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The Days Ahead: Healthcare, tax bills, elections.
What promised to be a turbulent week ended quietly. Coming into Monday, we expected an uptick in European stocks following the French election. Our money is still on Macron for Round Two but we also think a Le Pen victory may not be the catastrophe many expect. Unsettling yes, but not the complete wind down of the near 60-year old EU project. On other news that didn't happen, the U.S. did not pull out of NAFTA, or repeal healthcare or shut down the government. So, you know, one less thing.
We're tempted to launch into a critique of the tax plan presented to the world on Wednesday but the White House curiously deleted the transcript of the press release. In one page and, impressively, four fonts, it was a manifesto of reducing income tax rates (but no information on the bands), doing away with AMT (good to see a friendly face again), lower corporate taxes and elimination of tax deductions (including 401(k) but then that was not mentioned again, so perhaps they didn't mean it), Oh, and the whole repatriation-of-overseas cash thing. Ok, you got me monologuing. But in case we get too excited about tax cuts, it’s worth taking a look at what happens if they do pass.
Yes, in real terms, tax revenues plummet which means cuts don't really pay for themselves. They may increase growth if they hit the counter-cyclical spot dead on. And if credit demand is lax elsewhere, they may not change rates much. But they most certainly do not pay for themselves.
Anyway, the market probably thought that the legislative load was already pretty high and so paid it little concern. The more we think about it, the post-election rally seems to be about the absence of new regulation and taxes and less about new favorable regulation and taxes. So if either of those comes through, the market would respond well.
1. And weak economic growth arrived dead on time: Friday’s first look at Q1 GDP was always going to be a head-banger. First-quarter growth has been weaker and lower than the annual average for years now. It seems to be in the seasonality adjustments over at the BEA. We knew that Q1 was tracking low but the consensus was ahead of us and the news of 0.7% growth sent bond yields lower. Here’s the chart:
You can see the Q1 underperformance sticking out pretty clearly. We can dance around the numbers pointing to a big drag from inventories and housing but the U.S. is an economy where consumption accounts for 69% so the 0.2% in personal consumption growth (the lowest since 2009) shows a distinct lack of animal spirits. This may change in Q2 but the report explains the rally in Treasuries as, yet again, growth lags expectations.
2. Expectations the other way in Europe: The ECB recommitted to QE although at a lower level than April. This is some two-and-a-half years after the U.S. stopped its bond purchases. Growth is picking up and in some places, Spain and most of Eastern Europe, is over 3%. Inflation is low and is the chief reason that the ECB will stay off the monetary brakes. Meanwhile, here's stock market and economic sentiment on the rise:
European stocks are up around 8% year to date and 10% for a U.S. investor. We have high conviction for Europe. Regional surveys, retail spending and inflation have held up well. It’s a challenging time for Eurosceptics and we would argue that investors have been underweight for too long.
Bottom Line: Away from the politics, U.S. earnings have powered ahead, up 12% this year. And it’s not all in one sector: Financials, Materials and Tech are up over 15%. Revenues from energy are up 32%. So while U.S. and Europe politics will remain front and center, earnings are delivering in spades.
--Christian Thwaites, Brouwer & Janachowski, LLC
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All charts from Factset unless otherwise noted.