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• Market Update
• Some Charts & Stuff
• Market & Sector Analysis
• 401k Plan Manager

Note

This week’s newsletter is just going to be brief update as I am making the last minute preparations for the 2017 Economic & Investment Summit tomorrow morning.

With the event oversubscribed, and if you are unable to attend, we will be streaming the event live tomorrow on our Facebook page (www.facebook.com/realinvestmentadvice) as well as posting video presentations to the website over the next couple of weeks. 

I am really looking forward to some great presentations from Danielle DiMartino-Booth, Michael Lebowitz, Dave Collum and Greg Morris.

So, with that said, let’s do a quick broad market review.

Market Update – Resumption Of The Trump Trade?

As I discussed last week, the failure to obtain a vote on the repeal and replacement of the Affordable Care Act has now drawn into question that ability, and the magnitude, of other fiscal policy changes which have been the foundation of the rally since the election.  However, Wall Street was quick to spin the failure into a positive by suggesting a quick turn to “tax reform.”

Of course, as my good friend Caroline Baum wrote this past week:

“There are major party differences in the approach to tax reform. For example, Republican supply-siders want to cut top tax rates to incentivize work while Democrats favor a more progressive tax code to reduce the burden on low and middle-income Americans.

There are intra-party differences as well, including whether tax reform must be revenue neutral and the advisability of enacting a border-adjustment tax, which would tax imports and exempt exports. Then there are the constraints imposed by using budget reconciliation, an expedited process for tax-and-spending legislation that doesn’t allow for Senate filibuster.

But the real impediment to tax reform isn’t procedural, left versus right, or which industries benefit from a BAT. The real issue is my tax break versus yours.”

Everyone wants tax reform until it comes to sacrificing his or her deduction, exclusion or exemption. Therein lies the problem. The only way to lower tax rates without widening the deficit is to close every last loophole, from the huge and popular — the exclusion of employer-sponsored health care and 401-k contributions, the preferential treatment of capital gains, the mortgage interest deduction — to the obscure and arcane (‘credit for holders of zone academy bonds’).”

Good luck with that.

If lawmakers think rewriting the nation’s health care laws were hard, just wait until you try and take away the tax breaks that lower the average corporate tax rate of 12-16% versus the much hyped 35% statutory rate (not to mention the howls from the middle class.)

As Howard Gleckman laid out recently:

“There is a good reason why a major rewrite of the tax code has not happened for more than three decades. And here are eight reasons why true tax reform will be an even tougher climb than a health care redesign.”

1. The revenue problem. If lawmakers can’t agree on how much money they want their new tax code to raise, any initiative is doomed.
2. The winners and losers problem. It helped sink the American Health Care Act, where younger, healthier, and higher-income people would have come out ahead on average, while older, sicker, and lower-income people would have been worse off. Revenue-neutral tax reform will have a similar winners-and-losers problem– on steroids.
3. Who wants to slash tax breaks? This is the nitty-gritty of the winners-and-losers problem.
4. The baseline problem. As many have written, Trump and Ryan wanted to pass a health bill first because it would have made the job of passing a revenue-neutral tax reform about $1 trillion easier. Now, without that $1 trillion, it will be much tougher to pass a bill that the Congressional Budget Office and the Joint Committee on taxation certify is revenue neutral over the long run.
5. Corporate taxes, individual taxes, or both? Some believe that doing only corporate reform would be easier than tackling individual taxes.
6. The number of people affected. For all the controversy over AHCA, most Americans would have been largely exempt from the bill. By contrast, every one of the 324 million Americans and every business is directly affected by the tax laws.
7. Congressional politics. The AHCA was a case study in how deeply Congress was divided over a big complicated issue. The divisions were mostly partisan and partially ideological. When it comes to taxes, the splits are even more complex.
8. Trump’s depreciating political capital. Every new president comes to Washington with a supply of clout, but it has something of a half-life. Trump started off with less capital—and a lower public approval rating–than any president in modern history. He’s used up quite a bit in the failed AHCA effort.

So, why is this important? Simple.

The entire rally that began following the election has been based on the Trump Administration pushing through fiscal policy reforms to offset the tightening of monetary policy by the Fed.

As shown in the chart above, the “Trump Trade” was initially focused on small capitalization stocks which have begun to lose momentum as policy reform lingers.

Furthermore, while consumer confidence has soared since the election, there hasn’t been a translation into substantially stronger economic activity as of yet.

While this time could certainly be “different,” the last 5-times the gap between perceived and actual economic reality was near current levels, the S&P 500 struggled for a few weeks/months afterward:

• JUL 2007 -12%
• JUN 2009 -9%
• APR 2010 -17%
• MAR 2011 -19%
• NOV 2014 -6%

The point to be made here is that while there is much “hope” the Trump administration will get its “act together” and move legislative agenda forward, the markets are not going to wait forever.

There is a rising risk the “Trump Trade” may be nearing its end and, for investors, there is a much greater risk of “disappointment” than there is of “positive surprises” at this juncture.

Some Charts & Stuff

Short-Term

I noted at the beginning of the month that we had lifted some profits out of portfolios and rebalanced risk. I also stated that we were not adding any NEW positions at that time. Such has remained our stance since then.

However, as noted in the chart below, on a short-term basis the market is approaching a buy signal after finding support at the 50-day moving average. With there still begin a couple of months left in the seasonally strong period of the year, and confidence in the “Trump Trade” still high, if a “buy signal” is issued we will add short-term risk related exposure (tactical holdings) back into portfolios.

Intermediate-Term

However, do not confuse a short-term tactical positioning in the market with an intermediate holding period in portfolios.

Currently, portfolios remain nearly fully allocated to the markets and as noted above we are simply adjusted portfolio weightings for short-term tactical positioning. However, on an intermediate-term basis, the markets remain grossly overbought and very extended. As such, the possibility of a correction has risen markedly.

In fact, my friend, Salil Mehta from Statistical Ideas sent me the following note yesterday.

Long-Term

In the long-term, the picture worsens substantially. From extreme overbought conditions, to similar economic growth rate backdrops, this isn’t a market that currently suggests long-term returns will remain favorable for investors.

Too Bullish?

My friend Dana Lyon’s had a great post on Friday relating to investor confidence in University Of Michigan consumer confidence survey. To wit:

“Specifically, they are asked to guess as to the ‘Probability of Increase in Stock Market in Next Year’. Respondents’ answers are broken down into ranges of probability percentages, e.g., ‘1%-24%’, ‘25%-49%’, etc. One of the answer options is ‘100%’ probability of a stock market increase over the next year. We like to track this statistic as a measure of public sentiment towards stocks. And based on the most recent survey, as of February, the public is relatively quite certain about the prospects of a stock market rally.”

“With most sentiment-related statistics, extreme readings are contrary in nature. That is, the market typically moves contrary to the consensus opinion. That dynamic generally holds true here. Here are the 12-month returns in the S&P 500 following the above readings:

• February 2004 (+5.12%)
• November 2007 (-39.49%)
  
• January 2015 (-2.74%)
• June 2015 (+1.73%)

While 2 of the 4 precedents saw positive 12-month returns, they still paled in comparison to the median (-10.35%) and average (-8.02%) 12-month returns over the sample period. Plus the 2004 incident saw negative returns out to 8 months, and the June 2015 incident out to 9 months. So, in all 4 cases, the longer-term performance of the stock market was sub-par, at best.”

Final Point

As I noted last week:

That rally occurred as expected due to end of the quarter “window dressing” and portfolio rebalancing.

However, as noted above, on an intermediate-term basis be cautious.

As noted by RBC on Friday:

“Quick note of warning as we transition into the new quarter, with potential for major thematic / sector / factor reversals in stocks.  The following observation regarding April seeing a seasonal ‘momentum’ factor market-neutral strategy unwind is ‘equities wonk-ish,’ but with real potential cross-asset impact.

As we know, the Fed watches equities because there are potential implications with regards to broad US ‘financial conditions’ on consumer and economic confidence. Thus, the scale of potential equities volatility does matter across macro, especially in light of general buyside portfolio ‘crowding’ / ‘high beta’ exposure (into ‘growth’ right now especially) which could exacerbate the dynamic.”

Translation: “Watch your ASSets.”

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