Commentary

Fisher Investments Editorial Staff

Around the World in 80 Datapoints (Or Thereabouts)

By, 07/25/2014
Ratings104.55

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
Ratings74.642857

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
Ratings94.666667

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
Ratings253.92

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
Ratings193.552632

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
Ratings534.066038

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
Ratings823.45122

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.

Commentary

Fisher Investments Editorial Staff
Reality Check, Investor Sentiment

Yellen About Valuations

By, 07/16/2014
Ratings354.185714

“Some broad equity price indexes have increased to all-time highs in nominal terms since the end of 2013. However, valuation measures for the overall market in early July were generally at levels not far above their historical averages, suggesting that, in aggregate, investors are not excessively optimistic regarding equities. Nevertheless, valuation metrics in some sectors do appear substantially stretched—particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.” [i] 

So read the Fed’s July Monetary Policy Report, which accompanied Fed Chairwoman Janet Yellen’s testimony to the Senate Banking Committee on Tuesday. For those unfamiliar with Fed speak, allow us to translate: “Sure, market-wide valuations aren’t out of whack, but there are some signs of froth.”  While the punditry seized on the “it’s overvalued!” angle, to us, Yellen’s testimony says more about her methods of market analysis and forecasting than it does about  the actual state of the market—which, in our view, remains far from frothy.

One wonders if this report was intended for release in April or May, not July. That “notable downturn” Yellen mentioned is pretty much past-tense. The MSCI World Biotechnology Subindex had a -17.4% correction from February 24 through April 11, but it was back at new highs by July 3 (it’s down a shade since).[ii] Social media is a teensy slice of the MSCI World Internet Software & Services Subindex, which lost 16.8% from March 5 through May 8, before bouncing back 12.4%, putting the subsector 6.4% below its prior peak.[iii] So it largely goes without saying that valuations are up despite the downturn—prices corrected, then investors decided to bid them back up based on their perception of the companies’ potential. Whether that’s warranted or not is a topic for another day, but it’s just sort of how investors behave. It’s a post-correction rebound—totally normal. If anything, one can argue that correction shook out some of the euphoria that might have existed in these industries earlier this year, but we digress.

Commentary

Fisher Investments Editorial Staff

Pros Falsely Fear an Optimistic Ma and Pa

By, 07/15/2014
Ratings683.654412

Are mom and pop telling you to get out of stocks?

That’s the question a few pundits tried to answer Monday, as data from the Investment Company Institute apparently showed retail investors “piling” into equity funds in June. And naturally, the answer was a resounding “yes!” Retail investors are notorious for piling into stocks at suboptimal times, so of course their buying should be a big fat sell signal for the rest of us. Problem is, there is no—zero—evidence mutual fund flows are a reliable indicator or even terribly high currently. They’re a rough gauge of sentiment, but they aren’t a timing tool.

It is true folks have a history of flocking to stocks near market peaks. But peaks aren’t the only time retail investors buy. Not all new buying is evidence of heat chasing at the peak without any regard for the likelihood of a downturn. Some of it is a simple reversal of the deep pessimism of a bull’s early stages, when folks who got battered during the bear swear they’ll never own a stock again. As that wears off and folks realize they need at least some stock exposure to reach their long-term goals, they start wading back in. That’s just normal investor behavior. Not euphoria, just a rationally optimistic move away from the bear’s “it’s going to zero!” hysteria.

Commentary

Fisher Investments Editorial Staff

Catalysts and Wingdings

By, 07/14/2014
Ratings403.8375

Portuguese bank drama. Regional conflicts in Ukraine/Iraq. Falling US GDP. Slowing eurozone growth. All drew sensationalistic headlines claiming here—HERE!—was the trigger for negative volatility so overdue for stocks. Yet to date, markets have defied them. But lest you think this would change the skeptics’ song and dance, now they have a new target: Weak earnings growth is the next alleged correction catalyst. Yet this seems to us more like yet another example of the remaining skeptics showing their stripes before they again marvel at this bull market’s “resiliency.”  

What’s left out of this picture is the simple fact the economic and market cycle swamps such “events” routinely. This is normal bull market behavior, not exceptional. Folks hunt for bear catalysts and presume Event X equals Result Y, forgetting markets move most on the gap between expectations and reality. Ironically, the hunt for downturn catalysts implies folks just don’t get that the cycle vastly overpowers them. They don’t appreciate that while US GDP was bad in Q1, it’s also over and the cycle churned on. They don’t get that Portugal didn’t cease the bull in 2010, 2011 or 2012—and this concern is even less powerful today. These are great eyeball-grabbing headline tools, and they could cause near-term wiggles here and there. (Or not!) But the longer-term direction is unlikely to be swayed much by events you heard of on TV. Why? Chances are high you weren’t the only person tuned in. (And, by the way, someone had to tell the reporter that news, the channel may have been late to the party, and so on.) Markets are really just a collaboration of people (and machines programmed by people). If those people heard the news when you did—or earlier—they probably already acted on it, making their opinions and assumptions already reflected in current prices. While not perfectly so, markets are pretty darn efficient!

If most expect markets to zig based on all these “catalysts,” those expectations are quickly discounted, and stocks often do something different. For example, zag. But markets won’t necessarily do the opposite of the consensus—veering to the polar opposite merely because it is the consensus isn’t a winning strategy: This is not a case of the false either/or argument. Because Event X doesn’t automatically mean Result Y should not be taken to mean Event X always yields Result Z. It might mean Result .[i] It might mean nothing. You cannot memorize a list of rules and memes and forever invest successfully. Nor can you just do the opposite of what you think the crowd is doing to achieve success. It’s helpful in this probabilities business to know what the crowd thinks, but all that tells you is what isn’t likely to happen.

Commentary

Fisher Investments Editorial Staff
Geopolitics

About Ukraine and Russia …

By, 07/18/2014
Ratings534.066038

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
Ratings823.45122

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.

Commentary

Fisher Investments Editorial Staff
Reality Check, Investor Sentiment

Yellen About Valuations

By, 07/16/2014
Ratings354.185714

“Some broad equity price indexes have increased to all-time highs in nominal terms since the end of 2013. However, valuation measures for the overall market in early July were generally at levels not far above their historical averages, suggesting that, in aggregate, investors are not excessively optimistic regarding equities. Nevertheless, valuation metrics in some sectors do appear substantially stretched—particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.” [i] 

So read the Fed’s July Monetary Policy Report, which accompanied Fed Chairwoman Janet Yellen’s testimony to the Senate Banking Committee on Tuesday. For those unfamiliar with Fed speak, allow us to translate: “Sure, market-wide valuations aren’t out of whack, but there are some signs of froth.”  While the punditry seized on the “it’s overvalued!” angle, to us, Yellen’s testimony says more about her methods of market analysis and forecasting than it does about  the actual state of the market—which, in our view, remains far from frothy.

One wonders if this report was intended for release in April or May, not July. That “notable downturn” Yellen mentioned is pretty much past-tense. The MSCI World Biotechnology Subindex had a -17.4% correction from February 24 through April 11, but it was back at new highs by July 3 (it’s down a shade since).[ii] Social media is a teensy slice of the MSCI World Internet Software & Services Subindex, which lost 16.8% from March 5 through May 8, before bouncing back 12.4%, putting the subsector 6.4% below its prior peak.[iii] So it largely goes without saying that valuations are up despite the downturn—prices corrected, then investors decided to bid them back up based on their perception of the companies’ potential. Whether that’s warranted or not is a topic for another day, but it’s just sort of how investors behave. It’s a post-correction rebound—totally normal. If anything, one can argue that correction shook out some of the euphoria that might have existed in these industries earlier this year, but we digress.

Commentary

Fisher Investments Editorial Staff

Pros Falsely Fear an Optimistic Ma and Pa

By, 07/15/2014
Ratings683.654412

Are mom and pop telling you to get out of stocks?

That’s the question a few pundits tried to answer Monday, as data from the Investment Company Institute apparently showed retail investors “piling” into equity funds in June. And naturally, the answer was a resounding “yes!” Retail investors are notorious for piling into stocks at suboptimal times, so of course their buying should be a big fat sell signal for the rest of us. Problem is, there is no—zero—evidence mutual fund flows are a reliable indicator or even terribly high currently. They’re a rough gauge of sentiment, but they aren’t a timing tool.

It is true folks have a history of flocking to stocks near market peaks. But peaks aren’t the only time retail investors buy. Not all new buying is evidence of heat chasing at the peak without any regard for the likelihood of a downturn. Some of it is a simple reversal of the deep pessimism of a bull’s early stages, when folks who got battered during the bear swear they’ll never own a stock again. As that wears off and folks realize they need at least some stock exposure to reach their long-term goals, they start wading back in. That’s just normal investor behavior. Not euphoria, just a rationally optimistic move away from the bear’s “it’s going to zero!” hysteria.

Commentary

Fisher Investments Editorial Staff

Catalysts and Wingdings

By, 07/14/2014
Ratings403.8375

Portuguese bank drama. Regional conflicts in Ukraine/Iraq. Falling US GDP. Slowing eurozone growth. All drew sensationalistic headlines claiming here—HERE!—was the trigger for negative volatility so overdue for stocks. Yet to date, markets have defied them. But lest you think this would change the skeptics’ song and dance, now they have a new target: Weak earnings growth is the next alleged correction catalyst. Yet this seems to us more like yet another example of the remaining skeptics showing their stripes before they again marvel at this bull market’s “resiliency.”  

What’s left out of this picture is the simple fact the economic and market cycle swamps such “events” routinely. This is normal bull market behavior, not exceptional. Folks hunt for bear catalysts and presume Event X equals Result Y, forgetting markets move most on the gap between expectations and reality. Ironically, the hunt for downturn catalysts implies folks just don’t get that the cycle vastly overpowers them. They don’t appreciate that while US GDP was bad in Q1, it’s also over and the cycle churned on. They don’t get that Portugal didn’t cease the bull in 2010, 2011 or 2012—and this concern is even less powerful today. These are great eyeball-grabbing headline tools, and they could cause near-term wiggles here and there. (Or not!) But the longer-term direction is unlikely to be swayed much by events you heard of on TV. Why? Chances are high you weren’t the only person tuned in. (And, by the way, someone had to tell the reporter that news, the channel may have been late to the party, and so on.) Markets are really just a collaboration of people (and machines programmed by people). If those people heard the news when you did—or earlier—they probably already acted on it, making their opinions and assumptions already reflected in current prices. While not perfectly so, markets are pretty darn efficient!

If most expect markets to zig based on all these “catalysts,” those expectations are quickly discounted, and stocks often do something different. For example, zag. But markets won’t necessarily do the opposite of the consensus—veering to the polar opposite merely because it is the consensus isn’t a winning strategy: This is not a case of the false either/or argument. Because Event X doesn’t automatically mean Result Y should not be taken to mean Event X always yields Result Z. It might mean Result .[i] It might mean nothing. You cannot memorize a list of rules and memes and forever invest successfully. Nor can you just do the opposite of what you think the crowd is doing to achieve success. It’s helpful in this probabilities business to know what the crowd thinks, but all that tells you is what isn’t likely to happen.

Commentary

Fisher Investments Editorial Staff

The PIIGS Who Cried Wolf?

By, 07/11/2014
Ratings593.652542

Peripheral eurozone markets sold off Thursday after Portugal’s second-largest bank experienced a tumultuous few days. After falling around 32% for the week and dragging Portuguese stocks down around 10% with it, Banco Espírito Santo’s stock was suspended. As markets fell, a Spanish bank delayed a bond auction, Greek sovereign debt sold poorly, and an Italian pharma firm cancelled its IPO. Cue the inevitable media alarm: The eurozone crisis’s next phase was here! In our view, though, that interpretation is a tad hasty and quite overwrought—there is no evidence Banco Espírito Santo’s troubles are in any way a result of or catalyst for Spanish, Greek, Italian or eurozone-wide market issues. There is even little reason to believe the bank’s solvency is truly in question. Seems to us markets temporarily overreacted to a corporate governance issue, demonstrating how skepticism remains in the eurozone.

Banco Espírito Santo’s current troubles aren’t exactly its own—this isn’t a case of an overextended eurozone bank teetering on the brink. The problems lie with its parent company, Espírito Santo International SA—a privately held conglomerate regulators have been eyeing for its lack of transparency and questionable management decisions, including fundraising by selling debt through its own investment funds. Not an illegal move, but widely considered iffy and not so wonderful for its investors. So when Espírito Santo International missed a payment on some commercial paper on Wednesday, investors started fleeing. Banco Espírito Santo especially came under fire as Espírito Santo International is a major shareholder of Espírito Santo Financial Group, which owns about a quarter of Banco Espírito Santo. It’s all in the família—literally. This is a family-run conglomerate, with cross-shareholdings typical of the Korean chaebol. Corporate governance issues are fairly common under this structure.

This structure seems to be the primary source of investors’ angst with Banco Espírito Santo. Investors tend to like clear insight into the finances of a bank’s major shareholders, and the parent company’s ongoing accounting issues make it clear there is a lack of transparency. That also drove fears over the bank’s funding—investors didn’t know how much exposure the bank had to its parent company’s commercial paper and whether it would still meet regulatory capital requirements after taking losses (if need be). There was also the broader, scarier question of whether the bank could stay well-funded if the parent company went under (a big if, but one investors will logically consider). Questions on funding and solvency have a way of triggering bank runs, though in this case, with a buyer on the other side of every sale of the bank’s shares, we wouldn’t technically call this a run, per se. Fundamentally, though, the bank seems well-equipped to contain the damage. Espríto Santo Financial Group set aside €700 million in case of emergencies like this. And Friday, Banco Espírito Santo released information about its exposure to Espírito Santo International: about €1.6 billion in assets, which could easily be covered by the €2.1 billion in capital it keeps in excess of regulatory requirements.

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 Wall Street Journal, 07/24/2014

MarketMinder's View: Starting in 2018, the International Accounting Standards Board (IASB) will require non-US banks to book loan losses based on expected losses over the next 12 months—currently, banks don’t record losses until they actually happen. Its US counterpart, the Financial Accounting Standards Board (FASB), has proposed a stricter standard, forcing banks to book all losses expected over the lifetime of the loan up front. Problem is, you can’t forecast into perpetuity—how can a bank know today whether a new 30-year mortgage will ever default?—so pricing a loan for some far-future possibility may yield bizarre results. However, we don’t think this is a huge negative for Financials. The rule operates on banks’ own expectations of loan losses, not market prices a la FAS 157. Mark-to-forecast seems a far better standard since it’s tied directly to banks’ primary business, lending, and not the market’s occasionally irrational pricing of some illiquid assets they might hold on their balance sheet.

By , Bloomberg, 07/24/2014

MarketMinder's View: Color us skeptical on the likelihood these proposals become actual sanctions: "The options in the document for responding to Russia’s intimidation of Ukraine included something for virtually every EU government to dislike. France has held out against an arms embargo, German industry fears for its exports to Russia, Britain and Cyprus have been reluctant to scare away wealthy Russian investors, and Hungary has opposed wider sanctions altogether.” And all these countries (and 23 more) must agree on any measures enacted. That’s, like, hard. For reference: So far, the sanctions the US and EU have imposed on Russia—largely targeting individuals and specific companies—have been fairly muted.

By , Bloomberg, 07/24/2014

MarketMinder's View: “Food and energy loom disproportionately large in the budgets of retirees. They’ve already acquired a lot of stuff, so they’re less apt to get excited about fantastic deals on television sets and furniture manufactured in China. On the other hand, they buy food and gas and medicine every month. When they see how much those expenses carve out of their income, they think, ‘My income is not keeping up,’ and the idea that the government is using the wrong inflation index seems like a reasonable explanation for why it’s so hard to make their money stretch. But however compelling this explanation may seem, it’s wrong. The government knows about food and oil prices. And it’s taking them into account when it calculates your Social Security check.” For more, see our 06/30/2014 commentary, “Should the Fed Hike Rates to Make It Rain?

By , The New York Times, 07/24/2014

MarketMinder's View: Here be the latest on this protectionist solution in search of a problem, which we covered in detail last week. Treasury officials are pressing Congress to pass a law effectively banning “inversion” M&A deals that would apply retroactively, likely stripping at least some recently agreed-to deals of their tax benefits. Democratic Senators support the notion, but Republican Senators don’t want to backdate a crackdown. Perhaps they find a middle ground, but even if this clears the Senate, passing the House is a tall order. In our view, that’s a plus. Protectionism is a negative, and an inversion smackdown is simply protectionism dressed as patriotism. Retroactive tax grabs are also no bueno—they undermine confidence in America as a good place to do business (for an extreme example, see businesses’ reaction to India’s recent move to backdate a foreign merger supertax to the 1960s). Just because we’ve done it before, as this piece documents, doesn’t mean it’s wise to do it again.

Global Market Update

Market Wrap-Up, Thurs July 24 2014

Below is a market summary (as of market close Thursday, 07/24/2014):

  • Global Equities: MSCI World (+0.1%)
  • US Equities: S&P 500 (+0.1%)
  • UK Equities: MSCI UK (-0.1%)
  • Best Country: Portugal (+2.3%)
  • Worst Country: Japan (-0.5%)
  • Best Sector: Financials (+0.5%)
  • Worst Sector: Industrials (-0.2%)
  • Bond Yields: 10-year US Treasurys rose by .04 to 2.51%

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.