Fisher Investments Editorial Staff
Geopolitics

Seeing Through Politicians’ Spin on Brexit Phase One

By, 12/08/2017
Ratings173.676471


(Insert bad metaphor about the deal being a bridge to the next round of Brexit talks here.) Photo by Elisabeth Dellinger.

It is a truth universally acknowledged that two parties negotiating before arbitrary self-imposed deadlines will kick the can when said deadline arrives. To blatantly mix Jane Austen metaphors, you might call it good sense as well as sensibility. So naturally, one day after the US House and Senate kicked the can on a government shutdown for two weeks, the UK and EU kicked the can on Brexit. Of course, that isn’t how either side describes it. No, no, this is a major breakthrough on Brexit Phase One! Call the Queen! Alert the corgis! Pip pip! But once you see through their marketing spin and break down the deal, two things remain apparent: Not much has changed, and Brexit remains a glacial process with little to no ability to surprise markets for good or ill. We believe it is mostly a part of Britain and the EU’s long-term structural backdrop, not a reason for investors to be bearish or bullish today.

To understand how we got here, see Exhibit 1.

Fisher Investments Editorial Staff
Currencies, Interest Rates

Looking for Safety in All the Wrong Places

By, 12/08/2017
Ratings284.821429

“A risk of loss is involved with investing in stock markets.” No doubt you have seen this sentence (or ones like it) in countless disclosures at the end of financial statements and forecasts. It’s there for legal reasons, but also because it’s true—and critical to remember when making investment decisions. However, it seems few heed it. Instead, investors often seek out perceived “risk-free” assets, despite the fact no asset is “safe.” In our view, pursuing the mirage of “safe” investments can lead to behavioral errors and a portfolio that doesn’t match your long-term goals.

We blame industry jargon for much of investors’ misunderstanding. As analyst-types explain it, markets are “risk on” when investors are happy and willing to take risks, making “risk assets” like stocks zoom. But when markets are “risk off,” jittery folks are plowing into “risk-free” assets like high-quality sovereign debt (e.g., US Treasurys, UK gilts, German bunds and Japanese Government Bonds, aka JGBs),  “safe havens” like gold or sectors like Utilities and Telecom.

This might give you the impression stocks are riskier than other assets and some assets are free of risk. This, however, would be wrong. There is no such a thing as a riskless asset. A risk-off investment in allegedly risk-free safe haven assets can still lose money or relative long-term value. Yes, Treasury bonds are typically less volatile than stocks. Likewise, if you’re patient, there is minimal danger of losing principal. If you buy a US bond at issue and hold to maturity, your risk of realizing a loss is basically nil. But you likely lose purchasing power over time due to inflation.  

Fisher Investments Editorial Staff
Across the Atlantic, GDP

Eurozoom!

By, 12/07/2017
Ratings733.883562

A year ago, media looked at the eurozone economy skeptically. Yes, the 19-member currency bloc was growing—but what if growth stalled? Some big unknowns loomed, too. Headlines fretted over 2017 political developments and whether anti-EU populists like Geert Wilders of the Netherlands would seize power and destabilize order. Or what the ECB—allegedly responsible for growth—would do next with its monetary policy. Few experts thought the eurozone would be at the forefront of the global economic expansion. Yet on a year-over-year basis, that is exactly what happened: As of Q3 2017, the eurozone’s 2.5% growth rate leads the US (2.3%), UK (1.5%) and Japan (1.6%).[i] The data continue showing an expansion on firm footing and one that looks likely to continue for the foreseeable future—an underappreciated positive for eurozone markets.  

Eurozone GDP rose 0.6% q/q in Q3, its 18th straight positive quarter. All 11 reporting countries (as of December 5) grew, from powerhouse Germany to long-struggling Greece. While GDP is useful as a high-level economic snapshot, it also focuses on the past three months—not too meaningful for forward-looking stocks. However, more recent data like Purchasing Managers’ Indexes (PMIs) suggest the eurozone is ending 2017 on a strong note.

A quick primer: PMIs are monthly surveys tracking business activity across manufacturing and services. Purchasing managers report a spate of information like new orders, output, costs and employment, and survey compilers crunch the numbers. If the final number exceeds 50, a majority of businesses grew (and vice versa if the figure is under 50). While PMIs aren’t perfect—they are rough sketches that don’t indicate the magnitude of growth (or contraction)—they can provide a quick and timely estimate.

Fisher Investments Editorial Staff
Politics, Reality Check

A Week Without Washington Wouldn’t Wreck Stocks

By, 12/07/2017
Ratings284.517857

On the prospects for averting a government shutdown December 8, President Donald Trump last week tweeted, “I don’t see a deal!” Although this may sound ominous, going without government for a while isn’t inherently bad for the economy or stocks.

Stocks faced government shutdown prospects in April and September. Both times Congress agreed on (bipartisan!) short-term funding fixes—aka continuing resolutions—and markets moved on. September’s three-month can kick also included a temporary lift of the Treasury’s borrowing limit, so debt-ceiling drama also features this time around (that deadline looms on December 15). House Minority Leader Nancy Pelosi and Senate Minority Leader Chuck Schumer were scheduled to talk with Trump last week, but after Trump’s aforementioned tweet, they declined to meet.[i] Now, with beltway theatrics seemingly worked out of everyone’s system, they’ve decided to discuss matters Thursday. Can they hammer out a deal? What should investors expect? The Congressional choose-your-own adventure has a few options—kicking the can again (as short as a two-week stopgap),[ii] actually passing a budget[iii] or shutting down the government.[iv]

In the event of a shutdown, essential personnel report for duty. Unless you’re visiting a National Park, you probably wouldn’t notice. Active-duty military would still report, although their paychecks may be delayed. Patients would still receive treatments at the National Institutes of Health, but no new clinical trials would begin. Animals at the National Zoo would still be fed, but the park—and all Smithsonian museums—would close. NASA’s Mission Control in Houston would stay open, keeping the space station aloft, and you’d still get the weather from the National Weather Service. Federal air-traffic controllers would remain on the job, as would airport screeners. The State Department would continue processing visas and passport applications, since they’re paid for by fees,[v] and embassies and consulates would remain open for American citizens. The Postal Service, which has separate funding, would run as usual.

Timothy Schluter
Corporate Earnings, US Economy

Rational Optimism About Big Tech

By, 12/04/2017
Ratings1374.240876

After a multi-year stretch of almost uninterrupted outperformance, some investors are growing worried the Technology sector is partying like it’s 1999. Is this the second Tech bubble in recent memory, they wonder? As evidence, many point to lofty valuations, noting a few are at late 1990s-ish levels. But in my view, the evidence supporting Tech bubble 2.0 concerns misses the mark, as it relies mostly on valuations. Valuations just aren’t predictive and ignore important context.

As we’ve previously written (here, here and here), valuations alone tell you very little about returns over the next 12 or even 24 months. Cheap stocks can get cheaper; pricey ones can get pricier. As a result, you simply can’t judge a bubble on valuations alone. Consider: Was the Energy sector in a bubble in 2015 and early 2016? Those who remember the time—when Energy stocks were swooning and sentiment was in the tank—would surely say no. But if you define bubbles by super-high P/Es alone, you miss that context. You see, P/Es were soaring as Energy companies’ earnings (P/Es’ denominator) plummeted due to falling oil prices. Another example: Was the S&P 500 frothy in early 2009? That may seem ridiculous, but valuations were stratospheric by many measures due to the 2008 financial crisis’s earnings erosion. Widely used valuation metrics are just one measure that may describe sentiment. But you also have to dig in and actually analyze the components. Then, put them in broader context.

When put into such a broader context, even the basic claim of extremely high Tech valuations similar to the late 1990’s Tech bubble appears flawed. Select valuations such as Tech price-to-sales ratios may be elevated relative to history. But is that necessarily irrational? Consider: Tech margins are generating higher earnings growth for investors. Actually, Tech boasts the highest gross profit margins of all sectors (Exhibit 1)—a key differentiator from Tech in the late 1990s, when investors were clamoring for unprofitable firms with little more than a vague business plan. In the last 20 years, the net profit margin of the S&P 500 Technology sector has more than doubled, as high-profit margin Internet and software firms have rapidly surpassed lower-margin hardware firms as the dominant Tech industry group. Today, the sector is comprised of some of the most profitable companies on the planet. It stands to reason investors are willing to pay up for this—particularly in the late stages of a bull market, where rising valuations are perfectly normal and reasonable!

Elisabeth Dellinger
Commodities

You Might Be Near a Crypto-Top If …

By, 11/28/2017
Ratings1704.167647

For decorative purposes only. Photo by Elisabeth Dellinger.

Holy booming bitcoin, Batman! As the cryptocurrency flirts with $10,000 (that’s ¥1 million if you’re in Japan), we bring you the latest bubble chatter. No, we aren’t calling a peak—we aren’t market timers or commodity forecasters (or cryptocommodity forecasters). But it sure seems like we’re seeing a modern version of Joe Kennedy’s infamous “shoeshine boys” and Hetty Green’s “good-looking bankers.” So, in proper Jeff Foxworthy style, here are all the latest signs that bitcoin, while perhaps not peaking, is sheer speculation at this point.

Fisher Investments Editorial Staff
Across the Atlantic, Developed Markets, US Economy

Hidden Earnings at Home and Abroad

By, 11/28/2017
Ratings564.678571

While many wonder how tax cut proposals, Brexit chatter, Mifid, Trump tweets and Fed-head appointments might affect stocks, a key market driver remains healthy: earnings. As Q3 earnings season winds down, corporate earnings remain strong. But headlines focused on lower overall growth rates so far might have you thinking otherwise—with 98% of S&P 500 firms reporting as of 11/27, FactSet estimates Q3 earnings grew 6.3% y/y.[i] The slowdown from Q2’s 10.2% gets all the ink, but under the hood, we think reality is better than appreciated.

As in recent years, one industry skewed earnings—but with a twist. For the last couple years, the Energy sector distorted data. Dramatic oil price swings skewed sector earnings yuuugely. First, plunging oil depressed profits in 2015 – 2016. Then it flipped when oil prices and Energy firms’ earnings stabilized. Profits weren’t enormous, but growth rates flew thanks to meager comparison points from the prior year. But that impact is waning now. This time, the insurance industry is making a healthy reality harder to see. Hurricane-related losses drove a -63% y/y decline in earnings for the group.[ii] Omit insurance, and expected Q3 earnings growth improves to 9.0% y/y as of 11/27.[iii] But even with the distortions, earnings largely beat expectations. At Q3’s end, analysts expected earnings to grow 3.1% y/y.[iv] The current growth rate is more than double that, and it is due to sales, not cost-cuts. Revenues—up 5.8% y/y as of 11/27—are generally beating expectations.[v]

A similar story has unfolded in Europe, where earnings also slowed after rip-roaring growth in 2017’s first half. Hurricanes are to blame there, too. FactSet estimates a -57% y/y loss for the industry in Q3, depressing their estimate of headline earnings growth to 7.0% y/y.[vi] Exclude insurance, and estimated MSCI EMU earnings growth improves to 17.2% y/y.[vii] As in the US, one-off losses in one area are obscuring underlying strength. Most sectors—and even most other Financials—fared well. For example, bank earnings jumped 29.7% y/y.[viii] For the most part, earnings are strong and the outlook is optimistic.

Fisher Investments Editorial Staff
Monetary Policy, Media Hype/Myths

The Curious and Fallacious Case of the All-Powerful Fed

By, 11/28/2017
Ratings384.342105

Did you hear? Some experts believe the Fed looks vulnerable and unprepared to deal with the next crisis, so it should update its policy toolkit.[i] With new Fed head Jerome Hayden Powell waiting in the wings (and outgoing Chair Janet Yellen departing the central bank when he takes over), the time may seem ripe for change. In our view, though, this is yet another example of the folly of seeing monetary policy as an all-powerful tool that directly and immediately impacts the economy. Investors shouldn’t overstate what the Fed can and can’t do. 

Folks within and outside the Fed have different ideas about how to “improve” monetary policy to meet today’s needs. Some have argued for raising the Fed’s target inflation rate above 2% while others, like San Francisco Fed President John Williams, have suggested “price level targeting” (meaning the Fed will keep short-term rates low until CPI or PCE reaches a place policymakers deem appropriate). Some financial market experts claim the Fed needs to revamp its “forward guidance” communication and become less predictable in order to remove market complacency.[ii] While some of these ideas are well-intentioned, they also seem to be overcomplicating matters. We don’t think it’s necessarily a bad thing for the Fed to target inflation—pursuing price stability is a fine aim for a central bank—but obsessing over the level isn’t necessary. A specific CPI or PCE level doesn’t determine when things go from good to bad. Not only that, the Fed’s existing targets and framework are arbitrary to begin with.

Consider that annual 2% inflation target. Part of the Fed’s congressional statutory mandate is maintaining “stable prices,” but that doesn’t specify what the “right” amount of inflation is. Rather, the FOMC formalized a 2% inflation target in 2012 because they determined that to be “most consistent over the longer run with the Federal Reserve’s statutory mandate.” Yet there is nothing magical about 2% in and of itself. Inflation has mostly lagged 2% since 2012, but that hasn’t stopped the US economy from expanding. Plus, going back several years before the Fed formalized its target rate, inflation was as high as 3.8% in 2005—right in the middle of another economic expansion.

Fisher Investments Editorial Staff

Hiking the (Still) Upward-Sloping Yield Curve

By, 11/27/2017
Ratings904.427778

To the surprise of many, long-term interest rates are flattish this year—despite the Fed raising short-term rates. The result: The US yield curve has flattened. Some in the media fret the potential negative impact on bank lending, economic growth and stocks, worrying this leading economic indicator is flashing yellow. But in our view, this is premature. Yield curves are certainly worth monitoring, but contrary to “flattest in a decade” worries, we don’t believe they signal an approaching recession today.

Yield curves are critical indicators of credit market health. They plot different yields for a single issuer’s bonds across all maturity dates, with the difference between any two points called a spread. In America, the Treasury yield curve is the most significant. Since the US government is generally considered to have very little (if any) default risk, all other debt is priced based on Treasury rates. The influence isn’t just on bonds: Banks’ business model relies on borrowing short term (think: depositors) and lending long (think: businesses and homeowners). Thus, a steeper yield curve means more profitable lending and vice versa. Banks respond to incentives, so when lending is profitable they tend to make more loans. An inverted yield curve—when short rates exceed long—suggests banks will struggle to lend profitably. This is a signal credit markets aren’t functioning well—potentially impacting economic growth.

For that reason, yield curves are a very important leading economic indicator. It is no surprise, given this fundamental backdrop, that the US yield curve inverted before each of the last six US recessions. Today, while media cite a variety of different spreads in their discussions—the spread between 2-year and 30-year Treasury yields or 5-year and 10-year rates—none are inverted presently. Flatter than a year ago, maybe. But positive nonetheless.

Christopher Wong
Into Perspective, Media Hype/Myths

Giving Thanks for Stocks’ Resiliency

By, 11/22/2017
Ratings973.989691


We have much to be thankful for indeed. Photo by Chris Wong.

Here is a thought exercise: Imagine yourself a year ago, Thanksgiving week 2016. If I gave you a list of real headlines from 2017, would you have said stocks were higher or lower overall by Thanksgiving week 2017? I’m guessing many folks would say “lower.” Yet we know reality: Global stocks are up 19% year-to-date and 21.8% since Thanksgiving Day 2016.[i] In my view, this is a keen reminder of stocks’ ability to look past the noise and price in reality far better than any one person can—something investors can give thanks for this year.

Here is a non-comprehensive list of major headlines from 2017:

Elisabeth Dellinger
Inflation

How Not to Measure Inflation: Turkey Edition

By, 11/21/2017
Ratings953.747368


Wild turkeys frolic around Bryan Ranch in Alamo, CA, safe in the knowledge that they will not be your Thanksgiving dinner. Photo by Elisabeth Dellinger.

Every November, the American Farm Bureau Federation releases our favorite niche inflation indicator: the annual Thanksgiving Dinner Cost. It is our favorite not because it is the best. Rather, it is the most fun. We like Thanksgiving. We like turkey. We like pie. And we like some good-natured teasing of tongue-in-cheek fake indicators. And most importantly, we like reminding folks that very few inflation measures—silly or otherwise—bear any resemblance to one’s actual cost of living.

Trigger warning: I’m about to tear into the Farm Bureau’s indicator. Not because it’s dumb. Not because I’m an anti-farm-ite. Rather, because it’s illustrative.

Fisher Investments Editorial Staff
Media Hype/Myths

One Valuation Tool’s Extreme Backwards Bias, Revealed

By, 11/21/2017
Ratings644.25

High valuations are a common concern among investors lately, with many touting the Shiller P/E (or Cyclically Adjusted Price-to-Earnings ratio, CAPE) as particularly concerning. At 31.3, most commentary on the subject highlights the factoid this level has occurred only twice before in history: The late 1990s and 1929, which many claim suggests trouble looms. Yet here is the thing: CAPE is a broken indicator, and the math underlying it can help you see why.

Stocks look forward, but valuation measures are backward looking, to varying degrees. Forward 12-month price-to-earnings ratios (P/Es) are based on analysts’ earnings forecasts—projections made at a particular point in time. Trailing 12-month P/Es are based on past quarters’ results. CAPE, however, is far worse: In an effort to smooth earnings and get a longer view, it averages together a decade’s results (adjusted for inflation). As we have often noted on these pages, that means events from many years ago—like the Financial Crisis, presently—impact CAPE. But, of course, an event ending eight and a half years ago isn’t relevant to where stocks head in 2017 and beyond. It is over.

Yet CAPE is still inflated by the crisis. Exhibit 1 shows why, plotting the raw data behind the CAPE’s divisor—real earnings. The 2007 – 2008 crisis jumps off the page. We’ve circled it here, although we doubt it was necessary.

Fisher Investments Editorial Staff
Across the Atlantic, Reality Check

How to Break the Brexit Blues

By, 11/17/2017
Ratings513.990196

Based on recent headlines, the UK might not seem ok. Brexit talks are plodding along, leaving business leaders antsy. Conservative Prime Minister Theresa May is facing a rebellion from her own ministers. Projections are bleak on the economic front. Sounds bad! However, in our view, many investors fail to appreciate the UK economy’s strength—a sign of sentiment’s disconnect from reality—which sets up bullish upside surprise.

Brexit and its alleged negative consequences continue influencing just about every major economic and political UK narrative. Talks between UK and EU negotiators seem constantly stalled, frustrating both pols and businesses alike. Domestically, controversy has embroiled UK politics. Two ministers resigned from May’s government recently, prompting speculation that the prime minister has lost control—and rumblings of a leadership challenge have started. 20 Tory MPs have also threatened to revolt against a bill enshrining March 29, 2019 in UK law as the official EU exit date.

Beyond these developments, policymakers and experts bemoan the state of the UK economy. BoE Governor and metaphorical “unreliable boyfriend” Mark Carney said the economy would be “booming” if it wasn’t for Brexit. Analysts worry inflation’s 3.0% y/y rise in October—a repeat of September’s rate, which was the highest in five years—could choke consumer spending, especially since wages rose only 2.2% y/y in the same month (implying they fell in real terms). UK retail sales rose 0.3% m/m in October, beating expectations, but headlines dwelled on the first year-over-year contraction in four years.[i] UK industries have also expressed concern future trade deals could hurt them significantly in the long term. The underlying theme: Things are bad now, and they will only get worse when the UK actually exits.

Fisher Investments Editorial Staff
Finance Theory, Forecasting

Volatility (or Lack Thereof) Isn’t Predictive

By, 11/16/2017
Ratings413.963415

It has been 50 trading days since the S&P 500 fell more than -0.5% in a day.[i] Do you know where your children are? While it’s tempting to think danger lurks under still waters—and financial media provide prompts aplenty—calm periods don’t portend big price movements ahead. Nor do they herald further tranquility. Volatility—low or high; up or down—is incapable of foretelling the future.

Low volatility spans the world. US volatility is low whether you measure it by daily percent moves or the VIX’s “options-implied”[ii] volatility. US stocks’ streak without a half-percent decline is the longest since 1968. Moreover, the S&P 500 has risen every month year to date on a total return basis, a first-ever.[iii] October registered the VIX’s lowest monthly average on record (since 1990). Outside America, European stocks’ VIX—VStoxx—also hit record lows. Japan’s Topix index hadn’t fallen by -0.4% or more in 31 trading days until a recent spate of volatility last Friday. Up to then, the Nikkei VIX was near its lowest in a dozen years. Meanwhile, the MSCI All-Country World Index’s[iv] daily percent moves haven’t exceeded half a percent for a couple weeks. That’s some unvolatility! But none of this tells you about future moves. Stocks aren’t serially correlated. Past price movements, whether volatile or not, don’t affect what happens next.[v] Volatility just describes what already happened. It is a measure of past performance, which is never predictive.

Some argue sanguine stocks in the face of seeming threats—geopolitical, political, central bank-related or otherwise—are dangerously complacent. But markets deal efficiently with all widely known information, including headline fears. Yes, they can be irrational in the short term. But nothing widely feared today is new. Nor should stocks have some automatic reaction to any of the day’s news. While headlines dwell on an event or two, stocks consider everything that’s going on. What if all the other (good) variables simply outweigh whatever headlines are scared of? What if what people don’t talk about happens to be more meaningful (and positive) for future corporate profits?

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Recent Commentary

Fisher Investments Editorial Staff
Geopolitics

Seeing Through Politicians’ Spin on Brexit Phase One

By, 12/08/2017
Ratings173.676471

The “major breakthrough” in Brexit negotiations looks more like a can-kick.

read more
Fisher Investments Editorial Staff
Currencies

Looking for Safety in All the Wrong Places

By, 12/08/2017
Ratings284.821429

Despite what terms like “risk assets” and “safe havens” imply, there is no such thing as a riskless investment.

read more
Fisher Investments Editorial Staff
Across the Atlantic

Eurozoom!

By, 12/07/2017
Ratings733.883562

As 2017 wraps up, the eurozone’s latest economic data look smashing. 

read more
Fisher Investments Editorial Staff
Politics

A Week Without Washington Wouldn’t Wreck Stocks

By, 12/07/2017
Ratings284.517857

A government shutdown shouldn’t rattle markets.

read more
Timothy Schluter
Corporate Earnings

Rational Optimism About Big Tech

By, 12/04/2017
Ratings1374.240876

Fears of Tech bubble 2.0 miss the mark by fixating on valuations and not adding broader perspective.

read more

Global Market Update

Market Wrap-Up, Thurssday, December 7, 2017

Below is a market summary as of market close on Thursday, December 7, 2017:

  • Global Equities: MSCI World (0.3%)
  • US Equities: S&P 500 (0.3%)
  • UK Equities: MSCI UK (-0.1%)
  • Best Country: Israel (+1.2%)
  • Worst Country: Norway (-0.9%)
  • Best Sector: Technology (+0.7%)
  • Worst Sector: Consumer Staples (-0.5%)

Bond Yields: 10-year US Treasury yields rose 0.04 percentage point to 2.37%.

 

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. S&P 500 returns are presented including gross dividends. Sector returns are the MSCI World constituent sectors in USD including net dividends.