Commentary

Michael Hanson
Finance Theory

Book Review: Philosophy’s Stake in Finance

By, 05/25/2016

Models.Behaving.Badly.: Why Confusing Illusion with Reality Can Lead to Disaster, on Wall Street and in Life – Emanuel Derman
 

Early in Emanuel Derman’s quintessential book on financial theory, he delivers the punchline: “The longer you live, the more you become aware of life’s contradictions and the inability of reason to reconcile them.”
 

In the youth of serious intellectual life, for a very long time you search for “final” truths—ideas and theories to finally explain the world, and ourselves. It’s after the very long slog, decades of searching, reading thousands of books, watching ideas come and go, colliding and negating each other, seeing entirely new forms of knowledge and areas of study arise, that one arrives at something far different than the innocent objective of discovering “truth”: The contradictions of life can hold the greatest wisdom.
 

Commentary

Fisher Investments Editorial Staff
Commodities

There Is Nothing Inherently Special About Gold

By, 05/23/2016
Ratings214.380952

Gold has taken a breather from its 2016 rally this month, yet enthusiasm for the shiny yellow metal remains high—especially now that no lesser than George Soros has piled in. He is far from the only one. With the political uncertainty up and money pouring into gold ETFs, many believe the conditions are ripe for gold to run on and on.

But it’s all myth. Gold isn’t an inflation hedge, bulwark against low interest rates or a safe haven in troubled times. If you bought gold to hedge against inflation at pretty much any point in the 1980s or 1990s, it took years to pay off. Gold has also fallen during equity bear markets and periods of geopolitical turmoil, shattering that safety blanket myth. As an investment, gold has no special qualities. It is just a commodity, and a super volatile one. Its long-term returns trail stocks, yet its short-term returns are far more variable. Long-term gains, theoretically, are your compensation for enduring short-term ups and downs. Stocks deliver on this, but gold largely doesn’t.

Long term, gold has little utility in a diverse portfolio. Investing successfully in gold requires near-perfect market timing. As Exhibit 1 shows, gold isn’t a very viable long-term investment—with most of its positivity coming in short bursts. After one such burst in the late 1970s and early 1980, gold fell drastically and took 27 years to get back to the pre-drop high. During that span of time, the S&P 500 rose 2,861.7%, a wee bit of opportunity cost for gold holders.[i] Gold posted positive returns in 272 of 498 rolling 12-month periods since 1973, or a 54.6% frequency of positivity.[ii] Stocks rose in 398 of the same 498 rolling 12-month periods—a 79.9% frequency of positivity, crushing gold.[iii] Moreover, fully 132 of gold’s positive 12-month rolling periods came in the 11 years from 2001 – 2012. The hot streak in recent years (before the big gold bust) is probably why so many folks talk up gold these days, but recency doesn’t equal repeatability.  

Commentary

Fisher Investments Editorial Staff
MarketMinder Minute, Monetary Policy

MarketMinder Minute - Not So Negative Interest Rates

By, 05/23/2016
Ratings144.571429

This MarketMinder Minute looks at negative interest rates and what they mean for the global economy.

Commentary

Fisher Investments Editorial Staff
Behavioral Finance

Investing’s Timeless Challenge: Patience

By, 05/20/2016
Ratings344.338235

Birthdays. Anniversaries. Graduations. Bar mitzvahs. Promotions. Eagle scout-hood. Most milestones are a cause for celebration. But this weekend investors face one that doesn’t bring much joy: Saturday officially marks one calendar year since the S&P 500 price index last hit a new high, with the gauge down -4.3% since.[i] That markets have gone a year without producing any gains is frustrating, especially when you consider a primary reason for the flattish returns is the correction in between, which added big volatility and scary headlines to the mix. That one-two punch—volatility with no real rewarding payoff—likely has many wondering what’s in it for them: whether stocks’ volatility risk is worth it. Some pundits aren’t helping either, seeing the lack of upside as a sign the bull market is petering out. But here we’d counsel caution: Both these camps of investors could be setting themselves up to make a behavioral investing error. Past market trends—up, down or sideways—are never predictive of where markets are headed. As difficult as it may be, we humbly suggest now is a time to remain patient and disciplined, as fundamentals suggest the bull market likely has further to run.

First, to get a technicality out of the way: US market returns over the last year are actually a smidge better than mere price levels suggest. Including reinvested dividends (total return), the S&P 500 breeched last May’s levels about a month ago. It’s pulled back slightly since, to sit 2.8% below its new record as we type.[ii] Which raises an interesting point: Since 1926, dividends account for a little less than a third of average annual total returns. But most financial media outlets puzzlingly focus solely on market price levels. It is hugely unlikely you can invest in stocks and not earn a dividend, so a price-only fixation is pretty unrealistic. [iii]

But either way, price or total, returns are still basically flattish—and global stocks are a bit behind US and have not set new highs, dividends or no. However, though it may not seem so, flat (point-to-point) returns—even for periods as long as a year—aren’t all that unusual in bull markets. Typically, like the current one, a bull market correction plays a role.

Commentary

Todd Bliman
Across the Atlantic, Media Hype/Myths

Brexit, and the Creative Art of Misinformation

By, 05/20/2016
Ratings124.333333

Photo by Christopher Furlong/Getty Images.

Recently, Bank of England Governor Mark Carney claimed that if British voters elect to leave the European Union in June 23’s referendum, it will risk recession.

Commentary

Fisher Investments Editorial Staff
Into Perspective, Monetary Policy

Don’t Let the Yield Curve Flatten Your Spirits

By, 05/19/2016
Ratings654.223077

In these allegedly very uncertain times, one constant remains: the perpetually dour media. Headlines fret the state of the global economy daily, cycling through a steady stream of worries. This week, a fear from the recent past—a Fed rate hike—resurfaced, as the April Fed meeting minutes drove speculation Janet Yellen and Co. will hike in June if economic data are strong enough.[i] Perhaps related to shifting expectations of a hike, short-term US Treasury yields have drifted higher lately, spurring jitters over the yield curve flattening. While we have pointed out why rate hikes aren’t inherently bearish a handful of times (ok, many, many, many times), what are investors to make of the developments surrounding the yield curve, a forward-looking indicator we frequently refer to? Though the yield curve has indeed flattened a bit in 2016, that doesn’t automatically set the US economy up for a tumble, either.  

First, a refresher: The yield curve refers to the distribution of bond yields across all maturities from one borrower. The spread is the difference between long-term and short-term rates, which also serves as a proxy for loan profitability for banks. Banks’ core business is to borrow short (e.g., deposit accounts) to fund longer-term loans (e.g., mortgages, car loans, etc.), so the more long-term rates exceed short, the more money the bank would make. Hence, a positive spread would likely encourage banks to lend to capture the profit, and more plentiful capital stimulates economic growth.

Typically speaking, yield curves are positively sloped because longer-maturity loans mean the lender is exposed to risks for longer and rationally demands higher rates to compensate. However, that isn’t always true. An inverted yield curve—when it costs more to borrow short than long—indicates something isn’t right in credit markets and that weak economic conditions may be forthcoming. A flat yield curve lies somewhere in between—banks may be a bit more hesitant to lend, given they are paid less for the risk they take, but it still wouldn’t necessarily be unprofitable to do so. The importance of the yield curve to future growth is why The Conference Board’s forward-looking Leading Economic Index (LEI) uses the interest rate spread of 10-year Treasurys less federal funds—it provides a telling sign about the upcoming economic environment. So what are folks fretting about today?     

Commentary

Fisher Investments Editorial Staff
GDP, Media Hype/Myths

Quick Hit: A Few Bullet Points to Shoot Down Lingering Eurozone Fears

By, 05/18/2016
Ratings524.086538

Last week, the 19-nation eurozone reported revised Q1 2016 GDP growth, which showed growth ticked down from the preliminary estimate of 0.6% q/q (2.2% annualized) to 0.5% q/q (2.1% annualized). The media reaction, as it is with most things including the words “eurozone” and “economy,” was dour. Some bemoaned that only now had the eurozone “scraped” back to pre-crisis GDP levels. Others suggest this uptick is likely fleeting and too reliant on Germany. Others claim the eurozone crisis is just on pause. Still others remain fixated on the fact eurozone CPI was in negative territory in April, fretting a deflationary spiral looms. But a negative take on a growing eurozone is really nothing new. So let’s look at the data and assess whether there is really so much to be dour about.

Here are a few quick factoids and charts:

  • With 2.1% annualized growth in Q1, the eurozone grew faster than Japan (1.7%), the UK (1.6%) and US (0.5%).[i] Now, the eurozone posting the fastest growth rate of the four major developed economies isn’t the trend and we don’t expect it to continue, but it is worth noting.. Eurozone GDP, as noted above, has grown in 12 straight quarters and has now eclipsed pre-2008 levels.[ii]

Exhibit 1: Eurozone GDP at an All-Time High

Commentary

Fisher Investments Editorial Staff
GDP, Forecasting, Media Hype/Myths, Reality Check

The ‘Retail Recession’ Label Doesn’t Fit

By, 05/13/2016
Ratings1054.261905

It was some department stores’ turn in the Q1 2016 earnings season spotlight this week, and to say their results were weak understates the media reaction pretty dramatically. Declining sales and profits led to cries the US is in a “retail recession” and assertions the consumer is tapped out—bad signs for US growth looking forward. But we’d humbly suggest that is incorrect. A recession is a broad-based decline in economic output. This is more a story of narrow, virtually anecdotal data points and a shift in shopping habits—away from department stores and towards online and specialty retailers. Despite some retailers’ recent woes, there is ample evidence US consumers are in fine shape, and that the economy is not headed for recession anytime in the foreseeable future.

On Wednesday, Macy’s reported Q1 sales fell over -7% y/y while earnings tumbled -29% y/y. The following day, Kohl’s said Q1 year-over-year revenues fell more than expected and earnings slid -50%. The carnage continued after market close on Thursday when Nordstrom reported Q1 earnings contracted -61% y/y, badly missing estimates (though sales grew about 1%). All lowered their guidance for full 2016 results. Friday, JC Penney joined the “party,” also posting poor results.

To hear the media tell it, this is a sign consumers are materially tightening their belts. And, with consumer spending accounting for roughly 70% of US GDP, they suggest it signals a weak economy—and maybe an approaching recession. That narrative, however, is based on only a handful of companies, and is pretty darn odd when you square it up against broader economic data like, we dunno, US retail sales. April’s data happened to be reported Friday, and beat estimates with 1.3% m/m growth (3.0% y/y). And, as Exhibit 1 shows, this isn’t a new thing—retail sales are growing at a fine clip, which is especially clear when you remove the negative influence of falling gas prices by excluding gas station sales. (Which reversed in March and April.)

Commentary

Fisher Investments Editorial Staff
Politics, Inconvenient Truths, Media Hype/Myths

History Shows Election Nerves Don’t Stress Stocks

By, 05/13/2016
Ratings564.348214

Are US politics going to make this a cruel summer for stocks? Speculation about November’s US presidential election has ramped up now that some uncertainty has faded. Donald Trump is the presumptive GOP nominee and Hillary Clinton holds a commanding delegate lead on the Democratic side. Pundits are doing pundit-y things,[i] from postulating about hypothetical matchups to speculating about what the potential winner will do once in office. There is also lots of chatter about what the near-term market impact will be, with some arguing that the closer we get to the election, the greater uncertainty will be—roiling stocks. However, this is largely backward. History shows stocks don’t usually stumble as elections near. Instead, uncertainty falls as the election approaches and markets gain more insight on both candidates, getting used to the idea of either as president. Falling uncertainty is often a bullish force as the election nears. That doesn’t mean stocks are certain to do great this summer and autumn—we don’t make short-term forecasts—but it is powerful evidence they shouldn’t automatically suffer.

The “pre-election = volatility” crowd believes the campaign trail’s noise will raise uncertainty and fear about what either candidate will do once in office. However, this presumes markets will automatically hate everything candidates say—a sign of bias. While a ton of pundits analyze and speculate about what politicians say, these takes are opinions, not facts. And in an election year, political opinions bombard folks from every direction—the TV, the Internet, the newspaper and in regular day-to-day conversation.

Investors may be forgiven if they find themselves overwhelmed by all the noise, but the notion stocks are similarly unnerved isn’t quite right. While in the ultra-short term, talk can stoke volatility, the sheer volume of political noise also means basically every political opinion and take gets priced in. One person’s political feelings are unlikely to be radically unique or surprising—and surprises move markets. Moreover, everything discussed on the campaign trail for Democrats and Republicans alike is part of markets’ discovery process, which clears up question marks about the candidates. Stocks hate uncertainty above all else, and every little nugget about what Candidate X argues or Candidate Y focuses on chips away at that uncertainty.  

Commentary

Fisher Investments Editorial Staff
Media Hype/Myths

How to Lie With Statistics: Election-Year Stock Returns

By, 05/12/2016
Ratings654.238461

How will 2016’s election impact stocks?

We’ve seen a wealth of speculation in recent weeks, much of it purportedly based on market history—and much of it wrong. Here are three of the biggest fallacies:

All exemplify what Darrel Huff called “lying with statistics” in his seminal 1954 book, whose title we borrowed for this article. Some use limited datasets with averages skewed by extreme outliers. Others cherry-pick broken indexes like the Dow or ignore dividends. It all amounts to misinformation, and none of it is actionable for investors.

Commentary

Fisher Investments Editorial Staff
Into Perspective, Monetary Policy

Don’t Let the Yield Curve Flatten Your Spirits

By, 05/19/2016
Ratings654.223077

In these allegedly very uncertain times, one constant remains: the perpetually dour media. Headlines fret the state of the global economy daily, cycling through a steady stream of worries. This week, a fear from the recent past—a Fed rate hike—resurfaced, as the April Fed meeting minutes drove speculation Janet Yellen and Co. will hike in June if economic data are strong enough.[i] Perhaps related to shifting expectations of a hike, short-term US Treasury yields have drifted higher lately, spurring jitters over the yield curve flattening. While we have pointed out why rate hikes aren’t inherently bearish a handful of times (ok, many, many, many times), what are investors to make of the developments surrounding the yield curve, a forward-looking indicator we frequently refer to? Though the yield curve has indeed flattened a bit in 2016, that doesn’t automatically set the US economy up for a tumble, either.  

First, a refresher: The yield curve refers to the distribution of bond yields across all maturities from one borrower. The spread is the difference between long-term and short-term rates, which also serves as a proxy for loan profitability for banks. Banks’ core business is to borrow short (e.g., deposit accounts) to fund longer-term loans (e.g., mortgages, car loans, etc.), so the more long-term rates exceed short, the more money the bank would make. Hence, a positive spread would likely encourage banks to lend to capture the profit, and more plentiful capital stimulates economic growth.

Typically speaking, yield curves are positively sloped because longer-maturity loans mean the lender is exposed to risks for longer and rationally demands higher rates to compensate. However, that isn’t always true. An inverted yield curve—when it costs more to borrow short than long—indicates something isn’t right in credit markets and that weak economic conditions may be forthcoming. A flat yield curve lies somewhere in between—banks may be a bit more hesitant to lend, given they are paid less for the risk they take, but it still wouldn’t necessarily be unprofitable to do so. The importance of the yield curve to future growth is why The Conference Board’s forward-looking Leading Economic Index (LEI) uses the interest rate spread of 10-year Treasurys less federal funds—it provides a telling sign about the upcoming economic environment. So what are folks fretting about today?     

Commentary

Fisher Investments Editorial Staff
GDP, Media Hype/Myths

Quick Hit: A Few Bullet Points to Shoot Down Lingering Eurozone Fears

By, 05/18/2016
Ratings524.086538

Last week, the 19-nation eurozone reported revised Q1 2016 GDP growth, which showed growth ticked down from the preliminary estimate of 0.6% q/q (2.2% annualized) to 0.5% q/q (2.1% annualized). The media reaction, as it is with most things including the words “eurozone” and “economy,” was dour. Some bemoaned that only now had the eurozone “scraped” back to pre-crisis GDP levels. Others suggest this uptick is likely fleeting and too reliant on Germany. Others claim the eurozone crisis is just on pause. Still others remain fixated on the fact eurozone CPI was in negative territory in April, fretting a deflationary spiral looms. But a negative take on a growing eurozone is really nothing new. So let’s look at the data and assess whether there is really so much to be dour about.

Here are a few quick factoids and charts:

  • With 2.1% annualized growth in Q1, the eurozone grew faster than Japan (1.7%), the UK (1.6%) and US (0.5%).[i] Now, the eurozone posting the fastest growth rate of the four major developed economies isn’t the trend and we don’t expect it to continue, but it is worth noting.. Eurozone GDP, as noted above, has grown in 12 straight quarters and has now eclipsed pre-2008 levels.[ii]

Exhibit 1: Eurozone GDP at an All-Time High

Commentary

Fisher Investments Editorial Staff
GDP, Forecasting, Media Hype/Myths, Reality Check

The ‘Retail Recession’ Label Doesn’t Fit

By, 05/13/2016
Ratings1054.261905

It was some department stores’ turn in the Q1 2016 earnings season spotlight this week, and to say their results were weak understates the media reaction pretty dramatically. Declining sales and profits led to cries the US is in a “retail recession” and assertions the consumer is tapped out—bad signs for US growth looking forward. But we’d humbly suggest that is incorrect. A recession is a broad-based decline in economic output. This is more a story of narrow, virtually anecdotal data points and a shift in shopping habits—away from department stores and towards online and specialty retailers. Despite some retailers’ recent woes, there is ample evidence US consumers are in fine shape, and that the economy is not headed for recession anytime in the foreseeable future.

On Wednesday, Macy’s reported Q1 sales fell over -7% y/y while earnings tumbled -29% y/y. The following day, Kohl’s said Q1 year-over-year revenues fell more than expected and earnings slid -50%. The carnage continued after market close on Thursday when Nordstrom reported Q1 earnings contracted -61% y/y, badly missing estimates (though sales grew about 1%). All lowered their guidance for full 2016 results. Friday, JC Penney joined the “party,” also posting poor results.

To hear the media tell it, this is a sign consumers are materially tightening their belts. And, with consumer spending accounting for roughly 70% of US GDP, they suggest it signals a weak economy—and maybe an approaching recession. That narrative, however, is based on only a handful of companies, and is pretty darn odd when you square it up against broader economic data like, we dunno, US retail sales. April’s data happened to be reported Friday, and beat estimates with 1.3% m/m growth (3.0% y/y). And, as Exhibit 1 shows, this isn’t a new thing—retail sales are growing at a fine clip, which is especially clear when you remove the negative influence of falling gas prices by excluding gas station sales. (Which reversed in March and April.)

Commentary

Fisher Investments Editorial Staff
Politics, Inconvenient Truths, Media Hype/Myths

History Shows Election Nerves Don’t Stress Stocks

By, 05/13/2016
Ratings564.348214

Are US politics going to make this a cruel summer for stocks? Speculation about November’s US presidential election has ramped up now that some uncertainty has faded. Donald Trump is the presumptive GOP nominee and Hillary Clinton holds a commanding delegate lead on the Democratic side. Pundits are doing pundit-y things,[i] from postulating about hypothetical matchups to speculating about what the potential winner will do once in office. There is also lots of chatter about what the near-term market impact will be, with some arguing that the closer we get to the election, the greater uncertainty will be—roiling stocks. However, this is largely backward. History shows stocks don’t usually stumble as elections near. Instead, uncertainty falls as the election approaches and markets gain more insight on both candidates, getting used to the idea of either as president. Falling uncertainty is often a bullish force as the election nears. That doesn’t mean stocks are certain to do great this summer and autumn—we don’t make short-term forecasts—but it is powerful evidence they shouldn’t automatically suffer.

The “pre-election = volatility” crowd believes the campaign trail’s noise will raise uncertainty and fear about what either candidate will do once in office. However, this presumes markets will automatically hate everything candidates say—a sign of bias. While a ton of pundits analyze and speculate about what politicians say, these takes are opinions, not facts. And in an election year, political opinions bombard folks from every direction—the TV, the Internet, the newspaper and in regular day-to-day conversation.

Investors may be forgiven if they find themselves overwhelmed by all the noise, but the notion stocks are similarly unnerved isn’t quite right. While in the ultra-short term, talk can stoke volatility, the sheer volume of political noise also means basically every political opinion and take gets priced in. One person’s political feelings are unlikely to be radically unique or surprising—and surprises move markets. Moreover, everything discussed on the campaign trail for Democrats and Republicans alike is part of markets’ discovery process, which clears up question marks about the candidates. Stocks hate uncertainty above all else, and every little nugget about what Candidate X argues or Candidate Y focuses on chips away at that uncertainty.  

Commentary

Fisher Investments Editorial Staff
Media Hype/Myths

How to Lie With Statistics: Election-Year Stock Returns

By, 05/12/2016
Ratings654.238461

How will 2016’s election impact stocks?

We’ve seen a wealth of speculation in recent weeks, much of it purportedly based on market history—and much of it wrong. Here are three of the biggest fallacies:

All exemplify what Darrel Huff called “lying with statistics” in his seminal 1954 book, whose title we borrowed for this article. Some use limited datasets with averages skewed by extreme outliers. Others cherry-pick broken indexes like the Dow or ignore dividends. It all amounts to misinformation, and none of it is actionable for investors.

Commentary

Fisher Investments Editorial Staff
Forecasting

The Long and Short of Long-Term Forecasts

By, 05/11/2016
Ratings1114.315315

 
Do stocks face a bleak future? Photo by RubberBall Productions/Getty Images

Headlines questioning stocks’ long-term growth potential abound lately, and many reach the same conclusion: Investors should expect subpar returns for decades. The last 30 or so years were an aberration, they say, and the party is over. Here’s a word of advice: Beware all long-term forecasts, good or bad, as they are merely fallacies masquerading as research. Moreover, they are meaningless for markets, which don’t look more than 30-ish months ahead. As our boss, Ken Fisher, wrote in his 2015 book, Beat the Crowd, “Anything further out is sheer guesswork—possibilities, not probabilities, and markets move on probabilities.”

One recent study by the McKinsey Global Institute typifies the error, claiming “exceptional economic and business conditions” in the US and Europe over the last 30 years drove stock and bond returns above their hundred-year averages, and we’re about to go back to “normal”—lower—for the next two decades. It’s full of models and math, lending an air of precision. But it isn’t airtight. Nothing looking that far ahead can be. It’s impossible to say what the world will look like 20 years from now. For evidence, look to an array of other attempts to divine the distant economic future: fears of peak oil; the Congressional Budget Office’s projections; the famous “Dow 35000” call—we could go on. All had “data” supporting them; all seemed plausible given the zeitgeist of the day. None were right. Not all are this off-base, but these examples show long-term forecasting’s pitfalls.

Research Analysis

Pete Michel
Into Perspective

Why Bond Market Liquidity Fears Don’t Hold Much Water

By, 09/22/2015
Ratings933.956989

Market liquidity is usually a pretty banal subject, garnering little attention. But in the last year,  it has gone from being a dry afterthought to being the subject of frequent articles claiming it’s a major concern, particularly in the bond markets. So much so, that Bloomberg’s Matt Levine had a running section of his daily link wrap titled, “People Are Worried About Bond Market Liquidity” for months and rarely ran low on articles to share. It is now bigger news when there aren’t “People Worried About Bond Market Liquidity!” So what is market liquidity, and are the recent fears justified—or overblown?

Market liquidity refers to how easily an asset can be bought or sold without dramatically impacting the price or incurring large costs. It’s a defining feature separating asset classes, a key consideration for investors. Some financial assets, like listed stocks, are easy to buy or sell with little price impact and small commissions—they’re “liquid.” Conversely, commercial real estate takes time to sell and likely includes high commissions and significant negotiations—it is “illiquid.” For most investors, particularly those with potential cash flow needs, liquidity is an important facet of any investment strategy.

Bonds are among the more liquid investments available for investors, though liquidity varies among different types. Treasurys, among the deepest markets in the world, are highly liquid. Corporates and municipals are less so, and some fancier debt is actually quite illiquid.

Research Analysis

Scott Botterman
Into Perspective

Greek Contagion Risk Is Minimal

By, 08/11/2015
Ratings274.703704

Flags fly in front of the Parthenon in Athens. Photo by Bloomberg/Getty Images.

After five years of Greek crisis, two defaults and going-on three bailouts, many still fear a contagion across the eurozone. While default and “Grexit” risk persist, the risk of a contagion has fallen significantly over the last few years. The eurozone economy is improving, foreign banks hold less Greek debt, bank deposits aren’t fleeing other peripheral nations, and euroskeptic parties poll well behind traditional parties across the eurozone.  Greece’s problems are contained and shouldn’t put the broader eurozone at risk.

Research Analysis

Fisher Investments Editorial Staff
Reality Check

Quick Hit: ‘Corporate Profits Recession’ and Stocks—There Is No ‘There!’ There

By, 03/27/2015
Ratings364.069445

In Friday’s third revision to Q4 US GDP growth, one thing that seemed to catch a few eyeballs was a drop in US Corporate Profits[i], which some hyperbolically labeled “the worst news.” Others claim a “profit recession”—whatever that means—looms. But here is the thing: A down quarter for corporate profits is not unusual amid a bull market. Here are two charts to illustrate the point. The first shows the Bureau of Economic Analysis’ measure of corporate profits excluding depreciation. The second includes depreciation. The gray bars indicate bear markets and the blue dots denote a negative quarter of profits in a bull market. As you can see, such dips aren’t exactly rare and occur at random points throughout a bull market and expansion.   

Exhibit 1: US Corporate Profits After Tax Without Inventory Valuation and Capital Cost Adjustment

Research Analysis

Scott Botterman
Into Perspective

European Parliament Elections—Setting Expectations

By, 05/23/2014
Ratings493.295918

Thursday marked the beginning three days of voting across the 28 EU nations in the first European Parliamentary (EP) elections since 2009. Also, the first pan-EU elections since the eurozone’s debt crisis and 18-month long recession that ended in mid-2013. When the polls close, voters are expected to add more euroskeptics—members of parties favoring less federalism and, in some cases, leaving the euro. With euro jitters still lingering in the background, some suspect this will rekindle breakup fears anew. However, polls suggest euroskeptics gain some ground but fail to shift power away from more traditional European political parties. The movement toward a more integrated Europe likely continues and, with it, support for the common currency likely remains strong. Should polls hold true, the biggest influence I believe the euroskeptics may have is pressuring the pro-euro groups on economic policy.

European Union Government

  • European Council: Heads of each EU member state with no formal legislative power. The Council defines general EU political directions (and addresses crises).
  • European Commission (EC): Executive body of the EU, consisting of a President (elected by the European Parliament) and 27 commissioners selected by the European Council and the EU President. They are responsible for proposing legislation, implementing decisions and addressing day-to-day EU operations.
  • European Parliament (EP): Directly elected legislative body of the European Union (five-year terms). The EP is an approval body. They do not initiate legislation, instead voting on and amending European Commission proposals. The EP directly elects the European Commission President and confirms the European Commission after its formation.

There will be slight structural differences in Parliament, regardless of the voting. Between 2009’s election and this year’s, the EU ratified the Lisbon Treaty, altering the structure of the body, modestly reducing the influence of larger nations like Germany. The EP will consist of 751 seats, 15 fewer than before. Representation will still be based on population, but with certain caveats. The Lisbon Treaty caps each member state at a maximum of 96 and mandates a minimum of six seats to all. This will automatically reduce Germany’s standing from the present Parliament and slightly boost the power of small EU nations. However, national distribution isn’t really at issue in the race. It’s much more about pro-euro versus euroskeptic.

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What We're Reading

By , The Wall Street Journal, 05/24/2016

MarketMinder's View: A classic critique of stock buybacks is that they soak up money that could otherwise go towards investment in growing the company, boosting future earnings. This article notes a key flaw in this model: New capital expenditures aren’t always the best use of cash reserves. “[W]hen shareholders cheer on corporate investment, it is worth paying close attention to the risk that they are merely driving up competition and so driving down future profitability.” Many Energy firms, for example, sunk profits into new drilling and exploration projects, only to see prices plummet. This is how markets work: In any industry, firms risk getting too far out over their skis. The lure of future profits drives investment, firms raise production (supply), they overshoot, and trouble follows. Plowing cash reserves back into a business isn’t a sure ticket to ever-higher profits. Buybacks, by contrast, return profits to shareholders to reinvest elsewhere, perhaps to more efficient near-term ends.

By , MarketWatch, 05/24/2016

MarketMinder's View: None of these seven items is a sign of a bear market—they are just things, interesting observations and nothing more. Let’s go in order: 1) Stocks have risen despite, not because of the Fed’s actions, which flattened the yield curve (a headwind) for most of this bull market, and a hypothetical rise from today’s ultra-low short-term rates lacks the power to curtail the bull market. 2) Earnings are skewed downwards by Energy’s ongoing weakness, long priced into markets and lacking an economy-wide punch. Profits continue growing in key sectors like Health Care and Consumer Discretionary, and excluding Energy, S&P 500 revenues are rising. 3) Small business confidence is backward-looking, influenced by recent economic data like below-average Q1 earnings and GDP numbers. 4) Same goes for consumer confidence. Plus, recent strong retail sales show consumers often say one thing and do another. 5) GDP is also backward-looking, and slowdowns in Q1 2014 and 2015 didn’t last. 6) Mutual fund flows tell only half the story. Money leaving funds could easily have gone into individual stocks. Moreover, every share sold is by definition a share bought. There is no such thing as money flooding out of the market. It’s an auction market, folks. 7) Uncertainty over other factors like the Brexit referendum and US presidential election is just that—uncertainty. As these events approach, doubt should diminish, fueling stocks. All in all, bearish lists like this one are actually positive, as they show investors’ skeptical state: Even modestly positive news can surpass low expectations.

By , Reuters, 05/24/2016

MarketMinder's View: This article is less about one day’s price movement and more about the very widespread expectations for oil supply to falter, boosting prices. Indeed, it seems like oil market disruptions are everywhere: Wildfires in Canada hit production, port closures in Libya reduced shipments and strikes in France are hampering refineries. Might these forces finally push oil supply down and prices up? Not so fast—the disruptions are one-offs, and supply increases elsewhere should counterbalance them. As the fires abate, Canadian oil facilities are coming back online; Libyan oil exports started up again on Friday; and French labor unrest should also prove temporary. Meanwhile, local officials in North Yorkshire approved the UK’s first fracking project in five years, potentially further boosting output down the road. With OPEC still unable (or unwilling) to freeze production and US producers standing ready to add capacity if prices go up, we think it’s still too soon to expect oil’s rise.

By , Bloomberg, 05/24/2016

MarketMinder's View: We award a point for debunking a very silly toy model of the Fed’s influence over markets (Fed threatens rate hike --> stocks fall --> Fed delays hike --> stocks happy --> repeat), but we deduct it for the odd methodology. It takes the top 20 single-day moves in the S&P 500 over the last year, looks at the headline of one publication’s daily market wrap-up, observes the Fed isn’t mentioned, and concludes the Fed had no impact. This misses a couple things: First, Fed meetings are some of the most talked-about events in finance. Markets have plenty of time to dissect all the jawboning leading up to each and price in the likely outcome. Second, nailing down the impetus behind any single day’s stock movements is usually mere guesswork. Simply slapping together a daily gain or loss with the hot topic of the day doesn’t prove a connection, much less causation. Third, what about the many other days besides those 20? Investors should keep a broader view: Early rate hikes in a tightening cycle have no history of killing bull markets, and yield curve remains positively sloped, encouraging bank lending. Close readings of day-to-day headlines and stock fluctuations merely muddy the waters.

Global Market Update

Market Wrap-Up, Tuesday, May 22, 2016

Below is a market summary as of market close Tuesday, May 22, 2016:

  • Global Equities: MSCI World (+1.1%)
  • US Equities: S&P 500 (+1.4%)
  • UK Equities: MSCI UK (-0.7%)
  • Best Country: Italy (+2.9%)
  • Worst Country: Japan (-1.4%)
  • Best Sector: Information Technology (+1.8%)
  • Worst Sector: Materials (+0.2%)

Bond Yields: 10-year US Treasury yields rose 0.02 percentage point at 1.86%.

 

Editors' Note: Tracking Stock and Bond Indexes

 

Source: Factset. Unless otherwise specified, all country returns are based on the MSCI index in US dollars for the country or region and include net dividends. Sector returns are the MSCI World constituent sectors in USD including net dividends.