The Week Ahead:
Investors are optimistic. International looks strong.
Stocks edged higher…again. Although there will come a time when that won't be the opening of our weekly blog, for now U.S. stocks are riding the reflation story. Last week there was enough talk about tax changes from the newly minted Treasury Secretary to give stocks a rally (as we write this Thursday evening in a balmy New York). The news was mainly about middle-class tax breaks passing before the August recess and the diminishing likelihood of a “border tax” which importers, and especially retailers, clearly dislike.
Remember what supports this rally: i) corporate and ii) personal tax cuts iii) deregulation iv) infrastructure and v) a general pro-business agenda. Congress will likely kick infrastructure into 2018. We believe tax reform may not pass until late 2017, effective for 2018, especially as there are core opponents of any federal debt increases. If nothing passes for a few months, this does not yet impair the broadly positive investment story.
Here’s where it may be helpful to recall the last time big tax changes were in the air. The 1980 post-election rally spluttered out in early 1981 and fell 30% in the next 18 months. The first batch of Reagan tax cuts (the one that reduced top rates of income tax from 75% to 50%) passed in August 1981, some seven months after he took office. Not much happened. Then came the Tax Responsibility Act in late 1982, which reversed many of the tax cuts. That’s when the market took off and rallied 250% in three years. The second big round of tax cuts didn’t come until 1986. Here’s what the market did:
So the path was: i) tax cuts coming so big rally but ii) they were slow to pass so a big correction and then iii) they came but the market didn’t like them as they ballooned the deficit and so the market corrected more and iv) the tax cuts were partly reversed and the market took off. Now, we are not in the 1980s. But it suggests that markets won't wait forever for some fiscal action, time is not boundless and tax cuts have to be deemed responsible.
1. Global Equities: continue to move higher. The following chart shows just about all the developed economies’ stock markets lumped together. They have reached a record high. All those vertical shades are recessions in Japan, Germany and the UK. We left out U.S. recessions because they overlap but are not as frequent or as durable.
So, four points from this. One, the climb back from the double bear markets was long and tortuous for global stocks. The U.S. did fine but many markets are only just getting back to 2000 levels. Two, below the headlines all is not what it seems. Out of the roughly 1,600 stocks in the above, only 246 have hit record highs. Third, within the broad U.S. universe of all stocks, about 30% are loss-making (think the Twitter, Tesla, SalesForce, Alcoas of the world but many smaller companies) and, finally, even with a robust earnings season behind us, there are still four major industries (Autos, Transportation, Telecom and Energy) which have shown four quarters of successive earnings declines.
H/T UBS and John Authers of the FT.
2. We’re looking for ways to judge the market: and came up with this one. It measures the market capitalization of the S&P 500 to U.S. nominal GDP. The numbers are a bit tough to get one’s head around but U.S. GDP is around $18.3 trillion and if you had $20.3 trillion you could buy every major company on the New York Stock Exchange (assuming the anti-trust folks were looking the other way).
Now, in hindsight, a number below 0.8 was a buy signal and above 0.9 a sell. We’re at 1.04. This is not a definitive metric of course. But it does show what we know: stocks are no longer cheap. The outlook remains positive but a correction may come.
U.S. Treasuries had a good week with the yield dropping to 2.38% from 2.50%. Mortgages also had a good week although that may be down to technical reversal from a poor January. For now, all markets seem on a positive momentum.
--Christian Thwaites, Brouwer & Janachowski, LLC
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All charts from Factset unless otherwise noted.