Trump’s Tax Plan Takes Center Stage
And just like that the bull was back … A ferocious 450-point two-day rally to kick off the week re-engaged investor appetite for risk, and left many wondering if the good old days of, ummmm, February, were back. The fiscal policy side of the Trump administration’s intentions are becoming clearer. And France has his electoral match-up. I say this a few times per year, but this is one of those Dividend Café editions I am very happy with, meaning, I think there is a lot here worthy of consumption.
Never trust the smart guys?
Financial markets often move in tandem with “narratives,” and narratives are more often than not a by-product of media expectations. In other words, they’re not usually very accurate. Unfortunately, most investors don’t have a lot to go off of in formulating their expectations, fears, hopes, and general market framework besides the “narratives” that end up in their mind, generally from the media. One of my favorite weekly reads, Michael Gayed (Pension Partners), pointed out this week how the recent batch of narratives that have been baked in by the press have been, well, stunningly bad. Consider the following (in order):
- If Trump is elected markets and risk-assets will tank! (result: markets went on unprecedented rally)
- Well, markets have rallied but a new era of volatility can be expected (result: lowest volatility levels in over two decades)
- Trump will rally the dollar and crush emerging markets (result: emerging markets up 15%)
- Watch out for technology b/c he fought them on campaign and the HB1 visa issue (result: leading sector so far 2017)
- Trump will be inflationary and bond market to be pummeled (result: the bond market has now had four consecutive positive months and ten-year is 40 basis points lower)
Look, there are often smart reasons to form a narrative and those reasons simply change, but our point here is a sort of non-controversial one: Consensus media narrative is wrong so often, and so dramatically, that to allow it to create Investment Policy for you is self-destructive.
I normally don’t merely pass on the ruminations of our key research influences, but I thought this particular insight from our friends at Strategas Research was particularly astute. Coming into 2017, the great “opportunity” for markets was perceived to be the fiscal reform/pro-growth measures of the Trump administration (tax reform, repatriation, health care changes, etc.), but the big headwind or risk was perceived to be President Trump’s anti-trade biases (the threat of a trade war, general protectionist overhang). Now, a hundred days into the administration, markets are digesting the fact that (a) The great opportunity of the growth agenda is not going as well as hoped (political difficulties and slowness), and (b) The great risk is not materializing as negatively as feared (he backed down on calling China a currency manipulator, NAFTA renegotiation looks much more benign, Pete Navarro has been seemingly sidelined in his economic team, he has now walked away from that Border Adjustment Tax, etc.). President Trump’s announcement of a tariff on Canadian lumber this week was up against the decision that he will not rip up NAFTA, after all. So markets basically are in the same healthy spot they were, because the good news has not been as good as hoped but bad news not as bad as feared – even-steven. I think they have nailed this assessment perfectly …
By now you should know that France avoided the run-off scenario of two total extremists running against each other, and ended up with the match-up in the May 7 run-off that the polls predicted and markets wanted. Now, we are not going to bother predicting what the result will be May 7 even though we are 95% confident we know. What we do know is this: The two major political parties that have dominated France for sixty years just lost, and lost big. Will a center-left French politician likely be the new president of France? Yes. But for the traditional socialist party of France to have lost the way it did says a lot about the changing world around us, particularly as it reflects upon Europe. What we do know is that even if Macron defeats Le Pen, the new leader of France is unlikely to have much more than a 40% mandate for leadership, and governance of the highly dividend country is not going to be easy. The political center may hold for now, but the forces of radical isolationism have gained disruptive momentum due to the failures of the European Union to deliver. The cultural crisis is the real story; the economics just flow from that. But for now, the Franco-German axis remains the core on which Europe turns. For now.
[Incidentally, and we know the bettors were wrong on Brexit, but the betting markets are giving Le Pen a 16% chance of winning]
In all thy getting, get this
The Bahnsen Group is constantly in a unique position when traditional or conventional investment thinking presents questions to us about tactical market particulars. Do you like small cap right now? What will do better this year – growth or value? These are common questions that come from the conventions of “style box” thinking that categorizes equities in a certain way. And we are obviously very familiar with these style and capitalization categories, and of course, understanding of why people talk and think that way. But the unique position we are in when asked conventional questions like this is that while we know the vocabulary, we do not think or talk this way, and we do not invest this way. As my investment mentor, Lowell Miller, has often said: “Our question to answer is – ‘is the dividend safe, and will it grow?’ In those questions we find investment opportunity, and let capitalizations and styles and other such labels and categories to be retroactively descriptive, but never decision-making.
The precedent is clear – there is no precedent
Fascinating analysis here regarding the historical lesson from the Fed raising rates three times in one year. Half the time the market goes up a year later; half the time it goes down. Next.
As earnings go, so goes the market
We are coming up on just the half-way point for Q1 earnings season, but projections look quite strong that we will end up with a stunning 10.1% jump in earnings for the quarter, the largest quarterly increase since early 2014.
When there’s flows it’s time to goes
The emerging markets equity asset class has been one of the big surprises and rewards thus far in 2017, and the move higher has been justified by fundamentals pretty much across the board. Indeed, if one does accept the “global reflation” theme – the idea we wrote about last week suggesting there is a continued pick-up in global nominal GDP growth expected – then we believe emerging markets will prove to be the best beneficiary of such in terms of asset class investment returns. Indeed, the other theme starting to work its way around reality is that the consensus view of dollar strength in 2017 has been wrong as the Fed begins tightening relative to the rest of the world (as longstanding history of the dollar rising in advance of Fed tightening, but dropping after the actual Fed tightening begins, plays out). The idea that perhaps emerging markets do not face the short term headwind and external pressure of a rapidly rising dollar has begun to be priced in, and we think represents additional tailwind to the sector (though we should note – this is not the type of tailwind we care about; it may boost short term results, but fundamentally we care much more about company performance). The reason I bring up “flows” in the grammatically challenged headline for this blurb is that fund flows into the sector remain just 50% of what they were in 2013, despite the fact that they have picked up year-to-date. The heavy, aggressive inflows into the sector into 2013 set the table for an ugly turnaround in the space 2014-2016 that was as typical a contrarian activity as you will ever see. We are watching to see if flows get frothy here yet again, but thus far, it isn’t happening, which is yet another indication of sustainable growth in the asset class. In fact, the large liquidity-driven growth that took place in Q1 should now lead to more earnings-driven recovery, a development that would greatly benefit the way we are invested to the asset class. Fundamentals matter in emerging markets too.
The stock market isn’t the only thing to go up since the crisis!
In 2007 just before the financial crisis, the aggregate level of unfunded liabilities in local and state pension costs (public employees) was $292 billion. A decade later, despite a nearly 300% increase in the stock market since 2009, unfunded liabilities across American cities, counties, and states total almost $1.9 trillion. Investment returns in public pensions have been brutally inadequate despite the bull market as bureaucrats practiced classic rearview-mirror investing. More than that, though, the real cause comes down to laughably inadequate funding. Current fiscal woes from current budget gaps became the priority, and one easy way for politicians to deal with this was to exercise the option simply not available to corporate pension plans: Not funding them (or inadequately funding them). Unfunded pension liabilities in public employee pension plans matter to three categories of people: (1) The pensioners relying on the future income (likely not you), (2) Taxpayers who owe the money if it isn’t there (likely you), and (3) Investors who will see an impact in capital markets should this situation not be addressed (for sure you).
Getting to the mall on time
We have seen 14 national retail chains declare bankruptcy so far in 2017, almost surpassing the total level of retail bankruptcies for all of 2016. 2,880 store closings have been announced, with projections now for 8,600 closings by year-end (higher than store closings in 2008, believe it or not). This is not just a massive acceleration over 2016, but actually an all-time record pace. Bankruptcy enables retailers to void lease contracts and deal with backlogged bills for inventory. Many are transitioning to more e-commerce oriented models; others are liquidating altogether. It is a true paradigm shift in the world of consumer shopping, and transitions driven by evolving consumer preferences are ultimately a healthy part of a market economy.
Chart of the Week
The big twist in the conversation around tax reform this week, certainly a factor in the market rally, is that the Trump administration and key Republican lawmakers have embraced the idea that the proposed tax cuts need to be scored by the Congressional Budget Office in a dynamic way (accounting for the economic growth they will create), as opposed to with mere static assumptions. The reason this matters politically is that dynamic scoring is sure to reflect a lesser impact on the budget deficit, making the odds of passage with various deficit hawks far more likely. So the political odds for tax reform improve – great; but how realistic is this that supply-side tax cuts can actually lead to better revenues than the Congressional Budget Office anticipates? Let’s allow history to be our guide:
Quote of the Week
“Do what you can, with what you have, wherever you are.”
– Teddy Roosevelt
It really has been a fascinating week for those who live inside capital markets. We had a little bit of everything – heavy fundamental bottom up action for individual stocks, particularly around quarterly results; huge political activity between tax reform announcements and progress on the repeal of ObamaCare; and international intrigue between the French election clarity, trade hustle-bustle with Canada, and ongoing drama with North Korea. We had it all, and markets mostly responded well.
We recently remodeled our office lobby in Newport Beach and are in the process of doing so throughout the whole office. Here is a quick “before” picture:
Originally published on the Dividend Café.
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