Financial Review

Buy Rumor, Sell Fact

…Stocks slip. Tech bounce. Monetary and fiscal policy and the bond market. Buy the Hake hike rumor and sell the news? Some mistakes in the tax plan. Shutdown? LA burning. Silence breakers.

Financial Review by Sinclair Noe for 12-06-2017

 

DOW – 39 = 24,140
SPX – 0.30 = 2629
NAS + 14 = 6776
RUT – 23 = 1508
10 Y – .03 = 2.33%
OIL -2 .39 = 55.97
GOLD – 3.10 = 1263.80

 

Shares of Microsoft, Facebook and Google-parent Alphabet rose more than 1 percent as the technology sector recovered from a recent selloff. Microsoft was up more than 2 percent.

 

For the past 9 years, the Federal Reserve’s monetary policy has been the driving force in stock price appreciation. The Fed cut interest rates to near zero and then injected monetary credits into the economy through quantitative easing. Take a look at a chart of the Fed’s balance sheet and then overlap a chart of the S&P 500. The 2 charts match almost perfectly. Now the Fed has stopped investing into new asset purchases and stopped rolling over existing holding, a tapering process that will eliminate more than $1 trillion from its balance sheet, slowly and gradually. The removal of nearly $1 trillion in asset price support in 2018 is hardly insignificant. Further, whenever there was a dip in the markets, the Fed would step in with a little extra dose of accommodation. We became so accustomed to Fed intervention that we call it a Fed “put”, which in turn made it easy for investors to buy the dip. We don’t know if the Fed has extra tools to provide a backstop for Wall Street, and if they have those tools, we don’t know if they will use them. But just when it looks like the Fed’s toolbox is empty, we have a tax plan.

 

Many believe that Republican-led tax plan is a phenomenal positive for bull market continuation stateside. Indeed, there’s little doubt that stock investors have been buying the proverbial rumor since the November 2016 election. The question is, should people consider selling the actual news of passage? Granted, greater profits at public companies will make their way into dividends, mergers, and buybacks. Yet, there’s little evidence to suggest that the domestic economy will improve dramatically. Tax cuts might be inconsequential. Even if tax cuts produce a lot of stimulus out of the gate, it may not be a sustainable force. All credible analysis so far indicates the tax cuts will not produce enough growth to be deficit neutral. And there is nothing to suggest that we will see a sustained burst of growth this late in the economic cycle. For a quarter or two? Sure. For another 5-10 years without a recession? Not a chance.

 

The Treasury bond market does not support the notion that tax reform will light the domestic economy on fire. Immediately following the November 2016 election, the difference between 10-year Treasury bonds and two-year Treasury bonds spiked from 1% to 1.35%. The implication at that time? Tax reform should stimulate economic growth beyond post-Great Recession levels. Since the start of the year, however, the spread between 10-year Treasury notes and 2-year Treasuries has been whittled down to a mere 0.5%. If the bond market believed tax cuts would really provide solid, sustainable economic growth, the spread would stay elevated or widen, rather than compress. The spread between key Treasury bond rates sits at a decade low. Should the spread turn negative, a phenomenon known as “yield curve inversion,” fears of recession would creep into everyday conversation. The fact that the Federal Reserve is raising its overnight lending rate and seeing little reaction from the yields of intermediate and longer-term bonds is an indication that bond investors do not believe in the strength of the economic outlook going forward. And you have to think most of the tax cut hype has already been priced into stocks; resulting in valuations not seen since 2000 and 1929. Again, we could still see a short to intermediate pop higher on positive tax cut news, and December is a seasonally strong month on Wall Street; that just means now is a good time to make sure you have an exit strategy in place.

 

As Republicans hurtle toward making their massive tax plan into law, experts are starting to find a slew of errors they say are most likely the result of a rushed process. Republicans have argued that the plan is the culmination of years of work. But the resulting bill has moved through both chambers of Congress at legislative light speed; about 2 weeks in the House, and 2 weeks in the Senate. Given the breakneck speed and last-minute dealmaking — Senate Republicans were making handwritten changes hours before passing their bill — it’s no surprise that experts have discovered complications in the immediate aftermath of the legislation’s passage. Perhaps the biggest was in the Senate bill, which, at the last minute, kept intact the corporate alternative minimum tax. Leaving the corporate AMT could have major consequences on businesses, such as eliminating the benefit of the research and development tax credit. Repealing the corporate AMT could cause a revenue shortfall of an additional $300 billion. That would force Republicans to find more revenue in other places. I say it is a last-minute error but it might not be a bad idea. Critics of the corporate alternative minimum tax have two big complaints. First and most obviously, if the alternate minimum tax and the new corporate tax rate were both 20 percent, it would mean that almost everyone who is a corporate taxpayer will also be an AMT taxpayer. It would mean that all companies pay the same rate. A 20-percent corporate alternative minimum tax — one that taxes all of a company’s income — would effectively eliminate international tax breaks without attempting the politically daunting task of actually passing a law to eliminate international tax breaks. Indeed, it would also eliminate the incentive to park profits abroad in the first place. Secondly, new tax breaks that have been written into the Senate bill for, say, spending on new equipment, would be rendered meaningless. That would mean companies would have to make decisions about capital spending, hiring, intellectual property and so on, based purely on what’s best for the business rather than for a big tax break. Anyway, this is seen as an error.

 

There are multiple other errors. Republicans are now convening a conference committee — made up of members of both chambers, mostly from the tax-bill-writing House Ways and Means and Senate Finance committees — to hash out differences in the versions of the bills –  and work out the errors. From there, the House and Senate would both have to approve the compromise bill. And the next vote is not a slam dunk. Deals were made to secure votes and those deals might come undone in the reconciliation process.

 

That is based on the assumption that the government stays open past Friday. A partial shutdown looms. While the House potentially could pass upcoming spending bills without any Democratic support, that tactic would not work in the Senate where procedural rules give Democrats bargaining power. As a condition of backing a new spending measure, many Democrats have demanded legislative protections for the nearly 700,000 undocumented immigrants who were brought into the United States as children. Trump has criticized that condition, saying it could set the stage for an impasse. Beyond that are questions about defense spending versus funding for domestic programs. A partial government shutdown would leave “essential” government services operating, but could disrupt programs ranging from the operation of national parks to educational programs and scientific research. Of course, lawmakers could vote for an extension, but whatever happens, it will need to happen soon. The deadline is Friday.

 

Private-sector employment slowed down in November, as ADP reported employers added 190,000 jobs. According to ADP, small private-sector businesses added 50,000 jobs in November, midsize businesses added 99,000, and large businesses added 41,000. Most of those gains were in the service sector. Markets look to ADP’s report on private-sector payrolls to provide guidance on the Labor Department’s jobs estimate, which will be released Friday and includes information on both private- and public-sector payrolls. The consensus estimate for the Friday jobs report is just over 200,000 new jobs in November, down from 261,000 in October.

 

Los Angeles is burning. Wildfires have hit densely packed urban areas of greater Los Angeles, including Ventura, Bel Air, Sylmar, and Santa Clarita. The first and largest blaze, dubbed the Thomas Fire, started Monday night in Ventura County. As of Wednesday afternoon, it had grown to more than 65,000 acres and destroyed at least 150 structures out of at least 12,000 threatened. The flames have crossed the 101 Freeway near Solimar Beach in Ventura County and have now reached the Pacific Ocean. Mandatory evacuation orders affect nearly 200,000 people, and authorities have closed the 405 Freeway, causing gridlock throughout the region. The Los Angeles Unified School District closed more than 50 schools.  Gov. Jerry Brown has declared a state of emergency, freeing up state funds to help tackle the wildfires. Weather conditions aligned to make the LA area a tinderbox. The region is under a “red flag” advisory because of Santa Ana winds. Gusts of up to 80 mph are expected throughout the region.

 

Time magazine named the “Silence Breakers” for its 2017 person of the year, dedicating the magazine’s annual title to the “women and men who have broken their silence span all races, all income classes, all occupations and virtually all corners of the globe” on sexual harassment.

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