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Political Update: Stay Focused on Taxes, Not Impeachment

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Before getting into the market implications of the latest political headlines, I want to remind everyone that any political coverage I give in the Sevens Report is solely from the perspective of the markets, they don’t reflect my preference or lack of preference for any specific politician or party. My personal opinions are not important. What is important is giving you analysis that cuts through the steadily rising amount of sensationalist noise in the financial media (on both sides), and keeping you focused on what’s really moving markets.

That said, given the latest revelations on President Trump, I wanted to take a moment and push back on some of the sensationalism.

Specifically, I want to explain clearly that any talk of impeachment is not realistic in the near term. The reason is simple: Impeachment is a political process, not a legal process. The House of Representatives must start the impeachment process, and since it’s controlled by Republicans, short of having incredibly damning evidence against the president, that simply won’t happen.

In all likelihood, even if Robert Mueller’s commission finds that President Trump likely obstructed justice during the Russian investigation, the evidence would have to be unequivocally conclusive in order to cause the Republicans to impeach. That means we would have to have the equivalent of a video or audio tape of Trump telling someone to break the law.

Obstruction of justice, unlike perjury, is an opinion derived from conclusions; it’s not a hard and fast fact (i.e. you told the truth under oath, or you did not).

So, to be clear, impeachment of President Trump is very unlikely over the next 1.5 years, again because of political reasons, not legal ones (and to be fair to Republicans, Democrats wouldn’t impeach a president either without undeniable evidence).

Now, all this might change if the House changes hands in 2018, and frankly that’s more than possible. On average, the president’s party loses about 30 seats in the House in the first midterms, and the Republicans enjoy a 45 seat majority. So, if the average holds, it’ll be close. If the Democrats take control and this is still an issue, impeachment is a real risk… but that’s a problem for another day.

In the near term, the key is to stay focused on tax reform. Expectations are pretty low at this point, but the market does expect corporate tax cuts in 2018, and the ongoing Russia saga does continue to reduce the chances of that expectation being met.

The biggest risk to stocks continues to be if the market begins to factor in no tax reform in 2018. If that happens, it’ll be good for at least a mild pullback. Taxes, not Russia, remain the number one risk to this rally.

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Two Markets Down, Three to Go?, May 18, 2017

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The most important trading across markets Wednesday was not in the stock market, it was in the bond market… and the signals sent there were not good. Both the absolute level of bond yields, and the shape of the yield curve, deteriorated materially… and this is a concern that should not be ignored.

First, the 10-year Treasury yield imploded, falling 11 basis points to close at 2.22%, the lowest in three weeks and now just above the 2017 low of 2.17%.

Second, and potentially more importantly, the 10’s—2’s Treasury yield curve also flattened materially, as the spread fell from 1.04% to 0.92%.

sevens report - trumponomics

This is especially important, because the 10’s—2’s yield spread has now retraced the entire post-election steepening, and the curve is more flat than it was pre-Trump presidency. That is a very bad sign for banks, and since banks must lead a market higher in a reflation expansion, that is a bad sign for the entire stock market.

The 10’s—2’s spread has more than retraced the entire post-election move, as has the US Dollar Index (two down).

The 10-year yield is threatening to fall to fresh lows for the year. Yet, the BKX (Bank Index) remains nearly 20% above the pre-election close, and the S&P 500 still trades almost 10% above its pre-election close.

So, are we now looking at a situation where we are two down, three to go?

This situation cannot exist in perpetuity, and the collapse in yields yesterday is a warning sign that should not be ignored.

It’s not definitive yet, and one bad day doesn’t break a trend, but the price action in the bond market is becoming outright worrisome. And, I must continue to stress (as I’ve been doing since mid-March) that the bond market is the leading indicator for stocks. If the 10-year yield breaks below 2.17%, that will add to that warning. At that point, I will consider becoming more defensive in our portfolios.

Again, for context, the entire 2017 stock market rally is based on a expectation of an economic reflationary expansion. But, that expansion likely can’t occur unless the pro-growth policies from Washington actually materialize, and that probability is decreasing daily.

So while stocks have held up, reflationary-sensitive as-sets have negatively reacted (banks, bonds and cyclicals). These sectors must lead a reflationary bull market, yet all of them are breaking down or are in danger of breaking down. If they go, then the broad market isn’t far behind.

Again, I’m not saying get materially defensive yet, as one bad day doesn’t invalidate the market’s resilience. But caution signs are growing on this market, and I do not want anyone blindsided.

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Trumponomics Update, May 17, 2017

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Politics remains a deafening influence on the markets in 2017, but amidst the ongoing circus (which again got bigger overnight) I wanted to step back and take a look at the current state of the Trumpenomics agenda, revise current markets expectations, and re-examine what will create positive or negative political surprises for stocks over the coming months and quarters.

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Finally, I want to provide some independent context to the recent political headlines. First, they are net negative because they are causing some Republicans to start to distance themselves from Trump, and that reduces the chances of tax cuts. Second, if there was some crime committed (obstruction of justice, etc.) that is clearly a bearish gamechanger—but we are not there yet. Third, impeachment claims are currently overblown. It’s a Republican Congress and Congress must decide impeachment. Every Republican, at this point, has a better chance of getting re-elected if they pass tax cuts rather than dump Trump, and we can always count on politicians to focus on their re-employment. Bottom line, these never ending headlines are a headwind on stocks, but they are not a bearish gamechanger, yet.

Trumponomics Pillar 1: Tax Cuts

What Was Expected By Markets: An agreement in principle by the August Congressional recess to cut corporate taxes to the low-20% range, and include a one time, 10% repatriation tax holiday for foreign profits.

Reality: Nothing. There has been little-to-no progress on the tax issue, and major sticking points remain between Republicans, including border adjustments and removing interest deductibility for corporations.

Market Impact: So far, stocks have generally weathered the ineptitude here because there is still the broad expectation that there will be corporate tax reform before the mid-terms in 2018 (people are now pointing to Q1 2018).

Current Expectation: A small corporate tax cut into the high-20% range in place by Q1 2018, and some foreign profit tax repatriation holiday (around 10% tax rate).

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Bearish If: Withheld for subscribers. Sign up for your free trial today.

Trumponomics Pillar 2: Deregulation (Especially Obamacare)

What Was Expected: Repeal and replacement of Obamacare in the first 100 days; massive deregulation via executive order, especially regarding environmental regulations.

Reality: Virtually nothing. While the House passed an Obamacare repeal/replace, there is no credible path for the legislation to make it out of the Senate. Meanwhile, there has been progress on reducing one-off regulations, but it’s not the type of large-scale deregulation that will ignite economic growth.

Market Impact: Healthcare has outperformed on the reduction of political risk (XLV, IHF, IBB). Overall, however, no macro impact.

Current Expectation: Not much. The healthcare bill is in limbo, and there’s no expectation of a Obamacare repeal/replace anytime soon. Meanwhile, Dodd-Frank banking regulations remain largely in place and it’s unlikely we’ll see a large overhaul of that legislation, either (that’s anecdotally negative for regional banks as they bear an outsized compliance burden compared to money center banks).

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Bearish If: Withheld for subscribers. Sign up for your free trial today.

Trumponomics Pillar 3: Infrastructure Spending

What Was Expected: $1 trillion over a 10-year period (this was always an exaggeration, but a lot was potentially expected).

Reality: Virtually nothing. Infrastructure spending has been soundly buried between the healthcare drama, tax cut bickering, and the constant media battles emanating from the White House.

Market Impact: Infrastructure stocks that rallied hard following the election have lagged so far in 2017, but this hasn’t had any macro impact on markets.

Current Expectation: Nothing. Some hope that we will see a bipartisan infrastructure bill by Q2 2018, but it’s so buried by everything else right now that’s not very likely.

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Bearish If: Withheld for subscribers. Sign up for your free trial today.

Bottom Line

Earnings and economics have helped to offset any Trumponomics disappointment as Q1 earnings were strong, and $138 2018 S&P 500 EPS is supporting stocks in the face of repeated Washington failures. Meanwhile, economic data has been “fine” on an absolute basis despite the slight loss of momentum recently.

Point being, markets have been lucky that earnings and economics have provided a shock absorber for the policy disappointment; but considerable risks remain should no further policy progress occur in the coming months and quarters, and given the seemingly unending scandalous headlines emanating from the White House, the probability of nothing happening is rising.

If we do not see real political progress by the end of ’17 or ’18, then its unlikely that economic growth will be able to hold up as the uncertainty surrounding these policies will begin to act as a headwind.

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What Comey’s Firing Means for Markets, May 11, 2017

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Regardless of how the rest of the year turns out, I personally will always remember 2017 for the fact that I had to try and figure out the market implications of political events that I never thought I would have to worry about.

What Comey’s Firing Means for Markets.Case in point, Tuesday’s firing of FBI Director James Comey moved markets yesterday, and I wanted to cover what that means going forward (it’s a mild and potentially negative, but not a bearish game changer). Now, to be clear, the market is agnostic to the politics of this drama and as such so am I. Whether you or I think the firing was a coverup or justified, it matters not from a market standpoint, so as I always do with political coverage, I will strictly stick to market implications.

The reason Comey’s firing is a mild negative on markets is because it further undermines President Trump and the Republicans’ ability to pass their pro-growth agenda.

Case in point, just yesterday, we saw part of the fallout from the Comey firing as the Republicans were unable to pass a reversal of an Obama rule against methane gas capture on oil and natural gas wells (Republicans say the environmental regulation increases the cost to drill natural gas and oil wells).

Three Republicans; Graham, Collins and McCain, voted with the Democrats, and the repeal measure failed 49-51. Graham and Collins were always “no” votes on the rule, but McCain was expected to vote “yes”—so much so that Vice President Pence was in the Senate to cast the tie breaker. McCain didn’t say so explicitly, but his “no” vote is widely seen as a protest vote against Trump.

Bottom line, the controversy now surrounding Trump’s move to fire Comey is a political hot stove, and some Republicans are already distancing themselves from the President as they are already thinking about re-election. Point being, the path to passing meaningful tax reform or other pro-growth policies just got more difficult.

Now, the good news is that this isn’t a bearish game changer for markets in part because expectations for tax cuts in 2017 are already pretty low.

Still, there is risk here, because the market does still assume some corporate tax cuts/foreign profit repatriation in 2018. If Trump/Republicans lose enough political capital to put a corporate tax cut in 2018 in doubt, then that will be at least a modest negative on stocks.

More specifically, after June 2018 (at the latest), everything in Washington will stop as focus shifts to the mid-term elections. So, if the market begins to think there will be no corporate tax cuts and no foreign profit repatriation, then that will begin to weigh on stocks later in 2017/early in 2018.

Bottom line, unfortunately politics remains an important influence on markets in 2017. On balance, expectations have been tempered from a policy standpoint, but the “gap” between likely policy reality and policy expectations remains wide… and it got wider this week with the Comey controversy.

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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.

Did Trump Just Kill The Reflation Trade? April 13, 2017

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Did Trump Just Kill The Reflation Trade? An excerpt from today’s Sevens Report.

Trump - YellenPresident Trump, in an interview with the WSJ yesterday, appeared to change his policy on the Fed and interest rates. Specifically, Trump said he thought the dollar was getting too strong, that he favored a low interest rate policy, and he was open to keeping Yellen as Fed Chair. It was the second two comments that caught markets attention and caused a “dovish” response in the dollar and bond yields (both of which fell).

The reason these comments were a surprise was because it was generally expected Trump wouldn’t keep Yellen and was in favor of a more hawkish Fed Chair and appointing more hawkish Fed governors (there are currently three vacancies on the Fed President Trump can fill).

So, the market was expecting Trump to be a hawkish influence over the coming years, but yesterday’s comments contradict that expectation.

Going forward, from a currency and bond standpoint (the short term reaction aside) I do not see Trump’s comments as a dovish gamechanger for the dollar or rates. Yes, near term it appears the trend for the dollar is sideways between 99.50ish and 102 while the 10-year yield has broken below support at 2.30%.

But, I don’t see Trump’s comments sending the dollar back into the mid 90’s, nor do I see them sending the 10 year yield below 2%.

I also don’t expect this dovish reaction to be a material boost for stocks, because dovish isn’t positive for stocks any more (in fact the comments are causing the stock sell off this morning—more on that in minute).

Bigger picture, the longer-term path of the dollar and bond yields will be driven by growth, inflation and still ultra-accommodative foreign central banks.

Better economic growth (either by itself or with policy help) is the key to the longer-term direction of the dollar and rates (and we think that longer-term trend remains higher).

However, in the near term, his comments sent the 10 year yield decidedly through support at 2.30%, and that is causing stocks to drop as Treasury yields continue to signal that slower growth and lower inflation are on the horizon. And, since the market has rallied since the election on the hopes of better growth and higher inflation (i.e. the reflation trade) this drop in yields is hitting stocks.

The violation of support in the 10 year yield at 2.30% is important and a potentially near term bearish catalyst for stocks. If the ten year yield doesn’t stabilize and make some effort to rally over the next few days, a test of 2300 or 2275 in the S&P 500 would not shock me.

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How Does Trump’s Approval Rating Impact The Stock Market? March 8, 2017

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Leading Indicator Update: Showing Signs of Fatigue

An excerpt from today’s Sevens Report… Skip the jargon, arcane details and drab statistics, and get the simple analysis that will improve your performance.

At the start of the year, I said that beyond the normal economic data and fund flow data, we’ll be watching two other specific leading indicators:

  • Trump’s approval rating, and the
  • Semiconductor Index.

As a refresher, we watch Trump’s approval rating because it is an imperfect, but still effective, measure of political capital.

Earlier this year, we said that if his approval rating dips in the weeks and months following Inauguration Day, that won’t be a positive sign for corporate tax cuts (i.e. it will be stock negative). Conversely, if his approval ratings rise following his inauguration, the chances of tax reform will rise (i.e. it will be stock positive).

Turning to the Semiconductor Index (see chart on Pg. 1), we view semiconductors as a destination for incremental capital that comes off the sidelines or out of bonds.

It’s our proxy for money flows, or “chasing” into the US markets.

That reasoning here is based on watching the price action in semis and observing that they handily outperformed post election (implying they were a destination for capital coming off the sidelines), and we continue to believe that is the case.

LI #1: Trump’s Approval Rating Updated. The outlook here hasn’t been that positive, and the movement in the approval rating anecdotally confirms our opinion that the market remains too optimistic regarding corporate tax cuts in 2017.

Why is the president’s approval rating a leading indicator?

From a broad standpoint, Trump’s approve/disapprove gap has gotten worse since the inauguration, and we think that represents a slight erosion of political capital.

Last week, we saw a slight bounce following his speech to Congress, but the numbers look to be rolling over again.

I am particularly focused on his raw approval rating numbers (as opposed to just the spread between approve/disapprove). So, while the spread between approve/disapprove has gotten worse, the reason this leading indicator isn’t flashing negative for me is because Trump’s raw approval rating is still about the same as it’s been since the inauguration (about 44%).

However, if that raw number were to drop below 40%, I would view that as a material negative for pro-growth policies… and a potential negative for stocks.

LI #2: Semiconductor Index Updated. The Philadelphia Semiconductor Index, our loose proxy for incremental money flows out of bonds/other assets and into stocks, has until recently confirmed the 2017 rally.

The SOX rallied 9% from the first of the year till February 22, at which point the index stalled, and it’s traded side-way for nearly two weeks.

Going forward, support at 955.11 now is an important level to watch, as a break of that level would constitute a “lower low” on the charts.

Below that, support at the 20-day moving average at 947.25 has supported this index three times over the past few months. So, that also will be an important level to watch.

Bottom Line

Neither of these leading indicators have sent a non-confirmation signal of the rally at this point. Yet after confirming the rally earlier this year, both of these leading indicators are starting to wobble.

Again, we’ll be watching 40 in Trump’s approval rating and 955 and 947 in the SOX. If those levels are broken that will likely prompt us to become more defensive near term for stocks.

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