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.
Editors’ note: MarketMinder is nonpartisan and favors no party or politician, as we believe political bias blinds and leads to investing mistakes. Our political commentary serves only to assess elections’ potential economic and market impacts—or lack thereof.
In one sign 2020 is slowly returning to normal, the presidential campaign has moved to more traditional ground in recent days: Former Vice President and presumptive Democratic nominee Joe Biden has begun unveiling sweeping economic proposals, previewing the tack he will likely take on the campaign trail. Pundits have accordingly been crunching the numbers in his tax package, $700+ billion “Buy American” economic plan and $2 trillion in proposed energy infrastructure spending, commencing the typical election year speculation about proposals’ impact on the deficit, taxes, the economy and markets. In our view, this is all quite premature. It is far too early to assess not just the presidential winner, but also the Congressional races and the likelihood any sweeping proposal from any party can become law. For now, campaign pledges are merely a way of drumming up election support. In the process, they help markets slowly get clarity on how the political backdrop may look post-vote.
Given the scope of Biden’s proposals—which is not at all unique for any candidate in any party—and his large polling lead, it is natural for investors to try to discern some market impact. Last week’s plan featured $400 billion to buy American goods, $300 billion in research and development and $50 billion in worker training. Tuesday, Biden announced a $2 trillion, four-year infrastructure plan attempting to spur an energy transition to carbon-neutral electrical generation by 2035. Biden’s previously announced tax plan aims to pay for at least some of these efforts by reverting individual tax rates for those earning over $400,000 to 39.6% from 37% and corporate tax rates to 28% from 21%. Elsewhere on the tax front, Biden proposed raising Social Security payroll taxes. Currently, earnings above $137,700 aren’t subject to Social Security taxes. Biden would keep this but re-impose the tax on incomes exceeding $400,000, creating a barbell structure.
The UK released monthly GDP for May today, giving the first official look at how the broader British economy benefited from the gradual reopening that began in the month. The results—1.8% month-over-month growth—missed expectations for 5.5%, generating disappointment and worries that renewed lockdowns will derail an already feeble recovery.[i] Our perspective is rather different. For one, given this unprecedented situation, analysts’ expectations were always guesswork—you can see that in the widely varied US Q2 GDP expectations we discussed a couple of weeks ago. Two, if you look at the details underlying the headline results, modest GDP growth seems consistent with May’s limited reopening.
As in the US, the UK’s reopening wasn’t universal or all at once. The government’s reopening plans covered only England—the other three constituent countries (Scotland, Wales and Northern Ireland) set their own policies and generally reopened more slowly. Even within England, May’s reopenings largely covered factories and offices. Among retailers, only garden centers reopened in May, and that happened mid-month. All other non-essential retailers didn’t get the green light until mid-June, and most personal services and restaurants weren’t allowed to reopen until early July. Some, namely estheticians and other beauty providers, still aren’t open. Considering UK GDP is about 80% services, a recovery was always going to depend on a more complete High Street reopening.[ii]
GDP’s categorical breakdown vets this out. The heavy industry component, which includes manufacturing and mining (primarily oil drilling), grew 6.0% m/m.[iii] Further under the hood, manufacturing output jumped 8.4%, while mining notched a 5.0% rise.[iv] That meshes well with factories’ May reopening. But services grew just 0.9% m/m, which is more stabilization at a low level than actual growth, in our view.[v] It also seems about what one should expect given the very limited scope of reopened businesses. Even those who returned to office life had very limited options to shop or dine after hours.
What do you do now if you exited stocks during this year’s bear market? The New York Times ran a piece yesterday attempting to answer that question:
Once You’re Out of the Market, It’s Tricky Getting Back In
Brian J. O’Connor, The New York Times
This is a relevant topic worth highlighting, but we found the article itself a mixed bag. Several of the interviewed experts provide sensible, if cliché, advice (e.g., buy low and sell high), but they primarily focus on how to re-enter the market: tactics or strategies like dollar-cost averaging or waiting until a COVID-19 vaccine is available. The questionable wisdom of that advice aside, the article overlooks a simple but critical question all long-term investors must answer:
Ever since COVID-19 began spreading globally, headlines speculating about how the pandemic will forever change the world have spread almost as fast. Consumer behavior, the retail industry, travel, voting, handshaking, religious worship, city life, office life, even beer drinking—pundits say all these and more may never be the same. Are they right? Your guess is as good as mine—or theirs. With governments taking unprecedented measures to control a virus researchers are only beginning to understand, uncertainty abounds. Enduring changes are possible. Many may seem to carry investment implications, too. But good investing relies on identifying what is probable—not merely possible. Counting on drastic, permanent change amid such uncertainty is a dangerous practice.
“The possibilities are endless,” the phrase goes—and those who envision unlikely outcomes can change the world. Had Orville and Wilbur Wright not considered far-flung possibilities, they never would have invented the airplane.[i] Similarly, Michelangelo might have slapped a coat of powder blue on the Sistine Chapel ceiling and called it a day. George Lucas never would have bothered with Star Wars, and Jonas Salk could have tipped his cap to polio. The pondering of what is possible has given us suspension bridges, computers, organ transplants and chocolate chip cookie dough ice cream. It has made our world better.
Possibilities capture our imagination and headlines, but they don’t drive markets—probabilities do. Markets know all sorts of possible events, positive or negative, could occur at any moment—natural disasters, productivity-stoking inventions, wars or extended periods of peace and prosperity. But unless any of these has a strong likelihood of coming to fruition, they generally don’t move stocks over any meaningful period.
Though COVID-19 still dominates headlines, it seems some are now seeking new worries. So far, they seem to have found two: swine flu and, um, the Bubonic Plague. The former has circulated through Chinese hog farms for over a decade, occasionally infecting people. The latter turned up in a shepherd in Inner Mongolia. Don’t be shocked if either stays in the headlines for a while—or if other diseases hit the headlines with the words “pandemic potential,” which have accompanied most of the swine flu coverage. One regular feature of new bull markets is the near-universal tendency to fight the last war. Heightened awareness of every illness percolating in a corner of the world doesn’t mean a new disease is set to truncate this recovery.
For now, there is no evidence this strain of swine flu is circulating broadly among humans. As Bloomberg highlighted, research suggests it has infected “dozens” of people since 2016, and it is getting headlines now solely because of a research report noting that it has characteristics making it a pandemic “candidate.”[i] That doesn’t mean it is likely to cause a pandemic, much less one on the scale that would inspire a mass global lockdown. The last swine flu pandemic, in 2009, didn’t. As for the plague, it is actually fairly normal for a handful of cases to turn up in rural areas each year, typically arising from human contact with infected wildlife. As The New York Times pointed out, even the US averages seven cases annually.[ii] Additionally, while society’s view of the plague is shaped by history books’ depictions of the Black Death in the middle ages, in this day and age it is a highly treatable bacterial infection.
But we aren’t here to play armchair epidemiologist. Rather, we thought it worth highlighting how utterly typical this behavior among investors—seeking a repeat of the last bear market’s cause—is in early bull markets. As a general rule, investors spend much of a bull market on the lookout for a repeat of whatever caused the last bear market—a phenomenon called fighting the last war. In the bull market that ran from 2009 to 2020, investors were on perpetual alert for “the next Lehman Brothers” or “the next 2008.” Early on, many feared Alt-A mortgages were the second shoe set to send stocks far lower and kill off any recovery. Later, it led to mini freakouts and a litany of think pieces on distressed auto loans, student loans, collateralized loan obligations, leveraged loans, junk bonds, Energy sector bonds and Italian banks. None caused the next bear market. But all received heaps of scrutiny. In the 2002 – 2007 bull market, all eyeballs were on Technology stocks for any renewed signs of froth. That even lingered into the most recent bull market, with people parsing every uptick in IPO activity for hints of Dot-Com Bubble Version 2.0. But Tech euphoria didn’t cause the next bear market, either.
2020’s first half is in the books, and we reckon it is fair to say the MSCI World Index’s -5.8% decline hardly hints at all investors had to deal with over the past six months.[i] We won’t recap the main events here—you lived them. However, we do think it is worth highlighting a couple of market-related developments and the lessons they impart.
Chief among them: Markets anticipate developments few foresee. On February 12, global stocks closed at an all-time high.[ii] The next day, they fell -0.2%.[iii] It seemed like a typical daily blip, the kind history doesn’t bother remembering. The world was aware of COVID-19, but cases outside Asia were isolated and seemingly rare. Considering no pandemic in history had ever ended a bull market, there seemed no rational reason to treat it any differently than SARS in 2003 or swine flu in 2009. Both hit sentiment, but neither caused deep economic or market problems. Lockdowns weren’t even in the conversation at a regional level, never mind a global one. But as politicians acted over the next month to contain the pandemic, stocks were forced to digest lockdowns and their economic consequences in short order. They hit bear market territory (-20% from a prior high) on March 12, the fastest ever.[iv] On March 23, they closed down -34% from the high.[v] Most of the US and Europe were under shelter-in-place orders. Japan was headed that way. No economic data had yet measured the negative impact, but everyone was sure it would be bad.
But the next day, stocks rose. They kept rising, overall and on average, for the next several weeks—even as economic data began emerging and notching record-awful readings. Pundits said rising stocks were ignoring reality, but we think dispassionate observation shows stocks had simply shifted to looking further into the future. Past the immediate hemorrhaging, past the gradual fall in COVID caseloads, past the baby steps toward reopening the US and Europe, past occasional setbacks, and to a day further out when society learned how to live with the virus and maintain some semblance of normal economic activity. As Q2 progressed and more cities reopened, that eventuality became more apparent. By June’s end, those who hung on were rewarded with global stocks’ 38.2% bounce off the low.[vi]
In recent weeks, what seemed like a receding COVID outbreak in America has reversed course, with US daily cases troublingly hitting new highs on Tuesday and some states reporting tight hospital capacity. The resurgence has many pundits expecting a return of broad lockdowns—which they argue could upend stocks’ rally. While the increased spread is unquestionably bad news, we caution against drawing market conclusions from it. Lockdowns are political decisions—unpredictable. Moreover, it isn’t remotely clear a return of restrictions on the scale of this spring is coming. In our view, basing investment decisions on renewed lockdown fears amounts to dangerous speculation on a factor no one really has—or can have—any special insight into.
Daily new cases have risen in three-quarters of states from two weeks ago and topped 48,000 on Tuesday—the highest figure yet in the outbreak.[i] About a fifth of states—concentrated in the South and West—saw record highs over the last week, while only a handful of mainly Northeastern states experienced declines.[ii] New cases in Arizona have quadrupled in the last two weeks, with reports of ICU units running over capacity.[iii] In Texas and Florida, two of the largest states by population and GDP, cases have tripled over the past two weeks, pressuring their regional hospital systems’ capacity.[iv] In response, Texas paused reopening, shuttered bars anew and halted elective surgeries in its biggest cities. Florida, Arizona, California (the largest state by population and GDP) and others have also postponed their reopening plans. Many investors fear it won’t stop here. A pause leaves most businesses open, if at reduced capacity. Most seemingly fear a return to broad-based lockdowns seen in March and April, cutting short the nascent economic recovery evident in recent data.
Although spiking caseloads is alarming from a public health perspective, we think the key question for investors is the degree to which markets expect economic activity to shut down. Considering stocks have grappled with second-wave risks for months, the latest events aren’t exactly coming out of the blue. For a new lockdown to sway markets beyond a near-term hit to sentiment, it would likely need to be worse than presently feared—which seems to be quite a lot. In June, a second wave topped concerns in Bank of America’s widely followed fund manager survey for the third straight month.[v] Among economists, 73% surveyed by FiveThirtyEight last week predicted “a steep [GDP] drop followed by a quick partial recovery and a longer period of slower, mixed growth,” with a second wave the top risk to their forecasts.[vi] Meanwhile, the Business Roundtable’s Q2 survey of chief executives showed most expect recovery by year end, but 27% think a recovery could stretch beyond 2021 as hot spots flare.[vii]
During and after a bear market, interest in investments aiming to hedge against volatility or play off the bear market’s themes tends to spike. Wall Street often obliges by proffering a range of products to meet demand. While some of these may be fine depending on your circumstances, we think it is important to understand what is driving the hype—emotions and, in some cases, marketing. In our view, investors benefit from cutting through it all and rationally weighing the pros and cons.
First up: Low-volatility exchange-traded funds (ETFs), which contain stocks with less measured volatility—typically based on the average daily move up or down over some past time period. Since these purport to ensure a smoother ride, investors often flock to them in turbulent times. But this strategy has a critical flaw, in our view. Like past prices, past volatility doesn’t predict. One month’s (or quarter’s, or year’s, or decade’s) placid stocks could be the next period’s bounciest. Hence, low-volatility ETFs’ composition is necessarily backward-looking.
In one case, a recent low-volatility ETF rebalance shifted its holdings away from Utilities and Real Estate and towards Health Care, Consumer Staples and Technology, on the grounds that the latter had become relatively less volatile. We think this highlights how shedding (recently) bumpier stocks for (recently) calmer ones is just a twist on heat-chasing—a decision hinging on past performance metrics of one form or another. Moreover, since volatility and market returns aren’t correlated, low-volatility strategies can—and often do—lag broad markets. This can include stretches when stocks are falling—ostensibly low-volatility ETFs’ time to shine.
Q2 draws to a close today, and with it, perhaps the ugliest quarter in modern US economic history. Since most shelter-in-place orders didn’t take effect until late March, Q2 data will bear the brunt of the national lockdown. Soon earnings season will kick off, showing how the institutional response to the pandemic hurt corporate profits. Then, toward July’s end, the first reading of GDP will display the broad economic damage that narrower monthly indicators, especially April’s, have hinted at for months. In our view, this makes now an excellent time to remember that when these numbers come out, they will be old news to stocks—not a new shock or catalyst for lasting market weakness.
Exhibit 1 rounds up several headline-making earnings and GDP forecasts. As you will see, they range from ugly to awful.
Exhibit 1: Major Q2 Earnings and GDP Forecasts
Retirees take note: The IRS just issued further guidance on revised rules governing 2020 required minimum distributions (RMDs)—mandatory withdrawals from retirement savings accounts like traditional IRAs and 401(k)s (those funded with pre-tax dollars). If you already took an RMD this year and don’t require the funds for living expenses, this may be news you can use.
Ordinarily, savers must withdraw a percentage of their retirement accounts annually (calculated based on life expectancy) or pay a 50% penalty. Last December’s SECURE Act raised the age at which savers must begin taking RMDs from 70.5 to 72. But then the coronavirus hit. Now 2020 is an exception for RMD takers of all ages. In an effort to spare retirees from liquidating a portion of their portfolios after stocks’ steep late-February and early March declines, Congress suspended 2020 RMDs as part of the CARES Act, which President Trump signed on March 27.
By that time, however, some folks had already begun taking 2020’s RMDs. Since the Act retroactively classified year-to-date RMDs as not required, a pre-existing rule kicked in that permits savers to return non-required distributions to the same tax-deferred account or roll them over into a new account within 60 days—provided the retiree hasn’t conducted another rollover within the last year. As of March 27, this covered anyone who took an RMD after January 28 and hadn’t executed a rollover since January 28, 2019. Anyone taking a distribution before that date—and some typically do so early in the year—was left out. Further, those taking RMDs soon after January 28 had little time to get their act together before the 60-day window expired.