Have the Markets Peaked?

The Senate passed their version of tax reform Friday night. It set the stage for both bodies of Congress to reconcile tax reform into a final bill to be voted on again before being sent to the White House for the President’s signature. Clearly tax reform was the cornerstone of Trump’s pro-growth, pro-business agenda and he got virtually everything that he wanted. No doubt now that it will pass.

While the magnitude of the implications on our economy will be debated and the naysayers will nitpick many parts of it, clearly tax reform on the whole, was a necessity for the U.S. to compete and thrive in a global economy. There will be both short and long term consequences from the bill that will create investment opportunities from both the long and short sides of the markets. The implications stretch to foreign countries and companies too that will be impacted by this legislation as well. U.S. domiciled companies with U.S. plants will be the clear winners especially if they have high nominal tax rates as well as high capital spending plans. Besides reducing the corporate tax rate to 20%, the most important other feature was the immediate write-off of capital spending which is a huge benefit to cash flow and longer term returns on investment.

But don’t view tax reform in a vacuum, as it will effect Board decisions both here and abroad. This bill will also impact our trade balance over time, as there are incentives for foreign and some domestic companies who import from abroad to build plants here which will create jobs! Note the multiple benefits to our GNP: more capita spending, more jobs and a smaller trade deficit.

Lastly, there are the incentives in both tax plans for U.S. multinationals to repatriate the nearly $3 trillion in cash held abroad. How that will be used is debatable but it is clearly a positive at the margin.

I have focused my comments on corporate tax reform even though there are huge changes to individual taxes too. The reason is that individual tax reform won’t do much for our economy while corporate tax reform will. There will be more growth and jobs created in the U.S. by this bill which will benefit individuals more than their cut in taxes.

The bottom line is that this is a victory for Trump, the Republicans, our economy and the stock market.

As you know, we predicted many months ago that tax reform would become a reality by the end of 2017 or early 2018 and positioned our portfolios accordingly. We had a very simple thesis: the Republicans had to pass it or lose big time in 2018. Self interest rules in the end. And yes, I am cynical.

As it became apparent that the Senate would pass tax reform, the markets took off and hit major new highs this week despite Flynn making a plea bargain with Mueller. Our job is to anticipate these things; be positioned for them before it is obvious to all and benefit while watching others play catch up. That is what sets us apart and always has. Paix et Prospérité continues to outperform all averages. And for the right reasons!

It is our job to not rest on our laurels but to continue to look through the proverbial windshield for what’s next. Will the market peak soon anticipating all the benefits of tax reform? Or is there something new on the horizon that will give us another leg up? We wrote a few weeks ago that the Republicans’ would tackle infrastructure next. If you live in this country, it is clear that we need to rebuild our transportation system: our bridges, roads, airports and ports to make us more efficient, competitive and safer. Rebuilding our infrastructure is a huge undertaking and will cost well over a trillion dollars but this is a necessity that both parties acknowledge. I expect an infrastructure bill to emerge and be signed in 2018 before elections. Here again, U.S.-based manufacturers will stand to benefit most and don’t forget the job creation that will accompany it with decent pay.

As we enter the 2018 election season, the Republicans will have several notches on their belt to show the American public: tax reform, an infrastructure bill, and financial reform. All will add to growth over the next few years from what it would have otherwise been. The stock market has not been blind to this. The key is how long and how fast our economy will continue to expand; will inflationary pressures build and rise to the point where the Federal Reserve really tightens policy, becomes restrictive and hence the beginning of the end for the stock market?

What can the Democrats show the voting public, as they will most likely vote against all of this legislation although they know it is the right policy for America. What alternatives have they presented, not only over the last year, but also over the last 5 years, including a period when a Democrat was President? They will be considered obstructionists rather than a party with a vision for America to compete in the 21st century.

The pendulum continues to swing globally away from overly restrictive financial, regulatory, budgetary policies that have inhibited growth over the last several years. Growth is strong from the East to West without normal inflationary pressures that would have popped up in a different period. Core inflation in Japan and the Eurozone remains stubbornly low and is not expected to reach the BOJ and ECB 2% target for many more years. China is the only country that is tightening financial regulations, which will restrain growth from it otherwise might. Down cry for China as growth will still likely exceed 6% next year.

The OECD has raised its growth forecasts: 3.6% in 2017, 3.7% in 2018 and 3.6% in 2019. Inflation is not expected to reach 2% before the end of 2019. The monetary authorities still don’t get why inflationary pressures have not built as the unemployment rate has declined. The Phillips curve just is not working as in the past and for got reason: technological change is rapid, global competition is intense and disruptors are popping up everywhere. Expect interest rates to stay unusually low while corporate profits take off. That is not a bad recipe for higher stock prices. But again, not all markets or all stocks will share equally. Change is everywhere!

The bottom line is that the preconditions for a market top are still not present. The markets continue to rise on a wall of worry and most investors remain cautious and under invested. If I may paraphrase Janet Yellen “economies and markets don’t stop due to old age.”

If Trump and the Republican are successful at passing both tax reform and a major infrastructure program in 2018, it will be very difficult for the Democrats to take back control of Congress. I’d rather have a pro-business, pro-growth administration than not.

Paix et Prospérité continues to concentrate its portfolio on financials, mainly the largest banks; global industrials, low-cost industrial commodity producers including domestic aluminum and steel, technology at a fair price to growth, and special situations including DWDP, FMC, HUN, and PX.

So remember to review all the facts; step back, pause and consider mindset shifts; analyze your asset composition and risk controls constantlyl do independent research and…

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

Leave a Reply

Your email address will not be published. Required fields are marked *