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.

April’s Astounding Employment Report Confirms What We All Expected

Friday morning, the US Bureau of Labor Statistics’ much-watched Employment Situation Report confirmed what we all expected: an unprecedented spike in the unemployment rate. In April, the rate surged from March’s 4.4% to 14.7%, underpinned by a 19.52 million decline in private-sector payrolls.[i] State and local governments cut another 980,000 jobs, bringing the total drop in non-farm payrolls to an astounding 20.5 million.[ii] This—plus each week’s lofty-and-previously-unheard-of millions of new unemployment insurance claims—has many fretting weak consumer demand forestalling an economic recovery, dooming stocks to more downside ahead. While we can’t know if March 23 was this bear market’s low, we are quite confident employment issues won’t impede the next bull market—and economic recovery—from starting.

The massive hit business shutdowns have caused the labor market is unmistakable. To put its scope in some sort of perspective (to the extent that is possible), the BLS has published the unemployment rate in its current format monthly since 1948. Prior to April, the biggest single monthly increase in the unemployment rate was October 1949’s 1.3 percentage points.[iii] That rate rose by 10.3 percentage points in April. The biggest single monthly decline in private-sector payrolls? 1.766 million in September 1945, a clear effect of World War II ending. More than 10 times as many lost jobs in April. Those are all just statistics, but make no mistake: Joblessness is a personal tragedy. These highlight the macroeconomic scope of the issue, but they don’t speak to what individuals are going through. If you or a family member have been affected, you are in our thoughts.

Now, there are reasons to think looking at the headline unemployment rate (what the BLS’s statisticians call the U-3 rate) understates reality. As many likely recall from the last recession, the unemployment rate isn’t calculated by dividing the number of unemployed by the population. The numerator is the number of unemployed who sought work in the last four weeks divided by the labor force (the number who worked or sought work in the last four weeks). Laid-off workers who don’t seek a job because they don’t think they can find one (so-called discouraged workers) fall out of the calculation. To see them—and people working part-time for economic reasons—you must look to the U-6 rate, the broadest BLS measure of unemployment. The U-6 rate ticked up from 7.0% in February to 8.7% in March.[iv] Last month, it spiked to 22.8%.[v] This is of course the largest monthly increase to U-6’s highest level ever, dating to its 1994 inception.

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COVID-19 Highlights the Perils of Relying on Dividends for Cash Flow

Editors’ note: MarketMinder doesn’t make individual security recommendations; those mentioned here are part of a broader theme we wish to highlight.

With COVID-19 responses squelching sales, many companies are looking to build up cash reserves to help get through lean times. For some, that puts dividend payouts in the crosshairs. In our view, this is a timely, albeit tough, reminder for investors about the limitations of relying on dividend-paying stocks alone for cash flow.

As COVID-related restrictions disrupt normal business, companies are seeking myriad ways to stay afloat. One easy target: dividend payouts. Per one research outfit’s analysis, more US firms have suspended or canceled dividends this year than in the past 10 years combined. On April 30 Royal Dutch Shell, one of the UK’s most well-known dividend stocks, cut its payment for the first time since World War II.

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Stocks for the Long Run?

US Treasury yields have plunged this year, lifting most bond prices during stocks’ bear market. One byproduct: Various bonds’ total returns now outpace US stocks’ since 2000’s start. For example, 10-year Treasurys have returned 213.7% compared to the S&P 500’s 187.1%.[i] We have noticed some news commentators seizing on this, arguing it means stocks no longer compensate investors for their higher volatility via higher returns. In our view, though, bonds’ outperformance over the last two decades doesn’t alter stocks’ superiority for investors needing long-term growth.

It seems popular among articles touting bonds’ 20-year edge to note that long-term US government bonds have outperformed in 26% of 20-year rolling periods ending in 2000 or later.[ii] This is a fair point to a limited extent, but we see a problem: It uses monthly rolling periods. Since bonds’ historical stretches of outperformance tend to cluster around bear markets, any figure using monthly rolling calculations could easily be double counting (or more)—overstating the phenomenon’s frequency. We think it is clearer to use rolling annual returns, which better isolate bonds’ leadership stretches.

On that basis, there have been two previous annual 20-year stretches of 10-year Treasury outperformance—1929 – 1948 and 1989 – 2008.[iii] As Exhibit 1 highlights, neither prevented big subsequent stock market gains. In the latter case, the most recent bull market—history’s longest—kicked off the following year. Investors who concluded stocks’ historically higher returns wouldn’t resume might have missed out. Cumulative US stock returns have also far outpaced 10-year Treasurys from 2009 onwards, current bear market included—299.4% to 52.2%.[iv]

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Why Falling Prices Don't Mean Falling Stocks Ahead

In the depths of the global financial crisis in late 2008 and early 2009, an odd thing happened: People simultaneously feared runaway inflation and depressionary deflation. In the past couple weeks, we have started seeing this phenomenon once again. The former we addressed last week. Lately, deflation seems to be gaining primacy, with the OECD’s announcement Tuesday that global inflation fell by the most since the financial crisis in March, making this a good time for us to weigh in. In short, while investors have myriad risks to grapple with right now, deflation shouldn’t be one of them, in our view. 

The popular deflation narrative holds that growing economies and rising inflation are sympatico, with gradually rising prices helping spur demand, while crises like the present destroy demand, driving retailers and service providers to slash prices. That supposedly creates a vicious circle in which consumers perpetually hold out for a better deal while sellers repeatedly discount, and before you know it, we are Japan during its lost decade or the US in the early 1930s.

In our view, the problem with this theory is that it flat out ignores what drives prices. Inflation, as Milton Friedman summed it up, is a monetary phenomenon of too much money chasing too few goods. Deflation, then, is the opposite—not enough money chasing too many goods. In either scenario, the key variable is money supply. In the early 1930s, a series of Fed errors caused money supply to plunge, as Friedman and Anna Schwartz documented in their classic work, A Monetary History of the United States, 1867 – 1960.[i] The modern money supply measure most analogous to what they displayed is M1, which the Fed describes as including bank notes, coins, bank reserves and checkable deposits. As policymakers sucked money out of the system, capital dried up, wrecking investment and consumption. Deflation was a symptom of this destruction, not the cause.

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Q1 GDP: More Hint Than Revelation

Q1 US GDP came out Wednesday, giving investors their first glimpse at how well economists have accounted for COVID-19 business disruptions in their projections. In The Wall Street Journal’s most recent survey, estimates ranged from 1.5% annualized growth to an -8.1% contraction. The actual result: a -4.8% annualized decline. That is in the mid-low end of the range and below the general consensus’s average. However, due to the way the Commerce Department’s statisticians calculate the preliminary GDP estimate, it still doesn’t provide a great look at how much social distancing restrictions have hit economic activity. So our advice for investors is: Don’t draw firm conclusions, for better or worse, and remember stocks look forward.

Exhibit 1 shows a more detailed breakdown of GDP’s major components. Note, all of the figures here are seasonally adjusted annualized growth rates. So not only are they manipulated a bit to smooth out seasonal skew (e.g., holidays and weather), but they show the rate GDP would grow or contract in the full year if the quarterly growth rate persisted. In other words, GDP did not shrink by nearly 5% in one quarter. The quarter-over-quarter contraction rate was -1.2%.[i] We point this out because European nations, which will soon begin reporting, use the quarter-over-quarter numbers. So to compare them to the US’s result, you will have to compound them by converting them to decimals (i.e., 1.2% becomes 0.012), adding one, taking them to the fourth power, and then subtracting one.[ii] And here endeth the math detour.

Exhibit 1: GDP and Its Main Components

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Why the COVID Response Likely Won’t Ignite Inflation

With the Fed responding to the COVID-19 lockdown’s economic damage with trillions of dollars’ worth of lending and liquidity, it was only a matter of time before people started fearing a massive money supply increase fueling runaway inflation. Based on a slew of articles we have seen recently, that time seems to have arrived. Some of the jitters stem from unlimited quantitative easing (QE) bond purchases and the related increases in bank reserves. Others take the recent jumps in various money supply measures, extrapolate them, and warn an uncontainable genie has left the bottle. We don’t think either case for turbocharged inflation withstands scrutiny, much as similar fears during and after 2008’s global financial crisis didn’t pan out.

The current crop of inflation fears do get one thing right: the focus on money supply. As Milton Friedman summed it up decades ago, inflation is a monetary phenomenon. Too much money chasing too few goods. Hence, major money supply gauges’ double-digit surges amid a sudden halt in economic activity raise the specter of mountains of money chasing a very small pool of goods and services, making prices surge.

Trouble is, this ignores the larger factors at play. In an economic crisis, one of the biggest risks is money drying up, forcing businesses under. The hints of that happening this time were fairly obvious, including the sudden stop in businesses’ sales and a temporarily frozen high-yield corporate bond market. Central bankers have learned a lot since 1929, when Fed policy following the stock market crash reduced money supply and forced a grueling, years-long recession and bear market accompanied by deep deflation. That is what policymakers sought to stave off this time around. Rather than model out the 24.8% y/y rise in M1 (mostly notes, coins, bank reserves and checkable deposits) or 15.9% y/y rise in M2 (M1 plus savings deposits, money market funds and CDs), we think it is more logical to interpret the increase as a sign the Fed isn’t repeating the early 1930s’ errors.[i] Whatever else happens, we quite likely aren’t staring down a prolonged deflationary decline.

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What Would a 'Second Wave' Mean to Markets?

As countries “flatten the curve” and politicians debate the best way to reopen economies, a new concern has started brewing: COVID-19’s potential “second wave” prompting renewed lockdowns later this year. While a second wave could happen, we think there are far too many unknowns about this possibility to let it factor heavily in your investment outlook, which should sway on probabilities.

A second wave could happen in a number of different ways. One, COVID-19 could come back during fall and winter. Experts aren’t exactly sure why, but influenza tends to strike during colder stretches, and COVID-19 could eventually behave with similar seasonality. Alternatively, the virus could mutate, becoming unrecognizable to most people’s immune systems—even those who already suffered from the first wave. Recent research indicates the coronavirus strain afflicting New York came from Europe rather than Asia—evidence of how the virus could change as it spreads over time. Still others think it is simply a matter of easing restrictions and social distancing too soon. Regardless of “how,” though, many pundits worry a COVID-19 return will again threaten to overrun health care systems and retrigger economic lockdowns. That could truncate any nascent economic recovery and/or prolong some interruptions to business and normal life.

Countries worldwide are concerned. While life in China has mostly returned to normal, officials there have imposed new restrictions in certain northern regions—particularly Harbin, a city of 10 million—after a spike in new infections locally. In Europe, Scottish First Minister Nicola Sturgeon warned people in the UK should prepare for sudden, unexpected lockdowns if a second wave occurs. UK Prime Minister Boris Johnson—officially back to work after falling ill with COVID-19 himself—echoed that sentiment, saying the government would have “to slam on the brakes of the whole country and the whole economy” if a new wave emerged.

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What Underlying Trends Say About This Bear Market

Bear markets—fundamentally driven declines exceeding -20%—usually take time to develop. Not so this time. While the average US bear market since 1925 took 8 months to hit the -20% mark, this one took 16 trading days—by far history’s fastest.[i] World stocks entered a bear market similarly quickly—20 trading days.[ii] This bear market’s speed is highly atypical—and is more in keeping with historical corrections (sentiment-driven moves of about -10% to -20%). Thus far, this bear market has another similarity to corrections: Leadership hasn’t shifted.

From the bear market’s beginning to now, growth and large-cap growth stocks have outperformed value and small-cap value. The MSCI World Index peaked February 12, falling -34.0% to its March 23 low.[iii] As Exhibit 1 shows, global growth stocks have beaten value by a whopping 11.9 percentage points over this same time period.[iv] The difference is even starker between large-cap growth stocks and small-cap value: 26.6 percentage points.[v] Now, this isn’t unusual on the downside in a bear market—smaller, value-oriented firms tend to be more sensitive to economic cycle shifts. Recession causes many investors to fear such firms won’t survive, causing them to trail in the decline. However, since the lowest point seen to date on March 23, large-cap growth is continuing to outperform small-cap value—unlike most recoveries from bear markets.

Exhibit 1: Large Growth Leading Small Value Throughout 2020

Source: FactSet, as of 4/23/2020. MSCI World Growth Index and MSCI World Value Index, both with net dividends and indexed to one at 12/31/2019. MSCI World Large-Cap Growth Index and MSCI World Small-Cap Value Index, both with net dividends and indexed to one at 12/31/2019. Each line plots the growth index divided by the value index. 12/31/2019 – 4/22/2020.

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What Rising Deficits Mean for US Debt

US federal spending is surging thanks to a series of aid packages designed to alleviate COVID-19 containment measures’ economic toll. With the deficit all but assured to spike, we already hear lots of chatter about runaway debt risking eventual economic ruin. In our view, though, US debt still isn’t a looming economic or market catastrophe.

The scale of 2020 fiscal measures—both past and planned—is indeed significant. Congress has allocated $2.2 trillion in emergency aid to date.[i] The House just passed another $484 billion package targeted at small businesses that President Trump is set to sign, and most expect Congress to direct additional funds to states and municipalities next month. The result is a ballooning 2020 deficit. The Congressional Budget Office’s 2020 debt forecast, released in January, projected a $1.0 trillion annual deficit.[ii] According to a Bloomberg analysis, existing fiscal measures alone plus falling tax revenue could lift this to $3.8 trillion, well beyond 2009’s record-high $1.5 trillion.[iii] COVID-19-related restrictions on commerce likely hit GDP this year, too, potentially lifting America’s debt-to-GDP ratio past its 1946 peak of 106%—the result of heavy borrowing to fund the war effort.[iv]

While recently passed new spending and bailouts are big, they aren’t all permanent balance sheet entries. $454 billion thus far backstops Fed loans to small businesses.[v] To the extent these are repaid, the money isn’t spent. The Fed will also return interest on those loans to the Treasury, as it does all its profits, further defraying the cost. Another $211 billion represents deferred—but not canceled—employer payroll taxes.[vi] Those measures representing actual transfer payments are also likely a one-time splurge, not a new, permanently higher spending plateau. After 2009’s big increase, annual deficits fell for six straight years.[vii]

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'Sell in May' Still Isn't Sound Strategy

As if investors need any more reasons to be gloomy these days, another is sure to start hitting headlines in the coming days: The calendar’s turn from April to May. “Sell in May and go away,” the adage says, citing stocks’ history of lower average returns in late spring and summer than during autumn and winter. This year, we suspect the bear market will heighten the chatter, with “Sell in May” touted as a way to protect yourself against the proverbial “next shoe to drop.” In our view, it is impossible to know what markets will do this summer—short-term volatility is unpredictable—and whether March 23 is the bear market’s low is unknowable today. However, seasonality is a poor reason to cut equity exposure, especially now.

For one, summer months’ weakness has always been overstated. The most common version of “Sell in May” focuses on returns from April 30 through Halloween. Those are indeed weaker, on average, than returns in the other six months. Yet at 4.2% since good S&P 500 data begin in 1926, they aren’t negative.[i] They just aren’t as positive as the 7.3% from Halloween through April 30.[ii] Yes, returns in individual years vary greatly, and the dataset spans bear markets as well as bull markets. Accordingly, don’t be shocked if pundits trot out the dismal May – November returns from 2008 or 2000 – 2002 as evidence you should sell now. The trouble with that logic is that those bear markets, like the one that began in February, had fundamental causes that had nothing to do with the calendar. Their extended length and multiple downdrafts had nothing to do with the calendar, either. Coincidence isn’t causality.

At the most reductive level, selling when May arrives and sitting out the summer results in one of two scenarios: You miss the bear market’s second leg down, or you miss its V-shaped recovery. (Yes, there are other scenarios in between, such as a flattish spell or a second downdraft and quick recovery, but we are trying to keep things simple.) If this bear market has material, longer-lasting downside ahead, it will likely have a fundamental cause. Correctly identifying that before the crowd does—and, hence, before markets have an opportunity to factor it into pricing—is crucial in any decision to reduce equity exposure. Absent that, selling just because summer months in bear markets have been awful—or because summer returns are lower on average—has the potential to be a costly error.

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