Financial Review

Waiting on Markups

…..Tax plan mark ups followed by possible vote this week. Philly Fed forecast 2.2% GDP growth for 2017. October deficit grows. NY Fed inflation expectations up. CAPE too high. GE’s train wreck.

Financial Review by Sinclair Noe for 11-13-2017

 

DOW + 17 = 23,439
SPX + 2 = 2584
NAS + 6 = 6757
RUT – 0.21 = 1475
10 Y un = 2.40%
OIL – .04 = 56.70
GOLD + 2.70 = 1278.60

 

The Senate tax-writing committee is hammering out the details of its tax cut proposal. The House may vote on its own bill as soon as Thursday. The House bill would end existing federal deductions for state and local income taxes and sales taxes. It would preserve a property tax deduction, capped at $10,000. Meanwhile, a Senate plan that’s being debated this week by the Senate Finance Committee, would fully repeal each of the deductions. House Ways and Means Chairman Kevin Brady of Texas has said the House of Representatives wouldn’t accept a bill that fully eliminates deductions for all state and local taxes as the Senate’s does. Some representatives from New York, New Jersey and California have expressed concerns.

 

Another complicating factor is that the tax plans are each proceeding on parallel tracks. House GOP members may not want to take a politically painful vote when the bill is on the House floor if Senate tax writers have taken some provisions off the table. Trump repeated his call for Congress to repeal the Obamacare law’s requirement that individuals purchase health insurance. The problem is that the Congressional Budget Office has already determined that would leave 30 million without insurance and increase the deficit by $338 billion. Neither the House bill nor the current Senate proposal includes the repeal of the individual mandate. A new study by Congress’s official tax scorekeeper suggests that in 2019, households earning $1 million a year or more would get an average tax cut of about $58,000, while those earning between $50,000 and $75,000 would see an average tax cut of about $688. Those amounts, based on a Saturday report from the Joint Committee on Taxation, contradict Trump’s repeated assertions that the GOP tax plan would benefit the middle class but not the highest earners. Several recent studies show that plenty of benefits would go to the highest earners — and some middle-class taxpayers might actually pay more.

 

Adding further difficulty to the Senate side of the tax equation, is the senate race in Alabama to fill the seat vacated by Jeff Sessions. The Republican nominee is Roy Moore, and today another woman accused Moore of sexual assault back in the 1970s, when she was a teenager and Moore was a 30-something county attorney. That makes 5 women who have accused Moore of inappropriate behavior. Moore denies the allegations and has threatened to sue the accusers. Today, Senate Majority leader Mitch McConnell said he believes the women and that Moore should “step aside” from the Dec. 12 special election. As crazy as it might sound, there are several polls showing Moore’s Democratic opponent has taken the lead in the tight race.

 

The Philadelphia Fed said in its quarterly Survey of Professional Forecasters show economists now expect the U.S. economy to expand at a 2.6% annual rate in the fourth quarter, up from the previous estimate of a 2.3% rate made three months ago. This will bring U.S. growth up to a 2.2% annual rate for all of 2017, the forecasters said, an impressive gain from the 1.5% rate seen in 2016. Still, the forecasters do not see growth getting up to 3% over the forecast horizon. They predict the economy will expand at a 2.5% rate in 2018, and then slow to 2.1% in 2019 and 1.9% in 2020. According to the survey, inflation will only slowly rise to the Fed’s 2% annual rate target. Core personal consumption expenditure inflation is expected to average 1.4% in 2017, 1.8% in 2018 and 2% in 2019. On the employment front, forecasters slightly revised down their estimates for job gains for this year and next. They see nonfarm payroll employment rising at a monthly rate of 178,000 in 2017, down from the previous projection of 180,400. In 2018, nonfarm payroll gains will average 163,400, down from the previous estimate of 165,800. The unemployment rate will average 4.4% in 2017 and fall to 4.1% next year, 4% in 2019 and then pick up to 4.1% in 2020. Just a reminder – for the tax cut plan to work, the economy needs to grow at more than 3% per year, otherwise there will be a huge hole blown in the budget.

 

The Treasury Department reports federal government ran a budget deficit of $63 billion in October, the first month of fiscal 2018. The shortfall was $17 billion more than in the same month last year. Spending was up 12% in the month, while revenues rose 6%. Major drivers for higher spending in October included homeland security programs and education. Receipts of individual income and payroll taxes were 7% higher than in October 2016, a factor usually attributed to increases in wages and salaries.

 

According to a Federal Reserve Bank of New York survey, inflation expectations edged up again in October, touching their highest level in six months. The survey of consumer expectations showed the one-year-ahead measure was 2.61 percent in October, its second monthly rise. That’s up from 2.54 percent the month before and the highest since April. The three-year-ahead expectation was 2.81 percent, slightly up from the previous month and also at the highest level since April. Both gauges have generally slipped since the survey began in mid-2013, covering a period in which spot inflation levels have lingered below a 2-percent Fed target. The central bank has nonetheless raised rates four times since late 2015 in a nod to strong employment and steady economic growth, and expects to tighten policy again next month. And this data provides the green light for the Fed to raise rates again at their December FOMC meeting.

 

The Bank of England has posted research from a Harvard professor, who looked at interest rates and inflation over a 700-year period. The current period – since the 1980s – is the second-longest period of depressed interest rates recorded and its closest historical analogy is the global “Long Depression” of the 1880s and 1890s which saw low productivity growth, deflationary price dynamics, and the rise of global populism and protectionism. The takeaway from the study is that when interest rates rise from a depressed period, the turnaround could be sudden.

 

A popular measure of valuing stocks looks set for a decline, and stock returns will suffer because of it, according to new research published Monday by the Federal Reserve Bank of San Francisco. The cyclically-adjusted price-to-earnings, or CAPE, ratio is the inflation-adjusted value of the S&P 500 index divided by the real earnings of companies in the index averaged over the most recent 10 years. Going back to 1881, big run-ups in the CAPE ratio—usually from the advent of new technologies including high-speed rail, automobiles and the internet—were met with substantial decline in stock prices. The quarterly average CAPE ratio now stands at around 30, exceeded only by the peak values of 43 in 2000 and 31 in 1929. The CAPE ratio can remain elevated for quite some time – it does not mean there is an imminent decline, but the projected path of that model implies a 13% decline in the CAPE ratio over the next 10 years.

 

General Electric had a train wreck on Wall Street today, figuratively speaking. Shares suffered their worst session in 8-1/2 years. GE  cut its dividend, as expected, but also provided a downbeat profit outlook for next year, and said the Securities and Exchange Commission’s new revenue recognition rules would cut its 2017 revenue by $1.4 billion and operating profit by $2.1 billion. The much anticipated transformation plan unveiled by new Chief Executive John Flannery gave investors little to cheer about in the short term, and more reason for pause. GE stock fell more than 8%. The stock has tumbled more than 40% year to date.

 

Among GE’s other revelations was its plan for a “smaller, simpler” portfolio of industrial businesses that focus on powering the world, transporting people safely and saving lives (health care).  Smaller and simpler means they are also looking to sell some units of the company. The piecemeal divestitures GE is targeting won’t cut it. Even if it gets rid of transportation and lighting, the company is still huge and highly diverse. The company said it would focus on cash generation and returns, revise its compensation program to better align management with investors, trim its board of directors to 12 members from 18 and be more disciplined with capital allocation. The new annual dividend rate of 48 cents a share, or half the previous rate of 96 cents a share, implies a dividend yield of 2.55% at current share prices. The reduced dividend still costs about $4 billion annually. And while GE’s targeting $6 billion to $7 billion in industrial free cash flow next year, that’s probably overly optimistic. The real number appears to be close to zero if you account for pension and capital expenditures as other industrial companies would; which means GE still has a cash flow problem even after cutting its dividend.

 

Shares of Roku surged another 10% today, extending gains made last week after better-than-expected earnings. Roku last week reported earnings for the first time as a public company, sending its stock price soaring. Roku believes its TV operating system – known as its platform business in filings – is the key to growth, and platform revenue reached 46% of total sales. Shares were last up $2.40 at $35.65, a full 155% above the company’s IPO issue price of $14.

 

Shares in Mattel traded 21% higher in the wake of a report late Friday that rival toymaker Hasbro has made a takeover offer. A Wall Street Journal report on Friday revealed Hasbro’s approach to Mattel, but provided no details of the offer.

 

Home Depot reports earnings tomorrow morning before the opening bell.

 

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