Market Strategy Radar Screen Weekly December 4, 2017

Fasten Your Seatbelts

As noise level increases in Washington, a focus on what the market is saying makes best sense to us

As we enter the first full week of trading of the new month US and international equities are at or near all-time highs.

Economic growth stateside is showing sustainability for the foreseeable future in a range of 2-2.5% annualized (notwithstanding any additive effects from potential stimulus via tax reform or infrastructure spending); improvements in revenue and earnings growth at the corporate level; synchronous economic recoveries outside the US as well as signs that longterm stock market skeptics and bears have begun to capitulate; these all appear to be “riding shotgun” for the bull market’s continued climb of the proverbial “Wall of Worry” even as the volume of noise coming from Washington has been turned up.

Last Friday the stock market’s resilience was tested after a late morning decline that was sparked when news broke that former National Security Advisor Michael Flynn would be cooperating via a plea agreement with investigators. From when the news broke through mid-day the market swooned, shedding 1.5% in about a 40 minute period of time.

Then nearly as quickly as it had stumbled, investors appeared to give consideration as to what material effect the news of the former General’s decision might have on the US and world economy and markets. From that point forward till the end of the day the market gained a little more than 1.3% to recover most of the ground it had lost earlier.

In our view the bull market derived from the depths of March 2009 showed once again that it is not so much driven by animal spirits, irrational exuberance, fear or greed, or even complacency but rather by what we (and others) have called “rational exuberance”.

Whether it’s the “algos or the bots” (algorithms or the robotics) embedded in today’s digitalized global markets or the collective experience present amongst investors who have grown to accept uncertainty of varying degrees over the last nearly nine years, there appears to be a response mechanism beyond a mere “buy the dip” mentality at work.

While the S&P 500 dropped as much as 1.6% percent on Friday in around a 40 minute period it bounced off the lows quickly and ended the day just 0.2% off from where it had started the day.

Tax Reform Passes the Senate

Also coming out of Washington last week and over the weekend has been a plethora of news items pertaining to the Republican Tax Reform packages from the Senate and the House of Representatives. These stem from the combined determination of the Administration and the Republican Senate and Republican House members to get something done before the end of the year. The result has been two proposed packages from which one will (based on current news crossing the transom) very likely be derived.

As market and investment strategists we do not attempt to claim political savvy and in fact labor to maintain a politically agnostic stance when we consider what crosses the transom from the politicians.

Among our concerns with the tax reform package proposals as they currently stand we’d include:

• The fairness and prudence related to reduction or elimination of mortgage deductions—particularly considering the potential knock-off effect on residential real estate, which accounts for a substantial portion of the assets held by individuals and contributes to the economies of communities across the country;
• The potential negative impact of the reduction or elimination of state and city tax deductibility— particularly in states that provide outsized tax revenue contributions to the Federal government as well as significant contributions to the nation’s GDP;
• Reduction of interest deductibility for corporate entities could disrupt long-established financing mechanisms across sectors;
• A decidedly overwhelming weighting of tax cut benefits in favor of corporations at the expense of the middle and lower income levels at a time when many corporate leaders have shown reluctance to apply any tax savings to hiring and investment rather than share buybacks and dividends;
• The risk of over-inflating an economy which has achieved a rate of sustainable growth and shows prospects for additional growth without stimulus;
• The possibility of risking a sizeable increase to the deficit at a time when stimulus in its proposed form does not appear to be needed.

Lastly, we have to think that consideration of the age-old adage “Haste makes waste” just might be all too applicable in how tax reform is being designed in Washington.

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