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Capital Markets Update: Winter 2018 | Fisher Investments

Capital Markets Update: Winter 2018 | Fisher Investments


Hello and welcome to the 2018 Winter Capital
Markets Update video. Filling in for Jessica Smith, I’m Erik Renaud,
a Group Vice President in Private Client Services. I’m joined today by the Investment Policy
Committee. Ken Fisher. Great to be with you. Bill Glaser. Great to be with you Erik. Jeff Silk. Hello Erik. Aaron Anderson. Hi Erik. And Michael Hanson. Hello Erik. The bull market turns nine this year. How much longer can the bull market keep running? There’s no age factor that tells you when
a bull market either ends or begins. Age is not really a feature of it. It’s under the same category in our view of
things like valuation, or how many new market highs, all-time highs does the market hit? None of those things actually tell you whether
a bull market ends or not. Bull markets don’t die of old age, they die
of something happening. We like to say “the wall or the wallop”,
which is, do you have a euphoria based outcome where expectations just get significantly
higher than reality, and reality can’t deliver that expectation any longer, or do you have
some kind of fundamental event that we call a wallop, which would take capital markets
offline, most likely take global GDP off to the tune of several trillion dollars because
we’re thinking in a global sense these days. That’s what we would have to happen, and today
we just don’t see the conditions for those things at all. When you hear a lot if you are skeptical on
the market or if you’re scared of the market you hear people saying, “The market keeps
hitting new highs. How much further can the market rise? We have all these new highs.” And the answer to that is, you shouldn’t be
afraid of that because what a bull market is, is it continually hits new highs, which
is why it keeps living on. So just because the market is long, in terms
of duration, and just because we keep hitting new highs is not a reason to think that stocks
can’t move further very strongly. So the way most people think about things
is naturally. And naturally doesn’t really apply to capital
markets. Naturally tends to be sort of linear, and
relate to thinks you know from nature. So it’s in essence the concept of old age
leading to demise and death. It is a concept that’s very normal to us in
a natural world. Plants suffers in essence, humans suffers
in essence. It’s just natural. Markets, as we decided earlier, actually accelerate
in the last phase and keep going, until, as Michael points out, they hit that wall or
that wallop. But there’s all these things that we talk
about near endlessly where people look for natural phenomena to be answers to markets,
and they almost never are. “The P/E’s too high.” Well as long term clients know we’ve diced
and sliced P/Es every which way but lose, and on a one, three and five year basis P/E
tells you nothing about the future direction of the market. People don’t want to believe that, but we
have a very long history of P/Es, a very long history of parallel securities prices. We can run correlation coefficients and prove
zero correlation. Pure randomness. But people look for natural phenomena. Heights as a frame, that is scary, almost
always when it’s presented to us that way, and so high valuations look scary. Bull markets run their own course regardless
of valuations. In the end, eventually, bull markets end. There is a final new high. To Jeffrey’s point about new highs, new highs,
new highs, when you actually get to the euphoria parts people stop worrying about new highs. It’s the last new high you need to start worrying
about. Not that we’ve had a lot. Every new bull market has a lot. It’s this process that goes on, which is non-linear,
and it’s non-natural, and therefore very hard for most humans to think in those terms ’cause
they keep looking for natural ways that would be the end. The end is not natural. It’s been about a year since President Trump
was inaugurated into the White House. How has he stacked up relative to our expectations? Well I think what’s been clear is you’ve actually
seen a lot of tweeting of course, but a lot less actual action than I think people perceive
today. You know, if you look at actual legislation
that’s been put in place over the course of the last year, there’s been one big bill of
course, the tax reform bill that went through. Other than that there hasn’t really been a
lot of big political action. If you just look at the number of bills that
have been signed, it’s been low relative to other presidents. There are bigger and more complex bills, they’re
very swampy, which just tells you a little bit about the complexity and swampiness of
Washington today that the swamp certainly has not been drained. But overall, even though you’re hearing a
lot about politics in the news, it makes a lot of headlines, you do see a lot of tweeting
and so forth, in terms of actual action you’re not seeing all that much, and I think that
that’s giving the market a lot of comfort. We always highlight the fact that gridlock
is optimal environment for equities because it lowers political risk. People often get frustrated there isn’t things
happening in Washington. Why aren’t we getting more passed? Why aren’t we getting more done? The market actually doesn’t like all of that. What the market likes is less political action,
less political risk, and that’s exactly what you’re seeing today. And that’s true not just here in the U.S.,
that’s really true globally. As we move past a number a big elections in
Europe last year, the outcomes of that I think gave people more confidence that the status
quo would be maintained. And so, I think what you’re seeing for equities
at least is a pretty good backdrop. And one that’s just not featuring a lot of
activity. And if we look forward, I think there’s more
of that to come in 2018. We’re going to have more political headlines
this year, particularly in the U.S. as you get into midterm elections. But all of that probably adds to the gridlock
as people who are going to be running for re-election just aren’t as inclined to want
to sign on to big controversial bills. They’re more inclined to focusing on getting
themselves re-elected. And we’re right in the midst of that starting
to happen. It pains me to say it a little bit, but we’re
in for another election season here before too long. And so as folks are just focusing on their
re-election versus focusing on getting big controversial legislation done, political
risk should be pretty low this year, and that should be a good backdrop for stocks. What we said about the reality of President
Trump before he got elected is that if he got elected, because so little of Congress
on the Republican side, had been supportive of him in the campaign, that you would get
this, what we call new form of gridlock where he would have inter-party fighting. And even though they would have the majority
in both chambers, they wouldn’t be able to pass much. That’s been abundantly clear that that’s been
the case. Regularly, Republicans have tried to float
things through Congress to have this largely same group of Republicans batten it down and
vote with the Democrats not pass things. That’s a form of gridlock. In this election coming up in the midterms,
that Aaron referenced, we’re going to have an outcome that is either A or B. “A”
is that the Republicans keep control of one or both houses of Congress by a hair’s whisker. Or “B”, the Democrats get control of one
or both houses of Congress by a hair’s whisker. If you look at the structure of the elections
it really isn’t possible to get outside that bandwidth. And what that says very simply, that most
people just don’t get this way, is we’re either going to get a continuation of this new form
of gridlock that we’ve had all throughout 2017 and into 2018, or, we’re going to revert
to conventional gridlock. And either one of those means we don’t have
much potential shift for major… Maybe one thing investors have to look forward
to as we move through the midterm elections this year, then we get into the back half
of President Trump’s term, and that really tends to be the sweet spot for stocks, politically
speaking. Where, if you compare the first two years
of a president’s term relative to the second two years of a president’s term, the second
two years, the last two years, you have a much greater consistency of positive returns
relative to the first two years. And the reason for that, what we believe,
is because when you go through those midterm elections, almost always with very few exceptions,
the president’s party tends to lose power. And when you get into that second half of
a president’s term it’s much more difficult to get various forms of legislation to be
passed, you reduce that political uncertainty, you reduce that political risk, and all else
equal, that bodes well for stock prices. You know, if someone is a fan or opponent
of President Trump either way, and they’re very firm in their belief, they tend to extrapolate
that into their views about the stock market, and that’s always a bad idea. The fact is, there are many who would say
President Trump is great and he has made the stock market do well. “Look, it’s gone up!” But the fact is, that makes them more confident
of future, and that helps them into the greater fool whelm. There’s the others who say, “Oh my gosh,
President Trump’s terrible, and the market’s gone up anyway. The market’s crazy.” That actually also helps them look for other
reasons that lets them also play into that later greater fool theory phenomena. You can play this in a lot of ways and in
a lot of functions. How will the market react to the passage of
the tax reform recently? And the second part of the question is, does
the passage of that bill challenge our thesis of gridlock looking forward? Well first off as we said, we’ve got a long
history of tax cuts, tax hikes, of all different kind. Corporate tax hikes and cuts, income tax hikes
and cuts, capital gains, which of course is particularly relevant for investments. And what you can see very clearly is there’s
just no “there” there. I mean getting back to that notion that markets
pre-price all of this stuff, and it’s debated and discussed for so long that all of those
expectations very efficiently get baked into stock prices, that if you look at market returns
before and after you get any of those types of hikes or cuts, there’s no consistency to
how the market does. It just tells you these ultimately become
non-issues. This bull market is in no way reliant on the
tax bill that’s been passed. And if we hadn’t gotten it, then the bull
market would’ve continued for other reasons as well. So, we don’t think it really has much market
impact whatsoever. And so, I think the notion that now Republicans
have kind of got their one big win leading into midterms, there’s not the urgency to
do something controversial, all that supports the notion that we’re in for a lot of gridlock
going forward. Which as we’ve said, is a pretty good environment
for stocks. And, it’s not a bull market that’s reliant
on what’s going on with taxes. Bull market’s roaring for a lot of very good
reasons, but it’s not just because of tax cuts. You know, one way to keep your sanity in all
this is to go back to the basic concepts we’ve been describing for so many things tied to
bear markets, and corrections. How does market pre-price? You take something like the tax cuts, the
first thing you can say is, there are not many things on the planet Earth that have
been more widely discussed, and therefore already digested in the stock prices. The surprise power isn’t there. I mean even you might be able to argue because
certain things got jammed in at the last second. Maybe there’s some surprises there. The truth is the whole Earth is look at this
thing, and particularly the financial community. Second piece is scaling, and we talked about
this with bear markets and other things that effect markets as well, which is that, the
idea that even for a country as large as the United States, that a single piece of legislation,
and particularly this tax bill, is of an order of magnitude large enough to really change
the entire trajectory of the global capital market system, let alone the economic system. When you scale it right you realize it’s really
not, and that these things are relatively small compared to what it really takes to
cause let’s say a recession, or a bear market, and so forth. And when you scale those things, or you think
about market pricing, you can really keep your sanity pretty well from all things you
get bombarded with in the media each day. Now, let me just keep playing with that for
a minute. Because there’s just so much nonsense that’s
said about stuff like this. One of the pieces of nonsense that you’ve
heard quite a lot about is, and in fact, President Trump and Republicans have promoted this,
and again we’re not pro-Trump or anti-Trump. The tax bill, with the lowering of the corporate
rate, will motivate huge amounts of money that have been captively imprisoned overseas
to flow back into America. You’ve all heard that. Now just think about that for a second. Let’s presume it’s true and then presume it’s
not true. ‘Cause it’s either A or B, right? If it’s true, then the money flows from overseas
back into America, it might help America, but it would hurt non-America. And we have a global stock market, so how
do you get the global stock market to go up in a zero sum game? You follow the simplicity of this? Real simple. If it’s just transferring the money from overseas,
back into America, that might help America to hurt the rest of the world and the global
stock market. But where America is about half the weight
of the total world, how can market grow up a lot because of that? Secondarily, I just want to get to the insulting
part. Insulting is actually an interesting point. A statement like that is blatantly insulting
to the CEO and the CFO of major global corporations. I mean it’s just a statement that is beyond
over the top insulting to them because it assumes that with rules that existed before,
they weren’t smart enough to separate income statement issues from balance sheet issues
and move money around the world wherever they wanted it, which at most cost a couple of
tiny transactions. The fact is, if you got operations all over
the world, you name the company, you can move money all around the world without that tax
effect. You want to get money back in America, you
know how to do it. It’s not that tough. Let me say that a different way. Who is smarter on average? The CEO and CFO of Google, or the average
member of Congress? This is not a tough one. I don’t care which party’s in power. It’s not a tough one. The fact is, those guys know how to do what
they have to do to move the money. If you just think of kind of the biggest global
corporations can go all over the world, borrow here, lend it there, put it into that division,
ship it over to that subsidiary, make an equity investment and lend over there. You can move the money around without any
real impact. A little tiny impact, what the transaction
cost. And to think you can’t is blatantly insulting
to those people. I don’t know, people just don’t seem to get
that. I’ll go back to my simple point before, who’s
smarter? The average major global CEO, CFO, or the
average member of Congress? Take your pick. And you know here again it’s important to
think globally. I mean, a lot of people have said for a while
that maybe the U.S. is behind the rest of the world in terms of revising the tax code
and bringing down marginal corporate tax rates, that type of thing. And if that’s actually true, then you would
have expected these other countries in Europe and Japan and elsewhere that have been cutting
their corporate tax rates well before we did, that their economies would have gotten an
out-sized boost from that. Their equity markets would have done tremendously
well. But if you think about the last decade or
so, it’s been the U.S. economy up until very recently that really stood out as being a
better performer in U.S. equity markets that really did. So, if those foreign economies that were cutting
rates before we did suddenly got some out-sized boost from doing that, you’d expect that to
have been reflected in their economic activity and how their equity markets perform. But the opposite was true. And so, in that same regard, I wouldn’t expect
that U.S. tax cuts, and I would give the U.S., or U.S. equities some great advantage over
foreign economies and foreign markets because as we pointed out here today it’s a global
world. Companies, multi-national companies can move
money around, take advantage of tax rates all over the world, or interest rates, they
really can port that money around very efficiently. And just like those foreign economies didn’t
get some extra benefit from cutting tax earlier, I don’t think the U.S. necessarily gets some
benefit from cutting taxes now. We’ve got midterm elections coming up soon
here in the U.S. We’ve talked a little bit about potential
outcomes, slight majority for either party. Why do we think that will be the most likely
outcome? There is a lot there. This conversation could go on for a long,
long time. Fundamentally, the structure of the Senate
seats this year favors to Republicans a lot. Normally in a midterm, the President’s party
loses some relative power to the opposition party. Those two play against each other. If you actually look at the seats that are
up, it’s hard to find very many at all that are Republican seats that have much potential
to go Democratic because they’re basically in Republican states. That’s the basic story. When you look at House seats, they tend to
go the same macro direction that the Senate seats go, which means Democrats have a big
year to pick up a few seats. They could take control of the Senate. If the Republicans can do better than normal,
as happened in the first George W. Bush midterm, the Republicans might pick up a seat. Most of the vulnerable seats are Democrats
up for election now, who won in states that were more Democratic when they won, and are
now very, very Republican states like Joe Manchin in West Virginia, John Tester in Montana,
Donnelly in Indiana, Heidi Heitkamp. These are, now mind you on the other hand,
there’s other conflicting features that are going on. And it’s hard to balance these correctly except
for to say that they largely offset each other. The Republican party is raising money a heck
of a lot better than the Democratic party is. The Democratic candidates are raising money
better than the Republican candidates are. When you get down to the end, if the candidates
spend their money well, that gives an advantage to the Democrats. If the parties spend their money well it gives
an advantage to the Republicans. Do I have any confidence that any of them
spend the money well? No, not particularly, it’s too early to know
that. We talked a bit about yield curves earlier
today, and how they’re narrowing in the U.S. but perhaps widening overseas. Can we talk about our expectations for global
monetary policy and interest rates in 2018? Yes, and we attack that from a few different
ways. The first one is just as you say, yield curves
particularly in Europe are a little bit steeper than they are in the U.S. today which we think
favors non -U.S., and in particular European banks. We think that’s bullish. But in terms of the question
Their monetary growth is faster there also. Indeed, monetary growth is faster there, and
monetary growth is fine around most of the world but it’s not particularly high, which
I think gets into the second part of this equation, which many people think about the
inflation question when they talk about interest rates, and particularly when you talk about
the yield curve. You know if you go back a year ago, as Donald
Trump becomes President Trump, you had a lot of folks saying, “Well this is the time. We’re going to start getting high inflation. You’re going to get a strong dollar. You’re going to get higher inflation.” Well as a matter of fact none of those things
happened. And now you fast forward one year and you
have many of the same people singing the same song. And in our view it’s just not the time for
higher long term interest rates. It is in fact the case in the U.S. that perhaps
they will raise short-term interest rates some, and perhaps they will flatten the yield
curve a bit. But there’s no reason to forecast that today. We’re just going to wait and see what they
do because I think the part that gets forgotten about in all of this is by definition, if
you start to tighten monetary policy, whether it be by raising short term interest rates
and tightening up the yield curve, or perhaps even starting to sunset your quantitative
easing program, which a lot of folks have forgotten. That actually does, although in a minor way,
start to suck liquidity out of the system. These things are in relationship. And by definition doing those things is actually
going to probably decrease inflation expectations which probably keeps long term interest rates
a little bit lower than people think. And, the way that we think about that is,
a long term interest rate, particularly for a treasury bond, or United States, or a sovereign
yield of some kind, is a risk-free rate, plus some inflation expectation component in most
cases. If inflation expectations, or inflation itself
is not going to be as high as people expect, that argues for long term interest rates being
a little bit lower than people think. That’s pretty much where our forecast is. Money supply growth as Ken said, is growing
but not so quickly that it would cause for alarm in terms of high inflation. With some minor tightening starting to go
on in places like the United States, we think inflation can be lower than people expect,
and therefore long term interest rates probably stay lower than people expect. To Ken, Bill, Jeff, Aaron and Mike, thank
you all very much for our conversation today. Thank you, for viewing the Capital Markets
Update. For views on current events in the world of
investing, visit Marketminder.com. Updated daily, it offers on-demand access
to Fisher Investments’ most current thoughts on capital markets and the global economy,
as well as our sometimes irreverent commentary. We hope you’ll enjoy it.

1 comment on “Capital Markets Update: Winter 2018 | Fisher Investments

  1. "Who is smarter, the average major global CEO & CFO or the average member of Congress? Take your pick." Wow, so obvious when you said this. Thanks, Ken!

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