The ongoing thoughts from Greg Valliere, the Chief Global Strategist for Horizon Investments, who has a lot of great insights to politics & the ramification on financial markets.
February 27, 2018
The 3% Economy – With Low Interest Rates
WE DINED WITH SOME BRILLIANT ECONOMISTS last night, giving us a chance to poll them on a great puzzle: how can the Treasury 10-year bond yield be near 2.85% with surging economic growth, a tight labor market, rising budget deficits, etc.? What are the fixed income markets trying to tell us? Are inflation fears overblown?
FIRST OF ALL, these economists – an elite group, on TV seemingly every day – agreed that the economy should grow by 3% this year; that seems baked in the cake in light of enormous fiscal stimulus. They disagreed, however, about how sustainable this growth will be – just for a year, or perhaps into the next decade?
IN THE SHORT-RUN, they agreed that interest rates will rise only moderately – even as the Federal Reserve gradually takes away the monetary punch bowl. Why? In a word, demand – demand from global investors seeking a safe haven in U.S. Treasuries, and demand from U.S. money managers who are always seeking better yields.
COULD THE ECONOMY BE HEADED FOR AN AIR POCKET? There's a minority view that last week's slide in rates reflects a cooling in the housing market and high consumer debt levels, both of which could drag down economic growth – but the housing slump may be weather-related, and consumers have gotten a booster shot from tax cuts.
MANY FORECASTERS initially underestimated the impact of tax cuts, but the anecdotal evidence is undeniable: Americans are getting fatter paychecks and they're pleasantly surprised. An interesting piece in this morning’s Washington Post focuses on happy consumers – and the political challenge this poses for Democrats who mocked the tax cuts as "crumbs."
BUT WHAT ABOUT DEFICITS? The Federal Reserve and other experts have argued for years that there's not much of a correlation between high deficits and high interest rates. That certainly proved true a decade ago, as soaring red ink had virtually no impact on rates, and it appears to be true in countries like Japan, where deficits are far greater than 100% of GDP, with rock-bottom interest rates. The lack of inflation seems to be far more important than budget deficits in these countries.
SOME ECONOMISTS think this year's GDP surge will fizzle out because of a very tight labor force and a more aggressive Fed. They also worry about trade protectionism and political instability as Robert Mueller prepares fresh indictments. But other economists think this above-trend GDP growth could last for a few more years; some even make comparisons to Ronald Reagan's era, although they quickly add that Donald Trump brings liabilities that are far greater than Reagan's.
THIS MUCH IS CLEAR: Virtually all economists, including the friends we saw last night, have increased their GDP forecasts for this year – and we suspect Fed Chairman Jerome Powell will do so in testimony today. Why this hasn't led to a significant rise in market rates is the big surprise, and it suggests to us that if rates only inch up slowly, this bull market may be far from over.
February 26, 2018
All Eyes on Jerome Powell; Total Paralysis in Congress
JEROME POWELL, GOING SLOW: Investors will get an opportunity to size up Jerome Powell this week. The new Fed Chairman will testify tomorrow before a House committee and Thursday before the Senate. Powell, a centrist, won't rock the boat, in our opinion.
LIKE ALL CENTRAL BANKERS, Powell has to talk tough about inflation, but there are no signs of a breakout; the Fed still hasn't achieved its goals yet for higher inflation. Economic growth is another story – we think the Fed will raise its 2018 GDP forecast to something close to 3%, despite a worrisome spike of consumer debt levels. Powell's likely forecast of a solid economy with moderate inflation seems like a great combination to us.
POWELL PROBABLY WILL HEDGE HIS BETS on the extent of Fed rate hikes following a near-certain move at the March 20-21 FOMC meeting. Another hike, at the June 12-13 session, is probable but beyond that it all depends on the data – and a Treasury bond market that continues to enjoy solid demand whenever yields inch higher. Powell won't utter the word "Goldilocks" but we will.
JUST WHEN YOU THOUGHT CONGRESS couldn't get any worse, there are signs of total paralysis on its two most pressing issues: immigration and guns. Lawmakers return today from a one-week break so hopelessly deadlocked on the issue of so-called "Dreamers" that a kick-the-can solution is starting to come into focus: a continuation of the status quo with no deportations for another year, plus a few extra billion dollars for border security.
THIS COULD BE A DEAL THAT WILL SATISFY NO ONE: Liberals and Hispanics will accuse Democrats to selling them out, not offering a permanent solution, and President Trump – desperate for a wall even if it fractures relations with Mexico – still will not get enough money to build one. But kick-the-can buys time; the idea of a deal by the March 5 deadline is absurd.
AS FOR GUNS, it's a classic case of Washington agreeing on the concept but not the details. Everyone wants to do something, but there's virtually no chance the conservative House would agree to raise age limits on gun purchases or pass tougher background checks; the NRA would mobilize its enormous army if a Senate bill in March seeks those two objectives.
IT COULD BE A PAINFUL LESSON for President Trump, who jumped into this issue intending to get something done, but he can't seriously challenge the NRA, and his call to arm some teachers is a non-starter in the Senate. So the focus may be on mental health, which will never get adequate funding. Anyone who wants serious gun reform will have to focus on the states and corporate boycotts.
MARCH MADNESS: As winter loosens its grip, two huge issues loom in March – pending U.S. trade tariffs on steel and other imports, hitting China and many other producers within the next few weeks. And The Big One: the near-certainty of more indictments from Robert Mueller, who has some former Trump aides singing like canaries, paving the way for Mueller to move up the chain of command and penetrate Trump's inner circle.
February 22, 2018
Trump Backed Into a Corner on Guns
DISPLAYING THE BRAVADO that everyone expects from him, Donald Trump pledged yesterday to fix the gun problem. But just ask Marco Rubio: it's not that simple, and the fixes – if any – are likely to be modest.
TRUMP DESERVES CREDIT FOR CONFRONTING THE ISSUE HEAD-ON, and his demands for action appear to be sincere. He can get a bill out of the Senate within a week that would bolster background checks, outlaw gun "bump stocks," and possibly increase the legal age limit for purchasing guns like the AR-15 that was used in the Florida massacre.
BUT THEN THE PATH WILL GET ROCKY in the House, where the Freedom Caucus will insist on the inclusion of a "conceal and carry" provision that would allow teachers and school administrators to carry weapons (a ban on so-called assault weapons has no chance of passage in the House).
TRUMP AND OTHERS who favor some action would then attempt to strip out the controversial "conceal and carry" provision, but that probably wouldn't fly in the House – and even if it did come back to the Senate with conceal and carry, the entire bill would stall, killed by Democrats who would never agree to arming teachers.
THUS THE EMOTIONAL reaction to the Florida school shooting could result, once again, in no action by the politicians, with angry students unwilling to accept the political realities and Trump frustrated by House conservatives and the NRA. Trump's high-visibility White House meetings have raised hopes, perhaps unrealistically, for some action, yet action may be nil or modest – until the next school shooting reignites the issue.
SO THIS WILL TAKE REAL LEADERSHIP, a willingness by Trump to spend political capital and confront the NRA. Trump's family and most of his campaign contributors have urged him to act, and we think he will. But he won't get much out of the House.
* * * * *
TOTALLY DIFFERENT SUBJECT: It's becoming clear that even a hint of higher interest rates spooks the stock market, which reacted poorly to the release of FOMC minutes yesterday afternoon. We'll get to hear from new Fed Chairman Jerome Powell in congressional testimony next week, but in the meantime our sense is that strong economic growth without much inflation is a very good thing.
INFLATION CLEARLY IS THE KEY, with some analysts predicting it will increase. But it hasn't, at least not yet. Higher interest rates because of solid GDP growth is acceptable; higher interest rates because of inflation is not. But the inflation that apparently worries the markets has not materialized yet; it still hasn't even risen to the Fed's goal. The markets are getting way ahead of themselves on inflation fears.
February 21, 2018
Whatever Happened to the Democrats?
SQUABBLING OVER STRATEGY and bereft of new ideas, Democrats are worried about new polls showing Donald Trump climbing. Instead of being mortal locks to win both houses of Congress this fall, Democrats are adrift.
MALAISE AT THE TOP: Senate Majority Leader Chuck Schumer has not fully recovered from his disastrous move to shut down the government earlier this winter; instead of bonding with Hispanic groups, they now distrust him. Schumer is a vast improvement over Harry Reid, but neither could get much done.
THE HOUSE LEADERSHIP, elderly and out of touch, is a liability for young Democrats running for office, many of whom are promising not to support Nancy Pelosi in her next run for Speaker. Pelosi will turn 78 next month; her chief lieutenants – Steny Hoyer and James Clyburn – are 78 and 77, respectively.
THE LACK OF FRESH BLOOD is particularly acute among the likely 2020 presidential candidates. Bernie Sanders is 76, Joe Biden is 75, John Kerry – rumored to be running – is 74 and the youngster in the pack is Elizabeth Warren, 68. One wonders about the availability of Mike Dukakis, 84, and Walter Mondale, 90. The irony is that the Democrats have some eager younger candidates, but no one has ever heard of most of them.
THE ISSUES: The Democrats are increasingly divided between progressives and pragmatists. The latter group may have enough bipartisan support to pass a bill this spring to ease regulatory burdens on small community banks, but the progressives – led by Warren – are outraged that any bill helping any bank might move toward enactment.
AND THEN THERE'S THE TAX CUT: Pelosi has been derided for her comments that the tax law will give "crumbs" to most recipients, but new polls show voters are happy to get more in their paychecks – an issue that could lessen the GOP losses this fall. Democrats also are sharply divided over immigration, trade policy, a single payer national health plan and – of course – impeachment.
SO WHAT'S THE AGENDA FOR THE FALL? Hillary Clinton proved that running on the theme that "Trump is horrible" is not sufficient. The Democrats have to stand for something, not criticize everything. And right now national health insurance for everyone seems to be the party's mantra.
A MONTH IS A LIFETIME IN POLITICS, and by spring the country could be transfixed by Robert Muller's upcoming indictments – especially if Trump reacts furiously – and the Republicans could be headed for a November debacle. But by summer the economy could be growing by 3%, with unemployment below 4%, which could be the dominant theme in the fall election.
WHAT'S APPARENT RIGHT NOW is that the Democrats aren't doing as well as they should. They have a decent chance of taking the House by a seat or two, especially if courts keep overturning gerrymandered state redistricting. The Senate, where the Democrats have about 10 vulnerable seats compared to two or three for the Republicans, could remain under GOP control.
WE ANTICIPATE SOME ANGRY EMAILS from our readers on the left this morning, but our friendly advice is to ask why Trump – for all of his enormous flaws – is climbing in the polls. One of the reasons, we would argue, is that the Democrats are stale and reactive; they still don't have their act together.
February 20, 2018
A Shift in the National Mood
AS WE WROTE LAST FRIDAY, Donald Trump undoubtedly knows he has to do something about guns; the national mood on this issue has shifted dramatically and he needs to step up. Trump can read the polls, which show overwhelming support for some action; when there's a major shift in the nation's mood, Washington has to pay attention.
GUN CONTROL LITE: What outraged students want – a ban on assault weapons – looks unlikely but not impossible. The fallback would be new background checks; it's an issue that everyone can agree on – even the National Rifle Association would back some type of background deal.
FOR TRUMP, THIS IS AN OPPORTUNITY to change the subject from the dreamers, the Russia probe, and the disarray in the White House. He has an opportunity in a meeting with students tomorrow to show some leadership on guns, and he may be able to look presidential after his furious twitterstorm this past weekend.
OTHER ISSUES HAVE BOGGED DOWN IN WASHINGTON: The Senate has stalled on an immigration bill, and the House would never agree to a path toward citizenship, so the March 5 DACA deadline probably will have to be extended. There's no imminent deal, so the judiciary could be pivotal; the Supreme Court may get involved, delaying any deportations.
WHITE HOUSE OFFICIALS THINK THEY CAN RIDE OUT the deportation issue, and the controversy over Chief of Staff John Kelly, whose halo clearly has slipped. But the White House cannot ride out the Mueller probe; more indictments are coming within a few weeks. Trump thinks he has been vindicated on the Russia probe, but he most definitely has not been. Even his GOP allies ask – why can't he utter one word of disapproval of the Russians' attack on the U.S. election?
SO WHAT DOES ALL THIS MEAN for the markets? An angry electorate, demanding action, always gets Washington's attention, so the student movement cannot be dismissed. But for the beleaguered president, there's one very important plus – an economy that continues to grow, with rising support for his tax bill. In December only 37% supported it; now, according to a New York Times poll, 51% support the new law.
OUR TAKE ON THE MARKETS is that they have factored in the likelihood of three rate hikes this year; they have factored in the likelihood of slightly higher inflation; and they have factored in the likelihood of significantly higher budget deficits. The stock market can tolerate these factors – and the dysfunction in Washington – as long as corporate earnings stay red-hot.
February 16, 2018
Will Trump Spend Some Political Capital on Guns?
A CLEAR SHIFT OF VOTER SUPPORT FOR REPUBLICANS has thrilled the party's leaders, who now enjoy a tie in generic polls for this fall's congressional races; Democrats were ahead by about 10 points just two months ago. President Trump may be battling ongoing White House dysfunction, but his approval rating has moved back above 40%.
THE SHIFTING POLLS clearly are a result of the tax bill and prospects for an improving economy, as the public enjoys fatter paychecks. And, suddenly, a "wave" election this fall – a landslide for the Democrats – looks a little less likely.
WE'VE NEVER JUMPED ON THE "WAVE" BANDWAGON although the Democrats clearly have more motivated voters – angry women, Hispanics, young people, etc. But pocketbook issues usually dominate, which leads us to believe that the GOP will retain the Senate, maybe even gaining a seat or two. The House, where the Democrats need a net pickup of 24 seats, is too close to call.
ALL SORTS OF VARIABLES COULD INTRUDE: Indictments from Robert Mueller are coming by spring. White House Chief of Staff John Kelly has been grievously wounded. Who knows what Stormy Daniels will allege now that she has abandoned terms of her deal with Trump's lawyers? But the biggest wild card may be whether Trump will continue to defy his own party.
RARELY HAS A POLITICAL PARTY BEEN SO TRANSFORMED, so quickly. Republicans have gone along with an enormous increase in budget deficits, as Trump abandons the GOP goal of balancing the budget. His proposed deep cuts in next year's budget were all show, designed to mollify the base; even Trump knows these draconian cuts will not occur.
TRUMP'S SUPPORT IN THE REPUBLICAN BASE is so strong that he now has widening options. He has the option of suggesting a gasoline tax, which has strong opposition from conservatives. He has the option of bucking his Senate allies on immigration – an issue so hopelessly divisive that he may have to extend the March 5 deadline for resolving the issue of dreamers. He has the option of taking piecemeal infrastructure bills, moving that issue forward.
BUT THE MOST INTRIGUING OPTION TRUMP HAS is to expend some of his enormous political capital among his GOP base by advocating modest gun control. It would be a huge political winner; even Republican voters support some type of curbs. Hard-liners fear any reform – they seem to think, absurdly, their guns could be confiscated (fears that Trump fanned in his campaign against Hillary Clinton).
BUT NOW TRUMP HAS AN OPPORTUNITY to actually do something on this issue. It would be a political stunner, and the National Rifle Association would have to go along; there's no preferable candidate for the NRA. So we end this depressing week with a fearless forecast: Trump will have to do something on guns, and he knows it.
February 14, 2018
Trade Issues Heat Up; Kelly May Not Survive; New Candidate for Fed Vice Chairman
RUMBLINGS ON THE TRADE FRONT: We'll say this for Donald Trump – he's adamant about keeping campaign promises, whether they involve tax cuts, regulations or border security. He's methodically checking off issues on his list of promises, and now comes trade.
TRUMP AND HIS BASE: The president feels strongly about abandoned factories, and he knows the Electoral College map broke just right for him in large part because voters in the Rust Belt feel victimized by trade deals. So Trump made it clear yesterday that some kind of sanctions may be coming in April on steel and aluminum imports that he feels have been dumped in the U.S.
THE BIG TRADE ISSUE TO WATCH IS NAFTA, where talks have slowed to a crawl. Trump said yesterday that Canada "has treated us very, very unfairly when it comes to lumber and timber," while the chief Canadian NAFTA negotiator said yesterday that the U.S. "has shown very little flexibility" in negotiations, which resume later this month in Mexico.
THE PROSPECT OF TRADE DISPUTES worries many U.S. businesses, farmers and mainstream Republicans, but the most they can hope for is that Trump will only impose modest sanctions, while coming just short of pulling out of NAFTA. The president is determined to show his base that the U.S. won't get pushed around on trade – and on this issue, he has support from most liberal Democrats, who intensely dislike NAFTA.
JOHN KELLY, ON THIN ICE: The controversy over alleged wife beater Rob Porter has exploded and could result in the ouster of Chief of Staff John Kelly; President Trump reportedly is considering replacements. This story has become toxic on three levels: Kelly's version of the timeline does not appear to be accurate; security clearances at the White House are inadequate; and Trump's refusal to console victims reinforces a perception of him as tone-deaf on the issue of spousal abuse and sexual harassment.
LOOKING FOR REPLACEMENTS: Trump apparently is considering three possible replacements: his golfing buddy Kevin McCarthy, the House Majority Leader, who has told friends he doesn't want the job; OMB Director Mick Mulvaney, whose star continues to rise; and Gary Cohn, the sharp-elbowed chief economic adviser, who we consider the favorite. The key angle is that Kelly was a restraining force on Trump, probably counseling him not to fire Robert Mueller. Whether any of these three candidates could rein in Trump as effectively remains to be seen.
NEW FED VICE CHAIRMAN EYED: Cleveland Fed President Loretta Mester is the frontrunner to become the next Fed Vice Chairman, filling one of four open seats at the central bank. Mester quite clearly is a hawk on monetary policy; during her long tenure at the Philadelphia Fed she was an ally of Charles Plosser, who consistently opposed accommodative Fed policies. So for Trump, be careful what you wish for – if confirmed, Mester would not be shy about rate hikes.
RECOMMENDED READING THIS MORNING: There's a deal on immigration if the two parties really want one. Initial negotiations in the Senate have gotten off to a very slow start, but we think there's a chance for a limited bill at the least – boosting border security and creating a path to citizenship for so-called dreamers. This morning's Wall Street Journal editorial is a useful primer on where the issue stands.
February 13, 2018
Who Cares About the Budget Deficit?
AFTER YEARS OF CRYING WOLF about the budget deficit, fiscal hawks now have to deal with a grim reality: red ink is exploding, and the public doesn't give a damn.
WE GOT QUITE AN EARFUL from sources in both parties yesterday. Democrats don't like Donald Trump's priorities but they have no problem with spending more money on his watch, and they're happy to bash Trump for hypocrisy on the issue since he promised to balance the budget. Most Republicans are aghast – one of their signature issues is gone for a generation, as deficits soar.
THE NEWS ON DEFICITS WILL GET EVEN WORSE in coming days, members of both parties agree, once the Congressional Budget Office issues its updated projections. Deficits of $1 trillion a year for as far as the eye can see are likely, with this clear conclusion: virtually all of Trump's draconian spending cuts will be rejected, while most of his spending hikes will be accepted.
THE VOTERS BACK HOME HAVE SHIFTED: Public anxiety over the deficit peaked earlier this decade, as voters listened to politicians who predicted dire consequences if the deficit rose. So fiscal austerity was adopted, with surprisingly strict budget caps, but the economy didn't get healthier. Perhaps more important, all of the warnings about deficits did not produce high interest rates or inflation, as the budget hawks preached.
SO THE VOTERS NO LONGER LISTEN to the Cassandras; no more than a quarter of the public thinks the deficit is a serious threat. And there surely isn't support for the prescription: steep spending cuts, especially for entitlements. With the stock and bond markets on a tear for the past few years, the American public has concluded that the deficits aren't a huge problem if the markets seemingly don't care.
WE TALK WITH POLITICIANS ON CAPITOL HILL who believe that government borrowing costs will impose a terrible burden on the economy in the next decade, but they concede that it will take a catalyst – most likely an angry bond market – to prompt Congress to take action. But global demand for Treasuries is still robust.
WE'RE IN UNCHARTED WATERS: The economy is near full employment, GDP growth is likely to approach or exceed 3% soon, and most people are starting to see the impact of tax cuts in their paychecks. Only the fiscal scolds are worried about the deficit; the politicians don't have the backbone to do anything. This will end badly – maybe not for another couple of years – but make no mistake, it will end badly.
February 12, 2018
Modest Infrastructure Plan Could Pass; Gasoline Tax on the Table?
EVERYONE IN WASHINGTON AGREES that the crumbling U.S. infrastructure needs help. And everyone has pretty much thrown in the towel on fiscal restraint. So now we're just arguing over details of an infrastructure plan that could gain momentum later this year.
OUR EARLY PREDICTION is that a modest bill could win enactment – not one that would add $1.5 trillion over ten years to infrastructure spending, as the White House wants. Not a bill with a huge state contribution, because the states are nearly broke, but a bill that focuses on low-cost loans, private sector activity bonds and a capital funding plan. In other words, more borrowing – the theme du jour in Washington.
PRESIDENT TRUMP, WHO GOT WHAT HE WANTED on taxes, will now go all-out for infrastructure, introducing a bill today with great fanfare at the White House, then meeting with congressional leaders on Wednesday. Trump will also stress "streamlining" of regulations that delay implementation of infrastructure plans; this goal has widespread support. But what about the great wild card – a gasoline tax hike?
THE WHITE HOUSE HAS NOT RULED OUT a hike in the gasoline tax, which has been stuck at 18.4 cents per gallon since 1993. Many Washington lobbyists, including the U.S. Chamber of Commerce, think an increase is a good idea that could raise billions. But we think most politicians will balk; the Republicans hate tax hikes and the Democrats consider this a regressive tax. But something modest, perhaps indexed to ups and downs in gasoline prices, can't be ruled out.
OUR BOTTOM LINE ON INFRASTRUCTURE is that the Democrats are willing to listen; they want more blue collar jobs in their home districts and they have no problem spending money on Trump's watch. It's the Republicans who are uneasy, but Trump has his way with them on every major issue. So let's call this "infrastructure lite," a plan coming into focus later this year that could tackle some high-visibility projects, allowing Trump to boast about another legislative victory.
THE NEW DEFICIT ERA: Introduction today of the Trump Administration's fiscal 2019 budget confirms that balancing the budget is no longer a goal. The president will pledge to cut spending by $3 trillion over the next decade, but there's little chance that Congress will go along.
BUT LOTS OF NEW SPENDING: The lawmakers will agree to new spending for veterans programs, opioid enforcement and research, border security, etc – on top of the roughly $500 billion in new spending that was agreed to last week. Budget director Mick Mulvaney wants the new domestic spending to go to White House-approved programs, but the Democrats get to call many of the shots on specific outlays.
OUR ROUGH ESTIMATE is that the deficit will increase by at least $13 trillion over the next decade, even with decent economic growth. Deficits of $1 trillion or above will arrive in fiscal 2019 and continue unabated. As for the Trump budget forecasts, we can't disagree with a prediction of GDP growth next year of close to 3%. But a Treasury10-year bond yield averaging 2.6% this year and 3.1% next year? You've got to be kidding...
THE TOUGHEST JOB IN WASHINGTON, as the stimulus keeps skyrocketing, is Chairman of the Federal Reserve. Jerome Powell will have to grapple with unprecedented deficits – never seen in a period of economic expansion. A rate hike is virtually certain at the March 20-21 FOMC meeting, probably followed by increases at the June, September and December sessions as the Fed grapples with an economy that's getting far more stimulus than necessary.
February 9, 2018
Taking a Break From the Dysfunction
THERE WAS ONE LAST BURST OF DYSFUNCTION in the middle of the night, but a government shutdown will end quickly and there are some positive aspects of the budget deal for the markets.
FIRST, WE GET SOME PREDICTABILITY after months of uncertainty. The deal passed by the House this morning will set spending levels for nearly two years, the debt ceiling will be raised, the Pentagon will get a huge spending increase, domestic outlays will surge for agencies like the National Institutes of Health. Everyone seemingly got something, except the so-called "dreamers," but both houses will vote on that issue by spring (with uphill prospects for a compromise).
ONE LAST BIT OF THEATER came last night as one senator – Rand Paul – was able to shut down the government (don't get us started on Senate rules). Paul made a valid point – the budget deal is a spending pig-out – but he infuriated his GOP colleagues because he didn't have remotely enough votes to prevail.
THE SPENDING DEAL, OPENING THE GOVERNMENT, is a mixed bag for the markets. It ends the uncertainty but the extraordinary stimulus in this budget will simply add rocket fuel to an economy awash in stimulus. The bond market – clearly the catalyst in the stock market selloff – will continue to worry about inflation expectations that may percolate as the economy surges.
BUT INFLATION EXPECTIONS are not over-heating at the present time, cautions Horizon's head of investments, Scott Ladner. He believes the economic fundamentals are solid, but the stock market selloff has been exacerbated by "forced selling," the unwinding of exotic strategies – risk parity, targeted volatility, etc,. that virtually require selling when volatility rises and/or stock prices fall. Many of these crowded trades have been unwound, and Scott thinks this "systematic" selling should be tapering down, starting today.
FROM A POLICY STANDPOINT, we would also agree that the selloff may be overdone. While there's a risk of an overheating economy, a GDP growth rate of 3% or better by the second half brings major positives, including the likelihood of continued solid corporate earnings. The recovery is about to shift into a higher gear, seemingly able to tolerate a relatively modest uptick in interest rates.
February 8, 2018
The End of An Era on Fiscal Policy
WE'VE BEEN RANTING about the likelihood of explosively higher federal spending, and that could become a reality within the next few hours. After years of fiscal restraint – which probably deepened the recession – Congress is about to open the spigots, which will goose the economy at a time when goosing is not necessary. The result, obviously, will be higher interest rates.
TODAY'S VOTES: The Senate will pass its bipartisan budget deal late this afternoon; that's not in doubt. The real excitement will be in the House, where Republican deficit hawks are aghast at what they view as a $360 billion pig-out, and liberal proponents of immigration reform are furious that the DACA issue has been pushed aside. Chances of House passage are only about 55%, but this deal seems destined to prevail one way or another.
IF THE BILL PASSES, WHAT'S IMPORTANT FOR THE FINANCIAL MARKETS –
1. A debt ceiling train wreck will be avoided. The threat of a genuine debt ceiling crisis in early March was beginning to worry bond investors, but this deal would extend the debt ceiling for another year, depriving conservatives an opportunity to attach spending discipline to the bill.
2. Enormous defense spending increases – in the neighborhood of $180 billion over two years – will end the confusion for defense contractors who were dealing with the uncertainty of stop-gap spending extensions.
3. All sorts of domestic spending hikes are likely – for the National Institutes of Health, for veterans' programs, for the beginnings of infrastructure spending, etc. Discretionary spending will rise by 21% in the next two years as budget caps are demolished.
4. Deficits of close to $1 trillion annually are imminent, perhaps beginning as early as fiscal 2019. The White House budget for that year will be released on Monday, calling for deep spending cuts – which obviously will never occur in light of this deal.
BOTTOM LINE: If we wake up tomorrow morning with a done deal, avoiding a midnight government shutdown, there will be a brief extension to allow time to actually write the bill. The real story will be the end of an era – fiscal conservatism will be dead, the big spenders will have prevailed.
THE 3% GDP GROWTH RATE sought by President Trump seems within reach, probably hitting that level by the second half of this year, considering the massive fiscal stimulus that is about to flood the economy. The great wild card, of course, is a lack of skilled labor and a potential crackdown on legal and illegal immigration – where are the workers to accommodate such explosive growth?
WAGES OBVIOUSLY WILL HAVE TO RISE, contributing to what we believe will be an over-heating of the economy – the bond market's greatest fear. Everywhere we go, seniors tell us they hate low interest rates and want higher yields in their retirements. Be careful what you wish for – a new era is beginning.
February 7, 2018
Finally, a Consensus on the Budget – Let's Spend a Lot More Money!!
CONGRESS CAN'T AGREE ON MUCH, but there's a growing consensus on one point: both parties are nearing a two-year deal that will spend A LOT more money – $360 billion or maybe a little more – for defense and domestic programs, plus disaster relief. The massive economic stimulus that has worried the bond market will continue, unabated.
IN AN IMPORTANT BREAKTHROUGH, Congress appears to be willing to separate two contentious issues: a funding bill for this fiscal year and next, and the immigration issue, which will get a vote in the Senate but faces long odds in the House and at the White House. The DACA issue is far from resolution as a March 5 deadline approaches.
WITH PRESIDENT TRUMP CALLING FOR A GOVERNMENT SHUTDOWN over DACA and both Houses far apart on a solution, a consensus has emerged to break this issue away from a budget deal. This will produce an uproar from the left, just as an uproar looms on the right because of huge spending increases. But the leadership in both parties wants to get something done (and they have not ruled out adding a debt ceiling extension to the spending bill).
THE NUMBERS: A bill moving quickly in the Senate would provide an $80 billion increase for defense in this fiscal year, up from $549 billion last year, with outlays rising another $80 billion in fiscal 2019. In a major concession to Democrats, domestic spending would rise by $63 billion this year and next, above the current level of $516 billion. And $80 billion would be appropriated for hurricane disaster aid. Would there be spending offsets to pay for these new outlays? Nope.
THE LIKELIHOOD OF SPENDING $360 BILLION MORE has outraged fiscal hawks in the House; the Freedom Caucus will vote against this deal, almost unanimously. But there are plenty of House Democrats who will vote for it, even though they have concerns about abandoning a DACA compromise.
ONCE AGAIN, WE'RE AMAZED to see that concern over the budget deficit is negligible, despite all the hot air during the past campaign about curbing spending. The President isn't concerned about deficits, the Democrats aren't concerned, and only about a third of Republicans are worried about red ink that could surge close to $1 trillion annually in the next decade.
WITH THE ECONOMY BOOMING, this would be a great time to trim federal spending, even modestly. But calls for a tiny alteration to the CPI calculation in programs like Social Security prompts howls of protest. The feeding frenzy on spending is voracious – and no one seems to care that Treasury borrowing requirements are rising significantly.
February 6, 2018
The Blame Game
IT'S HUMAN NATURE TO SEEK A SCAPEGOAT when things go wrong, so Washington is in over-drive with the Blame Game as the stock market plunges. The easy explanation is that the market got frothy and a sell-off was long-overdue – but that isn't enough of a spin in this hyper-partisan city. So let's look at the four major factors:
1. Too much stimulus: We reiterate our major theme – the economy is in danger of over-heating, thanks to massive tax cuts, out-of-control government spending, synchronized global growth, and perhaps the most important factor: a U.S. labor market that's exceptionally tight, with inevitable wage pressure coming this year.
2. Bond market jitters: All of the above factors have spooked the bond market, although yields on the Treasury 10-year bond are still below 3% – hardly ominous for the markets or the economy. But the markets worry about the future direction of rates and rising inflation expectations – and, crucially, much higher Treasury borrowing requirements. Losing the most dovish Chairman in Fed history may be a factor as well.
3. Technical factors: Scott Ladner, Horizon's head of investments, notes that much of yesterday's move was "forced selling," dictated by many risk management models; it was not about inflation fears or the Fed, which were factors last Friday. The panicky selling yesterday, Scott says, sent S&P bid/offer spreads as wide as $50 (typically they are $1 or less), and there were times when prices simply weren't quoted, a phenomenon Scott hadn't seen since the "Flash Crash" on May 6, 2010. We agree with Scott that the market action over the past two days became disconnected from the fundamentals of very strong corporate earnings, surging consumer confidence, deregulation and other positive factors.
4. Political instability: President Trump's legions of detractors are gleefully asserting that if Trump lives by the stock market sword he can die by the sword. We can't blame Trump per se for the selloff, but a sense of political instability could be a factor, with the budget gridlocked and a debt ceiling crisis looming. And with Trump hinting that he could fire Rod Rosenstein or even Robert Mueller, the political climate is jittery.
THE POLICY IMPLICATIONS: Two points stand out – First, the GOP's chances of keeping the House and Senate this fall – which seemed to be improving in recent days – could be jeopardized if the selloff persists. You can be sure the Democrats will blame Trump and the Republicans. Second, Fed Chairman Jerome Powell may have to rethink
monetary policy; his plans to raise rates fairly aggressively could be slowed if the stock and bond markets stay volatile.
BOTTOM LINE: For now, this still looks like a normal correction of an over-bought market; the sense of extreme euphoria that gripped the markets since Trump's election was bound to fade. Yes, interest rates may head erratically higher in coming months, but with inflation still contained and corporate earnings still solid, a dramatic selloff looks unlikely with fundamentals as sound as they are now.
February 5, 2018
A Significant Shift in the Polls; More Trouble for the Bond Market?
IT'S THE ECONOMY: There isn't much public interest in memos about the FBI, but there's plenty of interest in paychecks, which already are headed higher because of the tax cut. And, suddenly, the polls have moved significantly toward the Republicans.
WE THOUGHT THE BOOMING ECONOMY and a decent State of the Union address by President Trump would boost his approval numbers past 40% and sure enough, a Monmouth University poll now has him at 42%, and the Rasmussen poll has him at 49% approval (although Rasmussen always seems 3 or 4 points higher for Trump than other polls). Still, this is a significant move – as is a major narrowing of the generic poll for congressional races, which shows a huge lead for Democrats has narrowed to just a few points.
ALL THE POLLS POINT TO ONE FACTOR: There's increased public confidence in the economy, as tax cuts begin to hit paychecks in early February. Whether this optimism persists depends on many factors, including the stock market, but we reiterate: it's too early to make a call on House and Senate races this fall, which may not produce a "wave" election after all.
NO NEED TO CELEBRATE: Trump bragged about the polls, naturally, but he still has to deal with Robert Mueller. Dueling memos have muddied the waters and eroded confidence in the FBI, but we quote Rep. Trey Gowdy on the investigation. "As I have said repeatedly, I remain 100 percent confident in Special Counsel Robert Mueller," said the arch-conservative Gowdy, who added that the contents of the GOP memo released on Friday "do not – in any way – discredit Mueller's investigation."
TRUMP HAS HARDLY BEEN VINDICATED, as he claimed on Friday night, but we'll make this point: if his poll numbers continue to improve, it will make most congressional Republicans reluctant to challenge him. They are his fire wall. Even if he fires Rod Rosenstein, Trump will have overwhelming support from the GOP base.
MORE TROUBLE AHEAD FOR THE BOND MARKET? Still another continuing budget resolution is likely before this Friday's latest deadline, kicking the can until late February. While there's only faint hope for a new immigration proposal from Sens. John McCain and Chris Coons, there's been some stirring on the budget component of a deal – and it's looking like a whopper of a spending bill.
SPENDING RESTRAINT? BE SERIOUS: With the economy booming (we wrote last Monday that the economy could over-heat), you'd think this might be a good time to trim federal spending. But we'll get even more stimulus since the 2018 budget plan that's moving in Congress would add $80 billion for defense and $63 billion for domestic outlays, with rigid spending caps lifted for fiscal 2018 and 2019.
GOP FISCAL HAWKS are aghast, but they're resigned to an eventual deal, possibly including a debt ceiling hike, in the next two months. Because so many Republican deficit hawks will oppose this deal, Paul Ryan and Mitch McConnell will have no choice – they'll have to plead for Democrats' votes, offering more spending as an inducement. Not only will the bond market have to sweat out a debt ceiling crisis in March, but the final product will be significantly higher spending.
LAST WEEK'S BOND MARKET SELLOFF stuck us as long overdue, finally reflecting three factors: Treasury borrowing needs will surge to the $1 trillion range this year and in 2019-20; the economy could over-heat, thanks to enormous fiscal stimulus and a labor market that's extremely tight; and there's a whiff of inflationary expectations. Suddenly we're seeing speculation about a 50 basis point Fed rate hike sometime this year, and now four rate increases – not three, as we expect – look possible in 2018.
February 1, 2018
The Next Crisis; A Major Signal Today from Trump; Paul Ryan Leaving?
THE NEXT CRISIS: As Washington struggles over the "dreamers" and a memo on alleged FBI abuses, a deepening crisis is brewing over the budget – not just the threat of another shutdown, but growing risk of a debt ceiling crisis. The deadline just got moved up, and the markets will have to pay attention.
THE CONGRESSIONAL BUDGET OFFICE previously had estimated that the government would run out of borrowing authority in late March or early April, but CBO officials said yesterday that the deadline could come in the first half of March. The major reason why? Tax receipts are projected to be $10 to $15 billion per month lower than expected because of the new tax law. Receipts are projected to fall by an extra $136 billion this year alone because of the tax law.
FIXING THE DEBT CEILING PROBLEM IS EXTREMELY COMPLICATED: There are two parts to the looming budget crisis. First is the need to pass still another continuing resolution on Feb. 8 to keep the government open but – incredibly – there's the threat of another embarrassing shutdown because members of Congress are sick of "kick the can" extensions. Republican defense hawks in particular will resist another extension; they're trying to pass a stand-alone Pentagon spending bill.
BUT THERE'S NO CONSENSUS on domestic spending levels, and of course the dreamers issue has Congress tied in knots. So we'll hear the same dreary rhetoric in coming days about a shutdown, although a Feb. 8 extension thru early March is the most likely option.
THE SECOND ANGLE, THE BIG ONE, is the debt ceiling, which must be raised or crucial outlays – even Social Security checks – could be threatened. We don't think the U.S. will default, but there could be anxiety in the bond market as the deadline approaches. Credit rating agencies could downgrade U.S. debt, a largely symbolic act, but it certainly would not be a plus for bonds, which are facing rising supply, growing budget deficits and a whiff of inflation.
AN OPTIMIST would conclude that the 2018 budget and a debt ceiling increase could be combined in a massive bill in March that also may include a bare-bones immigration deal. But a pessimist may conclude that the votes simply may not be available; Republicans in the House are extremely averse to raising the debt ceiling, which will force Speaker Paul Ryan to beg for votes from Nancy Pelosi's troops,who don't seem willing to compromise without huge concessions on spending and immigration. Stay tuned – this will be a cliffhanger.
HEADING FOR THE EXITS: Over 40 Republican House members have announced they will not seek re-election this fall; the latest is Rep. Trey Gowdy, Chairman of the Oversight Committee. Gowdy's South Carolina seat is safely Republican, but the unusually large number of GOP retirements is a sign that the party faces significant losses this fall; the Democrats need a 24-seat pickup, which is within reach.
RYAN DEPARTURE? Gowdy is a close ally of Speaker Paul Ryan, who has seen nearly a dozen GOP committee chairman announce that they will not seek re-election this year. This is still another reason why we think Ryan will step down, probably late this year. He has won his great legislative objective – tax cuts – and has little hope of winning his other goal, entitlement reform. Ryan, who sleeps on a cot in his office, is known to be anxious to return to his family in Wisconsin.
FINALLY, THE SIGNAL WE'RE WAITING FOR comes today from Donald Trump, who speaks to Republicans at their retreat in West Virginia. Will he maintain the more conciliatory and subdued posture we've seen in Davos and the State of the Union speech? Or will he mock Chuck Schumer and the Russia investigation? A good cop act would make us more optimistic about a budget and immigration deal. A bad cop act, just ahead of Groundhog Day, would portend a very very long winter.
DISCLAIMER: Horizon Investments, LLC is an SEC-registered investment adviser. The views expressed are those of the author, Greg Valliere, and do not necessarily reflect the views of Horizon Investments. They are subject to change, and no forecasts can be guaranteed. The comments may not be relied upon as recommendations, investment advice or an indication of trading intent. Horizon Investments is not soliciting any action based on this document. In preparing this document, the author has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. Investing involves risk, including the possible loss of principal and fluctuation of value. For more information about Horizon Investments, contact us by calling 866.371.2399 or visit our website at www.horizoninvestments.com.