Stock index & news
- Is the tax cut priced into the stock market?
- What the disconnect between stocks, bonds, and USD tells us about the tax cut.
- Global economic growth in Q4 2017 is solid.
- The Republican tax cut will give GDP a big boost in 2018 and 2019.
- Global stock markets and economic growth will be less synchronized in 2018.
4 pm: Is the tax cut priced into the stock market?
This is a big question now that the Republican tax cut has passed. I discussed this briefly a few days ago. Here are my in-depth thoughts.
Based on today’s price action (S&P 500 flat despite tax cut news), I think that the tax cut is indeed priced in with regards to the short term.
*I was wrong. I thought the S&P would go up in the short term on this tax cut news. Just shows you how unpredictable the short term is. It’s anyone’s guess.
But on a medium-long term basis, there is no such thing as “priced in”. The U.S. stock market has a long term bullish bias (it goes up on 59-60% of days). This means that given enough time, the S&P will always be higher as long as there is no reason for a significant correction or bear market (which our Medium-Long Term Model aims to predict). Here’s the profound implications behind this logic:
- The stock market DOESN’T need a reason to go up. As long as corporations grow their profits (which they do during economic expansions), the U.S. stock market will go up in the long run. The stock market doesn’t need bullish news to go up! Time is on the side of bullish investors.
- The stock market NEEDS a reason to go down. Without a strong fundamental reason to go down, all declines are just “small corrections” and pullbacks.
Notice the asymmetry here. The deepest insights are always the most simple. “Simplicity is the ultimate sophistication”.
Even if the stock market goes down because it’s “selling the news” in the short term, there will be no significant correction. The tax cut will not result in sustained selling. The tax cut is fundamentally a medium-long term bullish factor for the U.S. stock market. It boosts corporate earnings, share buybacks, and M&A deals.
Some people argue that the tax cut will inflate the Federal deficit. This is true. But this will only become a real problem during the next recession, when the government can’t borrow enough money. In the meantime, the Federal deficit has virtually no impact on the U.S. economy.
3 pm: What the disconnect between stocks, bonds, and USD tells us
CNBC published a good article discussing the disconnect between stocks, bonds, and the USD. In short, the stock market is reacting most bullishly to the tax cut, the bond market is reacting decently to the tax cut, and the USD is barely reacting to the tax cut.
Then the author asks “The disconnect between various asset classes is raising the question of whether the tax reform bill is truly going to have a major bearing on the economy. While the stock market is saying yes, the other markets are saying perhaps not so much.”
The answer to this question is already clear.
The stock market, bond market, and USD DO NOT reflect the same things. The stock market reflects Corporate America (which is a function of the U.S. economy). The bond market reflects the economy. The USD reflects international money flow (many USD bear markets occur during economic expansions).
The market’s price action tells us that the tax cut will have a very moderate impact on the U.S. economy.
- Over the long term, the U.S. stock market is a function of the U.S. economy. HOWEVER, corporate share buybacks can have a significant impact on the stock market in the medium term . The stock market has rallied like crazy in 2017 in anticipation of next year’s share buybacks. Lower taxes & capital repatriation = more money for share buybacks.
- Yields are rallying less than the stock market. Treasury yields (particularly the 2 year and 10 year) reflect the state of the U.S. economy. Via price action, the market is telling you that the tax cut will have a moderate impact on the U.S. economy.
- The USD is hardly going up on tax cut news. The USD reflects international money flow. Via price action, the market is telling you that capital repatriation will have a very limited impact on the USD. Do not expect the USD to soar on capital repatriation.
The Republican tax cut will benefit the stock market more than anything else. I’m an economic conservative, and I’m not going to pretend that this tax cut will do wonders for the U.S. economy. It won’t.
3 pm: Global economic growth in Q4 2017 is solid
FedEx just released its earnings report, which beat estimates on increased package volume. FedEx is often used to hint at the next earnings season (in this case, January 2018) because it is among the first to release earnings.
More importantly, FedEx is seen as an indicator for the global economy (more shipping = more global economic activity).
4 am: Republican tax cut’s effect on U.S. GDP in 2018 and 2019.
This is not wishful thinking. I already stated that the tax cut will have minimal impact on U.S. investment and real GDP.
The tax cut can increase U.S. GDP by 1.5% ($250 billion) over the next 2 years purely due to accounting reasons.
Most U.S. multinationals (particularly tech companies) engage in “base erosion and profit shifting”. Here’s how it works.
- The real economic activity takes place in the U.S.
- Through fancy accounting and bookkeeping, these companies depress their “official” U.S. profits and inflate their “official” foreign profits. This minimizes their U.S. taxes.
- In doing so, they artificially depress U.S. export data and artificially inflate U.S. import data.
- Since “net exports” is a component of GDP, base erosion artificially depresses U.S. GDP (an accounting gimmick).
For example, Apple Ireland (a tax haven) will sell iPhones to Apple USA at inflated prices. Apple USA barely books a profit, while Apple Ireland has inflated profits. Apple Ireland hardly pays any taxes due to Ireland’s tax structure.
The Republican tax bill will cut down on base erosion via a number of measures. This will boost the net exports data, which will boost U.S. GDP in 2018 and 2019.
4 am: Global stock markets and economic growth will be less synchronized in 2018
Global stock markets and economic growth were synchronized in 2016-2017. Everything went up, and it became a positive feedback loop. E.g. Improving European economy (rising European stocks) = Improving EM economies (rising EM stocks) = Improving U.S. economy (rising U.S. stocks) = Improving European economy (rising European stocks)…. and the whole cycle feeds on itself.
Here’s the German DAX Index (represents European equities).
Here’s Hong Kong’s Hang Seng (represents China and emerging markets).
And as you all know, the U.S. stock market rallied nonstop in 2017.
2018 will be a different story. Global (ex-U.S.) economic growth and stock markets will not be synchronized. The biggest potential threat is China. After meeting in October 2017, the Chinese Communist Party decided to
- Slow down heavy fixed investment (e.g. infrastructure).
- Control housing market (bad for residential investment).
- Focus on financial market control (prevent bubbles like 2015).
- Fix the environment.
At the very least, this is not good for China’s economy. Much of Europe’s economic recovery from early-2016 to present was due to China’s economic recovery. Chinese economic slowdown = European economic slowdown. This will not be good for German and EM stock markets.
If ex-U.S. stock markets experience increased volatility in 2018, then so will the U.S. stock market.
*Unlike the U.S., both China and Germany depend on exports. Hence China and Germany are sensitive to global economic forces.
Here’s what I think will happen based on my short term discretionary outlook.
- The S&P will make a small 6-10% correction in Q1 2018.
- Then the S&P will make a new high, before making a multi-month consolidation or multi-month “small correction” in the 2nd half of 2018.
- 2018 will be much chopper than 2017. As of October 2017, this is the longest rally in history without a 6%+ “small correction”. If you haven’t already, please read What will the S&P do after rising 8 consecutive months.
I do not use my discretionary outlook to trade. I remain 100% long UPRO because my Medium-Long Term model does not foresee a significant correction at this point in time. I ignore small corrections. I only sidestep significant corrections and bear markets.
I have been 100% long UPRO since September 7, when the S&P was at 2465 and UPRO was at $109.3
*I also have a small Day Trading portfolio. Click here to view my day trades.