Commentary

Fisher Investments Editorial Staff

Growth Abounds All Around

By, 07/31/2014

Q2 GDP is trickling in from around the world, and the early results shatter the notion of a weakening world. Forward-looking data show growth likely continues—and continues supporting the bull.

US Q2 2014 GDP grew at a 4.0% seasonally adjusted annual rate, rebounding from Q1’s (revised) -2.1% weather-driven drop. Growth was broad-based—as Exhibit 1 at the bottom of this page shows, every major category except net exports contributed positively, and even that dip isn’t bad news (more on that momentarily). Most welcomed goosy growth, but a loud minority pointed to the 1.66 percentage points inventories added to growth and claimed the feat is unlikely to repeat—growth isn’t sustainable. Perhaps inventories’ rise doesn’t continue. It likely was partly a reversal of Q1’s weather-related slide. If factory power outages and iced-over shipping routes force firms to strip shelves to meet demand in one quarter, they’ll probably restock the next. That isn’t weakness—just logic. If this were the only factor driving growth, we’d be iffy. But even if you subtract inventories, growth was fine. 

To see this, consider Q2 trade. Yep, we know, net exports detracted 0.61 percentage point. But that skewed measure treats rising imports, a sign of healthy demand, as a negative. In the quarter, imports rose a whopping 11.7%, shaving 1.85 percentage points off headline growth. Demand! Export growth wasn’t too shabby, either, at 9.5%. This may be revised—trade data are incomplete in the first read. But consumption may be revised, too—health care spending was noted as adding only 0.08 percentage point in Q2—small, considering Q1 showed Affordable Care Act policy subscriptions and associated medical treatment were likely pushed back by technical difficulties (and this wasn’t apparent until the third reading).

Commentary

Fisher Investments Editorial Staff

The Myth of the Monetary Airbag

By, 07/30/2014

Are central banks protecting markets from reality? Some argue yes, with loose monetary policy an airbag against a geopolitical-tension driven crash. Yet market history argues otherwise: Regional conflicts regularly have fleeting market impact, whatever the monetary policy may be at the time. 

The concern is understandable, considering 2014’s events thus far. Ukraine has descended into war, with “pro-Russian” separatists going so far as to shoot down Malaysia Airlines Flight MH 17. The terrorist group Islamic State of Iraq and al-Sham ignited war in Iraq, tearing through the country’s northwest in June. Violence between Israel and Hamas has escalated. In the past several months, Russia annexed the Crimea, the Thai military staged a coup d’état, and a Chinese vessel sank a Vietnamese fisherman’s boat in the South China Sea leading to a water gun fight on a naval scale. Not to mention continuing past stories, like the Syrian War and hot rhetoric in East Asia from China, Japan and North Korea blowing some more fish to smithereens with a missile test. Yet for the year, global markets are up 6.3%.[i]

Many folks may wonder, “Why are markets so blasé toward these events? Are they—gasp—unaware? Do markets not correctly see the severity of war?” Of course they do! But they also know regional tensions and violence don’t grind the global economy to a screeching halt. In most of the world, normal life goes on. Maybe folks are more concerned and monitor the news closer. But the economy doesn’t stop. In this five-year old bull market alone, tensions have flared from Egypt and Syria to Tunisia and Sudan, along with plenty of threats for more—yet stocks continue running higher.

Commentary

Fisher Investments Editorial Staff
Media Hype/Myths

What a Real Bubble Looks Like

By, 07/29/2014
Ratings763.868421

Headlines are back on bubble watch, and they’re as hysterical as ever: “We’re in the Third Biggest Stock Bubble in US History.” “Yes, This Is a Bubble (and It May Be Worse Than 1929).” “Say Hello to US Economy’s Newest Bubble” (the stock market). With the S&P 500 nearing 2000 and P/Es rising, it might seem like the bubble-bears are right. Yet rising prices alone don’t make a bubble—true bubbles happen when sentiment is off-the-charts euphoric. When folks rationalize higher prices by saying reality has changed—it’s different this time, so it’s ok. We don’t see this today. Stocks are in a big bull market, and in our view, there is nothing bubbly about it.

In a real bubble, charts won’t compare today to 1929. Pundits won’t complain a near-average (or below) P/E is too high. Or worry a rate hike will knock stocks. Instead, pundits will say “it’s different this time” to explain why high P/Es are a-ok. They’ll say risk is over. We’re in a new age where things are only ever good, they’ll claim.

This probably sounds weird—how could today’s negative media turn so sunny? But we’ve seen it before. In early 2000, this euphoria—irrational exuberance, if you will—was everywhere. Here are some examples, courtesy of The New York Times’ archive. These types of articles were everywhere, but the Times has the most robust, easily searchable archive of all the major publications, so we took advantage.

Commentary

Fisher Investments Editorial Staff
Into Perspective, Media Hype/Myths

More Bulls to Come

By, 07/28/2014
Ratings174.411765

If you’ve missed stocks’ rally since 2009, have you missed your chance for long-term growth? Some say yes, arguing this bull is swiping gains from the next 10 to 30 years. But in our view, that ignores the many positives supporting stocks today, and it underestimates markets’ long-term potential. In our view, stocks’ future is much brighter than many believe. 

To assume this bull market’s gains are stolen from the future assumes markets today are pricing in what will happen over the next decade or three. But this isn’t how markets work. Short-term wiggles aside, markets move on investors’ expectations for the foreseeable future—12-18 months out. Anything further in the future is too unknowable. Stocks are incapable of valuing matters decades from now.

This isn’t just theoretical. Market movement comes from millions of people’s trading decisions—all based on their own beliefs, opinions, knowledge and expectations. With perhaps a few exceptions[i], those are based on what they know at any time. Consider the swingin’ 60s bull: by the “stocks are stealing” logic, stocks then might have priced in the tech boom. But how could markets discount the Internet when computers were bigger than your fridge, PCs weren’t even science fiction and calling long distance was a pricey hassle? What about the 1974-1980 bull market? If you believe stocks are stealing from the far future today, you’d have to accept stocks priced in the shale boom back then. At a time when people panicked over falling oil supply due to the Mideast embargo and most assumed US oil production was entering perma-decline? Rule 1: If stocks can’t see it, they can’t price it.

Commentary

Fisher Investments Editorial Staff

Around the World in 80 Datapoints (Or Thereabouts)

By, 07/25/2014
Ratings923.652174

In our continuing effort to cover matters most of the financial press has abandoned in favor of all things geopolitical, here is a look around the wonderful world of recent global economic indicators. Tensions might be above the boiling point in the world’s conflict zones, but across the rest of the globe, life is going on—and the latest data show the world economy is still growing.

Eurozone Flash July Composite Purchasing Managers’ Index (PMI), the first reading on the 18-nation bloc’s manufacturing and services industries, jumped to 54, accelerating from June’s 52.8 and the 13th consecutive month of growth. Analysts expected another 52.8 read. Now, if you are new to fun things like Eurozone Flash Composite PMI, here is a brief tutorial of what all those fancy-sounding words mean. PMI is merely a survey. Markit, the organization that publishes many of these gauges, polls businesses in a particular region (5,000 in the case of the eurozone) and asks them a series of questions about how business went in the month. It’s all later cobbled together and voila, you get a reading. That reading is the percentage of firms that reported growth, so above 50 is supposedly growthy because more than half of firms reported expanding activity. It’s imperfect, of course, because that doesn’t tell you the magnitude of output or orders, but it’s worthwhile to note anyway. “Flash” is used as in “Out in a…” because the Flash PMI readings are the preliminary ones. How do they get these Flash readings out so lightning quick? They use an incomplete series of data, of course! Finally, the “eurozone” is the 18-nation[i] bloc of countries sharing the euro as their currency and the ECB as their central bank, which you probably already knew. These early data center on Germany and France. German services and manufacturing grew, while French data were mixed, with manufacturing slightly down, while services grew slightly. The press focused more on France.

The HSBC/Markit China Flash Manufacturing PMI showed growth accelerated as well, to an 18-month high. The gauge registered 52.0 in July, topping analysts’ estimates of 51.0 and accelerating from June’s 50.7. All the same caveats from above apply here, and arguably even more so. The HSBC/Markit Flash Manufacturing PMI gauge includes neither China’s larger industry group (services) nor the large state-run firms that dominate manufacturing. China’s “official” PMI covers the latter, but it wasn’t published this week, so we can’t include it. But this gauge can tell you a thing or two about sentiment, as it did last month when the first reading above 50 met weird statements alluding to a Chinese economic “recovery”—all while most Chinese economic data series are growing at high single-digit percentage rates.

Commentary

Fisher Investments Editorial Staff
Into Perspective

The SEC Does Some Things to Money Market Funds

By, 07/24/2014
Ratings363.527778

The SEC finished overreacting to a side effect of Lehman Brothers’ bankruptcy on Wednesday, passing long-awaited reforms of money market funds. As with most of the regulatory moves aimed at preventing a repeat of 2008, the new rules (and the nearly six-year debate preceding them) are largely an exercise in futility, but as far as unintended consequences go, we’ve seen worse. They might not make the financial system “safer,”[i] as some have suggested, but they shouldn’t materially impact retail investors or the many corporations who rely on these funds for financing.

For those who haven’t followed closely (and we envy you), the saga started on September 16, 2008, the day after Lehman’s bankruptcy, when a $62 billion money market fund called Reserve Primary “broke the buck.” Or, translated from bankerspeak, its share price fell below $1. Most folks think this shouldn’t happen to a money market fund, which is designed to be a higher-yielding cash alternative. But money funds get this higher yield by investing in a smorgasbord of short-term debt, including T-bills, commercial paper (short-term debt issued by banks and other firms) and repurchase agreements. Which all carry at least some risk. And Reserve Primary—which, despite its name, was not run or guaranteed by the Federal Reserve—owned some commercial paper from Lehman. Which, naturally, tanked after Lehman went bankrupt, driving Reserve Primary’s share price down to 97 cents.

Times of panic being what they were, investors freaked and fled—even “cash” wasn’t safe! The run spread throughout the money market fund universe, threatening to freeze corporate financing and ultimately forcing the Fed to backstop the entire industry. Soon after, with bailouts widely seen as a scourge on society, regulators started knocking heads to figure out how to keep this from happening ever again.

Commentary

Fisher Investments Editorial Staff
Emerging Markets, Reality Check

Are the Reds in the Red?

By, 07/23/2014
Ratings314.258065

China debt jitters made a comeback Tuesday, on the heels of a report claiming the country’s debt to GDP ratio hit a lofty 251% at the end of June. Cue the clamor over the world’s second-largest economy over-extending itself, with hypothetical outcomes ranging from hard-landing to global meltdown. In our view, though, this is a classic case of headlines overreacting to what is some fairly benign Chinese data—we won’t argue China is in perfect fiscal shape, but this statistic doesn’t spell doom for China or the world. 

Details, as ever, are key. “Debt,” in this case, isn’t just government debt, which is most folks’ default (sorry) interpretation of “debt to GDP.” This figure includes all credit, public and private—traditional bank loans, corporate bonds and various shadow banking debt in addition to local, regional and federal government debt. Combining all these and trying to find some big takeaway about a country’s health, as you might intuit, is rather bizarre—the banking system isn’t the state isn’t the companies isn’t the people. Even in a People’s Republic. The notion any country’s outstanding credit hitting some arbitrary level is a snowball of financial problems ready to roll down the mountain is a tad misplaced. That’s abundantly evident if you compare China with the rest of the world. Based on this report’s data, at the end of 2013, South Korea’s debt was just north of 200% of GDP, Germany’s was a tad under, the US was at about 260%, and the UK was at 277% (and Japan, being Japan, shocked no one at 415%). Which all makes China look fairly normal—and not exactly at-risk, considering these countries are all growing, albeit to varying degrees, and not on the verge of debt crises. Japan might be a global laggard, but this statistic isn’t why.

But, some object, China is different! It isn’t as developed, and all that debt was really leverage to make things grow faster—and with that model petering out, China is “indebted before it has become rich,” leaving it extra vulnerable to slowdown and shock. There is a kernel of truth here—China’s debt-fueled stimublitz in 2008 and 2009 drove gangbusters growth, but it also left a supply glut in its wake. The steel, shipping and real estate industries are still dealing with the aftermath. However, the assumption this oversupply is a debt-fueled sinkhole is pretty misplaced. Consider the most widely cited example of excess, those fabled “ghost cities.” Those are largely there to accommodate the next wave of urbanization, which policymakers are pursuing aggressively. This is all very much a work-in-progress, which those taking a surface level view at China’s finances generally don’t see.

Commentary

Fisher Investments Editorial Staff
Market Risks

Growing Up With Dodd-Frank

By, 07/22/2014
Ratings393.871795

Four years ago Monday, President Obama put his John Hancock on the biggest package of financial sector regulation since the Great Depression: The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Champions hailed it as a too-big-to-fail-ending, crisis-preventing, Wall-Street-whipping, consumer-defending victory for mankind. Critics derided it as an incomplete, toothless piece of gobbledy-gook that would ensure employment for lawyers. Senator Chris Dodd asked for a delay of verdict, saying, “No one will know until this is actually in place how it works.” One might think we could render judgment today, with the law now 28 in dog years, but alas, we can’t—several provisions aren’t implemented or even drafted.[i] The measures that have taken effect are largely benign, but there is still a chance regulators could write rules markets won’t like.

When Dodd-Frank passed, our take was simple: It missed the causes of 2008’s panic, by no means prevented future financial crises and was a rather poorly crafted piece of legislation—and because it was “a 2,319-page bill mostly creating studies and deferring action altogether,” the world would have to wait and see whether it was a net benefit.

Not much has changed during Dodd-Frank’s journey from infancy to preschool-age. When President Obama signed the law, it contained 398 “fill in the blanks” for regulators to write the final rules. As of July 1, 208 of these have been finalized. 96 haven’t even been proposed, and 94 are somewhere in between.[ii] One of those initial placeholders—the “Insert Volcker Rule here” blank—spawned over 800 pages of rules and definitions. That tells you what a tangled ball of yarn Dodd-Frank is.

Commentary

Fisher Investments Editorial Staff

Taper On, Lending Up

By, 07/21/2014
Ratings424.119048

Ukraine stayed atop the headlines through the weekend as the world continued digesting the aftermath of MH17. But while folks focused on the movement of missile launchers and reports from the crash site, economic news on the home front fell under the radar. Like one report showing bank lending sped up in Q2, bringing more fuel for the economy. The world doesn’t come to a halt when tensions rise and, while it’s challenging, investors must not fall into the trap of exclusively staring at conflicts—doing so can invite a bearish mindset that’s out of step with recent data suggesting more economic growth ahead.

Rising bank lending, accompanying the taper of quantitative easing (QE), likely catches many folks by surprise. Most presumed the Fed’s bond buying—which depressed long-term interest rates—was hugely stimulative, supporting loan demand. So they feared the Fed pulling its support would sap the economy. Long-term rates would rise, loans would be more expensive, consumers would stop borrowing and stocks would lose their party punchbowl. Most folks didn’t realize this punchbowl was laced with sedatives—QE didn’t boost the economy. It slowed things down. In trying to lift demand, QE hurt credit supply and slowed bank lending. The same low long-term rates folks presumed would boost borrowers pinched banks’ loan profits. Traditional banking is all about borrowing cheap at short-term rates and lending long-term at higher rates. The spread is profit, maturity-transformation manna. Folks can’t borrow if banks aren’t willing to lend!

Thus, the money from the Fed’s bond purchases has largely accumulated on banks’ balance sheets, where it does nothing but gather dust.[i] While the Fed boosted the monetary base with QE, broad money supply—the actual money circulating in the economy—didn’t grow much because banks weren’t lending. That is a necessary step for stimulus to, well, stimulate. But after the Fed alluded to slowing bond buying in May 2013, long-term rates started rising and by-year end they were up 1.01 percentage points.[ii] While they’ve pulled back some in 2014, they’re still higher than before that initial announcement.

Commentary

Fisher Investments Editorial Staff
Geopolitics

About Ukraine and Russia …

By, 07/18/2014
Ratings584.12069

Violence between “pro-Russian separatists” and the Ukrainian military in eastern Ukraine continues. More sanctions from the West are being piled on Russia for its role in allegedly sponsoring these rebels. The death toll continues to mount, including some innocents caught in the crossfire aboard a Malaysian Airlines flight from Amsterdam to Kuala Lumpur Thursday, in what seems to be the bloodiest episode to date. These events took center stage Thursday, with many in the financial press postulating markets would surely shake in response. Despite the shifts in specifics, our position remains unchanged: For the Ukraine crisis to have a material impact globally, it has to escalate far beyond its present level.

Since we last touched on the conflict in Ukraine, there have been some shifts worth noting, though they don’t much affect our view of the equity-market impact of the fighting (which we expect to be minimal barring major escalation). Several Ukrainian aircraft have been downed, including a military transport jet in June, another in July and a fighter earlier this week. The cast of characters has shifted some, with Ukrainian voters electing billionaire chocolatier Petro Poroshenko president on May 25. Poroshenko is a strong anti-Kremlin figure, his business having been targeted by Russian economic measures in 2013, and was a major force in the demonstrations that led to the ouster of Kiev’s formerly pro-Russian government. Upon taking office, he supported a unilateral ceasefire aiming to quell conflict. But the rebels didn’t cease firing, and Poroshenko fired—launching a major new offensive July 1. That offensive put the separatists on their heels, with Russia staying mostly quiet until a stray shell hit Russian territory in mid-July, killing one. Russian Deputy Foreign Minister Grigory Karasin claimed “it would not be left without a response,” and that response has reportedly taken the form of additional military and logistical support for the separatists.

That support triggered a response from the West. Over the July 12/13 weekend, the EU announced it would add 11 more individuals to those already sanctioned. The US followed suit Wednesday night, with President Obama announcing he would sanction four Russian companies, including Rosneft, Russia’s national oil firm, Gazprombank (a bank related to gas giant Gazprom) and two others. In announcing the measures, Obama claimed they would “hit the Russian economy hard,” and Putin has vowed to respond. We presume the intent is to hit harder than the initial round, which has proven largely feckless. US/Russia trade data show declining imports since March, but only slightly so. Russian GDP growth slowed to 0.9% y/y in Q1, but that’s not out of step with the prior year’s quarterly year-over-year growth rates of 0.8%, 1.0%, 1.3% and 2.0% respectively. Russian stocks took a dip out of the gate, but as Exhibit 1 shows, the MSCI Russia Index soon rebounded.

Commentary

Fisher Investments Editorial Staff
Into Perspective

The SEC Does Some Things to Money Market Funds

By, 07/24/2014
Ratings363.527778

The SEC finished overreacting to a side effect of Lehman Brothers’ bankruptcy on Wednesday, passing long-awaited reforms of money market funds. As with most of the regulatory moves aimed at preventing a repeat of 2008, the new rules (and the nearly six-year debate preceding them) are largely an exercise in futility, but as far as unintended consequences go, we’ve seen worse. They might not make the financial system “safer,”[i] as some have suggested, but they shouldn’t materially impact retail investors or the many corporations who rely on these funds for financing.

For those who haven’t followed closely (and we envy you), the saga started on September 16, 2008, the day after Lehman’s bankruptcy, when a $62 billion money market fund called Reserve Primary “broke the buck.” Or, translated from bankerspeak, its share price fell below $1. Most folks think this shouldn’t happen to a money market fund, which is designed to be a higher-yielding cash alternative. But money funds get this higher yield by investing in a smorgasbord of short-term debt, including T-bills, commercial paper (short-term debt issued by banks and other firms) and repurchase agreements. Which all carry at least some risk. And Reserve Primary—which, despite its name, was not run or guaranteed by the Federal Reserve—owned some commercial paper from Lehman. Which, naturally, tanked after Lehman went bankrupt, driving Reserve Primary’s share price down to 97 cents.

Times of panic being what they were, investors freaked and fled—even “cash” wasn’t safe! The run spread throughout the money market fund universe, threatening to freeze corporate financing and ultimately forcing the Fed to backstop the entire industry. Soon after, with bailouts widely seen as a scourge on society, regulators started knocking heads to figure out how to keep this from happening ever again.

Commentary

Fisher Investments Editorial Staff
Emerging Markets, Reality Check

Are the Reds in the Red?

By, 07/23/2014
Ratings314.258065

China debt jitters made a comeback Tuesday, on the heels of a report claiming the country’s debt to GDP ratio hit a lofty 251% at the end of June. Cue the clamor over the world’s second-largest economy over-extending itself, with hypothetical outcomes ranging from hard-landing to global meltdown. In our view, though, this is a classic case of headlines overreacting to what is some fairly benign Chinese data—we won’t argue China is in perfect fiscal shape, but this statistic doesn’t spell doom for China or the world. 

Details, as ever, are key. “Debt,” in this case, isn’t just government debt, which is most folks’ default (sorry) interpretation of “debt to GDP.” This figure includes all credit, public and private—traditional bank loans, corporate bonds and various shadow banking debt in addition to local, regional and federal government debt. Combining all these and trying to find some big takeaway about a country’s health, as you might intuit, is rather bizarre—the banking system isn’t the state isn’t the companies isn’t the people. Even in a People’s Republic. The notion any country’s outstanding credit hitting some arbitrary level is a snowball of financial problems ready to roll down the mountain is a tad misplaced. That’s abundantly evident if you compare China with the rest of the world. Based on this report’s data, at the end of 2013, South Korea’s debt was just north of 200% of GDP, Germany’s was a tad under, the US was at about 260%, and the UK was at 277% (and Japan, being Japan, shocked no one at 415%). Which all makes China look fairly normal—and not exactly at-risk, considering these countries are all growing, albeit to varying degrees, and not on the verge of debt crises. Japan might be a global laggard, but this statistic isn’t why.

But, some object, China is different! It isn’t as developed, and all that debt was really leverage to make things grow faster—and with that model petering out, China is “indebted before it has become rich,” leaving it extra vulnerable to slowdown and shock. There is a kernel of truth here—China’s debt-fueled stimublitz in 2008 and 2009 drove gangbusters growth, but it also left a supply glut in its wake. The steel, shipping and real estate industries are still dealing with the aftermath. However, the assumption this oversupply is a debt-fueled sinkhole is pretty misplaced. Consider the most widely cited example of excess, those fabled “ghost cities.” Those are largely there to accommodate the next wave of urbanization, which policymakers are pursuing aggressively. This is all very much a work-in-progress, which those taking a surface level view at China’s finances generally don’t see.

Commentary

Fisher Investments Editorial Staff
Market Risks

Growing Up With Dodd-Frank

By, 07/22/2014
Ratings393.871795

Four years ago Monday, President Obama put his John Hancock on the biggest package of financial sector regulation since the Great Depression: The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Champions hailed it as a too-big-to-fail-ending, crisis-preventing, Wall-Street-whipping, consumer-defending victory for mankind. Critics derided it as an incomplete, toothless piece of gobbledy-gook that would ensure employment for lawyers. Senator Chris Dodd asked for a delay of verdict, saying, “No one will know until this is actually in place how it works.” One might think we could render judgment today, with the law now 28 in dog years, but alas, we can’t—several provisions aren’t implemented or even drafted.[i] The measures that have taken effect are largely benign, but there is still a chance regulators could write rules markets won’t like.

When Dodd-Frank passed, our take was simple: It missed the causes of 2008’s panic, by no means prevented future financial crises and was a rather poorly crafted piece of legislation—and because it was “a 2,319-page bill mostly creating studies and deferring action altogether,” the world would have to wait and see whether it was a net benefit.

Not much has changed during Dodd-Frank’s journey from infancy to preschool-age. When President Obama signed the law, it contained 398 “fill in the blanks” for regulators to write the final rules. As of July 1, 208 of these have been finalized. 96 haven’t even been proposed, and 94 are somewhere in between.[ii] One of those initial placeholders—the “Insert Volcker Rule here” blank—spawned over 800 pages of rules and definitions. That tells you what a tangled ball of yarn Dodd-Frank is.

Commentary

Fisher Investments Editorial Staff

Taper On, Lending Up

By, 07/21/2014
Ratings424.119048

Ukraine stayed atop the headlines through the weekend as the world continued digesting the aftermath of MH17. But while folks focused on the movement of missile launchers and reports from the crash site, economic news on the home front fell under the radar. Like one report showing bank lending sped up in Q2, bringing more fuel for the economy. The world doesn’t come to a halt when tensions rise and, while it’s challenging, investors must not fall into the trap of exclusively staring at conflicts—doing so can invite a bearish mindset that’s out of step with recent data suggesting more economic growth ahead.

Rising bank lending, accompanying the taper of quantitative easing (QE), likely catches many folks by surprise. Most presumed the Fed’s bond buying—which depressed long-term interest rates—was hugely stimulative, supporting loan demand. So they feared the Fed pulling its support would sap the economy. Long-term rates would rise, loans would be more expensive, consumers would stop borrowing and stocks would lose their party punchbowl. Most folks didn’t realize this punchbowl was laced with sedatives—QE didn’t boost the economy. It slowed things down. In trying to lift demand, QE hurt credit supply and slowed bank lending. The same low long-term rates folks presumed would boost borrowers pinched banks’ loan profits. Traditional banking is all about borrowing cheap at short-term rates and lending long-term at higher rates. The spread is profit, maturity-transformation manna. Folks can’t borrow if banks aren’t willing to lend!

Thus, the money from the Fed’s bond purchases has largely accumulated on banks’ balance sheets, where it does nothing but gather dust.[i] While the Fed boosted the monetary base with QE, broad money supply—the actual money circulating in the economy—didn’t grow much because banks weren’t lending. That is a necessary step for stimulus to, well, stimulate. But after the Fed alluded to slowing bond buying in May 2013, long-term rates started rising and by-year end they were up 1.01 percentage points.[ii] While they’ve pulled back some in 2014, they’re still higher than before that initial announcement.

Commentary

Fisher Investments Editorial Staff
Geopolitics

About Ukraine and Russia …

By, 07/18/2014
Ratings584.12069

Violence between “pro-Russian separatists” and the Ukrainian military in eastern Ukraine continues. More sanctions from the West are being piled on Russia for its role in allegedly sponsoring these rebels. The death toll continues to mount, including some innocents caught in the crossfire aboard a Malaysian Airlines flight from Amsterdam to Kuala Lumpur Thursday, in what seems to be the bloodiest episode to date. These events took center stage Thursday, with many in the financial press postulating markets would surely shake in response. Despite the shifts in specifics, our position remains unchanged: For the Ukraine crisis to have a material impact globally, it has to escalate far beyond its present level.

Since we last touched on the conflict in Ukraine, there have been some shifts worth noting, though they don’t much affect our view of the equity-market impact of the fighting (which we expect to be minimal barring major escalation). Several Ukrainian aircraft have been downed, including a military transport jet in June, another in July and a fighter earlier this week. The cast of characters has shifted some, with Ukrainian voters electing billionaire chocolatier Petro Poroshenko president on May 25. Poroshenko is a strong anti-Kremlin figure, his business having been targeted by Russian economic measures in 2013, and was a major force in the demonstrations that led to the ouster of Kiev’s formerly pro-Russian government. Upon taking office, he supported a unilateral ceasefire aiming to quell conflict. But the rebels didn’t cease firing, and Poroshenko fired—launching a major new offensive July 1. That offensive put the separatists on their heels, with Russia staying mostly quiet until a stray shell hit Russian territory in mid-July, killing one. Russian Deputy Foreign Minister Grigory Karasin claimed “it would not be left without a response,” and that response has reportedly taken the form of additional military and logistical support for the separatists.

That support triggered a response from the West. Over the July 12/13 weekend, the EU announced it would add 11 more individuals to those already sanctioned. The US followed suit Wednesday night, with President Obama announcing he would sanction four Russian companies, including Rosneft, Russia’s national oil firm, Gazprombank (a bank related to gas giant Gazprom) and two others. In announcing the measures, Obama claimed they would “hit the Russian economy hard,” and Putin has vowed to respond. We presume the intent is to hit harder than the initial round, which has proven largely feckless. US/Russia trade data show declining imports since March, but only slightly so. Russian GDP growth slowed to 0.9% y/y in Q1, but that’s not out of step with the prior year’s quarterly year-over-year growth rates of 0.8%, 1.0%, 1.3% and 2.0% respectively. Russian stocks took a dip out of the gate, but as Exhibit 1 shows, the MSCI Russia Index soon rebounded.

Commentary

Fisher Investments Editorial Staff
Taxes, Into Perspective, Globalization

Economic Patriotism or Protectionism?

By, 07/17/2014
Ratings843.464286

Editors’ Note: Our discussion of politics and elections is purely focused on potential market impact. Neither Republicans nor Democrats are favored by stocks. Believing in the market/economic superiority of one group of politicians over another can be a source of bias—and investing on biases can cause significant investment errors.

Patriotism. A beautiful word. We love the Stars and Stripes and chanted “USA! USA!” with the best of them during the World Cup. But sometimes, when patriotism bleeds into economic policy, it can have a dark side. That’s the case, in our view, of the administration’s efforts to crack down on US companies buying or merging with foreign firms to get a new address for tax purposes—the so-called inversion deal. On Tuesday, Treasury Secretary Jack Lew wrote a letter to key members of Congress urging legislation to all but ban the practice, later saying a ban was tantamount to “economic patriotism.” In practice, however, seems to us it would be more like another ism: protectionism, which is generally negative for markets. If the proposed ban were to become law, it wouldn’t be great. However, the probability is slim in a gridlocked Congress, limiting the risk this disrupts the bull market.

We’ll step away from the third rail of whether paying US corporate taxes is “patriotic.” For investors, the issue is more whether inversion deals are an economic negative. We’ve had 76 since 1983. They spiked in the 90s, then leveled off after Congress tried to kill the practice in a 2004 law requiring firms to keep their US address—and pay US corporate taxes—if shareholders of the foreign company they acquired received less than 20% of the resulting entity’s stock. Companies soon realized that’s a pretty easy workaround and activity resumed in earnest, with 42 inversions completing since 2008. Yet the US economy has grown overall (notwithstanding the business cycle’s normal ups and downs). So has business investment—those companies still keep their existing US offices, R&D facilities, factories and employees. So far, so fine.

Research Analysis

Fisher Investments Research Staff

MLPs and Your Portfolio

By, 11/26/2013
Ratings813.882716

With interest rates on everything from savings accounts to junk bonds at or near generational lows, many income-seeking investors are looking for creative or, to some, exotic means of generating cash flow. Some are turning to a relatively little-known type of security—master limited partnerships (MLPs). MLPs may attract investors for a number of reasons: their high dividend yields and tax incentives, to name a couple. But, like all investments, MLPs have pros and cons, which are crucial to understand if you’re considering investing in them.

MLPs were created in the 1980s by a Congress hoping to generate more interest in energy infrastructure investment. The aim was to create a security with limited partnership-like tax benefits, but publicly traded—bringing more liquidity and fewer restrictions and thus, ideally, more investors. Currently, only select types of companies are allowed to form MLPs—primarily in energy transportation (e.g., oil pipelines and similar energy infrastructure).

To mitigate their tax liability, MLPs distribute 90% of their profits to their investors—or unit holders—through periodic income distributions, much like dividend payments. And, because there is no initial loss of capital to taxes, MLPs can offer relatively high yields, usually around 6-7%. Unit holders receive a tax benefit, too: Much of the dividend payment is treated as a return of capital—how much is determined by the distributable cash flow (DCF) from the MLP’s underlying venture (e.g., the oil pipeline).

Research Analysis

Elisabeth Dellinger
Reality Check

Inside Indian Taper Terror

By, 11/08/2013
Ratings174.294117

When the Fed kept quantitative easing (QE) in place last week, US investors weren’t the only ones (wrongly) breathing a sigh of relief. Taper terror is fully global! In Emerging Markets (EM), many believe QE tapering will cause foreign capital to retreat. Some EM currencies took it on the chin as taper talk swirled over the summer, and many believe this is evidence of their vulnerability—with India the prime example as its rupee fell over 20% against the dollar at one point. Yet while taper jitters perhaps contributed to the volatility, evidence suggests India’s troubles are tied more to long-running structural issues and seemingly erratic monetary policy—and suggests EM taper fears are as false as their US counterparts.

The claim QE is propping up asset prices implies there is some sort of overinflated disconnect between Emerging Markets assets and fundamentals—a mini-bubble. Yet this is far removed from reality—not what you’d expect if QE were a significant positive driver. Additionally, the thesis assumes money from rounds two, three and infinity of QE has flooded into the developing world—and flows more with each round of monthly Fed bond purchases. As Exhibit 1 shows, however, foreign EM equity inflows were strongest in 2009 as investors reversed their 2008 panic-driven retreat. Flows eased off during 2010 and have been rather weak—and often negative—since 2011.

Exhibit 1: Emerging Markets Foreign Equity Inflows

Research Analysis

Brad Pyles

Why This Bull Market Has Room to Run

By, 10/31/2013
Ratings864.098837

With investors expecting the Fed to end quantitative easing soon, the yield spread is widening—fuel for stocks! Photo by Alex Wong/Getty Images.

Since 1932, the average S&P 500 bull market has lasted roughly four and a half years. With the present bull market a hair older than the average—and with domestic and global indexes setting new highs—some fret this bull market is long in the tooth. However, while bull markets die of many things, age and gravity aren’t among them. History argues the fundamentals underpinning this bull market are powerful enough to lift stocks higher from here, with economic growth likely to continue—and potentially even accelerate moving forward as bank lending increases.

Research Analysis

Christo Barker
US Economy

Let’s Call It FARRP

By, 10/10/2013
Ratings93.777778

While the rest of the country fretted over taper terror, government shutdown and debt ceiling limits, the Federal Reserve tested its Fixed Rate Full-Allotment Reverse-Repo Facility (a mouthful—let’s call it FARRP) for the first time September 24. FARRP allows banks and non-banks, like money market funds and asset managers, to access Fed-held assets—i.e., the long-term securities bought under the Fed’s quantitative easing—via securities dealers’ tri-party repo (and reverse-repo) market for short-term funding. (More on repos to follow.) FARRP aims to address what many feel is a collateral shortage in the non-bank financial system caused by too much QE bond buying concentrating eligible collateral on the Fed’s balance sheet, where it doesn’t circulate freely. As a result, many private sector repo rates turned negative. But, should FARRP be fully implemented, the facility could actually hinder some assets (in this case, high-quality, long-term collateral like bonds) from circulating through the financial system—much like quantitative easing (QE) locked up excess bank reserves. A more effective means of freeing collateral in the repo market is tapering the Fed’s QE.

Repurchase agreements, or repos, are used to generate short-term liquidity to fund other banking or investment activity—a means to move liquidity (cash) from one institution to another. In a repo, one party sells an asset—usually long-term debt—agreeing to repurchase it at a different price later on. A reverse repo is, well, the opposite: One party buys an asset from another, agreeing to sell it back at a different price later. In both cases, the asset acts as collateral for what is effectively the buyer’s loan to the seller, and the repo rate is the difference between the initial and future sales prices, usually expressed as a per annum interest rate. The exchange only lasts a short while—FARRP’s reverse repos are overnight affairs to ensure markets are sufficiently funded. In the test last Tuesday, the private sector tapped the facility for $11.81 billion of collateral—a small, but not insignificant, amount.

FARRP’s first round is scheduled to end January 29, and during that time, non-bank institutions can invest between $500 million and $1 billion each at FARRP’s fixed overnight reverse-repo rates ranging from one to five basis points. A first for repo markets: Normally, repo and reverse-repo rates are free-floating, determined by market forces. Another of FARRP’s differentiating factors is private-sector need will facilitate reverse-repo bids instead of the Fed. Ideally, FARRP’s structure will encourage unproductive collateral to be released back into the system when it’s most needed—and new sources of collateral demand may help ensure this. Swaps, for example, are shifting to collateral-backed exchanges due to Dodd-Frank regulation—meaning more collateral will be needed to back the same amount of trading activity. Collateral requirements for loans will likely also rise.

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What We're Reading

By , The New York Times, 07/30/2014

MarketMinder's View: Well, there are caveats, for sure. But there usually are in any series as broad and wonky as GDP. The article notes 1.66 percentage points of growth came from inventories—which are open to interpretation as to what they say about Q2 growth—but doesn’t note that bare shelves subtracted 1.16 percentage points in Q1, largely caused by ice-jammed shipping routes. The article also doesn’t quantify the assumed boost from health care—just 0.08 percentage point (that’s it!)—which likely gets revised up when full data are in. Finally, it totally avoids the issue of an 11.7% import surge subtracting 1.85 percentage points from headline growth. GDP’s math tallies imports as a negative, but they actually show strong demand at home—which, you know, isn’t bad. We’d suggest this is just confirmation Q1 was a one-off and not something worse.

By , The Telegraph, 07/30/2014

MarketMinder's View: This pretty much sums it up: “The oil and gas fields generate a heck of a lot of money. Except the trouble is, you are not going to get any of it. Most of it will go to the Government and the exploration companies – and practically nothing will go to you. One reason the industry has developed so fast in the US is that under American law the oil and gas is owned by the people under whose land it is discovered. If a developer finds it under your property, you make a fortune. In this country, you only own the first few feet, which isn’t any use – the shale gas is a lot deeper than that.”

By , The Wall Street Journal, 07/30/2014

MarketMinder's View: The US and EU officially released details of their expanded sanctions on Russia tied to the ongoing Ukraine conflict. And, here again, the sanctions lack teeth and are more noteworthy, arguably, for what they omit than what they hit. As shown here, major Russian banks can’t issue long-term debt in either EU or US capital markets, but the banks targeted have relatively little debt due in the next nine months. Also, the US sanctions on banks miss Russia’s largest bank, which is majority state-owned, no less. Other measures taken include a ban on future arms sales and some energy technology.

By , Reuters, 07/30/2014

MarketMinder's View: If you are concerned that the Shiller Cyclically Adjusted Price-to-Earnings Ratio (CAPE) shows stocks are overvalued, we prescribe this excellent article. The CAPE’s theory is faulty, “… Arbitrary 10-year averaging takes no account of the length and  depth of business cycles and makes no allowance for accounting write-offs. The Shiller price-earnings ratio will continue to be upwardly biased until 2019 because of the longest recession in U.S. history and the biggest-ever corporate write-offs then suffered by U.S. banks.” And isn’t accurate in practice: “But leaving aside the theoretical arguments, what about the practical usefulness of the Shiller ratio as an investment tool? Recent evidence is conclusive: For the past 25 years, the Shiller ratio’s signals have been almost uniformly wrong. Since 1989, the S&P 500 has multiplied eightfold, while total returns, including dividends, have increased the value of an average equity investment 12 fold.”

Global Market Update

Market Wrap-Up, Wed July 30 2014

Below is a market summary (as of market close Wednesday, 07/30/2014):

  • Global Equities: MSCI World (-0.2%)
  • US Equities: S&P 500 (0.0%)
  • UK Equities: MSCI UK (-0.7%)
  • Best Country: Hong Kong (+0.6%)
  • Worst Country: Portugal (-3.3%)
  • Best Sector: Health Care (+0.3%)
  • Worst Sector: Utilities  (-1.3%)
  • Bond Yields: 10-year US Treasurys rose by .1 to 2.56%

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.