Editors’ Note: Our discussion of politics is focused purely on potential market impact and is designed to be nonpartisan. Stocks don’t favor any party, and partisan ideology invites bias—dangerous in investing.
Are drug prices running rampant? After The New York Times reported on Sunday that a small private Pharmaceuticals firm, Turing Pharmaceuticals, jacked up the price of a 62-year-old drug by 5,000-ish percent, that question has sparked a media firestorm.[i] Monday, partly in reaction to the news, Democratic Presidential front-runner Hillary Clinton fueled further debate by vowing to “deal with skyrocketing out-of-pocket health costs and particularly, runaway prescription drug prices.” All week, media articles aplenty have focused on the issue and wondered whether Federal price controls are necessary to put a lid on the rise. But whatever your opinion of the sociological merits of this plan or drug prices, price controls in general have a long history of causing more harmful unintended consequences—including dinging stock prices—than any positive they may bring. That being said, pharmaceutical price controls seem unlikely to come to fruition any time soon.
For those interested in the details of Mrs. Clinton’s plan, here are the major proposals:
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.
|By Christo Barker, 03/28/2014|
It seems the IRS is going global, a development that has some pundits up in arms about potential stock market impact. The Foreign Account Tax Compliance Act (FATCA) is what I’m referring to. Under FATCA, the IRS is moving toward taxing US citizens’ offshore financial activity, including money held in banks abroad—effectively eliminating “tax havens” for US citizens. US expatriates and foreign banks are up in arms. The law conflicts with local banking laws in other countries, and banks have responded by simply slashing access to banking services for Americans living abroad. But while it creates hassles, barring a big international regulatory blowback, the law doesn’t seem poised to create many ripples for stocks.
FATCA, now four years old, was conjured following a 2009 scandal, which revealed a major Swiss bank was helping well-to-do Americans dodge taxes. The backlash against the scandal peaked in 2010, when Congress passed FATCA as a provision of HR 2847, the Hiring Incentives to Restore Employment Act. An effort to boost US government tax revenue by broadening the base, FATCA also has some grassroots appeal as it carries the label of reducing tax dodging. FATCA was supposedly a means to get fatcats to pay their fair share. (My apologies for the pun.) Foreign banks were also not the most popular group in the immediate aftermath of the Global Financial Crisis.
Initially, FATCA seeks to provide the IRS information about US citizens’ and green card holders’ taxable accounts exceeding $50,000 in market value held at foreign financial institutions. International banks (Foreign Financial Institutions or FFIs) are required to ink a special deal with the IRS, under which they report all US taxpayers’ qualifying accounts and holdings. Account disclosure began January 1, 2014. After June 30, 2014, foreign banks will have to provide details regarding investment account holdings, and by January 1, 2015, FATCA’s full implementation will install a 30% withholding on US sourced income (salary/capital gains/interest/dividends).
|By Fisher Investments Research Staff, 12/10/2013|
In its second release, Q3 US GDP was revised up to a seasonally adjusted annual rate of 3.6%—the fastest growth in more than a year and among the quickest rates in the current expansion to date. However, most economists and pundits greeted the acceleration with a resounding thud. Under the hood, they claim, the data were not so hot. Reason being, the most notable contributor to growth was increasing inventories, adding 1.7 percentage points to the headline number. Some posit this means growth is hollow—after all, inventory change is open to interpretation. It could be due to slowing sales, a potential negative for profits and growth ahead. Or due to inventory build ahead of an expected pick-up in sales this holiday season. If the pessimists are right, one would expect wholesale inventory growth to sharply slow as we enter Q4. Yet Tuesday, the first inventory report of the quarter suggested no such thing: US wholesale inventories grew at their fastest clip in two years.
In October, wholesale inventories grew 1.4% m/m (3.3% y/y) vs. estimates of 0.3%. Both durables and non-durables stockpiles grew (0.4% m/m and 3.0% m/m, respectively.) So what gives?
While inventory growth undoubtedly contributed strongly to GDP in Q3, that never meant inventories were at historically high levels. As Exhibit 1 shows, the inventory-to-sales ratio isn’t overall elevated. Total goods and non-durable goods are at relatively low levels compared to history, and while durable goods inventories are somewhat higher relative to sales, they are not alarmingly high. In short, there is nothing suggesting inventory growth is unsustainable overall relative to the pace of sales. Of course, maybe inventory growth does slow in the period ahead, but it wouldn’t seem to be related to overall overstocked shelves. This is yet another factor illustrating the fact reality may be considerably better than skeptics presume.
Five years ago, on Black Friday 2008, quantitative easing (QE) was born. In its quest to battle the deflationary effects of the financial panic, the Fed launched the “extraordinary” policy of buying long-term assets from banks. In exchange, the Fed credited banks’ reserve accounts, believing the banks would lend off these reserves many times over—a big money supply increase to boost growth.
To date, through multiple rounds of (now infinite) QE, the monetary base (M0) has swelled by nearly $3 trillion. Yet this economic expansion has been the slowest in post-war history.
Exhibit 1: Cumulative GDP Growth
Is the UK housing market overheating, or is it merely the latest example of froth fears that are detached from reality?
Recent home price data and the UK’s Help to Buy scheme’s early expansion already have some UK politicians and business leaders wondering—some going as far as calling for the Bank of England to cap rising home prices. Taking a deeper look, however, I see a different story: Rapid housing price gains have been concentrated in London. Restricting overall UK housing with more legislation likely won’t fix that, and it probably won’t help spread London’s gains to UK housing elsewhere. More importantly, the fact UK housing gains aren’t widespread tells me a nationwide bubble neither exists nor is particularly probable—even with an expanded Help to Buy program.
While UK housing started slowly improving after Help to Buy began in April, the program has only been lightly used in the early going—suggesting the housing recovery is coming from strengthening underlying fundamentals and isn’t purely scheme-driven. In Help to Buy’s first phase, the government promised to lend up to 20% of a home’s value at rock bottom rates (interest free for five years, 1.75% interest after) to buyers with a 5% down payment—providing up to £3.5 billion in total loans. Only first-home buyers (of any income strata) seeking newly built houses valued at £600k or less could participate. The Treasury began a second (earlier-than-expected) iteration in October, in which it guarantees 20% of the total loan to lenders, instead of lending directly to the buyer. The program was also expanded another £12 billion for buyers purchasing any home (new or not).
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|By Michael D. Shear and David M. Herszenhorn, The New York Times, 10/02/2015|
MarketMinder's View: Please, for the love of all that is good and right in this world, can we all stop calling hitting the debt ceiling a “default”? Default means one thing and one thing only: Failing to pay interest or principal on our outstanding bonded debt. Default does not mean having to delay pension contributions or other non-essential accounts payable. Hitting the debt ceiling does not mean we default. It means the Treasury must operate with cash on hand and incoming tax revenue. The 14th Amendment, as interpreted by the Supreme Court decades ago, says the Treasury’s first priority with those incoming revenues is to service debt. Other services get the leftovers, and this is always how it has been. Interest payments are currently less than 8% of tax revenue. There will be no default, regardless of when Congress ultimately knuckles down and raises the debt ceiling for the 110th time.
|By Claudio Borio, Leonardo Gambacorta and Boris Hoffman, Bank for International Settlements, 10/02/2015|
MarketMinder's View: Yes, this is a whitepaper, and whitepapers are usually longish and joke-free. (Sad face.) But please, just go with it, because this study does a great job of illustrating (and supporting with over 20 pages of data) a point we’ve long made: The bigger the spread between short- and long-term interest rates, the more profitable bank lending becomes. (And the slimmer the spread, the less profitable.) This matters because profitability influences loan supply—bigger profits make banks more eager to lend, which boosts the quantity of money and, by extension, economic growth. Interestingly, these researchers found that the interest rate spread’s influence is particularly strong when the spread shrinks, which as we’ve written many times, explains why economic growth crawled the more the Fed and Bank of England engaged in quantitative easing, which shrank the spread by reducing long-term rates. Now, none of this is new, and literature dating back over 100 years discusses and shows the interest rate spread’s importance. But central bankers have ignored the spread in recent years, much to the world economy’s detriment, and it’s nice to see the fine folks at the BIS (known as the central bank for central banks) help it make a comeback.
|By Leonid Bershidsky, Bloomberg, 10/02/2015|
MarketMinder's View: Here is yet another example of why GDP is not a perfect measure of an economy’s size: It doesn’t capture the “informal” sector, also known as the shadow economy, under-the-table commerce or whatever euphemism you prefer. Employment and transactions happen off the ledger all the time, particularly in countries where the rule of law is weak and regulations are complex and onerous (and might require a bribe or two to comply with). As this piece notes, Romania’s underground economy is nearly 30% of GDP. Roughly one-third of Mexican workers were under the table before labor market reforms took effect a couple years ago. GDP doesn’t include this hidden growth, making it difficult to compare growth across nations, particularly in the developing world.
|By Paul Vigna, The Wall Street Journal, 10/02/2015|
MarketMinder's View: Not very, if you base your verdict on valuations, but that doesn’t really mean anything. Valuations aren’t predictive. In addition to all the math wonkery noted here, valuations are also backward-looking—they measure past performance, and past performance doesn’t predict future returns. Valuations are a handy, albeit loose, measure of sentiment, but that is about it. Right now, they point to mild optimism. Not because of their relationship to the long-term average, but because we’ve only recently started seeing a steady uptick during this bull market. We haven’t seen the long rise that usually signifies investors’ gaining confidence and bidding stocks far higher.
Market Wrap-Up, Thursday, October 1, 2015
Below is a market summary as of market close Thursday, 10/1/2015:
Global Equities: MSCI World (+0.4%)
US Equities: S&P 500 (+0.2%)
UK Equities: MSCI UK (+0.3%)
Best Country: Japan (+2.5%)
Worst Country: Germany (-1.1%)
Best Sector: Consumer Discretionary (+0.8%)
Worst Sector: Utilities (-0.7%)
Bond Yields: 10-year US Treasury yields were unchanged at 2.04%.
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.