, the Asset Purchase Programme, central banks create new reserves to purchase long-term assets from commercial banks. In the UK’s case, that means the BoE will buy an additional £150 billion worth of UK gilts between now and the end of 2021. Having that big of a buyer gobbling up that much supply drives bond prices up and yields down. Since sovereign yields are a reference rate for the rates banks charge on loans, the thinking goes, reduced borrowing costs will drive demand for loans, while the added reserves increase banks’ ability to lend, boosting loan growth and stimulating economic activity. That, at least, is the theory.

But since central banks began broadly experimenting with QE in 2009, reality hasn’t quite matched the theory. Rather, there is a large volume of evidence that QE doesn’t work as advertised. For one, when the central bank lowers long rates while pegging short rates near zero, it flattens the yield curve. Banks borrow at short-term rates, lend at long-term rates and profit off the spread, which represents their net interest margin on new loans. Therefore, the yield curve heavily influences loan profitability, which in turn influences banks’ incentive to lend. Since banks create most new money through lending, when loan growth sags, it weighs on broad money supply growth, robbing economies of fuel.

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Biden Gets the Call, Investors Get Falling Uncertainty

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

What now? The Associated Press and most other major media outlets called the presidential race for Joe Biden on Saturday, after his margin in Pennsylvania surpassed the threshold for a mandatory recount. Those electoral votes put him over 270, with Nevada and Arizona the icing on the cake a few hours later. Meanwhile, the counting continues in Georgia and North Carolina, and the Trump campaign has mounted several legal challenges. But should the results stand, Biden will be the next president, and pundits are already speculating about his cabinet appointments and economic policies—and how these will affect stocks. In our view, it is far too early for this sort of analysis. Keep your focus at a higher level: Uncertainty is falling, and as this continues, stocks should enjoy it.

Despite the headlines’ decisive tenor, we have a long way to go before full political clarity arrives—more opportunities for uncertainty to fall and boost stocks. The recounts, court challenges, Electoral College process and Georgia Senate runoffs will extend the drama for several weeks. Don’t be surprised if volatility perks along the way. Get ready, too, for chatter about challenges to the Electoral College process, faithless electors and other trivialities. Train yourself now to stay cool as headlines become more charged. While headlines have largely dismissed the Trump campaign’s legal challenges as meritless, ultimately the courts will decide, and only time will end this uncertainty. But it will end. On December 14, the Electoral College will vote. On January 6, a joint session of Congress will count and certify those votes. A president and vice president will be inaugurated January 20. By then, the Georgia runoffs will be done, and the new Congress will be seated. Crucially, markets will have priced this clarity before it arrives. Falling uncertainty throughout the next several weeks is a bullish tailwind, in our view, even if there are a few speedbumps along the way. Even in rallies, stocks don’t move in a straight line.

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Election 2020 Flash: Georgia on Our Minds

Editors’ Note: MarketMinder is intentionally non-partisan, favoring neither any party nor any politician. We assess political developments solely for their potential impact on stocks.

The counting continued Thursday, and investors didn’t get much new information. A widely anticipated update from Nevada in the morning didn’t add much to the state’s presidential totals, and other too-close-to-call states revealed little more. The Senate, however, came into a bit sharper focus, raising questions for anyone who bought into one bit of stock market trivia making the rounds this week. If, as the headlines suggest, stocks are rising because the combination of a Democratic president and split Congress is bullish, what happens if Congress isn’t split after all?

Officially, each party has now won 48 seats. Republicans are leading in Alaska and North Carolina, but both are too close to call and could flip as more absentee ballots arrive. But most eyes are on Georgia, where Republican David Perdue, though leading, has slipped under 50% of the vote. If that holds, he and Democrat John Ossoff will contest a January runoff. That puts both Georgia seats up for grabs then, as a runoff between Democrat Raphael Warnock and Republican Kelly Loeffler for retired Republican Johnny Isakson’s seat was already a foregone conclusion (that race was an all-party jungle primary). From our vantage point, the campaigning basically started today, and it wouldn’t shock us if these runoffs became the most expensive in the history of Senate races, as they basically determine which party controls the upper house when the 117th Congress convenes in January.

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