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.


August’s Dog Day PMIs

August flash purchasing managers’ indexes (PMIs), released last Friday, showed the developed world largely continued recovering from its lockdown-driven recession. Yet many pundits focused on perceived pockets of slower growth. True, PMIs didn’t improve everywhere, but in our view, that shouldn’t matter much for forward-looking global stocks.

IHS Markit’s flash PMI surveys—preliminary releases based on around 85% – 90% of expected responses—are an early glimpse at each month’s economic activity. PMIs essentially ask firms whether different kinds of business activity—e.g., output, new orders, backlogs and employment—improved or deteriorated during the month. A reading of 50 indicates no change. Above that implies expansion, although PMIs don’t say anything about the amount of change—how much activity rose or fell. They speak only to its breadth—how many firms saw activity grow or shrink in the month.

Except for export-dependent Japan, August PMIs show major developed economies continued expanding. Composite PMIs, which combine services and manufacturing, signaled a second straight month of growth in the US, UK and eurozone. (Exhibit 1)

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Making Sense of Calls for Eurozone Outperformance

Eurozone stocks have lagged US since this bull market began on March 23—48.3% versus 54.6%—continuing the last bull market’s geographic leadership trends.[i] But that hasn’t stopped many commentators from arguing the eurozone is poised to lead the US in this new market cycle. Yet in our view, most of the reasons they offer are backward-looking and, crucially, ignore the region’s market structure. While we think global investors should own eurozone stocks for diversification purposes, we wouldn’t expect the region to outperform absent an unlikely rotation to value leadership.                                

Principally, the reasons headlines cite for likely eurozone leadership are as follows: The euro has strengthened against the dollar, which adds to US investors’ returns on eurozone stocks; Congress is deadlocked over new COVID relief measures, while the EU recently approved an expansive budget; and US price-to-earnings ratios are higher than the eurozone. We don’t think any are good reasons to favor eurozone stocks presently.

Let us start with the currency swings. It is mathematically true that a weaker dollar adds to US investors’ overseas returns. In euros, eurozone stocks have risen 35.7% since March 23.[ii] But the euro’s appreciation versus the dollar adds to that, boosting US investors’ returns on eurozone stocks to 48.3% when denominated in dollars.[iii] This is because Americans investing with dollars get the companies’ appreciation plus the extra juice from currency translation. But that isn’t the sole driver of relative returns, and currency cycles don’t align with geographic stock market leadership. The euro was born on January 1, 1999. It weakened significantly against the dollar for over a year and a half, reaching its all-time low versus the dollar on October 25, 2000.[iv] US stocks did outperform the eurozone during that stretch. But they kept outperforming, overall and on average, through mid-March 2003—by which time the euro had climbed back near its beginning exchange rate.

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The Best Way to Play the Vaccine Races? Don’t.

Several companies have announced various degrees of progress on a COVID-19 vaccine in recent weeks, cheering investors. But the enthusiasm stretches beyond broad markets. We have seen a steady trickle of articles encouraging investors to chase quick riches in the vaccine arena, purportedly with tricks to identify the frontrunners as well as the overlooked dark horses. We aren’t here to offer securities recommendations or pass judgment for or against any one company, and we think investors do benefit from owning some large, growth-oriented Pharmaceuticals firms for diversification. However, we don’t think trying to reap big returns from a COVID-19 vaccine is a wise approach.

Markets are efficient and forward-looking, quickly digesting widely known information and then moving on. Given the amount of attention on vaccine candidates and clinical trials, basing investment decisions on vaccine news is the very definition of buying on widely known information. Presuming it offers any sort of an edge is to presume markets aren’t efficient at all, with a blind spot toward one of the most discussed news items on Earth. That strikes us as heat chasing and a recipe for error.

Even if you don’t buy the conceptual argument above, we see practical problems with the vaccine-winner investment thesis. By US News & World Report’s count, there are over 100 vaccines in the works, with about one-fifth already in human trials.[i] With such a broad pool, how do you identify the winner? A 1-in-20 chance, presuming one of the drugs that has already advanced to human trials crosses the finish line first, amounts to a 5% probability of choosing correctly. If you try to overcome this by owning a bunch of companies in hopes that one of them will be the winner, you run the risk of the totality of your investment disappointing. If you buy now, investors’ vaccine hopes are likely baked into every contender’s price. Therefore, it stands to reason that even if there are some excess gains left in the winner, disappointment over the rest is probably more than enough to cancel it out.

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What the Debate Over Fed Minutes Misses on Yield Curve Control

The Fed released the minutes from its July meeting last Wednesday, capping days of unusually high anticipation. Usually Fed meeting minutes are a predictable, rather snooze-inducing affair. But this time, word on the street was that the FOMC had a big discussion about its ongoing inflation target review and how it might change tack to improve its accuracy. One tactic getting frequent mention among financial commentators is yield curve control, which basically amounts to setting targets for long-term interest rates—something the Bank of Japan has done since 2016. As the minutes reveal, that did get a lot of discussion last month, and policymakers decided not to pursue it—at least for now. In our view, this is good news, as adding complicated programs generally increases the potential for error.

The Fed’s view differs from ours. As the minutes sum up, the FOMC “judged  that  yield  caps  and  targets  would  likely  provide only modest benefits in the current environment, as the Committee’s forward guidance regarding the path of the federal  funds  rate  already  appeared  highly  credible  and  longer-term  interest  rates  were  already low. Many of these participants also pointed to potential costs associated with yield caps and targets. Among these costs, participants noted the possibility of an excessively rapid expansion of the balance sheet and difficulties in the design and communication of the conditions under which such a policy would be terminated, especially in conjunction with forward guidance regarding the policy rate.” In other words, they think capping long-term yields is presently unnecessary, given yields are already near historic lows, they fear capping them in the future may require a boatload of bond purchases, and they worry eventually lifting the cap would cause investors to freak out.

We find it rather perplexing that this discussion apparently centered around the possibility of reducing long-term rates further, as that would flatten the yield curve, which is the opposite of stimulus. Japan, by contrast, used long-term yield targets to steepen the yield curve a teensy bit, which led to a stealth tapering of quantitative easing (QE). That made more sense to us. The yield curve, in addition to being a leading economic indicator, influences bank lending. Banks borrow at short-term rates and lend at long-term rates, and the spread between the two is their profit on the next loan made. The wider the spread, the more incentive banks have to lend broadly. But if the spread shrinks, then banks have incentive to lend to only the most creditworthy borrowers, as there isn’t enough of a reward to justify higher risk. Government rates are generally reference rates for deposit rates and lending rates, so a flat yield curve means lending is less profitable and probably less abundant than it would otherwise be.

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Jobless Claims’ Uptick Isn’t a Recovery Red Flag

Initial jobless claims increased more than expected last week, crossing back above one million. As we would expect in a young bull market, most coverage argued a deteriorating labor market is holding back the economic recovery. We won’t argue everything is in fantastic shape, and job losses are indeed devastating for those directly affected. However, when assessing how economic developments and stocks interact, we think it is important to tune down any emotional response and turn a more critical eye to the data. Do so, and we think you will find unemployment data are backward-looking, and stocks don’t wait for a strong job market to rise.

Initial jobless claims rose by 129,000 to reach 1.1 million in the week ending August 14.[i]

Exhibit 1: Weekly Jobless Claims

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Making Sense of Prices in These COVID Times

Last week the US July Consumer Price Index (CPI) posted its biggest monthly gain since 1991. While the year-over-year inflation rate was 1.0%, which is quite low by historical standards, some posited inflation is running hotter than what the national CPI says—implying COVID-19 fallout has resulted in a much higher cost of living than widely reported.[i] We found this an opportunity to discuss what inflation gauges do and don’t tell us—an important consideration for investors, especially those planning for retirement expenses.

CPI tracks how prices of consumer goods and services change over time. Several agencies have their own price gauges, but headlines usually focus on the BLS’s CPI. To measure CPI, the BLS monitors a basket of goods and services—updated annually—that aims to represent the spending patterns of US urban consumers, about 93% of the population.[ii] Besides its national index, the BLS also has CPIs for different metropolitan areas (e.g., Greater Houston in Texas) and geographical regions (Northeast, Midwest, South, and West).

Many see the monthly CPI report and say their experience doesn’t match it, implying the government must be underreporting inflation. Yet CPI isn’t intended to measure an individual’s personal cost of living. The BLS states this outright:

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Timely Takeaways From Q2’s Plunging Earnings

Q2’s earning season is wrapping up, and—likely surprising no one—the results were awful. Yet they also weren’t anywhere near as bad as analysts projected before firms began reporting. While we don’t think the big positive surprise is necessarily why the S&P 500 is hitting new highs, we do think it illustrates some important investing concepts.

With 478 S&P 500 companies reporting as of today, blended Q2 earnings—combining actual results and remaining estimates—fell -32.5% y/y, the largest decline since Q1 2009.[i] Yet this was much better than the -44.1% y/y decline analysts expected at June’s end.[ii] In aggregate, actual reported earnings were 22.4% above the latest estimates—a record amount.[iii] The previous record occurred in Q1 2010.

Three sectors reported year-over-year growth in Q2 earnings: Health Care, Utilities and Tech. Unsurprisingly, this is getting heaps of attention as pundits keep touting alleged COVID winners. There is also talk about how COVID-19 has accelerated trends—including cloud computing and drug development—which may benefit some sectors more than others. While that may or may not turn out to be true, guessing at how any event prompts long-term shifts is sheer speculation and, in our view, not a great investing thesis. We think what matters for sector leadership going forward is how more cyclical drivers evolve and how that compares to expectations.

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Don’t Thank the Fed for Stocks’ All-Time High

The S&P 500 price index closed at a new all-time high today, echoing what the total return index confirmed a week ago: The bear market officially ended on March 23, and a new bull market is underway. One common theme we saw in press coverage of the milestone is that the ginormous fiscal and monetary response from Congress and the Fed deserves most of the credit. We won’t argue their actions had no effect, as they probably did help shore up confidence early in the spring. But to argue fiscal and monetary policy drove the recovery is to argue this bull market can’t keep marching onward without help—a false premise, in our view.

To say a bear market ended because of monetary and fiscal support is to misunderstand how markets work. Stocks are leading indicators of the economy, and in general, they price in economic conditions and corporate earnings anywhere from 3 to 30 months or so out. During bull markets, they generally look toward the mid to longer end of that range, which is how they are able to see past volatility in monthly data and quarterly earnings. They also don’t need things to be anywhere near perfect, as long as expectations are reasonable. A reality that simply goes better than expected, overall and on average, is generally good enough to let stocks rise.

In a bear market, however, stocks shift focus to the shorter end of the range. As recession becomes increasingly likely, stocks’ primary concern is how deep it will get and how long it will last. A bear market’s decline is stocks’ way of pricing in the anticipated economic damage and its impact on corporate earnings. Once stocks have done this and are able to see an end to the recession, they can shift back to the mid-to-longer term and price in the economic recovery’s effect on corporate profits. Not over the next three or six months, but over the next year, two or three. This shift in focus can happen rapidly, which is why the first leg of a bull market tends to be so strong. This is also why that first leg can seem exceedingly out of touch: It immediately follows the most panicky part of a bear market, when fears of mass bankruptcies and sky-high unemployment reign. It also precedes any hint of economic recovery showing up in the data, leading pundits to argue stocks are detached from reality.

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Don’t Let Insider Sales Lead You Astray

As markets approach their February highs, reports indicate insiders—CEOs and other executives—are selling shares of their companies’ stock. Whenever this happens, it prompts financial journalists and others to question whether individual investors should broadly do the same, presuming corporate executives have unique insight. However, this oversimplifies the issue, and in our view, normal folks shouldn’t factor insiders’ moves into their own decisions. They aren’t a timing tool.

One reason insiders’ sales are gaining so much attention is that the founder and CEO of a certain online retail behemoth rhyming with Pentagon sold over $3 billion of his shares in early August.[i] (For perspective, this leaves him with a $173,543,851,365.12 stake.)[ii] More broadly, by some measures, the ratio of insider buying to selling is the lowest since 2000, seemingly in stark contrast to insiders’ big buying in March. Considering this bull market began March 23, some believe the flurry of buys illustrates their foresight.[iii] This creates the perception that executives must know something the rest of us don’t—leading them to jump out at an optimum exit point. It also adds to a general bout of an investor malady we term “Breakevenitis”—the urge to sell once stocks retrace prior declines in order to avoid the proverbial second shoe to drop.

Many think corporate insiders are especially sensitive to whether their firms are over or undervalued. By virtue of their unique vantage point and their job of leading their firms through changing business cycles, insiders are naturally privy to their industries’ inner workings. Who better to understand a company’s performance drivers than the executives holding the reins? And why would they sell if they aren’t pessimistic on their own company’s or the market’s foreseeable future?

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Explaining the UK’s Worst-in-the-World Q2 Contraction

UK GDP fell -20.4% q/q in Q2, which is not only the worst contraction in the country’s history, but also the worst of the major nations reporting thus far.[i] That is the headline news you may have seen in your Internet travels. What lies under the hood is rather more interesting, though. Because the UK reports monthly GDP as well as quarterly, we have more granular results to show how the timing of the country’s gradual reopening affected GDP, which can help set expectations for what comes next. While we think stocks are likely looking way beyond 2020 economic data, getting a sense of how growth is occurring can help you stay cool in the face of dire headlines.

Exhibit 1 shows the scorecard of major developed nations’ Q2 GDP reports. Japan, Australia and Canada haven’t yet reported, but it seems unlikely any will take the dubious distinction as worst of the lot away from Britain, which was relatively more locked down during Q2 than the others. Once again, we show both quarter-over-quarter and annualized results for all countries, in order to make comparison easier.

Exhibit 1: The Q2 GDP Scorecard

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