“We contend that for a nation to try and tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.”
-Winston Churchill
There are many great quotes about taxes. Aside from Churchill's quote above, another of our favorites about taxes is Benjamin Franklin’s quote saying there is nothing certain in life but death and taxes. Not to start your morning on a macabre note, but there is certainly some truth to that.
Well not quite as certain as death and taxes, we can likely be certain that tax cuts, for many people and almost all corporations, is likely coming. The challenge we face as stock market operators is that the details of the pending tax bill remain somewhat murky. Yesterday, President Trump clarified that 401(K) plans will remain untouched, so that at least provides some clarity. (Of course a change to this view is merely one tweet away . . .)
Even if we don’t know the full substance, we do think a tax bill is likely to pass given that the Senate has passed its budget resolution. On this note, the House of Representatives is expected to approve the budget resolution on Thursday. This procedural step allows the Republicans to pass a bill in the Senate with just 50 votes, instead of the 60 typically required for major bills. Hopefully, some of the murkiness around the bill should clear up with draft legislation to be released next week.
Based on that we’ve been hearing, there is likely a lot to be positive about, at least in the short term, with tax reform. Both lower corporate tax rates and retroactive depreciation holidays are inherently positive for corporate valuations. At all time highs, though, the question, as always, is what is priced in?
Back to the Global Macro Grind…
Back in fundamental company performance land, earnings season is off to a strong start. For the S&P500, 99 of the 500 names have reported with year-over-year sales and EPS up +7% and +9% respectively. Within that the tech sector continues to be a strong outperformer and tech earnings so far are up a “white hot” +39% year-over-year so far. No doubt that tech, already up more than 25% on the year is only set to continue.
On the quant side, an interesting call out this morning is that the VIX front month popped to 11.07, which is near the top-end of the Hedgeye Risk Range of 9.36 to 11.41. As Keith wrote in his morning bullets today, “that’s bullish for stocks in as much as SPY seeing implied volatility pop to a 106% premium to 30-day realized is bullish.” The moral of the story is that consensus continues to hedge instead of buy the dips on every correction.
On the monetary policy front, the biggest question at the moment is clearly who Trump will tap to be the next Chair of the Federal Reserve. The two clear front runners are old Hedgeye friend John Taylor from Stanford and Jerome Powell, a current Fed governor. While both are certainly conservative, this is a bit of a battle between the insider Powell and the rabble-rouser Taylor, who has been critical of the Fed and earlier this year said:
“One clear lesson from this historical experience is that the Fed should normalize policy and get back to the kind of policy that worked well in the past.”
It seems likely that Taylor, based both on his public comments and his eponymous Taylor rule, believes that interest rates should go higher. Ultimately, it is this view, which of course is bad for real estate development that may push him into the Vice Chair’s seat. Nonetheless, we’d be happy to see him there at a minimum. Rationality at a central bank is never a bad thing.
The most significant data of the morning comes to us from Europe. Eurozone manufacturing PMI came in at 58.9, which was broadly better than consensus and an increase sequentially. In addition, the results of the most recent ECB bank survey came out and indicated that demand for loans increased across the board in the most recent quarter. Both of these data points, though incremental, do point to a less dovish ECB.
Speaking of the ECB, it will have its work cut out for it ahead of its Thursday meeting. The central bank is expected to lay out plans to scale down its monthly asset purchase program from €60B to €20B or €30B. The ECB’s hope is that nothing changes as they wind this down.
In practice, of course, that’s a lot of cash that will no longer be in the market and as history has shown us central bankers aren’t the most effective at threading the needles on these types of policy changes. But, who knows, maybe this time is different?
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.31-2.42% (bullish)
SPX 2 (bullish)
NASDAQ 6 (bullish)
VIX 9.36-11.41 (bearish)
USD 93.03-94.11 (neutral)
Oil (WTI) 50.85-52.78 (bullish)
Gold 1 (bearish)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
