Heads Up!

The Republican race to overhaul the tax code broke into a sprint on Thursday, with House members narrowly clearing a budget blueprint that would allow a tax bill to pass Congress without any Democratic votes, and Senate leaders signaling that the bill could be introduced, debated and approved in both chambers by the end of November. (Source: New York Times)

You may wonder why we continue to emphasize this legislation in our communications to you. It is because this legislation has the potential to be a big deal – perhaps the most important tax legislation in over 30 years. But, we cannot be more specific until we get a chance to take a look at the details which are expected to be released this week. Assuming they are released as anticipated, you can expect to see details in the next Weekly Commentary.

Update – Washington

The U.S. stock market has jumped since the November 8th election. We identified 4 initiatives on which the U.S. stock market is speculating to be successfully accomplished early in the Trump administration.  What will happen next? It is still to be determined!

The 4 initiatives will have a tremendous influence on the “Heat Map” which forms the basis of our forward looking view of the U.S. economy. We consider the success or failure of the 4 initiatives to be “leading” indicators for the Heat Map.

Below are the 4 Trump administration initiatives upon which the stock market is speculating and what progress, if any, has been made:

  1. Tax cuts and tax reforms benefiting most individuals and businesses. SIGNIFICANT PROGRESS HAS BEEN MADE RECENTLY. CUMULATIVE PROGRESS TOWARD GOAL: 65%
  2. Infrastructure spending of up to $1 Trillion over the upcoming 7 to 10 years. PROGRESS MADE ON TAX REFORM POINTS TOWARD PROGRESS IN THIS AREA, TOO.  CUMULATIVE PROGRESS TOWARD GOAL: 25%
  3. Affordable Care Act amendment, reform or reorganization. CONGRESS HAS STUMBLED EVERY TIME IT TRIED TO ACT. CUMULATIVE PROGRESS TOWARD THIS GOAL IS 0%.
  4. Roll back of government regulations and Executive Orders considered to be difficult for businesses. ROLL BACKS HAVE CONTINUED. CUMULATIVE PROGRESS TOWARD GOAL: 50%

As the action happens in Washington on these 4 initiatives, don’t be surprised if the political “tug and pull” contest results in a wilder than normal stock and bond market.

We will continue to report in future issues on the progress on each initiative. 

The “Heat Map”

Most of the time, the U.S. stock market looks to 3 factors (call them the “pillars” which support the stock market) to support its upward trend – let’s grade each of the pillars.

CONSUMER SPENDING: This grade is a B+ (favorable).

THE FED AND ITS POLICIES: This factor is rated C- (Below average).

BUSINESS PROFITABILITY: This factor’s grade is A- (very favorable). So far, earnings reports for the 3rd quarter have been solid.

OTHER CONCERNS:  The “Heat Map” is indicating the U.S. stock market is in OK shape ASSUMING no international crisis. On a scale of 1 to 10 with 10 being the highest level of crisis, we rate these international risks collectively as a 5. These risks deserve our ongoing attention.

The Numbers

Last week, U.S. stocks increased, but Foreign Stocks and Bonds declined. During the last 12 months, STOCKS outperformed BONDS.

Returns through 10-27-2017







Bonds- BarCap Aggregate Index







US Stocks-Standard & Poor’s 500







Foreign Stocks- MS EAFE Developed Countries







Source: Morningstar Workstation. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. Three, five and ten year returns are annualized excluding dividends.

The Markets This Week

For the last three months, titans like Amazon.com, Alphabet, and Facebook have quietly lagged the market as investors bet on old-economy stocks like General Motors, Michael Kors Holdings, and Bank of America, all of which had double-digit gains during the same period.

Then last Friday happened. Stellar earnings from Amazon (ticker: AMZN), Alphabet (GOOGL), and Microsoft (MSFT) sent those stocks up 13%, 4.3%, and 6.4%, respectively. And just like that, tech is hot again. How hot? The Nasdaq Composite gained 2.2% on Friday, 2.06 percentage points more than the Dow Jones Industrial Average’s 0.14% advance, the widest single-day gap between the two benchmarks since 2002. The Standard & Poor’s 500 index rose 0.81% to 2581.07. Both the Nasdaq and the S&P 500 closed the week at new all-time highs.

The question is whether investors will wake up next week with a big tech hangover. Much will depend on earnings from Facebook (FB), which is set to report on Wednesday, and Apple (AAPL), scheduled for Thursday. But the situation isn’t all that different from tech’s June underperformance—the Nasdaq declined 0.9% that month–which was followed by a July rally, says Frank Cappelleri, a technical analyst at Nomura Instinet. And if financials, which have gained 3.5% in October, continue to rally, even after dipping 0.2% on Friday, you could have a recipe for an accelerating market with tech in the mix. “If people want melt-up potential, that narrative has a good chance of creating it,” Cappelleri says.

Unless one has already occurred. That’s a theory floated by INTL FCStone Financial strategist Vincent Deluard—based on the market’s low volatility. The Dow has returned 32% during the past 12 months, a great return, though there have been better. But the Dow’s realized volatility during that period has been around 7%, which would put its Sharpe ratio—a measure of an asset’s return relative to its volatility—at around 4.6. To put that in context, Deluard notes that in normal times, any hedge fund would be happy to deliver a Sharpe ratio that’s half of that. Another way to look at it is to consider what the Dow would have to return to maintain that Sharpe ratio if volatility returned to its average of 16% going back to 1900. The answer: More than 70%. “By any standard, a melt-up has already happened,” Deluard says.

And it is strange how quiet the market is. October, remember, is supposed to be the market’s most volatile month. Through Thursday, however, it was the least volatile October on record going back to 1928, according to Ben Bowler, global head of equity derivatives research at Bank of America Merrill Lynch. He chalks that up to the fact that the market assumes that the world’s central banks will backstop it no matter what, making every drop a buying opportunity. Bowler foresees two factors that might change that outlook in the U.S. One would be higher inflation, which could force the Federal Reserve to take a more hawkish stance. The second would be a new Fed chief—and that chairman’s outlook on the moral hazard created by central bank puts. “We need to break this psychology that shocks are good because it means an opportunity to buy the dip again,” Bowler says.

If tech stocks keep running, that might be easier said than done.

(Source: Barrons Online)