Financial Review

Cliff’s Edge

…..Markets on cruise control along the cliff’s edge. Tax bill tries to cut individual mandate. PayGo may be a NoGo. Billionaires for higher taxes. IEA says oil will flow. Home Depot’s hurricane quarter.

Financial Review by Sinclair Noe for 11-14-2017

DOW – 30 = 23,409
SPX – 5 = 2578
NAS – 19 = 6737
RUT – 3 = 1471
10 Y – .02 = 2.38%
OIL – 1.42 = 55.34
GOLD + 1.90 = 1280.80

 

With the quarterly earnings season winding down, the market has taken a breather after its rally to record highs last week. General Electric dropped more than 5% today, marking its worst 2-day decline in 8 years, and acting as a drag on the Dow Industrials. In the past 2 days, GE is down 13%, and has given up all the gains from the past 6 years. Oil prices fell more than 2.5% and dragged oil stocks lower. Metal prices pulled back after a weaker-than-expected economic data from China sparked concerns about demand. Copper miner Freeport-McMoRan slipped 5.5%, and was the biggest loser on the materials index.

 

Still, it’s not like stocks are going over the cliff. Nobody is calling this the start of a correction. Investors are nervous that the divide in Washington is too wide for tax cuts to happen this year. Plus, some unexpected softness in China has led to questions about the global synchronized economic recovery thesis. And now that earnings season is over, it’s not clear what the next catalyst that will push stocks higher, or at least keep them at these lofty valuations. The S&P 500 has not fallen by 3% to 5% for 12 months. The historical average is every 2 to 3 months on average. If the current streak without a pullback that large continues for two more weeks, it would become the longest-such rally ever. Pullbacks historically happen when investors make outsized bets that stocks would rise versus bets that they would fall, when economic growth is so unexpectedly good that there’s reason to believe it could worsen, and if there’s an unexpected negative catalyst. This market has seen good, but not great economic growth; and no great shocks since Brexit. Earnings per share for S&P 500 companies should rise 11% in 2018 to $146 from $131 this year; that’s solid growth, but not enough to justify the higher valuations. Traders are betting less on stock-market drops overall, although single-stock short interest has increased slightly.

 

In markets, it’s common knowledge that when things are going well, overconfidence can come back and bite you. And that, in turn, poses one of the great existential dilemmas of investing: Do you take a more measured approach, knowing that your hubris could eventually be your undoing? Or do you push aside those lingering doubts and forge ahead in blind pursuit of further returns? According to Bank of America Merrill Lynch’s latest monthly fund-manager survey, which includes 206 panelists who manage $610 billion, investors are continuing to chase after the quick buck. The firm finds that a record number of survey responders are taking higher-than-normal risk. That comes at a time when stock market valuations are sitting close to their highest in history, creating a precarious situation in which investors are feeling emboldened at a time when they should be exhibiting caution. In addition to their unprecedented risk threshold, 48% of survey participants also said they saw equity valuations at a record high. And all of this is happening as surveyed cash levels dwindle to 4.4% of overall holdings, their lowest since October 2013. The market has been able to avoid collapse for 9 years. It is getting harder and harder to find something you really want to buy – which is different than saying you want to sell right now. Still, you have to realize that this bull market run is closer to the end than the beginning.

 

The Senate tax-writing committee continues hammering out the details of its tax cut proposal, while the House may vote on its bill as soon as Thursday. Here’s the latest twist. Senate tax writers are considering including a provision to repeal the individual mandate that all individuals purchase health insurance. Essentially, this is another attempt to kill Obamacare. Making the change would produce an estimated $338 billion in savings over 10 years that would help tax writers meet fiscal targets. Those savings would come from reductions in government spending on health-coverage subsidies for an estimated 13 million Americans who would forgo coverage in 2027, according to an estimate from the Congressional Budget Office. Reopening the politically painful Obamacare debate could cost the GOP crucial votes on a tax bill. A “skinny” repeal of Obamacare that scrapped the individual mandate failed in July to pass the Senate. So, the idea is to take a failed idea with strong opposition and make that part of the tax bill because tax reform isn’t complicated enough. The proposal also confirms that, as of now – the tax cut math still does not work.

 

Specifically, the Congressional Budget Office says the tax legislation could trigger the “pay-as-you-go”, or PayGo, rule – a 2010 law that says all passed legislation cannot collectively increase the estimated national debt. In other words, if Republicans want to pass a tax cut, they have to pay for it with mandatory spending cuts — or, inversely, if Congress boosts funding for entitlement programs, it has to increase taxes. If Congress violates this law, the Office of Management and Budget, which keeps the deficit scorecard, “would be required to issue a sequestration order within 15 days of the end of the session of Congress to reduce spending in fiscal year 2018 by the resultant total of $136 billion.” That could mean sequestration across some major mandatory spending programs, like Medicare, federal student loans, and agriculture subsidies, and even some funding for customs and border patrol. Cuts to Medicare are capped at 4 percent, about $25 billion per year, meaning cuts to the other mandatory spending programs would have to make up the difference; the CBO calculates that would be about $111 billion in cuts across the board, in addition to the $25 billion cut to Medicare. Because PAYGO is a law, Congress will have to pass another law to change it. They aren’t allowed to do this through budget reconciliation — meaning Republicans will need to get at least 60 votes in the Senate to mitigate this sequestration. That means they would need Democrats to go along for the ride, which might be a tough sell when the GOP is trying to gut Obamacare as part of the tax plan. In other words, things might get ugly, fast.

 

More than 400 American millionaires and billionaires are sending a letter to Congress this week urging Republican lawmakers not to cut their taxes. The wealthy Americans say the GOP is making a mistake by reducing taxes on the richest families at a time when the nation’s debt is high and inequality is back at the worst level since the 1920s. The letter calls on Congress not to pass any tax bill that “further exacerbates inequality” and adds to the debt. Instead of petitioning tax cuts for the wealthy, the letter tells Congress to raise taxes on rich people like them.

 

The United States will be the undisputed leader of global oil and gas markets for decades to come – that according to the International Energy Agency in its annual World Energy Outlook, which predicts the US will be a dominant force in global oil and gas markets for many years to come as the shale boom becomes the biggest supply surge in history. By 2025, the growth in American oil production will equal that achieved by Saudi Arabia at the height of its expansion back in the 60s and 70s, and increases in natural gas will surpass those of the former Soviet Union. The boom will turn the US, still among the biggest oil importers, into a net exporter of fossil fuels. The agency raised estimates for the amount of shale oil that can be technically recovered by about 30 percent to 105 billion barrels. Lower prices are helping to support oil demand, and the IEA raised its projections for global consumption through to 2035, despite the growing popularity of electric vehicles.

 

The United Nations this week is holding its 23rd Conference of Parties to the United Nations Framework Convention on Climate Change, known as COP 23, in Germany. The US delegation is being led by Under Secretary of State for Political Affairs and they are trying to promote fossil fuels and nuclear energy; which is kind of like promoting tobacco at a cancer summit.

 

Home Depot raised its full-year profit and sales forecast after Hurricanes Harvey and Irma spurred demand for generators, flashlights and rebuilding materials. Home Depot got a huge boost in the quarter as the hurricanes drove customers to its stores in the southern United States for emergency supplies. Net income for the third quarter rose 10 percent to $2.1 billion, or $1.84 per share. Home Depot’s net sales rose 8% to $25 billion in the third quarter, helped by a 5 percent jump in average receipt and a 2.5 percent rise in transactions. The company posted double-digit rise in comparable sales of hurricane-related merchandise, including generators, wet-dry vacuum cleaners and tarps. Sales of big-ticket items, which are priced above $900 and accounted for over a fifth of total sales, rose 12 percent.

 

Buffalo Wild Wings’ shares rose nearly 26 percent in early trading, a day after a report said the company received a $2.3-billion takeover bid from private-equity firm Roark Capital Group. Roark’s takeover offer follows several other deals involving private equity firms buying restaurant chains. In October, casual dining chain Ruby Tuesday was bought by NRD Capital for about $335 million, while Luxembourg-based JAB Holdings took popular U.S. food chains Panera Bread and Krispy Kreme Doughnuts private in the last two years. Roark has stakes in other restaurants chains like Arby’s and CKE Restaurants, the owner of Carl’s Jr.

 

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