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.


The Relationship Between Rates and Stocks Isn’t as Straightforward as Many Think

In a week with monetary policy meetings scheduled in Norway, Switzerland, Sweden, Japan, the UK—oh, and the US—it was perhaps inevitable interest rates would feature prominently in financial commentary. Then, on Monday, the US 10-year Treasury yield hit 3.489%, its highest close since April 2011, triggering even more headlines. Many presume the rise in long-term yields is poison for stocks, and fear of rising rates seemingly has played a role in this year’s market decline. We don’t dismiss how challenging this market environment has been, as interest rate concerns have been one of at least eight stories weighing on sentiment over the past nine months. Yet in our view, it is an error to extrapolate forward this effect—chiefly a sentiment function—and presume rates simply must fall for a new bull market to begin.

Arguments positing the upturn in long rates undercuts stocks generally go like this: Low yields in the not-so-distant past presumably buoyed stocks. Proponents of this take said, “there is no alternative” (aka, TINA) to stocks providing a reasonable return. So, they argue, low rates lured more people out of bonds and into stocks. Still others carry this a bit further into theoretical territory, noting that, because rising interest rates reduce the current value of future revenues and profits, higher yields now weigh on stocks’ appeal.

Today, with most people projecting rates’ rise this year into ever-higher yields to come, many conclude there is more trouble ahead for stocks. There is an alternative now, they say, even if yields at 3.5% are far below inflation and further rises in yields would hit bond prices (which move inversely to yields).

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SarbOx, Revisited

Editors’ Note: MarketMinder doesn’t make individual securities recommendations. Those mentioned herein merely represent a broader theme we wish to highlight.

Chatter over regulation is a near-constant in the commentariat. But still, there seems to be an awful lot of chatter about regulatory risk right now. New UK Prime Minister Liz Truss has pledged to review the Bank of England’s mandate and overhaul the financial regulatory system, stirring fear. On our shores, the Securities and Exchange Commission has proposed broadening the definition of a securities dealer in a way that could ensnare entities investing their own money. And who can forget the ongoing global tussle over the definitions of “green” investing? Crypto regulation talk continues to simmer in much of the world. Some people favor these initiatives. Others oppose them, warning of decades-long economic and market consequences. This article isn’t about which sides are right. Rather, a simple point: Regulatory changes that bring big downstream consequences can have strong near-term effects. But it is a mistake to project or think they will have a very long-term market impact. Rather, their second, third and fourth-order side effects typically fade into the backdrop.

To see this, consider a US regulatory overhaul that turned 20 this summer: The Public Company Accounting Reform and Investor Protection Act, better known as the Sarbanes-Oxley Act of 2002. Or SarbOx, for short. Congress conceived it in February 2002 as a response to the accounting scandals at Enron, Tyco International, WorldCom and others, and after a short debate—including waffling back and forth between versions—a more extreme House version passed in overwhelmingly bipartisan fashion that summer, before receiving then-President George W. Bush’s signature at July’s end. Accounting fraud, of course, was already illegal, but lawmakers determined that its seemingly widespread nature rendered the extant rules insufficient—it needed to be illegal-er. So Congress added a bespoke public accounting regulator, cracked down on auditors’ conflicts of interests, made CEOs and CFOs criminally liable for inaccurate reports and ratcheted up public companies’ reporting requirements.

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Bonds’ ‘Bear Market’ Doesn’t Negate Their Purpose

By some measures, bonds have entered a bear market (typically a prolonged fundamentally driven decline exceeding -20%) this year along with stocks. In blended portfolios, bonds are usually supposed to provide asset-class diversification, cushioning against equity volatility for those whose goals, needs and comfort with volatility make that desirable. But given this year’s environment, you may ask: If bonds don’t mitigate portfolio swings, why own them at all? In our view, although bonds may disappoint temporarily, they still provide adequate cushion over investors’ required time horizons.

First, let us explore the so-called “bond bear market” headlines have touted recently. One widely watched bond benchmark, the Bloomberg Global Aggregate Bond Index, has fallen -21.2% from its January 4, 2021 peak on a total return basis.[i] But it includes non-US dollar-denominated investment-grade debt from 24 markets abroad. Given the US dollar’s strength over the last year, a big chunk of the Global Aggregate’s decline stems from currency translation.

In our view, most long-term investors whose portfolios include fixed income are probably better served investing in their own nations’ bonds. Unlike stocks, in our view, a bond allocation’s purpose is to dampen expected volatility versus an all-equity portfolio. Adding currency risk cuts against that objective. So for US investors, we think it is better to look at domestic bond indexes. The same goes for UK, Australian and Canadian investors, to name a few.

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Preparing For “Sudden Wealth” Inheritances

Last July, someone in Illinois won the $1.3 billion Mega Millions prize—the third-largest lottery jackpot in US history—though no one has claimed it yet, despite a payment option deadline looming.[i] This is the very Mega Millions jackpot your neighbors likely dreamt of. It is easy to imagine the benefits of a tremendous windfall, like paying off debt, erasing your family’s financial stress or purchasing a home. However, it is even easier to overlook the surprising possible downsides—which aren’t exclusive to lottery winners. Inheritors can also experience sudden wealth’s psychological effects. In my view, preparing to give or receive an inheritance can help mitigate these potential negatives.

Sudden wealth syndrome,” coined and described by the MMC Institute, can manifest in lottery winners and inheritors alike.[ii] As the MMCI’s research documents, feelings of guilt and paranoia may arise—along with anxiety, sleeplessness and thoughts like, “I don’t deserve this,” or “will this money disappear equally fast?” Furthermore, per the MMCI, guilt associated with newfound wealth may lead to self-defeating behaviors—such as an individual attempting to reconcile their past and present financial realities by spending (i.e., getting rid of) this new money as quickly as possible, consciously or not. This can include spending sprees, gambling or giving impulsively.

Identity crises and social isolation can also crop up. A sudden influx of wealth can force individuals to reassess their life goals and daily purpose. For example, an individual might suddenly question the purpose of their job—even if they enjoy it—when money is seemingly no longer relevant. They may need to redefine entirely what success looks like in their new reality. This can dovetail with social isolation. Without a sense of purpose or identity, suddenly wealthy individuals may self-isolate from friends and family. Familial resentment and requests for money—real or imagined—can drive isolation further. Meanwhile, the reality of one’s peers being comparatively financially limited means life plans may diverge. Friends might not be able to join on that big vacation or relate to new life goals. Financial mismanagement is yet another potential issue. As I touched on above, guilt can drive overspending and impulsivity—as can overconfidence. Conversely, an individual may fear financial missteps—leading to decision paralysis.

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Parsing Pessimism on Retail Sales

Amid a quite volatile week for stocks, investors continue hunting for hints at which way stocks will go. In the very short term, this is—of course—unknowable: Volatility cuts both ways, and it both starts and stops for any or no apparent reason. But over more meaningful periods, as stocks weigh fundamentals, they move on the gap between expectations and reality over the next 3 – 30 months. As bull markets begin, those expectations are colored by a phenomenon we call the pessimism of disbelief: investors’ tendency to emphasize bad news and hunt for negatives in news that would otherwise be good. While we can’t know now whether stocks’ latest rocky spell is merely a brief interruption of a nascent recovery or another leg down to a more W-shaped bear market low, that pessimism abounds today. The coverage of Thursday’s US retail sales is a prime example, in our view.

Retail sales resumed growing in August, following July’s (downwardly revised) -0.4% month-over-month slide with a 0.3% rise.[i] That rise was subject to big positive skew from autos and big negative skew from gas stations—both influenced mainly by price movements. But those canceled each other out, as retail sales excluding autos and gas stations also rose 0.3% m/m.[ii] Headline retail sales also rose 9.1% y/y, which—as many noted—outpaced August’s year-over-year inflation rate, implying sales continue to eke out some growth on an inflation-adjusted basis.[iii] Mind you, that is overly simplistic considering properly deflating retail sales would require squaring up the month-over-month sales growth and inflation rates in dozens of small categories, but the observation is interesting all the same.

Not because it was a cheerful observation—rather, in typical pessimism-of-disbelief fashion, most of Thursday’s commentary didn’t offer positive reasons why inflation wouldn’t be eroding spending on goods and food service. Articles didn’t tout strong demand, nor did they express relief that falling gas prices are freeing up more of people’s money for discretionary spending. Rather, much of the coverage centered on timing: Not only is August back-to-school month, which boosts sales of clothing and school supplies, but it is also typically when stores will slash prices in order to make room for holiday season inventory. Accordingly, pundits credited deep discounting for sales’ seeming resilience, implying that the only reason consumers are buying more is that they are raiding clearance sales in order to pinch pennies.

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Four Timely Timeless Lessons for 401(k) Day

Last Friday was 401(k) Day in the US, a day dedicated to retirement planning. We think 401(k) plans are great—a useful tool for those traveling along the most reliable road to riches: saving and investing well over the longer term. The occasion is also an opportunity to revisit some timeless lessons we think are particularly useful during a challenging year for investors.

Lesson One: Fathom the Power of Compounding

The max contribution to a 401(k) plan in 2022 is $20,500 (plus a catch-up contribution of $6,500 for those 50 and over), which doesn’t include any employer-matching funds. Of course, one contribution of $20,500 won’t provide for retirement. Moreover, not everyone can necessarily save that sum year in, year out. However, to the extent you are able, the combination of time and saving is critical to unleashing the power of compounding. Consider what a yearly contribution of $20,500 invested the instant the market opens on the first trading day of every year combined with an 8% annual return—a little below stocks’ historical average—can turn into over 30 years. (Exhibit 1)

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Our Take on Tuesday’s Sharp Swings and CPI

Stocks’ rocky 2022 certainly continued Tuesday, as the S&P 500 fell -4.3%—with most blaming disappointing inflation data.[i] But in our view, the large drop extends this year’s one constant: Sentiment seems detached from reality. While we don’t deny the pain of higher prices and interest rates—and negativity like Tuesday’s can sting—investors’ moods and reactions to incoming information seem overall too dour relative to the observable facts on the ground. In our view, Tuesday’s August US Consumer Price Index (CPI) report provides a timely example. Headline CPI decelerated, albeit less than expected, but an acceleration in “core” CPI, which excludes food and energy, triggered more handwringing over a potential 75 basis-point Fed rate hike later this month. Even though investors have been penciling in that large of a Fed rate hike for several weeks now. When stocks sink on emotional flashpoints rather than a materially negative shift in incoming information, we think it is a strong signal that staying cool remains the wisest move.

The CPI report itself held few new or surprising insights. The headline reading slowed from 8.5% y/y in July to 8.3%, missing expectations for 8.1%.[ii] The 0.1% month-over-month increase sped from August’s flat reading but remains below the long-term monthly average.[iii] Yet, extending August’s trend, falling gasoline prices drove much of the deceleration, masking continued price increases elsewhere. Those were more apparent in core CPI, which accelerated from 5.9% y/y to 6.3%, with the month-over-month change speeding from 0.3% to 0.6%.[iv] That may seem sharp, but the month-over-month figures have been quite volatile throughout this high-inflation stretch, and extrapolating any of them forward—whether they were faster or slower—would have been an error. Such is the nature of monthly data.

Much of today’s coverage tried to dig deeper, leading to conclusions that August’s results show inflation is stickier than first expected—hence all the talk of big Fed rate hikes to come. In our view, this is a philosophical error. You can’t look to current price moves to predict future price moves. Looking at CPI’s various subcategories can help identify trends, but these are generally backward-looking. For instance: It is probably fair to conclude that, with core services and core goods measures accelerating, higher energy and petrochemical feedstock costs are starting to bleed through into consumer prices … to some extent. That delayed reaction isn’t surprising, given producers will hedge these costs and try everything possible to avoid passing them to customers, lest they lose market share by reacting to temporary surges in commodity prices. (And it seems like a stretch to connect those theories to shelter, which was the single largest contributing category to the monthly rise, beyond the fact that many rental agreements include utilities.) But this isn’t guaranteed to continue indefinitely, especially with most US energy prices trickling downward more recently. Said differently: Just because core prices tend to be overall less volatile than headline prices doesn’t mean every move is part and parcel of a long-term trend.

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The ECB Hike-Inspired Table of the Day

As the world mourned the passing of Her Majesty Queen Elizabeth II Thursday, markets did what they always do at such times: got on with the job. In a way, it is a fitting tribute to the steadfast woman who exemplified this attitude during her remarkable 70 years on the throne. Yet a stiff upper lip doesn’t quite describe the way headlines reacted to the day’s biggest financial news: the European Central Bank’s (ECB’s) decision to raise its benchmark interest rate by 75 basis points (0.75 percentage point) from zero to 0.75%. There was much chatter about the tricky position the bank finds itself in as the eurozone economy seemingly teeters on the brink of recession as inflation accelerates. Most agreed rate hikes won’t do much on the inflation front and raised the likelihood of an economic downturn. Perhaps both of those prove true—and perhaps not. We have written at length about what rate hikes can and can’t do in this environment, and there is mounting evidence that inflationary forces outside central banks’ control are starting to turn, albeit to varying degrees in various regions. And, crucially, there is also evidence the broader fallacy underlying these fears—a mantra known as Don’t Fight the Fed—is as off-target now as ever.

Don’t Fight the Fed—which may as well be Don’t Fight Central Banks[i]—holds that stocks should generally party when monetary policymakers are cutting rates and struggle when central banks are hiking. This year, it might even seem to hold true, given central banks have tightened during a bear market, which is typically a prolonged decline of -20% or worse with a fundamental cause. To us, this bear market seems much more sentiment-driven, with about eight different issues weighing on investors’ minds. Rate hikes are one of those, so from that standpoint we will concede they bear some blame. But that doesn’t mean rate hikes—even big ones—are negative from a fundamental standpoint.

We generally don’t like looking to short-term returns to prove a point, as they are myopic and happen for any or no reason. Yet we also think it is fair to presume that if rate hikes were fundamentally bad for the economy or stocks—the bear market’s trigger—we would see a consistent pattern of negative returns in their wake. Thing is, we haven’t.

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What to Make of the European Commission’s Winter Plan

The western United States may be enduring an epic heatwave right now, but winter is front and center on many investors’ minds—specifically the European winter, now that Russian gas provider Gazprom has ceased supplying the EU through the Nord Stream 1 pipeline. European Commission President Ursula von der Leyen laid out a potential response plan ahead of an emergency summit to tackle the issue Friday, but her package of windfall taxes, price caps and mandatory conservation left most observers underwhelmed. In our view, that dour reaction is probably a good thing. Rationing, of course, adds to widespread worries of a forthcoming European recession. If this becomes the baseline expectation, which doesn’t seem too distant, then it should help stocks price the economic impact quickly and move on.

The European Commission doesn’t get the final say-so on the EU’s collective response. That honor goes to the European Council, which is composed of heads of state and government from every EU member state. Its decisions are typically unanimous, and they usually include exemptions for some nations in order to win approval. So von der Leyen’s statement—and the policy proposals leaked to The Guardian Wednesday—isn’t necessarily a blueprint of what EU leaders will agree to. But as the likely starting point for talks, it is worth a look.

The provision gaining the most attention: a revenue cap on electricity providers that use low-carbon power sources, including wind, solar and nuclear. EU energy regulations tie electricity prices not to input costs, but to the price of the most expensive source. Right now, that is natural gas, delivering a big revenue windfall to providers that use cheaper inputs. While she didn’t specify a cap, The Guardian reported the European Commission will propose a ceiling of €200 per megawatt hour for low-carbon sources, which their research claims is what the market price of electricity would be absent sanctions and supply hiccups, with a windfall tax running parallel.[i] There is also a proposed windfall tax for oil and gas companies, mandatory energy reduction of 5% during peak hours and a cap on Russian gas prices and measures to support the functioning of energy derivatives markets. Proceeds of the windfall tax would go to member states to help households and businesses cope with energy costs.

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How ‘Sell the Losers’ Can Be Very Counterproductive

With stocks tumbling again, we have seen a notable shift in financial commentary: an abundance of chatter about winners and losers, both in this current bear market and in recessions historically. The implication? Shifting into what has done well—and what usually holds up better during recessions—will help limit portfolio downside from here. This prospect, coupled with the emotional relief some investors feel when “selling the losers,” seems enticing to many. Yet we think it is one of the least beneficial things anyone seeking long-term growth could do right now.

Selling stocks that have suffered this year may seem appealing from a stop the bleeding standpoint.[i] But in investing, emotional appeal and wisdom rarely intersect. So it is with selling stocks that are down right now, in our view. For one, it amounts to selling a company because of what it has done, not what it will do. Two, overall and on average, the categories that get pounded the hardest during a bear market (generally a prolonged decline of -20% or worse with a fundamental cause) typically have the biggest, fastest bounce off the bottom. So if the bounce is close by, you likely limit your potential to capitalize on it if you sell the stocks most likely to drive it.

Then too, selling losers risks impeding diversification. The popular view of this bear market holds that Tech and Tech-like stocks in Consumer Discretionary and Interactive Media & Services (within the Communication Services sector) are primarily responsible for stocks’ trip below -20%. And to an extent, that is true, considering these categories have been hit the hardest. Yet the vast majority of stocks are down this year (Exhibit 1), and nearly half of MSCI World Index constituents are currently in bear market territory (Exhibit 2). If you were to sell all the down stocks, you would be selling over 80% of the global market’s constituents. Selling only those that are down big would take 749 of 1,510 MSCI World Constituents off the table. Ditching all of those and piling into what has held up well basically means taking concentrated positions in Energy, Utilities and Consumer Staples.

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