“Bolton is a known foreign policy hawk and, apparently, he and President Trump’s views began to diverge over time. Part of that very well could be that Trump’s keenly…” said Tyler Richey, co-editor at Sevens Report Research. Click here to read the full article.
“We’ve consistently repeated that the rally in stocks to essentially new highs has been driven by hopes of Fed rate cuts and a U.S.-China trade truce…” said Tom Essaye, founder of The Sevens Report. Click here to read the full article.
“Momentum can carry this market higher especially into the Trump/Xi G20 summit, but the bigger (and longer-term more important) question regarding…” says Tom Essaye. Click here to read the full article on CNBC.
Tom Essaye joined Yahoo Finance’s Zack Guzman and Heidi Chung to discuss how Trump’s tariff threat could influence global markets. Click here or the video below to watch the full interview.
What’s in Today’s Report:
- Time to Chase Stocks? Not So Fast.
Money flows were risk-on overnight thanks to continued trade-war optimism but stock futures are off the highs following more soft economic data overseas.
Trump said he would push back the March 1st tariff deadline, which was previously considered a “hard date,” if there is “good progress” towards a trade deal at that time while President Xi is now expected to attend talks on Friday. Both are incremental positives for the prospects of a successful deal.
Economic data out overnight was less optimistic however. EU Industrial Production fell –4.2% vs. (E) -3.2% Y/Y in December which is just the latest release fueling concerns about a global economic slowdown.
Today, the January CPI Report (E: 0.1%) will be watched closely ahead of the open while there are several Fed speakers before lunch: Bostic (7:15 a.m. ET), Mester (8:50 a.m. ET), Harker (12:00 p.m. ET).
The major focus of the market right now however remains the trade negotiations in Beijing and stocks will be most sensitive to any material headlines regarding the ongoing talks.
What’s in Today’s Report:
- Technical Update: Was that the Bottom?
Futures are lower and giving back about 1/3 of yesterday’s massive rally on digestion and potentially negative U.S./China headlines. There was no notable economic data overnight.
The Trump administration is considering an executive order banning U.S. companies from using Huawei and ZTE products (both Chinese firms). This represents a potential escalation in ongoing U.S,/China tech/trade conflict, although so far China has viewed the trade and tech issues separately, and that needs to continue otherwise this market will face additional headwinds.
Today markets will try and digest yesterday’s massive rally with the best case scenario being a continued rally that sees the Dow and S&P 500 close above near resistance levels. Economically, we do get multiple reports including Jobless Claims (E: 217K), FHFA House Price Index (E: 0.2%), New Home Sales (E: 560K) and Consumer Confidence (E: 134.0) although none of those should move markets materially.
We always need a story to tell about why the market is heading higher, and the one that’s making the rounds this morning is about the dollar. In an interview, President Donald Trump criticized the U.S. Federal Reserve for raising interest rates, and that has added uncertainty to what had been all but certain. As a result, the U.S. Dollar Index has dropped 0.2% today because one way a currency gains value against another is by being from a country where rates are anticipated to be higher. And a weaker dollar is supposed to be helping risk appetite in the U.S. and abroad. “Those comments mostly affected the dollar (pushing it lower), which on a longer time frame is bullish for stocks,” writes The Sevens Report’s Tom Essaye.
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Macroeconomic Drama Rundown (It’s Not That Bad, Yet)
Over the past week, the macro environment has suddenly become populated with multiple headline grabbing (and seemingly dire) macroeconomic dramas, and I imagine you might be getting calls about these dramas from clients.
So I want to: 1) Cover each drama, 2) Explain why it’s not materially important to the market yet (despite the headlines) and 3) Identify what has to happen for these events to cause a pullback. I’ve covered each event in order of their respective potential importance to the markets.
Drama 1: North Korea
What’s Happened? More communication, some official, some not. Secretary of State Tillerson is apparently in direct talks with the North Koreans on some sort of deescalation. However, that comes as President Trump tweets vague threats implying the only option is military. It’s unclear if this is some geopolitical game of “Good Cop/Bad Cop,” or just an administration that’s not on the same page (the answer likely depends on which papers you prefer reading), but the point is that on the surface, rhetoric remains unnerving (at least the public rhetoric).
What’s Next? North Korea is expected to test another long-range missile sometime between Oct. 10 and Oct. 22.
Bearish Game Changer If: This has remained consistent: Talk is just talk and it won’t cause anything other than a brief pullback. But, this geopolitical drama becomes a reason to de-risk if North Korea shoots the missile at anything US, including planes, ships and Guam. At that point, the potential for a US military strike on North Korea goes up considerably, and we would advise getting more defensive in nature (i.e. buying Treasuries or going to cash).
Drama 2: Iran Nuclear Deal
What’s Happened? President Trump is expected to decertify the Iran deal on Oct. 12 (Thursday). This is important, because once President Trump announces that he believes Iran is not in compliance with the deal, a 60-day clock starts ticking. Over those 60 days, Congress must decide whether to reimpose sanctions on Iran (it’s not President Trump’s decision).
What’s Next? Thursday’s official announcement on the Iran deal (it’s not a sure thing that Trump will decertify the deal, so there’s some drama here).
Bearish Headwind If: Congress decides to reimpose sanctions on Iran, causing a total collapse of the
international agreement. This outcome would not, by itself, constitute a reason to materially de-risk (i.e. sell stocks). I say that because stocks rallied for years while there was no agreement in place. However, taken in the context of the North Korea nuclear program, Iran/Russia ties, etc., this entire situation would get potentially much more complicated and dangerous, as markets will take notice and it would be a headwind (but not enough to cause a material pullback).
Drama 3: Catalan Independence
What’s Happened? On Oct. 1, Catalonia (a region of Spain where Barcelona is located) held a referendum on independence from Spain. That referendum passed with 90% of the vote choosing independence. However, less than 50% of the population voted, so that’s more impressive than it seems (meaning the majority of Catalans didn’t vote for independence). The proper analogy to understand this situation is to think of this like a US state having a vote to try and se- cede from the nation. States can’t just vote to leave the US, and neither can Catalonia vote to leave Spain. The vote was illegal and meaningless, outside of the fact that it has stirred up a Spanish political hornet’s nest.
What’s Next? The President of Catalonia will speak on the matter tomorrow night, and will either declare independence (legally it will mean nothing) or will vow to negotiate with the Spanish government on enacting some changes to make the Catalan people happy.
Bearish Headwind If: This one has been a bit exacerbated by the press. First of all, Catalonia has wanted to secede from Spain pretty much since it was conquered by Spain in the 1700s. Catalan culture is different from Spain (they speak Catalan, which is different than Spanish) and the people always have considered themselves different from the rest of Spain. So, it’s not shocking they held the vote.
Second, this is as much a money issue as a cultural one (surprise!). Catalonia is wealthy compared to the rest of Spain. And, the Catalan people perceive (somewhat correctly) that they subsidize the rest of Spain, and they are tired of it (years of recession will do that).
At this point, there are three ways it can go:
The “Good” scenario is that the Catalan government and Spanish government negotiate this out (this is the likely outcome). The “Bad” scenario is the Catalan government declares independence and the Spanish government fires the entire Catalan government and assumes control of municipal services and holds a new election. The “Ugly” scenario is the Spanish government declares martial law and occupies Catalonia (this is very unlikely).
But, even if the “Ugly” scenario come to pass, this is still mostly a local problem. For it to become a bearish game-changer for European ETFs and US stocks, we’d need to see Catalonia achieve independence, and spur an independence movement across Europe. ZeroHedge is warning of this, but in reality, it’s very, very unlikely.
This drama is not something keeping me up at night.
Drama 4: Turkish Diplomatic Drama
What’s Happened? The US has stopped issuing all non-immigrant visas in Turkey, and the Turkish government retaliated and is doing the same. This conflict is just the latest drama surrounding Muslim cleric Fethullah Gulen.
Over the weekend, the Turkish government arrested a Turkish US embassy worker the government believes is linked to Gulen. The Turkish government blames Gulen for the failed 2016 coup, and this is a problem, because Gulen currently lives in Pennsylvania and the US won’t hand him over.
What’s Next? Diplomats are working through it, and it’s unlikely to metastasize into a bigger problem.
Bearish Headwind If: The US and Turkey suspend all diplomatic ties (which is very, very unlikely).
Absent the North Korea flare up that began in August, 2017 has been largely devoid of any international dramas, which is a departure from most of the current decade. Yet clearly there has been an uptick in geopolitical uncertainty over the past few weeks.
However, while the financial media is quick to cover the worst-case scenarios from these events, the facts tell us that none of them, at this point, represent a reason to alter positioning or to de-risk. More importantly, tax cuts remain the key political and geopolitical event to focus on during Q4. That can obvi-ously change, but so far none of these dramas are nearly as important to stocks as whether we get tax cuts. And, if that changes, we will tell you first thing.
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Bottom Line: Fischer & Debt Ceiling Not Market Positives
The two big news items Wednesday were the resignation of Fed Vice Chair Fischer, and the agreement on a three-month debt ceiling extension/government funding deal.
Starting with the former, Fischer’s resignation makes the Fed very slightly more dovish (Fischer was a modest hawk) but really the future path of Fed interest rates depends a lot more on inflation data than it does Fed personnel.
From a market standpoint, the odds of a December rate hike appropriately declined slightly Tuesday. But again, Fischer’s departure isn’t a dovish gamechanger, and if inflation metrics move higher between now and December we’ll still get a rate hike. From a stock standpoint, other than the temporary pop yesterday, I don’t see this news as an influence.
Turning to Washington, as usual, politicians have kicked the can down the road. On a positive note, we won’t see a debt ceiling drama or shutdown drama in late-September.
On a negative note, we likely will see an even more intense budget battle into the year-end. This will be all the more contentious because now tax cuts will be thrown into the mix, assuming Republicans have a concrete plan by then.
From a market standpoint, this is a very short-term positive in so much as it removes the possibility of a crisis over the next few weeks.
However, it sets up an even bigger potential negative into the end of the year. Bottom line, the debt ceiling/government funding agreement is not an incremental positive for markets, and we don’t expect it to push stocks higher from here.
In sum, both of Wednesday’s headlines had no real impact on our overarching macro view. We remain cautiously positive on stocks, but continue to believe that tax cuts and earnings hold the key to performance for the remainder of 2017.
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What a difference a few days can make. By Thursday’s close, the S&P 500 was at a one-month low, and the prospects for any tax cuts or foreign profit repatriation tax holiday were dim.
Now, thanks to one Politico article, happy days are here again, as the S&P 500 surged on the idea that the leaders in Washington are actually making progress on tax cuts! Hopefully, you can sense my sarcasm.
The lack of liquidity and attendance in the market is making these tax-related market mood swings worse than they otherwise should be, so I wanted to step back and provide a clear, unemotional update on the tax cut situation.
Starting with Tuesday’s Politico article, there were two reasons it was positive: The “Big Six,” and 22% to 25%. Starting with the latter, you know from this Report that right now, the market is expecting a corporate tax cut in Q1 2018 down to 28%. If that happens, it likely isn’t a materially positive or negative catalyst.
However, the Politico article implied consensus was coalescing around a corporate rate between 22% and 25%, obviously less than 28%. If that happens, it will represent a positive catalyst and a boost to corporate earnings, which will send stocks higher.
Now, on to the former. The “Big Six” is apparently the nickname that a key group of Republican leaders have given themselves in regards to tax negotiations. For clarity, the “Big Six” are: Treasury Secretary Mnuchin, National Economic Council Director Cohn, Senate Majority Leader McConnell, Speaker of the House Ryan, House Ways and Means Committee Chair Brady, and Senate Finance Committee Chair Hatch.
The Politico article implied the “Big Six” have been working much closer than previously thought, and that they have made a lot more progress on the structure of tax cuts (although plenty of details remain).
The noise on this topic is officially deafening, but I want to cut through it and give you some hard takeaways on the outlook for tax cuts and the impact on the market.
1. Expect more tax-related volatility. If January through August is any guide, we can expect the ever-growing Washington soap opera to fully engulf the tax cut issue this fall. Like healthcare, there are multiple moving pieces, a lot of important, TV happy players (I’m not even including Trump), and a lot of pressure—as this is basically the Republicans’ last chance to get any legislative priorities accomplished before focus on the midterms starts in 2018.
2. The outlook for tax cuts wasn’t as bad as it seemed last Thursday, and it’s not as good as it seems right
now. The Politico article was positive, but it didn’t contain anything ground breaking. To boot, it appears that substantially controversial issues are being discussed in the tax cut package, including: Capping mortgage interest deductions, eliminating the deduction of state and local taxes against federal, corporate interest deductibility and other issues. These and foundational pieces of the current tax code, and removing them won’t be easy.
3. The sector winners from potential tax cuts remain the same as they’ve been all year: Super-cap tech (on foreign profit repatriation), healthcare (on foreign profit repatriation), retailers (they pay high corporate taxes) and oil and gas (high tax rates). FDN/QQQ, XLV/IBB/IHF, RTH and XLE/XOP are all ETFs that
should outperform if taxes surprise to the upside.
4. A prediction: Tax cuts happen in Q1 2018. I’m in the business of generating conclusions and opinions, so I’ll give one about this tax issue. I’d give it about a 65% chance that tax cuts/foreign repatriation holiday gets done by Q1 2018, and about a 50/50 chance those tax cuts positively surprise (i.e. the corporate rate drops below 28%). I do not expect any changes to personal taxes. The reason for this opinion, as I’ve said several times before, is self-preservation. Congressional Republicans are on the ballot in 2018, President Trump is not. If they fail to accomplish anything (no healthcare repeal, no tax cuts) and this Washington soap opera continues, then it’ll be Congressional Republicans who are out of a job. So, they have to get something done if they want to save their jobs. There’s no better predicator of action in Washington than the rule of self-preservation.
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