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.

Today in Brexit, Day 1,538

Editors’ Note: As always MarketMinder is politically agnostic. We favor no politician or political party and have no position for or against Brexit or similar geopolitical developments. We assess this and all political issues solely for their potential economic and stock market impact.

With COVID-19 dominating 2020, one of the past few years’ biggest headline grabbers had taken a backseat eight months in. But now Brexit is back—and stealing headlines with a vengeance. Some are going so far as to claim the UK government has introduced legislation that violates the exit agreement it struck with the EU last year, rekindling the risk of a messy, de facto no-deal Brexit. However, while the specific twists that bring it back to the fore are new and lead many to project potential damage to Britain’s economy, we believe the takeaway remains the same: However it plays out, stocks should gradually gain clarity as the year progresses, and even a no-deal Brexit shouldn’t bring disaster.

With free-trade negotiations between the UK and EU restarting, Prime Minister Boris Johnson introduced legislation called the Internal Market Bill. His government portrayed it as a “legal safety net” for the UK in the event that the country fails to ratify a free-trade agreement with the EU by year-end, when the post-Brexit transition period expires. The aim was to set out the legal framework (including customs rules) for trade with the EU if Brexit happens without a trade deal in place—injecting more clarity for businesses and investors.

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What August’s Jobs Numbers Say About Depression Comparisons

The BLS released August’s job report last Friday, which showed ongoing improvement. As usual in an early economic recovery, headlines fretted slower hiring and the long road ahead to regaining pre-pandemic employment. Fair enough, and for those suffering joblessness, slower hiring isn’t good news. Yet it also isn’t out of step with a typical recovery. In a way, that is the most interesting thing about August’s report—how much less extraordinary the numbers are starting to look. That guts the popular theory in April and May, which held that Depression-level unemployment would hinder the recovery and stocks. Consider this the latest evidence that employment numbers are late-lagging indicators.

At unemployment’s April apex, 23 million people were out of work, the unemployment rate hit 14.7% and the U6 rate that includes discouraged workers was 22.8%.[i] Many feared worse to come and drew comparisons with the early 1930s. The implication: that with tens of millions jobless, this wasn’t just a temporary economic contraction tied to forced business closures, but something much longer-lasting—an L-shaped recovery for the economy and, by extension, stocks. We never bought that, as unemployment is a late-lagging indicator and, in this case, the downturn’s most unique feature was that most layoffs were temporary, with workers set to return as counties lifted COVID-related restrictions. A deeper look at August’s nonfarm payroll report confirms that. Nonfarm payrolls rose by 1.37 million.[ii] Excluding big government hiring (mostly for the census), the private sector added just over a million jobs. That brings the cumulative total of new non-government hires to 10.5 million since April, cutting job losses since February in half.[iii]

Notably, all of this improvement comes from the temporary unemployment category. At April’s peak, 18 million workers were on temporary layoff and 2 million reported their job loss as permanent.[iv] Now roughly 6.2 million report being temporarily unemployed.[v] It seems fair to assume at least some of those temporary losses became permanent, considering the tally of people reporting permanent job loss rose to 3.4 million.[vi] Businesses small and large unfortunately had to dismiss workers as they cut back in hopes of surviving longer-than-expected restrictions on commercial activity—or folded altogether.

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What the Options Whale Watchers Miss

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

Market volatility is as old as markets themselves. It has always sprung randomly, for any or no apparent reason, catching folks off guard and testing disciplined investors’ patience. Enduring these normal wobbles is, unfortunately, the price that comes with stocks’ long-term returns. Market history shows reacting to volatility is usually a recipe for error. We think that is true of this latest volatility as well. Tuning down the noise associated with quick drops is usually key to maintaining discipline. But that isn’t the natural response, especially among financial commentators. Instead, the search for a cause—and, very often, someone to blame—seems to hog most folks’ energy. We are seeing a lot of that now, with most coverage landing on sensational technical reasons—rather reminiscent of 2010’s Flash Crash. Usually, this search for a story is a sign of a sentiment-driven correction, not a bear market, and we don’t think this time is different.

When Tech first sold off last Thursday, the consensus explanation was old-fashioned “profit taking” or that stocks were “exhausted” after a big August climb. That is a technical term for “we can’t see any rational reasons or underlying problems, and these companies are strong, so people are probably just locking in some gains.” But this isn’t much of a story, and to many, no story isn’t satisfying. So the hunt continued. It didn’t take long for many pundits to land on a whale: SoftBank, the Japanese Tech conglomerate turned de-facto investment fund, which a Financial Times report revealed had bought several billion dollars’ worth of call options on individual Tech stocks. A Wall Street Journal analysis gave some more specific numbers, saying: “The Japanese Technology conglomerate has spent $4 billion on options tied to $50 billion of individual technology stocks. The company also disclosed last month that, as of June, it owned nearly $4 billion worth of tech stocks like Apple and Tesla. It is unclear how much of those positions SoftBank is still holding.”[i] Combine that with reports of retail investors’ indulging in a call options frenzy in recent weeks, and now we have a volatility story: A whale and a school of little fish joined together in a unidirectional bet on Tech stocks, creating a rally built on sand and euphoria and setting things up for a big drop when the cheer wore off.

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Thoughts on a Tough Thursday

After a mostly placid and strongly positive August and start to September, volatility struck on Thursday morning. As we type this at 10:20 AM Pacific Daylight Time, America’s S&P 500 Index is down -3.5% on the day.[i] In another reversal from this year’s dominant trend, big growth stocks are leading the way lower—the Russell 3000 Growth Index is down -5.0% while the Russell 3000 Value Index is down -2.1%.[ii] We have already seen pundits deploying arguments that a reversal was “due,” as stocks were “exhausted” and valuations “stretched” after the record-fast bull market put stocks back at all-time highs. But to us, it is wildly premature to think this is anything other than a brief countertrend. Perhaps—and we stress perhaps—it is the start to a correction (a short, sharp, sentiment-driven drop of -10% to -20%). But rather than a call to action, we see today’s swings as a call for calm.

Most coverage of the move notes there is no real “cause” or “trigger” for today’s swings. Economic data out Thursday contained no surprises: US initial jobless claims report showed filings fell; services purchasing managers’ indexes (PMI)—surveys tallying the breadth of growth—were above 50 (implying more respondents reported growth than contraction) in pretty much every noteworthy nation except Spain, Italy and Australia, which were all narrowly below this mark. The JPMorgan Global Composite PMI, which combines manufacturing and services, hit 52.4, a 17-month high. There were no big earnings misses or corporate proclamations; no huge political developments; no Fed announcements for commentators to blow out of proportion; no big negative developments on the coronavirus front. As we have often said, market volatility—even corrections—can strike for any or no reason. Thus far, Thursday’s drop looks like a classic example of the latter.

Sentiment-driven drops like this are uncomfortable, but they aren’t hugely uncommon in bull markets—even strongly positive early bull markets. During the record-long 2009 – 2020 bull market, the S&P 500 experienced 22 daily drops that exceeded -3%.[iii] Some occurred during corrections, like the four in 2018 (two in that year’s early correction; two in the second, late-year one). But there were also four in the bull market’s first 12 months—a period in which US stocks rose 72.3% and had no corrections at all.[iv] Volatility can be just random; we would caution against overthinking it. No bull market in history has been smooth sailing—a feature that very often bites investors that react to volatility.

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After the Shortest Bear Market Ever, How Long Can the Bulls Run?

How long can this bull market last? That is a question we hear often, with the common presumption now being that the shortest bear market of all time, followed by the shortest-ever recovery to prior highs, must mean this will be a short bull market. Perhaps that is doubly true, considering this cycle has acted more like an oversized correction than a traditional bear market—and it all follows history’s longest bull market. But in our view, there is no realistic way to assess how long this bull market will last—you must assess conditions as they evolve. One thing, however, is clear: Age and the prior bear market’s length don’t really mean anything. All bull markets end one of two ways: when investors have run out of worries and developed irrationally high expectations, or when something wallops the expansion before its natural peak.

Exhibit 1 shows the length of every S&P 500 bear market—and ensuing bull market—since WWII ended. As you will see, short bear markets don’t mean much. Prior to 2020, the two shortest bear markets on record were 1987’s and 1990’s. The bull market that followed 1987’s crash was relatively short at 31 months. But 1990’s bear market was almost exactly as short. The bull market that followed the second was the 1990s’ boom—at 10 years, it is history’s second-longest. One short, one long, no pattern.

Exhibit 1: S&P 500 Bear and Bull Market Lengths (in Months)

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Stocks’ September Seasonal Slide Is Sensationalized

September is here, and you know what that means for stocks—absolutely nothing! Yes, September’s status as the S&P 500’s worst month of the calendar year is legendary, and without fail, every calendar flip from August 31 to September 1 brings a litany of warnings as to why this year (whatever year it is) will make the seasonal pattern extra-bad. This time around, the logic appears to rest on election uncertainty and stocks’ supposed need to cool off after a torrid summer. Don’t buy it. Volatility is always possible, for any or no reason. But it also defies prediction, seasonal patterns or none.

Usually this is the point in our annual September article where we would show average S&P 500 returns by month to concede that, yes, September is the worst one and the only one with an average negative return. But in the spirit of shaking things up, we will skip straight to the “averages aren’t telling or predictive” section. Any calculation of average September returns will have scores of data points. Some, like Septembers in 1930, 1931 and 1937, were horrible. September 2008 was pretty darned bad, too. But all of these awful Septembers occurred during bear markets with deeply negative fundamental factors at work. The calendar was coincidental. Moreover, there have also been some very nice Septembers, including 1954 and 2010. Since good S&P 500 data begin in 1925, September has delivered positive returns about 55% of the time.[i] Ask yourself what is more meaningful: an average return dragged negative by a handful of terrible years? Or a history of rising more than half the time, suggesting the likelihood of a positive September is modestly higher than a negative one?

Not that historical probabilities mean September 2020 will be good. They don’t predict anything. They just show that avoiding stocks because of September’s negative historical average is faulty logic.

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Sayonara, Abe-San

Japan’s Prime Minister Shinzo Abe unexpectedly announced his resignation last Friday, citing health issues. He will stay on in a caretaker capacity until his Liberal Democratic Party (LDP) selects a new party leader, who will presumably serve out the rest of Abe’s term as party leader, which was set to expire in September 2021. Headlines have already begun discussing Abe’s legacy, including what he was and wasn’t able to accomplish. In our view, Abe’s tenure is a reminder that one politician, regardless of popularity, typically can’t enact major changes singlehandedly—for better or worse.

Perhaps Abe’s most impressive achievement was bringing stability to the Japanese premiership, notoriously a revolving door following the departure of reform champion Junichiro Koizumi in 2006. Abe was his initial successor but stepped down a year later, citing ulcerative colitis—the same health condition sidelining him now. Japan then cycled through five more prime ministers before Abe returned in 2012. The man we affectionately called Japan’s Grover Cleveland would eventually become the Japanese prime minister with the longest consecutive tenure on record.   

Exhibit 1: Japan’s Prime Ministers in the 21st Century

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The Fed’s ‘Strategy Refresh’ Mirage

For a decade now, the annual central bank conclave at Jackson Hole has been one of the most-watched financial events, with commentators salivating over the potential for major announcements from the Fed or its global friends. This year, COVID rendered the event one big Zoomfest, with no boon for that lovely mountain town’s hospitality industry. But the content didn’t disappoint Fedwatchers, as Chair Jerome Powell introduced the Fed’s new monetary policy framework. Some hail this as a landmark shift, but we think that vastly overrates it. Actually, we don’t think it changes much at all—for the economy or markets.

Specifically, the Fed updated its “Statement on Longer-Run Goals and Monetary Policy Strategy.” To see the difference, you can track changes here, but there were two main shifts in how it pursues its mandate to foster maximum employment and price stability. Before, “deviations” from the Fed’s estimate of maximum employment and its 2% y/y inflation target guided policy decisions. Very roughly, if employment exceeded a shadowy threshold and inflation topped 2%, the Fed would theoretically raise interest rates. If employment and inflation were lower, that implied rate cuts (or at least holding them steady).

The new language supposedly means the Fed will address maximum employment “shortfalls” and target “inflation that averages 2 percent over time.” The popular simple interpretation is that the Fed won’t consider high employment as reason to hike rates anymore. Nor would inflation topping 2% for a month or two necessarily be grounds for a move. But we think the statement and explanation from Fed Chair Jerome Powell show some, ummmm, problems with that interpretation. It isn’t clear what “averages” means. Powell didn’t explain how it is calculating it. Also, what does “over time” mean? (Two months? Six? A year? More?) To us, this vagueness counters the popular notion that the change automatically means rates staying lower for longer.

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Chart of the Week: Surprise!

Wednesday morning, the US Commerce Department released the July tally of durable goods orders (products and materials aimed to last more than three years). The results? Orders grew for the third straight month, rising 11.2% m/m and smashing expectations for 4.8%. Pundits often make much of durables orders, calling them a proxy for business investment. We think that goes too far. But lately, almost no matter what economic series you look to, the results are blowing pessimistic pundits’ predictions out of the water.

To see this, our Chart of the Week[i] plots Citigroup’s US Economic Surprise Index. This series attempts to quantify the degree to which economic data are beating or missing expectations. When the line is above zero, data are broadly beating expectations—and vice versa. As Exhibit 1 shows, recent data are beating estimates to an extent unseen in the gauge’s 17-year history.

Exhibit 1: Citi US Economic Surprise Index

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Why High Debt Doesn’t Imperil Growth

All over the world, governments’ huge fiscal responses to COVID-related fallout has debt dotting headlines. Based on recently released Q2 GDP numbers, America’s debt exceeded GDP sometime in late June. UK national debt crossed the £2 trillion threshold for the first time—also surpassing GDP. Some worry about the implications of these inauspicious milestones, arguing they store up future economic problems or will inevitably lead to crushing austerity. Others disagree, citing a concept called Modern Monetary Theory (MMT). We agree debt doesn’t become much more problematic when reaching a certain level, but MMT isn’t why.

One common—and somewhat sensible—thread running through coverage of US and UK debt is the comparison of debt to GDP. Scaling is the only way to make sense of huge-sounding numbers that otherwise lack context. However, we don’t think US and UK debt surpassing 100% of GDP is too telling. Going over that threshold tends to evoke comparisons to long-struggling economies like Greece, but that actually illustrates the fallacy. Governments don’t pay all debt at once. They pay interest and principal on maturing bonds, and they don’t pay it with GDP. Instead, they use tax revenues for interest and refinance maturing bonds by selling replacements. The inability to do that is what broke Greece.

We think the best way to gauge debt’s sustainability is to measure affordability—interest relative to tax revenues. For the US, interest payments comprised 10.8% of tax revenues in fiscal year 2019.[i] That number likely rises based on recent issuance and revenue declines from the recession. Even so, US interest payments accounted for 15% – 18% of tax revenues for most of the 1980s – 1990s—a great period of economic growth. In the UK, interest payments were just 4.7% of tax revenues in 2019.[ii] An increase from the lowest level over the past 20 years likely won’t prove onerous to the UK economy, either, particularly with newly issued debt carrying historically low interest rates—a strong indicator of creditworthiness. 

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