Political Update for Investors, April 27, 2017

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Political Update for Investors

Trading yesterday was driven by multiple political-related headlines. Politics reasserted itself on the market narrative on Wednesday, helping stocks initially rally following renewed hopes for an Obamacare repeal/replace bill, and after the Trump Administration unveiled a significant (though expected) tax cut plan.

Yet despite the media focus on those two events, any actual progress with healthcare or taxes remains unlikely (and didn’t get better yesterday). The third piece of political news, an investigation into aluminum imports by the Commerce Department, was the most important (yet underfollowed) political development for markets yesterday.

I cover each issue below, cut through the noise, and get to any likely market influence. The bottom line is that despite generally favorable headlines, all the political news yesterday was a mild net negative for stocks.

Trump Administration Tax Cut Plan.

What Happened: The Trump Administration unveiled a sweeping tax cut proposal that included a 15% corporate rate, just three individual tax brackets, doubling the standard deduction, and repatriating overseas profits.

Why It Matters: Corporate tax cuts remain the easiest catalyst for a stock breakout, but unfortunately the tax plan revealed yesterday is very unlikely to pass Congress, and the reason is simple: There is no offset to the reduced revenue from lower taxes. As such, this plan will increase the deficit, and that likely means Democrats can filibuster the bill. Going forward, unless a tax plan contains some material offsets to reduced taxes (like border adjustments) then passage of any big tax cuts remains unlikely in 2017, and that’s stock negative.

How Markets Reacted: Tax-related headlines can still cause a pop in markets, but only a credible plan that can pass Congress will be a bullish gamechanger. (For more market insights in your inbox by 7am each morning, sign up for a free 2-week trial at 7sReport.com.)

Healthcare Bill (Obamacare repeal/replace).

What Happened: The details were fast and furious on this yesterday, but as of this writing it appears the House will vote on the bill potentially this weekend, and odds of passing are decent.

Why It Matters: Passage of an Obamacare repeal/replace increases the chances of tax cuts also passing, as it will increase Trump’s political capital and provide more revenue to offset tax cuts. However, even if this bill passes the House, the chances of passage in the Senate in the current form remain slim. So, while a potential moral victory, it won’t significantly increase the chance of healthcare reform, and as such I don’t see it as a bearish gamechanger for healthcare ETFs (XLV, IHF, IBB).

How Markets Reacted: Stocks (including health care names) largely ignored this news, as again the likelihood of any Obamacare repeal/replace becoming law remains slim. (For more market insights in your inbox by 7am each morning, sign up for a free 2-week trial at 7sReport.com.)

Tariffs and Trade.

What Happened: Yesterday the Commerce Department announced an investigation into aluminum imports. No tariffs were announced, but it certainly looks to be moving in that direction. This announcement comes one day after Commerce levied taxes on Canadian soft lumber imports. Additionally, a Politico story hit midmorning that President Trump was close to signing a document notifying Mexico and Canada that the US intends to withdraw from NAFTA within six months. The document does not guarantee a US exit (they can change course), but it is a necessary legal step to begin the process. Since yesterday the White House has said it’s not preparing this document yet but didn’t squash the idea all together.

Why It Matters: These trade events yesterday (and this week) are actually the most important political events of the week, not because of their immediate impact (Canadian lumber and aluminum tariffs don’t mean a trade war, and the NAFTA announcement is likely for negotiating leverage), but it does remind markets of Trump’s potentially disruptive trade policies. That matters, because right now markets have not priced in any trade-related headwinds, so this does represent at least a modest risk to the bullish narrative.

How Markets Reacted: All the trade headlines weighed slightly on stocks during the late afternoon, but the current headlines simply aren’t bad enough to warrant an outright reversal in stocks. (For more market insights in your inbox by 7am each morning, sign up for a free 2-week trial at 7sReport.com.)

Bottom Line on the Political Update for Investors:

Material “gaps” remain that must be filled if the S&P 500 can sustain a meaningful breakout above 2400, including 1) The gap between political expectations and political reality, 2) The gap between too-low Treasury yields and very high stock prices (although that’s narrowed some-what this week, but not enough), and 3) The gap between soft economic surveys and hard economic data.

In the very short term, investor sentiment seems skeptical, and the market acts as though investors are more afraid of missing a breakout than they are a break down (similar to what we saw when the S&P 500 broke through 2300). So, the “pain trade” looks higher short term and that’s helping stocks.

But given valuations (the S&P 500 trading nearly 18X 2018 earnings), I don’t think sentiment alone is enough to push us decidedly through 2400 without positive resolution on some of these gaps. That means we need 1) Actual progress on tax cuts (which didn’t happen yesterday), 2) A rally in the 10 year above 2.40%, or 3) Better economic data starting today.

I am therefore sticking with my call that the 2300-2400 broad trading range in the S&P 500 should hold, and I would not be chasing stocks at these levels.

Cut through the noise and understand what’s truly driving markets, as this new political and economic reality evolves. The Sevens Report is the daily market cheat sheet our subscribers use to keep up on markets, seize opportunities, avoid risks and get more assets.

The Case for Investing in Europe (Updated), April 25, 2017

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The Case for Europe, Updated

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European indices and ETFs exploded to new 52-week highs yesterday following the expected French election results. The likely removal of that French political risk overhang reinforces our bullish thesis on Europe, especially given some wobbling in US economic data recently.

On March 21 we presented “The Case for Europe,” which was our bullish thesis on Europe as a tactical investment idea. Since we presented that piece, the three Europe ETFs we recommended have rallied an average of 4.2% vs. the S&P 500 just being flat over the same period. We think that outperformance from Europe can continue for the coming months, so we are presenting an updated “Case for Europe,” and reiterating our bullish stance on three Europe ETFs.

Bullish Factor #1: Compelling Relative Valuation. The reasoning here is simple. The S&P 500 is trading at the top end of historical valuations: 18.25X 2017 EPS, and 17.75X 2018 EPS. There’s not much room for those multiples to go higher, and if we get policy disappointment or the economic data loses momentum, markets could hit a nasty air pocket.

(Specific data and ETFs withheld for subscribers – unlock with free trial: 7sReport.com) 

So, while it’s true Europe should trade at a lower multiple vs. the US given the still-slow growth and political issues, those discounts are pretty compelling. In a world where most equity indices and sectors are fully valued, Europe offers value.

Update: The valuation gap still remains and European indices trade at a still steep discount to the S&P 500. We continue to think we can see multiple expansion in Europe that can help European stocks outperform their US counterparts.

Bullish Factor #2: Ongoing Central Bank Support. This one also is pretty simple… the ECB is still doing QE. The ECB is still planning to buy 60 billion euros worth of bonds through December of this year. That will support the economy, help earnings and push inflation higher, all of which are positive for stocks.

Update: The ECB reacted dovishly to perceptions that it might prematurely end QE or raise rates, and with inflation metrics still uncomfortably low, the chances of a hawkish surprise from the ECB anytime soon are low.

Bullish Factor #3: Overblown political risk. We’ve been talking about this for a while, but the fact is that political risks in Europe are overblown, and just like people underappreciated risks in 2016, I believe they are now overreacting to Brexit and Trump by extrapolating those results too far.

Going forward, there are really two important elections this year: France and Germany.

Update: Macron beat Le Pen in the first round of voting, and according to both the Harris and Ipsos polls taken right after voting on Sunday, Macron holds a large 64% to 36% ad-vantage ahead of the May 7 election.

Turning to Germany, they will have elections in September, and Social Democrat leader Martin Schulz will challenge Merkel for the Prime Minster position. Schultz is a former President of the European Parliament, and he’s not anti EU at all. So, if he wins, from an EU outlook standpoint, it isn’t a negative. Now, I’m not going to get into the details of his politics, because they aren’t yet important for this investment. The bigger point is that it’s not really a problem for the European economy if Schultz wins.

Bottom line, we’ve done well in international investments in the past (Japan during Abenomics, Europe when they started QE), and we believe this is another opportunity to outperform.

How to Play It: (Specific data and ETFs withheld for subscribers – unlock with free trial: 7sReport.com) 

Cut through the noise and understand what’s truly driving markets, as this new political and economic reality evolves. Start your free trial of the Sevens Report today.

Last Week and This Week in Economics, April 24, 2017

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This week and last week in economics - The sevens report

Last Week in Economics – 4.17.17

April economic data started with a bit of a thud as all three April reports missed estimates last week. And while on an absolute level the numbers imply economic activity remains “fine,” the lack of additional progress is contributing to growing doubts about the strength of expected economic reflation (and that’s why bond yields are lower than most expect).

Last week’s headline economic report, flash April Manufacturing PMI, missed expectations at 52.8 vs. (E) 53.9, and declined from the March reading. Likewise, April Empire Manufacturing and Philly Fed also missed expectations and declined from very high readings in March.

Now, to be clear, on an absolute level all three readings show continued economic growth, but again it’s the pace that matters. Stocks have priced in reflation, but the loss of momentum in economic data undermines that thesis, and that’s why stocks have grinded sideways now for six weeks.

Meanwhile, the gap between soft sentiment surveys and hard economic data remained wide. March Industrial Production beat estimates but that was only because of strong utility production given the March blizzard. The manufacturing sub-component declined and badly missed estimates, again providing non-confirmation for the still high (in absolutely terms) manufacturing PMIs.

Bottom line, economic data wasn’t outright “bad” last week, but it didn’t help reinforce the expected reflation trade, and that did at least partially stoke concerns about the pace of growth. Meanwhile, economic data didn’t help close the gap between hard and soft.

This Week in Economics – 4.24.17

The slow drip of economic data continues this week (next week is the big one), although given the precarious nature of the bond market (10-year yields signaling a potential slowdown) all economic data is at least partially important.

With that in mind, the most important number will be Friday’s Employment Cost Index. Inflation is a key component of the reflation trade, and any broader uptick in inflation has to come from increased wages. In Q1, wage data in the government jobs report wasn’t particularly strong. So, if the Employment Cost Index shows no real uptick in wage pressures, that will further undermine the reflation trade.

Other important data next week includes the first look at Q1 GDP (which will be lucky to hit 1%) and Durable Goods. Starting with GDP, it’s not going to be a strong report, but if consumer spending (PCE) is stronger than expected that will be a silver lining. Meanwhile, Durable Goods offers yet another opportunity for hard economic data to meet surging sentiment surveys, and in doing so close the gap between strong soft data and lackluster actual data. Other notable data points this week include Pending Home Sales and Existing Home Sales, both of which will be under more scrutiny following the disappointing Housing Market Index and Housing Starts numbers from last week.

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French Election: The Good, Bad & Ugly. April 21, 2017

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This Sunday is the first round of voting in the French election, and the event has the potential to move markets depending on which two candidates come in first and second. Yet before getting into the expected results, I want to give some background on how the election works and who is running.

How It Works: The French election almost always has two rounds of voting. The first round, which occurs Sunday, contains all major candidates. If one candidate gets more than 50% of the vote, he or she be-comes president. However, because there are always so many candidates in the first round, this almost never happens (last time was in ’95).

So, the two top finishers from the first vote then face a run off in round two, which will take place two weeks from Sunday. Whoever wins that second vote becomes the French president. So, Sunday’s vote is important because it will determine which two candidates will advance to the second round on May 7.

Who Is Running: There are four candidates you need to be aware of: Macron, Fillon, Le Pen and Mélenchon. From a market standpoint, Macron and Fillon represent the status quo. The market would be fine with either winning the French presidency (i.e. no immediate sell-off).

That cannot be said for Le Pen and Mélenchon. To keep this simple and short, if Le Pen wins, the chances of a “Frexit” (France leaving the EU) go up considerably, as she is a far-right, anti-EU candidate. Conversely, Mélenchon is a far-left socialist. While he would keep France in the EU, his economic and social policies lie uncomfortably close to outright socialism. That clearly would not be good for the French economy, or French stocks.

Facebook - French Election

Election Results Scenario

The Good: Macron and Fillon Finish 1 & 2. Both are considered reasonably centrist, and the status quo in France would continue. Likely Market Reaction: (Withheld for subscribers. Unlock with a free trial — no credit card needed: 7sReport.com.)

The Bad: Le Pen or Mélenchon Finish 1 or 2. Based on polls, it’s likely that Le Pen will come in first or second in voting on Sunday, while Mélenchon is more of a dark horse. Likely Market Reaction: (Withheld for subscribers. Unlock with a free trial — no credit card needed: 7sReport.com.)

The Ugly: Le Pen and Mélenchon Finish 1 & 2. This is extremely unlikely based on polling, but as 2016 taught us, anything can happen. This is the market’s worst-case scenario, as it would introduce material political and economic risk into the European and global economies. We would view this result as a bearish gamechanger, and would likely exit HEDJ and EUFN longs. Likely Market Reaction: (Withheld for subscribers. Unlock with a free trial — no credit card needed: 7sReport.com.)

Bottom Line: From a macro standpoint, and for our position in HEDJ specifically, anything other than the “Ugly” scenario shouldn’t pressure markets materially. And while the “Bad” scenario will extend the possibility of political risk in France, all the indicators say that either Macron or Fillon will be the next French president—and that will only reinforce our bullish Europe thesis.

This is a volatile, politically sensitive investment global landscape—you need The Sevens Report to stay ahead of the changes, and to calm worried clients—help your clients outperform markets with The Sevens Report.

S&P Fails at Key Resistance

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The S&P 500 tested but failed at an important downtrend resistance line on the daily chart yesterday, and that leaves the current path of least resistance lower until that technical level (2360) is violated on a closing basis.

 

Oil Plunge

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WTI crude oil futures plunged well over 3% yesterday as the steady trend of climbing US oil production continues to weigh on the fundamental backdrop of the market.

 

Tom Essaye on “The Bell” Podcast with Kenneth Polcari and Adam Johnson

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I was a guest on Adam Johnson’s podcast “The Bell” last week. We talk about the reality of tax reform, tax trade, geopolitics, and the bond market, straight from the NYSE Floor. We were also joined by Kenneth Polcari, Director, O’Neil Securities, director of NYSE Floor.

Get a free two-week trial of Tom Essaye’s Sevens Report—everything you need to know about the markets in your inbox by 7am, in 7 minutes or less.

Are British Elections a Bullish Gamechanger for the Pound? April 19, 2017

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The Sevens Report is the daily market cheat sheet our subscribers use to keep up on markets, seize opportunities, avoid risks and get more assets. 

The pound was the big mover on Tuesday as it surged 2.2% following PM May’s call for elections in June. (As a bit of background, May calling for snap elections means that in the next few days Parliament will be dissolved, and then there will be national elections for all Parliamentary seats over the next six weeks).

The news took markets by surprise, but it is a politically savvy move by Ms. May. Right now, in part because a swell in national pride following the official start of Brexit, PM May is very popular. Calling for elections now will capitalize on that popularity, and help her Tories (Conservatives) increase their majority in Parliament.

From an economic standpoint, however, this isn’t likely to have much of an actual effect. Like the Republicans in the US, the Tories are viewed as the “pro-business” par-ty, so there was a knee-jerk positive reaction. However, Brexit will be the major influence on the value of the pound and the British economy over the next few years, not internal politics. Besides, as we’ve seen with Republicans here in the US, just because a party has power doesn’t mean it can actually get anything done!

Bottom line, the pound has surged to multi-month highs and clearly broken resistance at 1.25, and there’s more short covering to come. But, I do not view Tuesday’s events as a bullish gamechanger for the pound or British stocks, and if anything I’d be inclined to sell the pound if it approached 1.30 vs. the dollar.

For now, though, standing on the sidelines is warranted.

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Gold Futures Pull Back

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Gold futures rallied into resistance/our initial upside target just shy of $1300 yesterday before risk-on money flows spurred a reversal as fear bids unwound.

 

Last Week and This Week in Economics, April 17, 2017

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Week of April 17th and April 10th in Economics

Last Week in Economics – 4.10.17

The two important economic numbers came out Friday when markets were closed, so they didn’t receive much attention, although they should have. Both numbers (CPI and Retail Sales) further eroded the reflation trade thesis and will increase worries the economy is losing momentum.

Starting with retail sales, the headline on this number was plain ugly. March retail sales declined 0.2% vs. (E) 0.0%. Almost as importantly, February retail sales were revised down to -0.3% from the previous 0.1%. As longer-term readers know, we generally disregard the headline and instead look at the “control” group retail sales, which is retail sales ex autos, gasoline and building materials. That control group gives us a better read on truly discretionary spending.

Here the numbers are a bit better. Control retail sales rose 0.5% in March vs. (E) 0.3%, but February was revised lower from 0.1% to -0.2%. So, considering revisions, the March number wasn’t a beat.

Bottom line, this number is not good for stocks. Consumer spending was the engine powering the Q3/Q4 2016 economic acceleration, and the sluggishness in consumer spending now is extending beyond what we would consider normal slack following a big acceleration. These are not the kind of numbers we would see if a bigger economic acceleration is looming.

Turning to CPI, it also undermined the “reflation” trade in the near term. Headline CPI dropped -0.3% vs. (E) 0.0% while core CPI declined -0.1% vs. (E) 0.2%. Additionally, the year-over-year core CPI reading dipped from 2.3% in Feb. to 2.0% in March. This soft CPI reading isn’t a damning number, and clearly the trend of inflation is higher. Yet markets need modestly higher inflation and better growth to power stocks higher, and last week’s numbers did not suggest that’s happening.

Bottom line, this week now is very important, as it will go a long way to resolving the now-glaring discrepancy between still sluggish “hard” economic data and surging “soft” economic sentiment surveys.

Finally, to make this a bit more real, Friday’s numbers resulted in the GDP Now for Q1 dropping to just 0.5%. That type of economic growth simply cannot support stocks at these levels, and as such we should expect Friday’s data to further pressure bond yields and the dollar, which will increase stock headwinds.

This Week in Economics – 4.17.17

This week is important for markets because we will get a much more definitive answer to the question of whether the pace of economic growth is losing momentum. How that question is answered will go a long way to determining whether the S&P 500 takes out the March low of 2322, or if stocks can bounce.

To that point, the most important economic releases this week all contain March data, and the most important report will be the flash manufacturing PMIs out Friday, followed (in importance) by Empire Manufacturing (today) and Philly Fed (Thursday). The reason those numbers are so important is because it’s April data, so they will give us the most current view of the pace of economic activity in the US. If they further imply there is a loss of momentum, that will further undermine the reflation trade and hit stocks. Conversely, markets need strong data this week to help reinvigorate the reflation trade thesis.

Looking beyond those March data points, the next most important report this week is March Industrial Production. This number is important because a wide gulf still exists between “soft” sentiment -based data, and “hard” economic numbers. Industrial production is the next opportunity for some of that “hard” economic data to move higher and begin to close that gap.

Bottom line, we’re coming to a head on the debate over soft vs. hard economic data, and whether the recent economic acceleration can last. While there aren’t a lot of numbers this week, what data we do get is important to resolving that debate… and that will move markets.

The Sevens Report is the daily market cheat sheet our subscribers use to keep up on markets, seize opportunities, avoid risks and get more assets.