Financial Review

Everybody Wants to Go to Heaven

…..ISM manufacturing reverts to strong. Construction spending up. Fed FOMC stands pat. Jay Powell likely pick. GOP tax plan delayed due to math. Facebook beats. Tesla posts big loss. Wells Fargo, again.

Financial Review by Sinclair Noe for 11-01-2017

 

DOW + 46 = 23,424
SPX + 5 = 2580
NAS – 15 = 6712
RUT – 9 = 1492
10 Y – .01 = 2.36%
OIL – .04 = 54.34
GOLD + 3.90 = 1275.30

 

The Dow and the S&P closed near records. The Nasdaq slipped from a record high close yesterday.

 

The ISM manufacturing index fell to 58.7% in October, a month after hitting a 13-year high of 60.8%. Sixteen of the 18 industries tracked by ISM reported growth. After a flurry of activity in the wake of the hurricanes, we seem to be returning to more normal, yet still strong manufacturing growth.

 

Construction spending rose in September, led by a surge in government spending. Spending ran at a seasonally adjusted annual $1.22 billion rate. Spending increased 0.3% during the month, and stood 2% higher than a year ago. For the second month in a row, public works projects drove the spending increase. Public-sector outlays were 2.6% higher than in August, while private-sector spending was 0.4% lower. Compared to a year ago, however, the pace of total public construction spending is 1.6% lower, while overall private spending is 3.1% higher.

 

The Federal Reserve left a key interest rate unchanged in November but called the economy “solid,” which is Fedspeak to say policymakers remain on track to raise the cost of borrowing next month. The central bank had previously projected it would raise its benchmark fed funds rate, now between 1% and 1.25%, at its final meeting on Dec. 12-13. In a statement, the Fed also acknowledged core inflation “remained soft” and is likely to remain so in the short run. The Fed offered a lengthy explanation of what happened to inflation after Hurricanes Harvey and Irma. Higher gas prices boosted overall inflation in September and the after-effects will continue to impact inflation, though for items other than food and energy inflation remained soft.  The Fed still expects inflation to reach its 2% target in the “medium term.” The more muted language on inflation might be a clue the bank will proceed more cautiously early in 2018. But really no surprises from the Fed today. Fed Chairwoman Janet Yellen has said the strength of the economy justified more gradual rate hikes despite low inflation readings. The modest changes to the Fed statement shows that remains the majority view.

 

More indications that Jerome Powell will be nominated to replace Janet Yellen when her term expires in February. The Wall Street Journal reports Powell is the choice. An announcement is expected tomorrow. Powell has never dissented from any decision since becoming a Federal Reserve governor in May 2012. He’s agreed to lift interest rates four times in five years. Put another way – there is hope Powell will represent continuity at the Fed. Powell has made clear he’s a proponent of the “off ramp” the Fed has chosen as it’s begun to reduce the size of its $4.5 trillion balance sheet. In a speech in June, Powell also imagined the Fed balance sheet probably wouldn’t get below $2.4 trillion, and possibly not even $2.9 trillion. Stylistically, Bernanke called Powell a “moderate”.

 

We were waiting for the rollout of the GOP tax plan but it has been delayed. Maybe tomorrow. The problem is basic math – how to cut tax rates without eliminating popular tax breaks. The answer likely lies in smoke and mirrors. Even if the delay does not throw the Republican schedule off course, it signals potential difficulties ahead for a bill that Republicans are attempting to pass on a party-line basis, over what appear most likely to be loud objections from some business groups — and relentless criticism from Democrats. As Republicans rushed to lock down support from their members and key interest groups earlier on Tuesday, some new details of the bill began to trickle out. The draft bill is expected to cut the top corporate tax rate to 20 percent immediately, and not phase it in over a period of years, as had been discussed. The plan might give up on trying to cut the highest rate for the wealthiest earners, which would be above the 35 percent the Republicans identified as their top tax rate in the framework released in September; the idea is to keep that rate at 39.6% and then protest against the idea that they are cutting taxes for the wealthy. Maybe a phased in repeal of the estate tax over several years. Republican leaders also confirmed they would maintain a federal tax deduction for at least some state and local property taxes paid, while eliminating comparable deductions for income and sales taxes. This is going to be a big problem – first because it looks a lot like double taxation – next because states’ rights – next because nobody wants to be taxed on their taxes to give a big tax break to corporations and rich guys. It is now clear that the original plan to fully eliminate the deduction for state and local taxes is not dead – the big problem for people who believe in math is that the tax plan doesn’t work without those cuts. On taxes, everyone wants to go to heaven, no one wants to die.

 

Then, this morning Trump tweeted that the tax plan should include a repeal of the individual mandate on Obamacare, which would turn a difficult math problem into a big hot mess. Nobody is quite sure what the tweets mean, if anything, but tying the tax plan to the already failed effort to repeal Obamacare just doesn’t make sense. GOP leadership is scrambling to get a tax deal done on an extremely compressed schedule, not only because they want to have an accomplishment to tout, but also because the quicker they do it, the less chance there is that resistance will build. And right now, they seem genuinely spooked by the possibility that the public will conclude that their tax cut is little more than a gigantic giveaway to corporations and the wealthy.  This is a well-grounded fear: It is, in fact, a gigantic giveaway to corporations and the wealthy, and polls show the public doesn’t believe corporations and the wealthy desperately need relief from the oppressive burden of taxation. Morgan Stanley warned in a report this week that enacting aggressive tax cuts to businesses and individuals risks “overheating” the economy and causing stocks to “boom then bust.” The concern is that slashing the corporate tax rate from 35% to 20% could backfire by forcing the Federal Reserve to accelerate interest rate hikes. That in turn would raise borrowing costs for consumers and businesses, potentially unnerving the stock market along the way. Morgan Stanley strategists wrote: “Adding stimulus to an already strong economy likely stirs the Fed… pulling forward the end of an aging cycle.” Ironically, given all the excitement on Wall Street about tax cuts, Morgan Stanley argues that “failure of tax reform” would be the “best” outcome for extending the economic and market recovery from the Great Recession.

 

 

So, what’s a one day delay in releasing details of the tax plan? Well, that means there are just 10 working days for Congress between tomorrow and the Thanksgiving holiday. And while many things can be done in 10 days, re-wiring the economic engine might be overly ambitious.

 

Facebook beat earnings and revenue expectations. The company reported third-quarter net income of $4.7 billion, or $1.59 a share, compared to $2.63 billion, or 90 cents a share, in the year-ago period. Revenue rose to $10.3 billion from $7 billion in the year-ago period. Analysts surveyed by FactSet had estimated $1.28 a share on revenue of $9.8 billion. Daily active users, a metric closely watched by analysts and investors, rose 16% to 1.37 billion, compared with the year-earlier period. For the fourth quarter, analysts model earnings of $1.70 a share on revenue of $12 billion. The company’s shares, which hit a record earlier in the day, initially rose in after-hours trading, but later fell into negative territory. They have gained almost 60 percent this year.

 

Meanwhile, lawmakers released a batch of Russian-bought Facebook ads that showcased politically charged content allegedly spread on social media by Moscow ahead of the 2016 U.S. election. Lawyers from Facebook, Twitter and Google testified about Russian influence on their networks. After decades of relatively little regulatory scrutiny, the tech industry is now on the defensive on a range of policy issues.

 

Tesla reported third quarter earnings – or more accurately they reported their largest ever quarterly loss. Tesla also pushed back its target for volume production on its new Model 3 sedan by about three months, saying that while progress fixing bottlenecks was made, it was difficult to predict how long it would take for all production issues to be fixed. Tesla’s long-term viability depends on the Model 3, its new sedan that starts at $35,000, about half the price of its flagship Model S. Tesla plans to produce 500,000 vehicles in 2018, mostly Model 3s, a six-fold increase over 2016 levels. But the company made just 260 Model 3 sedans in the third quarter due to “production bottlenecks,” it said. It had planned to build more than 1,500. Tesla posted a net loss of $619 million, or $3.70 per share, even as revenue rose to 30% to $2.98 billion. Tesla shares dropped about 5% in after-hours trade.

 

Earlier this month, Wells Fargo fired four foreign exchange bankers.  No big deal, right? In its statement, Wells Fargo said, “The departure of these employees was not related to issues involving market collusion, front-running or market manipulation.” We’re pretty sure you can see where this is going. Federal prosecutors are looking into possible front-running of trades. If it’s not one thing, it’s another.

 

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