Politics & the Markets (Daily Thoughts from Greg Valliere)

These are the ongoing thoughts from Greg Valliere, the Chief Global Strategist for Horizon Investments, who has a lot of great insight to politics and the ramifications on the investment markets.  It has been balanced and fact-driven information on a topic that many people have been obviously very interested in.


June 8, 2017 

Four Angles We'll Be Watching Today

IT COULD HAVE BEEN WORSE:  There were no bombshells in James Comey's statement yesterday, largely because everything had already been leaked in the Brave New World of leaks and more leaks. And there was something for everyone – President Trump seemingly was vindicated on the issue of whether he is personally under investigation, yet Trump opponents still can make a case for obstruction of justice.

WE'VE READ COUNTLESS ANALYSES  on what constitutes obstruction of justice, but the legal arguments don't matter as much as the political climate in both houses. So we will reiterate – almost daily – that there are not sufficient votes in the House to indict or in the Senate to convict. The likelihood of impeachment is not remotely imminent; if it becomes a serious threat, it would involve action months from now by Robert Mueller, the special prosecutor.

NEVERTHELESS, THIS WILL BE A DRAMATIC DAY,  with all sorts of angles. Here are four we'll be watching:

1. Will Trump tweet?  We're hearing that Trump's attorneys and his inner circle are urging him not to tweet today – a point-by-point refutation of Comey's testimony could be used against the president in a future proceeding, his aides fear. If he tweets today, it will reinforce concerns about his temperament and it will be a sign that Trump listens to no one.

2. What will Republicans say?  This is important. Many leading Republicans were relieved last night that the Comey statement wasn't even more damaging, but in private GOP lawmakers are exasperated with Trump. Paul Ryan, usually a Trump supporter, said last night that "obviously" it was inappropriate to ask Comey to drop the Michael Flynn investigation. Most of Ryan's colleagues agree.

3. How will the markets react?  It depends on which markets. Stocks haven't reacted to this scandal, but the dollar (down) and bonds (up) have. We think stocks will hold up as long as tax reform still looks plausible, regardless of when. As for impeachment, that's not imminent – but if it was, we're convinced that the markets would welcome Mike Pence, who could get Trump's agenda enacted more quickly than Trump could, with far less drama.

4. Wild cards in Q&A:  Since Comey's opening statement is public, the real action will come in Q&A. Some possible wild cards – why was Trump so obsessed with Flynn? Does anyone have anything on tape? Who were the leakers and what were their motives? Has anyone actually seen salacious tapes? Has anyone seen Trump's taxes? The possibilities in Q&A are endless.

LIFE GOES ON:  After today's frenzy, there will be fresh stories to flog – the British election, changing policies from central bankers, the ground war against ISIS, North Korea's missile tests, etc. Trump will focus on his agenda and he may settle into a less bombastic path for the rest of the summer. But make no mistake: there's a growing concern among Trump's nervous allies about his ability to govern.


June 1, 2017 

The Re-emergence of Steve Bannon; Head-Scratcher for the Fed; Joe Biden for President?

BIG WINNER IN POWER STRUGGLE:  When Donald Trump is under siege, he doubles down. He won the presidency in places like Bethlehem, Pa., by preaching the fiercely populist message crafted by adviser Steve Bannon – and not only has Bannon survived amid White House power struggles, he's ascendant once again.

PULLING OUT OF THE PARIS CLIMATE ACCORD, which Congress never ratified and would not ratify today, will outrage the elites, but Trump needs to keep his base intact. The Trump/Bannon argument is simple – climate deals cost jobs, NATO has taken advantage of the U.S., free trade pacts have hurt blue collar America. Of course there's a push-back to all of these arguments, but here's the political calculation that Trump will embrace...

AS LONG AS TWO-THIRDS OF REPUBLICAN VOTERS support Trump (they do), Republicans in the House and Senate will not dare to defect, as they did in 1974, abandoning Richard Nixon during the Watergate scandal. Allegations of obstruction of justice are certain to intensify this month after James Comey testifies to Congress, yet we see virtually no chance that there are enough votes in the House and Senate to oust Trump.

HOW DOES TRUMP SURVIVE AMID NEW LEAKS AND ALLEGATIONS?Republicans in Congress will have to stick with him, and the only way Republicans will stick with Trump is if his base stays loyal. Bannon knows that the Trump base doesn't want Europeans to dictate to the U.S. on climate change; the base wants to revive coal and other industries that Trump has promised to help. It's all about the Electoral College map; all politics is local.

A rate hike is virtually certain on June 14, but suddenly the outlook beyond then looks quite uncertain. Inflation has softened, small business loans have dropped, and uncertainty over economic policies is rising as Washington looks dysfunctional. Janet Yellen's press conference on June 14 will be a must-watch; she will indicate that tapering of the balance sheet is still on schedule for the fourth quarter, but the timing of the next rate hike is very much up in the air.

JOE BIDEN FOR PRESIDENT? At least two dozen Democrats are considering a run for the presidency in 2020, and it sure looks like Joe Biden wants to get a jump on the rest. He held a campaign-style rally in New Hampshire last month, and he will announce the formation of a PAC today. Biden is personable and connects with blue collar workers, but really – Joe Biden, who would be 78 on inauguration day in 2020?

THE CUPBOARD IS BARE: The Democrats' early frontrunner for 2020 may be Bernie Sanders, who would be 79 on the next inauguration day. Elizabeth Warren would be 71. Hillary Clinton would be 73. Donald Trump would be 74, but the Republicans have a fairly deep bench and the Democrats don't. We think Kamala Harris, the new California senator, is someone to watch, but like all the party's young stars, most Americans have never heard of her. So Joe Biden sees one last opportunity...


May 31, 2017 

"Plan B" on Tax Cuts Gains Support

TIME IS RUNNING OUT TO PASS MAJOR LEGISLATION  as Congress eyes a five-week vacation later this summer, so for an Administration desperate for a high-profile victory, "Plan B" on tax reform is gaining support. A bill simply embracing tax cuts – not tax reform – has a chance, as long as a fight over the debt ceiling doesn't grind Washington to a halt later this summer.

FACING THE OBVIOUS: It's becoming clear that sweeping tax reform – killing wasteful tax breaks, replacing them with tax incentives – has encountered the usual obstacle: the details. Everyone wants tax reform, but no one can agree on the particulars, at least not quickly.

BUT SIMPLE TAX CUTS HAVE great appeal among many Republicans who are convinced that 3% GDP growth is achievable despite a growing shortage of workers. They think the economy could kick into a higher gear with three individual brackets of 35%, 25% and 15%, and a top tax on pass-through companies and corporations of 22-to-25% (President Trump's goal of a 15% top corporate tax is dead).

THE ADVANTAGE OF "PLAN B" is obvious – it could be done relatively quickly, by Washington standards. Lower tax rates, perhaps taking effect on Jan. 1, 2018, would be possible, while congressional committees spend most of next year working on thorny reform issues like the Border Adjustment Tax and the deductibility of debt.

THE OTHER ADVANTAGE is that this could give the staggering Trump administration a victory this fall, since an Obamacare replacement bill is on life support. (Actually, we think there was a victory yesterday that was worthy of some boasting – the successful shoot-down of a test missile over the Pacific, an important signal to North Korea. Why Trump isn't tweeting about that is a mystery.)

THE OBSTACLE TO "PLAN B" TAX CUTS is the growing risk of a crippling debt ceiling crisis either before or just after the August recess. The debt ceiling of just under $20 trillion was hit in March, and Treasury may run out emergency options by late summer, posing a risk that the government could default on its debt obligations.

DEFAULT IS UNLIKELY because a deal always materializes, but this will be tricky. Freedom Caucus House members will balk unless there are fresh spending cuts and budget reforms, and Treasury Secretary Steve Mnuchin is insisting on a clean bill. Just as John Boehner had to seek votes from Nancy Pelosi's Democrats, Paul Ryan may have to take a similar path – and you can bet on two things: Pelosi will seek major spending concessions, and the GOP base will howl.

THE DEBT CEILING FIGHT, and a fiscal 2018 budget brawl that could shut down the government when the fiscal year begins on Oct. 1 are two issues the markets will have to monitor. The Federal Reserve surely will, and it might complicate the central bankers' plans to hike rates in September, after the near-certain FOMC move on June 14.

SO EVEN A "PLAN B" package of simple tax cuts could run into obstacles, but it would be vastly easier to pass tax cuts rather than a complex set of reforms, with all the inevitable trade-offs. In any event, “Plan B” could produce a victory for the Trump administration, which faces months of leaks and hearings over the deepening Russia scandal.


May 25, 2017 

Republicans Have a Serious Problem – No Health Compromise in Sight

THE EAGERLY-AWAITED  "score" from the Congressional Budget Office yesterday didn't change much – the House-passed plan would result in 23 million fewer people covered, but it would save $119 billion and might lower premiums. Plenty of talking points for both parties – but not enough to rid the Republicans of a serious political problem.

regrets it – it's an albatross, no one is happy, everyone complains about it. Republicans think health care costs way too much, is inefficient, and gives government far too much power. Democrats think it's inadequate and requires more subsidies; in private they agree that a single payer system is their goal.

SO HOW CAN YOU GET A COMPROMISE? The logical answer is to seek a bipartisan deal, but that's out of the question in this bitterly divided city. There isn't even agreement among Republicans, who are increasingly worried about the 2018 election. They might squeak by in today's rowdy House election in Montana, but Georgia on June 20 is a race to watch; the Democrat leads in recent polls.

REPUBLICANS ARE SO DIVIDED ON HEALTH CARE that they are openly asking whether the Senate will ever find a compromise; Mitch McConnell has his doubts whether any plan can win 50 votes. And even if the Senate passed a bill, it's unlikely that conservatives in the House would accept it. In any event, getting a bill to President Trump's desk could take several more months.

THIS IS AN IRRITANT FOR THE MARKETS because the logical progression – health reform first, a budget deal, then tax reform – is bogged down and could stay bogged down. There's a strong temptation among many Republicans to shelve the health care bill, but it raises revenues that are needed for tax reform. They may have to simply pass a tax bill without the health revenues, while making the tax math work by assuming an economic boom and higher receipts.

ONE THING IS CERTAIN: Voters care about health reform. They may roll their eyes over what they consider "fake news" on Russia, but doctor and hospital bills generate real anxiety. The Republicans know this, yet they're caught in a Catch-22: they proclaim that Obamacare is failing, but they cannot come up with a replacement. And that poses a real risk to the GOP in the next election.


May 24, 2017 

Trump Budget Generates an Avalanche of Criticism – Except from the Markets

IT HAPPENS EVERY YEAR:  All the special interest groups in Washington rip the new budget as cruel and mathematically ignorant, and the press laps it up because simple sound bites make for good copy. But the verdict we focus on is from the markets – which yawned, as usual, at this latest budget controversy.

FOR NEARLY TWO DECADES, deficit Cassandras have warned that red ink would drive interest rates and inflation much higher – but that simply hasn't happened. Even with a tightening labor market and a national debt that exceeds $20 trillion, the Treasury 10-year bond yield is stuck at around 2-1/4 percent.

THE MAJOR REASON, IN OUR OPINION, is the insatiable demand – globally and domestically – for Treasury debt. We often encounter deficit hawks who claim that China, the largest external holder of U.S. debt, might suddenly stop buying Treasury paper – but why would China exit the largest and most stable debt market in the world, especially since the value of their own holdings would decrease if markets sensed a change in global demand?

SO FIRST AND FOREMOST, investors seem to view the U.S. debt market as the best house in a bad neighborhood, as long as American deficits are within normal parameters. And this year's U.S. red ink, which probably will be around $550 billion, should be just under 3% of GDP – traditionally a level the markets have easily lived with.

that similar deficits for the next couple of years will be an issue for the bond market, and that's important – voters need to see something bad, like significantly higher mortgage costs, before they will support harsh new spending reductions. So there's no catalyst from the markets to reduce deficits – the markets are fat and happy – and there's no catalyst from voters, who see no obvious manifestation of high deficits in their everyday lives.

OF COURSE, THERE'S A PUSH-BACK TO THIS COMPLACENCY: High deficits crowd out tax cuts or spending for more worthwhile causes than debt servicing costs, we get that. But in this city, high deficits not only have been accepted – but they they help each party with their narratives: the Democrats want to tax the wealthy (hardly a windfall of revenues there), while the Republicans want to fundamentally change the role of government spending.

THE AVALANCHE OF CRITICISM THIS WEEK: No one was happy – members of Congress from farm states are outraged over proposed agricultural cuts. Advocates of food stamps and other anti-poverty programs are enraged. John McCain and other defense hawks think a 10% Pentagon increase is stingy. And so on, it's a Washington tradition.

THE TOP BUDGET EXPERTS ON WALL STREET were nearly universal in their ridicule of the Trump budget math, and we agree – it doesn't seem to add up. But these experts surely know that the budget will be re-written from scratch by Congress, which will reject the hard right proposals from budget director Mick Mulvaney; even he expects a re-write.

SO THE KEY COMMITTEES WILL BEGIN WORK on a budget that will soften the rough edges; many Republicans, fearful of the 2018 election, will compromise with Democrats on spending levels. (Besides, they know if there's a stalemate, a continuing resolution when the new fiscal year starts on Oct. 1 would be an acceptable fall-back.) None of this in-fighting should upset investors, although we close with the one factor that could begin to worry the markets...

THE REAL SAVINGS won't come from food stamps or rosy scenarios – the real savings will come from Social Security and Medicare. Anyone who studies the budget knows that's where reforms eventually will become crucial. Trump won't go there – he has promised not to – and most politicians agree that major cuts to these two huge programs would be politically radioactive.

OUR BELIEF THAT THE MARKETS CAN LIVE with high deficits will be severely tested in the coming decade as Social Security and Medicare approach bankruptcy. But that's not an imminent challenge; the politicians and the markets only focus on the next few months, of course.


May 23, 2017 

Tax Reform – Some Movement, Finally

FAR FROM THE GRUESOME TERRORISM  in Manchester, life goes on. So we will focus today on tax reform, which is finally moving in Congress – a positive sign for financial markets, which are counting on a bill by next spring if not sooner. That timetable is still on track.

No one ever thought this would be easy, since there are two enormous differences that divide Republicans (the Democrats, who will unanimously oppose the Trump tax cuts, aren't the key factor – Republicans are). Their two major differences are on display this week:

1. The Border Adjustment Tax: Paul Ryan, who has waited for his entire career to pass a massive tax reform bill, is determined to include a 20% border adjustment tax (BAT) on imported goods. This is hotly opposed by firms like Target and Wal-Mart, and has only modest support among Republicans, many of whom consider it a de facto tax increase.

We think House Ways and Means Committee Chairman Kevin Brady, a Ryan ally, will pass a bill in his committee this summer that will include a BAT, which will not prevail in the Senate. But the key is getting a bill moving, and if nothing else, Ryan will get an airing for a BAT – and he just might win a much smaller, phased-in provision.

2. How to Pay for the Bill: 
This also divides Republicans. Ryan and fiscal conservatives are uneasy about assuming a huge revenue surge that would be generated by a GDP growth rate of close to 3%. Supply-siders respond: let’s go for it. "Economic growth is the mother of all pay-fors," Larry Kudlow says, and he's right.

Will rosy revenue scenarios pass muster with the Senate parliamentarian? Maybe not – but she could get overridden by Senate President Mike Pence. Plus there's always the option of simply passing a bill that loses tons of money – which, under terms of budget reconciliation rules, would "sunset" the tax cuts in ten years. So this Congress might take a gamble that the tax cuts would be re-authorized them.

THE TIMETABLE: Brady will begin markup of a tax reform bill when Congress returns on June 6 from the Memorial Day recess. He could have a bill finished in July, and passage by the full House is possible by the August recess or in September.

The Senate will move slowly this fall – hamstrung by health reform, the debt ceiling and other budget issues – and may not pass its bill until late this year. But we still think a House-Senate conference committee can finish a bill by early spring; an effective date of April 1, 2018 is possible. That would boost the economy, of course, heading into the mid-term elections.

A top rate for corporations and "pass through" companies in the low-20s. Repatriation of corporate profits stashed abroad, probably taxed at 7% or 8%. Immediate expensing. Three basic individual rates – 10%, 25% and 35% or 36%. A cap on deductions. Reform or abolition of the estate tax. Death of the hated Alternative Minimum tax. A dramatically higher standard deduction, which would make many tax breaks less attractive.

THIS IS TREMENDOUSLY EXCITING STUFF, likely to increase GDP growth to 2-1/2% and drive unemployment below 4% (yes, interest rates would rise, but to a level the markets could live with). Despite all the dysfunction and the Russian scandal, tax reform is do-able. Every journey of a thousand miles begins with a single step – and the tax reform journey has begun.


May 22, 2017 

An Epic Battle Over Fiscal Policy Begins This Week

DONALD TRUMP WILL BE MAKING HEADLINES IN ISRAEL  today and tomorrow, but there will be plenty of news in Washington, as his OMB director unveils the most ambitious budget since Ronald Reagan's days. Our major take-away: Trump can boast that he has produced a balanced budget with huge tax cuts, but he doesn't have the political clout in Congress to get all that he wants, not to mention the deep spending cuts that will be dead on arrival.

BUT WHAT A FIGHT THIS WILL BE:  This will divert attention away from the Russian story, as special counsel Robert Mueller digs methodically for more evidence. And make no mistake, this is will be an epic fiscal policy showdown that highlights a fundamental issue: concentrating spending power in Washington versus the states.  And it will pit the House, which is dominated by conservatives, against the Senate, which is dominated by moderates and liberals.

TRUMP'S BUDGET DIRECTOR, TEA PARTY CONSERVATIVE Mick Mulvaney, will roll out the budget tomorrow -- just a day before the Congressional Budget Office "score" of the House Obamacare replacement bill. Some highlights of the new budget:

A balanced budget within 10 years. You can get there by assuming low interest rates and 3% GDP growth, but the main flaw in that goal is becoming obvious -- not enough workers, as state after state reports unemployment rates of close to 3%.

Huge cuts in discretionary spending. This is the centerpiece of the spending proposal -- cuts of nearly $1 trillion over ten years in Medicaid, food stamps and other anti-poverty programs, with the states doing the heavy lifting. This will hit a brick wall in the Senate and Trump will get the worst of both worlds: scathing criticism from the left for these spending cuts, and the inability to get most of them enacted.

A renewed focus on "able-bodied" recipients of assistance. Trump's proposal to shift these programs to the states hinges on them rejecting aid for some recipients who are unwilling to work.  This gives Trump an issue to exploit with conservatives, but the left will focus on cuts to programs like school lunches and Habitat for Humanity.

Nothing, yet, to curb Social Security or Medicare. This is where the real money is, but neither party wants to go after these programs; even a modest change in the CPI component of the Cost of Living Adjustment is considered politically radioactive. A pity on the future president who eventually will have to take a meat ax to Social Security and Medicare in a few years.

Roughly 10% hike in defense spending. Democrats will go along, because this means jobs back home, and it gives them an opening to seek hikes in domestic spending as well. And the Trump budget will seek $200 billion for infrastructure, which Democrats may accept.

OUR BOTTOM LINE: Trump's foreign trip is off to a good start -- excellent photo ops, good speeches -- but the focus in this city will shift dramatically next week when James Comey testifies before Congress. As for Mueller, he may take a year to finish his work, and during that process it's difficult to envision Trump getting his way on his budget; Senate Republicans will be a major obstacle.

MARKET IMPACT: We still think a tax cut is likely next year, but the "scoring" will be a problem for Trump. Even using very rosy assumptions, his bill would lose trillions of dollars in the next ten years, so we have a hunch the tax bill will have to be scaled back. As for the spending cuts, there's no question Trump's proposals will be watered down. So if spending cuts are not realized and tax cuts aren't fully paid for, the major implication is obvious:  significantly higher deficits.


May 19, 2017 

What Trump Will Leave Behind

A CITY REELING, WITH UNCERTAINTY GROWING:  First of all, we highly recommend Peggy Noonan's weekend column, already posted on the Wall Street Journal web site, www.wsj.com. Her style is typically dramatic, but the substance is spot-on; if you want insight on what Donald Trump has wrought, start with Peggy's piece this morning.

EVERYONE HERE NEEDS A TIME-OUT, but there's the potential for more controversy in the week ahead as Trump visits key allies with plenty of uncertainties: how will he navigate a Saudi arms deal, his harsh criticism of NATO, the cooling U.S. relations with Israel, the simmering American antipathy toward Iran, etc. "He can't afford to screw up – there's little margin for error," a GOP Hill staffer told us yesterday.

TRUMP'S BELEAGUERED STAFF, bracing for a shake-up after the trip ends, will also have to focus on what's happening in Washington, where his departure won't mean a quiet week here. Early in the coming week, the Congressional Budget Office will issue its "score" of the House Obamacare replacement bill, which is likely to be a public relations disaster for Republicans, further jeopardizing passage any health bill. That, of course, would greatly complicate efforts to enact tax reform.

With Trump gone, he will leave the heavy lifting on the fiscal 2018 budget to OMB Chief Mick Mulvaney, who will get intense push-back (even from Republicans) on huge spending cuts for domestic spending programs – while both parties will scoff at economic assumptions of GDP growth of 3% or better – with virtually no increase in assumed interest rates. If ever a budget was dead on arrival, it will be next week's proposal from the White House.

THE STORY THAT WON'T DIE: Just because Trump will be abroad, that no longer is a reason to pipe down on criticism of the president; that tradition ended in the past decade. So the deepening criminal probe of Russian ties to the Trump inner circle will continue to intensify; former FBI director James Comey probably will testify during Trump's trip, which will dominate the news.

THE ONE STORY THAT MAY FADE, at least temporarily, is that impeachment is somehow imminent. It isn't. Even Democrats are urging a measured pace – they know that Robert Mueller's probe will take many months, and they are content to let Republicans squirm as the leaks continue. Comey and his allies seem to be leaking to the New York Times almost daily.

SO – WHAT DOES ALL OF THIS MEAN FOR INVESTORS? The Trump agenda has stalled, which is largely why the markets sold off this week. The dysfunction in this city is so intense that the idea of passing a tax reform bill this year is delusional, despite what Paul Ryan says. Tax reform can still pass next year (or later), but for now the fiscal policy outlook is a huge uncertainty for Wall Street.

THIS RAISES AN INTRIGUING MARKET ANGLE: How aggressive can Janet Yellen be in the face of fiscal policy uncertainty? A rate hike on June 14 is virtually certain, but she could hint in her press conference that additional moves in the second half will depend on whether there's any clarity on policy. With a tapering of the Fed's balance sheet still likely to begin in the fourth quarter, the pace of rate hikes could slow.

in times of uncertainty, and if anything is clear after the stunning last 10 days, uncertainty will persist – whether Trump is abroad or in Washington. Meanwhile, the long-shot drumbeat for Mike Pence will persist.


May 18, 2017 

Time to Look at Mike Pence, the Anti-Trump

WE GOT SEVERAL EMAILS YESTERDAY  from readers who wanted to follow up on our assertion that the markets would gladly live with Mike Pence as President. To reiterate: we don't think there are enough votes in the House to impeach Donald Trump, or in the Senate to convict -- but in this climate of a bombshell every day, it's not 100% certain that Trump will survive. So let's take a look at Michael Richard Pence . . .
THE ANTI-TRUMP: Pence, 57, is a devoutly religious born-again Christian, a former altar boy, unabashedly monogamous, well-liked among colleagues, not given to boasting or profanity.  In other words, the polar opposite of Donald J. Trump. 
A TRADITIONAL REPUBLICAN: For Wall Street, what's not to like? Pence is an unapologetic free-trader, reliably pro-business, a former budget-cutting governor (in the mold of his predecessor, Mitch Daniels), and a tax-cutter. He's also a fierce social conservative; his positions on abortion, gays and education are adamantly opposed by Democrats. But in the Republican base, Pence checks all the boxes (unlike Trump).
A FEARLESS FORECAST: Pence is so comfortable on Capitol Hill (he served 12 years in the House) that he would be able to get Trump's agenda enacted more easily than Trump would be able to get the agenda enacted. Pence is close to Paul Ryan and Reince Priebus, and is comfortable with Senate Republicans as well. Even Democrats, who loathe his positions on social issues, have generally positive things to say about the man and his trustworthiness.Bottom line: he could get things done. 
PENCE IS HUMAN and he must find it distasteful to defend Trump (he was harshly critical last fall after a tape surfaced showing Trump bragging about molesting women). Pence surely must have private moments in which he senses an opening if Trump cannot recover from his disastrous first four months. Pence has considered running for president in the past, and he must think that Trump, nearly 71, is not the picture of robust health and may only serve for one term (if that). 
SO IT'S TIME TO START THINKING about what Pence might be like as president. Our take is that Pence is a solid, boring, no-drama Midwesterner who is in total sync with Republican Party ideology. Incredibly, that is precisely the description of Gerald Ford, who took office in 1974 after Richard Nixon resigned.


May 17, 2017 

Trump Has the Votes to Survive Impeachment – For Now

OBSTRUCTION OF JUSTICE  could be an impeachable offense, but the allegations against Donald Trump are not legal issues per se; rather it's all about the number of votes he can muster in the House and Senate – where, we believe, he has enough support to prevail. But after yesterday's bombshells – with hints of more to come – it's not 100% certain that Trump will survive.

THIS STUNNING TURN OF EVENTS,  which has rocked Washington and demoralized Republicans, now pits a badly wounded president against the man he mocked as a "showboater." Former FBI Director James Comey has more memos to reveal, his colleagues report, which could deepen this crisis.

A GREAT IRONY IS THAT TRUMP  – who demands loyalty from his subordinates – does not give it in return, and a growing cast of Republicans may not be willing to fight for him. Do Paul Ryan, Mitch McConnell – or Mike Pence, for that matter – have any great loyalty for the president?

SO WE NOW HEAD INTO MURKY WATERS,  with subpoenas and hearings and more bombshells from anonymous leakers. Can Trump hang on? Here's the math: A simple majority – 218 votes in the House – would be required to impeach; the Republicans have 238 seats, with four vacancies. To convict, it would take a two-thirds vote in the Senate, a very high bar to clear, since the Republicans have 52 seats.

AS OF THIS MORNING, WE THINK TRUMP CAN HANG ON,  but who knows what comes next? Would a successful international trip next week help him? Possibly. Would a major White House staff reorganization make much of a difference? Nope. A speech to the nation? Maybe.

MONTHS OF TRENCH WARFARE – WHAT ARE THE IMPLICATIONS?  On the domestic front, we still expect the beginnings of movement on a tax reform bill, but other issues will have to come first: the debt ceiling and the fiscal 2018 budget fight, plus the Senate's re-write of the House Obamacare replacement bill, which actually is advancing. With the White House transfixed by bigger issues, there may be minimal legislative interference from Trump aides, which might be a good thing.   

ON THE INTERNATIONAL FRONT,  the specter of a crippled American president can't be positive. In an effort to save his presidency, Trump could become unpredictable – there's nothing like a foreign adventure to divert attention. In this kind of a climate, the dollar could lose some of its recent luster.

WE'VE BEEN THINKING FOR THE PAST COUPLE OF DAYS  about Vice President Pence, who could become a pivotal player if this crisis deepens. Is Pence fit to be president? Compared to Trump, absolutely. Pence would provide some stability and predictability – no drama. He's very conservative on social issues, so Democrats will fight with him, but on economic policies the markets could easily live with Pence's pro-business, pro-tax cut agenda.

BOTTOM LINE:  Everyone, including us, has proclaimed that the economic fundamentals are so good that the markets can withstand a political crisis. But an impeachment fight is another story – it would be demoralizing, not good for consumer confidence, and an enormous source of uncertainty for investors, who hate uncertainty.

FOR NOW  we'll say that Trump has a 70% chance of surviving – assuming, of course, there are no fresh bombshells or self-inflicted wounds. And, really – what are the chances that there won't be any more fresh bombshells or self-inflicted wounds?  This is a deadly serious crisis.


May 16, 2017 

Signs of Life on Taxes and Health Reform – But Still Another Controversy Grips Washington

DONALD TRUMP VERSUS THE INTELLIGENCE COMMUNITY:  Washington is buzzing this morning about who leaked to the Washington Post and other news outlets about what President Trump allegedly told Russian envoys last week. This bombshell almost certainly comes from career U.S. intelligence officials, who are in a blood feud with Trump, who has mocked and marginalized them.

DID TRUMP EXPOSE U.S. ASSETS? The Post article was shocking – but was it true? White House advisers pushed back immediately, so here's another story that will be clouded by the fog of claims and counterclaims that have gripped this administration. Who knows, precisely, what Trump told the Russians? The journalist Bob Woodward invented a new form of reporting – creating quotes that summarize what people are thinking and saying, even though those quotes are not verbatim. 

WHILE THE PRECISE WORDS MAY BE DEBATABLE, there's little doubt that White House officials scrambled to notify the CIA and the NSA immediately after the Russian meeting, telling them that agents and other assets may have been compromised. The reverberations from this will persist for many months – still another distraction that will take another two or three points off Trump's job approval rating.

THE POST BOMBSHELL elicited a telling response from Republicans – Trump's supporters cried "fake news," but within the Beltway, GOP lawmakers seemed willing to accept the worst. "The president is in a downward spiral," said highly regarded Sen. Bob Corker. The operative word on Capitol Hill this morning, from both parties, is "chaos" – and it seems that Republicans, who reluctantly backed Trump's firing of James Comey, are distancing themselves from the embattled president.

IRONICALLY, THIS WILL OBSCURE SOME PROGRESS ON TAX AND HEALTH REFORM: A bipartisan group of Senators has been making progress on a health reform compromise, which could be on the floor by summer. And tax reform is stirring – finally.

TRUMP'S ECONOMIC OFFICIALS – who have largely avoided the dysfunction that has gripped most of the White House – will travel to Capitol Hill today to meet with moderate Republican members of the so-called "Tuesday group." They will discuss tax reform ideas, and the first public hearing in this long process is scheduled for Thursday in the Ways and Means Committee.

A POSITIVE THOUGHT: Obviously the Russian allegations, if true, are a shocking breach of security. The resulting furor will allow negotiations on health and taxes to proceed in virtual anonymity. Washington will not obsess over the Border Adjustment Tax or the top corporate tax rate – there are bigger fish to fry.


May 15, 2017 

What Could Derail the Markets? Probably Nothing

IT'S NOT A PRETTY PICTURE:  An angry president, weighing mass firings, changing his narratives, embarrassing his vice president, inviting subpoenas from emboldened Democrats over potential tape recordings. It's a dysfunctional climate to be sure, but will this affect the markets? For now, probably no.

WE HAVE REITERATED FOR MONTHS  that the fundamentals are quite good: an accelerating economy, a tightening labor market, modest inflation, solid corporate earnings, and a Federal Reserve that won't overdo the rate hikes.And the big policy story is positive – a takeover by the pro-business Goldman Sachs faction in the White House.

SO WHAT COULD SEND THE MARKETS INTO A TAILSPIN?  Mass firings are probably coming soon, but that's background noise – just like President Trump's over-the-top tweets. The Democrats smell blood, but there are only two domestic scenarios that could upset the markets: clear proof of collusion between Russia and Trump aides, which would drive Republicans away from Trump and his agenda; or a sign that tax reform is dead. We aren't there yet on either threat (and we're not close to a serious impeachment threat).

COULD THERE BE A GEOPOLITICAL THREAT?  The biggest global story, in our opinion, is an upbeat one – economic growth is rebounding. The cover page on this weekend's Barrons proclaimed "Buy Europe." We agree – the radical threat to the EU and the Euro may have peaked, and economies on the Continent appear poised to grow by about 2% this year.

PLENTY TO WORRY ABOUT  – North Korea is getting closer to having an ICBM that could get close to Hawaii, with a scary payload; a U.S. pre-emptive strike is still on the table. And cybersecurity finally has emerged as serious threat (and an opportunity for companies such as Intercede, Inside Secure and F-Secure). Markets will have to worry about these issues, but they won't significantly affect interest rates or earnings.

THE ONE WILD CARD THAT MAKES US NERVOUS  in this otherwise positive climate is, of course, Trump himself. Sources describe him as seething at enemies real and imagined, eager to fire, inattentive to his agenda, and prone to self-inflicted wounds. Could the markets eventually conclude that Trump's agenda is dead? Not yet – GOP congressional leaders will push ahead on tax reform and other issues, but it's not easy for them in this environment, with public opinion turning sharply against the party and the president.

TIMING IS EVERYTHING:  For anyone wondering when (or whether) we might throw in the towel on Trump’s tax cuts, that wouldn’t come until fall, if at all. Tax reform will rev up in the next few weeks, with a bill starting to move in the House. 


May 12, 2017 

Key Tax Issue May be Resolved; An Encouraging Trade Deal With China; June Rate Hike Virtually Certain

AMID THE MEDIA FRENZY  in Washington over the Comey firing and the contradictory White House explanations, it was easy to overlook this week's Donald Trump interview in the Economist magazine. He offered major clues on tax reform...
First, the President affirmed that the bill will lose revenues, apparently resolving a key question – will the measure be paid for? Nope, it will not be "revenue neutral." This will put supply siders like Treasury Secretary Steven Mnuchin and deficit hawks like House Speaker Paul Ryan on a collision course.
Second, Trump was quite candid about his support for "priming the pump," a phrase he claimed credit for inventing. Of course, it's a classic Keynesian mantra for tax and spending policies that temporarily raise deficits in exchange for boosting economic growth. It makes sense when the economy is slumping, but U.S. growth seems to be on an upward trajectory already.
CALM BEFORE THE STORM: This year's red ink is projected by the Congressional Budget Office at $559 billion, although April tax receipts were strong and the deficit forecast may be revised slightly downward. There's no question, however, that surging entitlement outlays and a lack of any spending discipline will send deficits higher within the next two or three years.
FOR NOW, VIRTUALLY NO ONE IN WASHINGTON – including Trump – seems to care about deficits; with the stock and bond markets fat and happy, politicians see no reason to jeopardize their careers by slashing entitlement growth. A decade from now, net borrowing costs may exceed all non-defense domestic outlays, but that isn't an immediate concern – the deficit has disappeared from Washington's radar. 
GOOD NEWS ON TRADE: Trump has some hard-liners on trade in his inner circle, but we worry less about protectionism than a few months ago. First, the Goldman Sachs/Wall Street faction that dominates White House economic policies won't tolerate trade wars, because they know that could rattle the markets. Second, there's a desire for specific deals, as yesterday's agreement with China illustrates.
SOME REAL PROGRESS: Something must have been in the water in Mar-a-Lago when Trump met with Chinese President Xi. The two leaders set the stage for yesterday's deal, which increases U.S. exports of everything from beef to natural gas. Other clear winners include genetically modified U.S. seed companies and U.S. electronic payment firms such as Visa and Mastercard. U.S.-China relations "are hitting a new high," Commerce Secretary Wilbur Ross said.
FED RATE HIKE ALL BUT CERTAIN: Yesterday's Producer Price Index report raised eyebrows – a headline increase in April of 0.5% and a rise in core inflation of 0.7%. With inflation percolating and the labor market close to full employment,  the Federal Reserve is clearly behind the curve.  
THE CENTRAL BANKERS undoubtedly have concerns about fiscal policy uncertainty, but they have to send a signal at the June 13-14 FOMC meeting – we'll get a rate hike, plus a statement that telegraphs another one or two more moves in the second half as the Fed scrambles to keep inflation contained.


May 11, 2017 

Biggest Problem for Congress: Time is Running Out

INCREDIBLY, CONGRESS WILL BE IN SESSION  for only about 50 more days this year, not nearly enough time to tackle its huge agenda. The vacation-happy lawmakers will have to prioritize, because there's no way they can address everything on their – or Donald Trump's – agenda. Here's our take:

Russia and more Russia:  James Comey will go public soon, and Chuck Schumer thinks he has an issue that will return the Democrats to power (we're not convinced). So Schumer has begun a work slowdown that apparently will continue until a special prosecutor – or some type of independent panel – is appointed. Schumer wants Congress to grind to a halt, and that's not difficult to do.

Budget issues:  None of the 12 appropriations bills for fiscal 2018 are close to passage, and they will require weeks of markups and debate before an inevitable continuing resolution as the fiscal year ends on Sept. 30. In the meantime, an enormous issue looms when Congress returns from its five-week August break: the debt ceiling has to be raised,  and there aren't remotely enough Republican votes in the House to do that.

Obamacare reform:  The Senate will re-write the House bill from scratch – but there's no consensus among GOP lawmakers. Perhaps they'll finish by the August break, setting the stage for lengthy conference committee deliberations this fall. Health reform will continue to suck up an enormous amount of time, with a decreasing likelihood that it will win public support.

Tax cuts:  We still think the House will begin moving soon on a reform bill – a development that would be most welcome in the financial markets. But there are so many contentious issues – the bill's cost, a Border Adjustment Tax, curbs on deductions, etc. – that it would be quite an accomplishment for the House to produce a bill by August. Then the glacial Senate could take most of the fall to pass tax reform, and a final deal may not come until 2018. Could tax reform die? Not out of the question, but we still anticipate a bill.

Dodd Frank:  There are lots of proposals that could win passage of a bill in the House, but abolition of Dodd-Frank would require 60 votes in the Senate to break a filibuster, and that's not going to happen.

Supreme Court:  We keep hearing that Anthony Kennedy, who turns 81 this summer, would like to retire this year. And Ruth Bader Ginsburg, 84, is not in good health. Confirmation hearings would gobble up an enormous amount of time in the Senate.

BOTTOM LINE:  We don't see any big victories for Trump this summer (in fact, he lost a Senate vote yesterday on rolling back methane regs). Something will have to fill the legislative vacuum, and we suspect Russia and other geopolitical issues will dominate. The markets can live with a plodding Congress – just as long as the tax reform process is alive, and it is.


May 10, 2017 

The Comey Firing – and the Impact on the Markets

OVERVIEW:  Washington is abuzz this morning with speculation about the real reasons for James Comey's firing, the possibility of appointing a special prosecutor – and, seriously, the potential for impeachment. This a political earthquake, and the aftershocks will persist for the rest of Trump's presidency.

The argument among career FBI and Justice Department officials is that Comey was out of control, violating protocol, and was so imperious that the Russian investigation was all about him. Highly respected Rod Rosenstein, the Deputy Attorney General, made a powerful case that Comey's erratic behavior warranted his dismissal.

THE OTHER NARRATIVE involves timing – Trump sensed that Comey was closing in on Michael Flynn, Paul Manafort, Carter Page and others (perhaps even including Trump) and that removing Comey would stall the investigation. That's the Chuck Schumer narrative, which the Democrats will flog relentlessly. They will make this all about Trump, noting that Comey recently implied that Trump himself was under investigation (which may have sealed Comey's fate).

WHAT HAPPENS NEXT? Three things to watch: Who does Trump nominate to head the FBI? Picking a political ally like Rudy Giuliani or Chris Christie would simply inflame this crisis. Second, will Rosenstein appoint a special prosecutor? Probably – and that will guarantee a deepening probe that would be far more than just a distraction for the White House. Third, how will Republicans react – will they start to abandon Trump? Several appeared to last night.

WHAT DOES THIS MEAN FOR THE MARKETS? Trump's agenda already had stalled; now there's the likelihood that issues like tax reform will get crowded out by this political crisis. Key congressional committees will begin marking up a tax bill, but there will be little appetite for working with the White House. Make no mistake – tax reform is dead for this year. But the fundamentals – moderate GDP growth, low inflation, low interest rates, good corporate earnings – will persist.

BOTTOM LINE: We think impeachment talk is grossly premature – even if there was evidence that Trump himself had contacts with the Russians, we would not bet that two-thirds of the Senate would convict him; "high crimes and misdemeanors" is a mighty tall bar to clear. But there's one analogy to Watergate that's inescapable: there's the smell of blood in the water, as the press scrambles for the next bombshell and Trump's political allies abandon him. The specter of a presidency in trouble is not a good story for the markets – or the country.


May 9, 2017 

Could a Wave Election Sweep Republicans Out Next Year?

WE'RE NOT READY  to join the Washington bandwagon that is clearly rooting for a "wave" election in 2018 that could give Democrats control of the House. It's way too premature to make that call, 18 months ahead of the election, just because angry constituents are disrupting town hall meetings over a health reform bill that will be entirely re-written in the Senate.

BUT 2018 HAS BECOME A TOUGHER CALL since the House Obamacare replacement vote and the "spike the ball" celebration among the mostly white men who passed a deeply flawed bill that they hadn't even read. The ultimate question is whether this is sufficient to flip 24 House seats to the Democrats, giving them control.

WHY IT'S STILL AN UPHILL FIGHT: The House districts are drawn (or gerrymandered) in a manner that will make winning 24 net seats a daunting task. There simply aren't that many competitive seats where Republicans look vulnerable – maybe 30 at the most – which means they would have to lose virtually all of them for the Democrats to gain control. Plus, 18 months is a lifetime in politics – if the economy is humming by election day, that would make all the difference.

WHY DEMOCRATS HAVE A CHANCE: They have a motivated base, plenty of money and energetic new candidates with little baggage. And suddenly many races have tightened – veteran political guru Charlie Cook has moved his ratings for 20 Republicans, shifting them to tossup, or just leaning Republican, or just likely Republican. But even his changes, after the emotional health care vote, are not sufficient to predict a House takeover.

OUR BOTTOM LINE: You have to respect history – first-term presidents usually fare poorly in their initial mid-term election, and Trump's job approval rating is dismal. Yet his base is rock-solid, and some of the Democrats' key constituencies don't turn out in large numbers in mid-term elections. So for now, we'll predict a net pickup for the Democrats of about 15 seats, with the potential to go a little higher, but not hitting the magic number of 24.

in all likelihood, because of the stunning breakdown of seats that are up for re-election: of the 33 seats in play, 25 are held by Democrats. Of those 25, ten are in states that Trump won last fall. Of the ten, five are in states that Trump won in a landslide. We still think the GOP will add seats in the Senate, maybe two or three, to their total of 52.

HOW THIS AFFECTS THE LEGISLATIVE DYNAMICS: It makes life difficult for the Republican leadership, which has to deal with Freedom Caucus hard-liners who are in safe districts. More moderate Republicans will face tough challenges in the election, so they will distance themselves from the right wing and Trump – they'll write their own tax and health bills, which may only widen the fissures within the party, jeopardizing the Trump agenda.

THE BIG MO: Politics often gets swept up into a momentum story, and there's no question that Republicans have lost momentum; they are stunned by the town hall meetings, and at least a dozen GOP House members reportedly are mulling retirement. But the big political issues in May of 2017 may not be the big political issues in May of 2018 – and the "wave" scenario, which is embraced by the Trump-hating Washington establishment – still strikes us as premature. 


May 8, 2017 

The Interest Rate Inflection Point

RARELY DO THREE EVENTS CONVERGE  as dramatically as in the past four days, all pointing to the same market impact – significantly higher interest rates. On April 19 we wrote about the "interest rate fake-out" when the 10-year Treasury yield fell below 2.2%; today we reiterate: rates are headed higher, for the following three reasons:

1. The economy is re-accelerating: The jobless rate is now below the Federal Reserve's definition of full employment as still another fluky first quarter slump ends. GDP growth of 2-1/2% or better for the rest of the year seems likely; this quarter seems poised to grow by 3%. The recession fears of just a month ago are gone, a rate hike is certain next month – and now the debate is whether the Fed will need to raise rates once or twice more in the second half.

2. The safe-haven play is over: The European Union, for all its flaws, has prevailed and the center has held throughout most of Europe, where economic growth is accelerating. This will lead to tighter monetary policy from the European Central Bank. With the exception of North Korea, there don't seem to be any urgent "safe haven" plays in the world – still another reason why interest rates are headed higher.

3. The Trump spending boom: Last week's budget deal showed no fiscal restraint, and new calls for austerity from the White House have been shot down on Capitol Hill – by both parties. The massive tax cut legislation is still very much alive; Republicans will write their own tax bill, just as they are writing their own health reform measure in the Senate – no need for much White House input, thank you.

BE CAREFUL WHAT YOU WISH FOR: The mantra from politicians everywhere has been to seek higher economic growth and more jobs; thanks to stunningly accommodative monetary policy, that goal is within reach. A major implication is that the labor market will get so tight that a bidding war for skilled labor, already underway, will intensify – with a resulting spike in compensation costs.

BOTTOM LINE: There will be plenty of diversions in the coming days – endless ranting on health reform, new disclosures on Russia's involvement in last fall's campaign, and an uproar over the Kushner family's Chinese visa scheme. But financial markets have something more important to deal with – a dramatic inflection point on interest rates. We think the Treasury 10-year yield will be at 2.5% by summer and perhaps close to 2.75% by Labor Day.


May 5, 2017 

Five Quick Points on Health Vote; Why We Don't Worry About the French Election; Jobs Report Today

YESTERDAY'S DRAMATIC HOUSE VOTE  has several major implications. Our quick take on the five major points:

1. The key was simply getting something – anything – passed. The Senate probably will pass a bill this summer that doesn't look remotely like the measure the House agreed to. The goal, quite simply, is to get a bill to a conference committee later this year – that's when the real dealing will begin.

2. Can a House-Senate deal ultimately pass in both houses? Assuming the conference committee can produce an agreement, would the full House and Senate then agree to their product? Not out of the question, but unlikely.The most probable scenario is that a relatively moderate conference committee bill would be unacceptable to the House Freedom Caucus, sending this maddening process back to the drawing board late this year.

3. The Congressional score is important: Within a few days the Congressional Budget Office will assert that the House-passed bill would throw millions of people off health coverage, and that the measure would cost billions of dollars. This could make a difference in the Senate, where at least a dozen Republicans would never agree to anything close to the the House version. 

4. Don't bet against Donald Trump: Sure, he's weak on the details but Trump is astonishingly persistent. He made life miserable for Paul Ryan and House GOP leaders – he demanded that they produce a bill, and then he got personally involved in the arm-twisting. Bet against Trump at your own peril.

5. Here is our major takeaway – This bodes well for tax reform. In just this week alone, Congress has agreed to a massive spending bill to keep the government open, and the House has voted for a health bill that – despite its many flaws – moves the process forward. The House will pass tax reform, probably by fall. The Senate will pass tax reform, probably by winter. It's way, way premature to write off tax reform; it can pass next year.

First of all, it's highly likely that establishment moderate Emmanuel Macron will win Sunday's election. But even if Macron loses in an epic upset, Marine Le Pen has virtually no chance to pull France out of the European Union – she has so few seats in Parliament that her victory would result in no policy changes. A win-win scenario for opponents of Frexit.

JOBS REPORT TODAY: At what point will it become clear that the U.S. has full employment? Perhaps today, if the jobless rate falls below 4.5%. In any event, it would take an awfully weak report to dissuade the Fed from hiking rates at the June 13-14 FOMC meeting. Consensus is for a nonfarm payroll jump of about 180,000; anything close to that would give the Fed an open path to a rate hike next month.


May 4, 2017

And They're Off – Democrats Are Running; Here's Our Top Ten List

TODAY'S BIG STORY IN WASHINGTON  will be the House Obamacare replacement vote. Even though there's no official scoring on the cost – or the impact – of the bill, Republicans are on the verge of a very important win. But there's little enthusiasm in the Senate, which may not consider a health bill until July.

BENEATH THE SURFACE, there's another story that has suddenly heated up: several Democrats have put out feelers to fundraisers and party leaders – they're seriously thinking about running for the presidency in 2020. Every visit to Iowa or New Hampshire will be scrutinized, so let's join in the fun with our first (and earliest) Top Ten list...

10. Oprah Winfrey: She's worth $3 billion and has an enormous following. Everyone asks us whether a true outsider like her or Jeff Bezos (worth an astonishing $80 billion) might run. Can't rule it out – but Donald Trump has proved that having no experience has its downsides.

9. Martin O'Malley: He's running and probably will be the first to announce. He's has a reservoir of goodwill in the party but he's boring – a plausible vice presidential nominee, at best.

8. Someone from New York: Bright and personable, Kirsten Gillebrand has been the insiders' favorite for nearly a decade; it's time for the New York senator to make a move – yet she appears to be reluctant to run. Gov. Andrew Cuomo is starting to look like his father – always the bridesmaid but never the bride – but he could raise a ton of money.

7. Joe Biden or Hillary Clinton: We have to put them on the list, but...Despite the warm feelings toward Biden within the party, we think he's among the most overrated politicians in America, a windbag who has no new ideas. Clinton is unelectable, period.

6. Someone from Minnesota: Amy Klobuchar isn't well known but is well-regarded in the Senate – and she's headed for Iowa this weekend. Al Franken, a scathing Trump critic, is toying with a run.

5. An Hispanic dark-horse: Julian Castro has star power and probably will run. Nevada Sen. Catherine Cortez Masto is a fresh face with huge upside potential; she would make an ideal running mate.

4. Kamala Harris: The California senator isn't shy about going for it – she will embrace the Barack Obama template, running for president after only a brief stint in the Senate. Half African-American and half Indian-American, Harris may be a serious candidate, well funded and ambitious. Haven't heard of her? You soon will, she's got California star power.

3. Cory Booker: He's an intriguing guy – a relentless self-promoter but also a personable and bright problem-solver who is not reflexively liberal. The New Jersey senator almost certainly will run, and will have plenty of money. Booker is calculating and ambitious, and has a chance to finish in the top tier in a crowded field.

2. Bernie Sanders: He's 75, with socialist ideas that put him well outside of the mainstream. We hear that Sanders is still seething over an apparent conspiracy by Debbie Wasserman Schultz the Democratic National Committee to deny him the nomination – and he tells friends that he would have far exceeded Hillary Clinton's vote total in places like Bethlehem, Pa. Sanders has the highest favorability rating of any active politician, and he may run despite his age.

1. Elizabeth Warren: Don't shoot the messenger; this doesn't mean we support her. Warren is an electrifying demagogue who would be a disaster for our industry, which she vilifies as corrupt and greedy. We make Warren the early favorite largely because if Sanders doesn't run, she will inherit his massive army of young supporters. Can Warren win a general election? She can win the Northeast and the West Coast, but her Electoral College total could look remarkably similar to Hillary Clinton's – not enough.

BOTTOM LINE: This is a very weak field – a major reason why Trump may run again. He tells associates that he would love to run against Warren, who he mocks very effectively. The Democrats desperately need a fresh face, someone like Sen. Chris Murphy of Connecticut, someone to inspire young voters. Sanders can, but he will be 79 in the fall of 2020.


May 3, 2017 

Donald Trump is Angry

LIKE SO MANY PRESIDENTS BEFORE HIM,  Donald Trump is stunned to discover that he cannot get his way with Congress – which will be a major narrative, we suspect, in his second hundred days. To compound matters, most of Washington now accepts our view that Trump got taken to the cleaners in the recent budget negotiations, and that kind of criticism makes him angry.

SO IF HE CAN'T FIRE PEOPLE or bulldoze his way through Congress, Trump wants to change the rules. But leading Republicans said no yesterday – Mitch McConnell will not even entertain changes to Senate filibuster rules; no one wants to radically change the scoring process for tax cuts; and Trump's suggestion that a government shutdown might help was greeted with scorn in both parties.

WELCOME TO WASHINGTON, where still another long recess is about to begin, without progress on a health bill (the current one is on life support), with still another budget crisis looming this summer as Treasury scrambles to avoid a U.S. default. Trump seemingly is incredulous that Washington is this difficult, and he's especially angry that Republicans have defected from him – but the estrangement will only intensify.

MUCH OF THE WHITE HOUSE IRE is directed at Paul Ryan, who is loathed by the GOP grassroots base and faces a potential crisis over the debt ceiling this summer. But in private, House Republicans are angry over getting repeatedly blindsided by Trump over issues that have no chance of enactment – resurrecting Glass-Steagall, building a border wall, raising gasoline taxes, etc.

WE TALKED WITH A SAVVY REPUBLICAN YESTERDAY who believes a major problem is managing expectations. Trump proclaims that a terrific health bill will pass, that tax cuts will get finished quickly, that Dodd-Frank soon will be killed. None of those things will happen this year, which simply makes the GOP base frustrated over promises made and never kept.

WE SUSPECT TRUMP WILL THROW UP HIS HANDS and change the subject to issues where he can have a major impact – campaigning for Republicans ahead of the 2018 Senate election, where the GOP has a chance to pick up three or four seats; bringing specific trade cases, like the U.S. lumber tariffs imposed on Canada; and foreign policy, as he and Vladimir Putin attempt to seek a cease-fire in Syria.

TRUMP ABHORS A VACUUM that keeps him out of the news, so while he will maintain his anger toward Congress, he now may focus on the Middle East, Iran, China and North Korea. Foreign policy is the next big story to watch, an area where Trump could enjoy some success, unlike his dealings with Congress. There's upside potential with Russia and China, but we worry that even the slightest provocation from Iran will invite a strong reaction from Washington.


May 2, 2017 

Donald Trump Gets Taken to the Cleaners

THE DUST IS SETTLING AFTER SUNDAY NIGHT'S BUDGET DEAL  – which is looking like a capitulation by President Trump, who caved on almost every issue. GOP conservatives in this town are aghast; Trump's base is wondering if he really can negotiate. Democrats, in the minority in both houses, are chortling about repeating this success on the 2018 budget.

WE WROTE YESTERDAY MORNING that both sides got something in the deal, but a closer inspection reveals that Democrats got everything they wanted, while Trump got virtually nothing. Consider: there will be no cuts in domestic spending, as Trump demanded; there will be no money for a wall with Mexico; Planned Parenthood will be fully funded; there will be no crackdown on sanctuary cities; EPA funding will not be cut be by one-third, it will be cut by 1%. The White House got more money for the Pentagon, but not as much as the President wanted.

TRUMP ADVISERS said they wanted to get the government shutdown threat out of the way so they could focus on an Obamacare replacement bill this week, but that measure seems to be on life support – there's not quite enough support for it in the House, and nowhere close to enough support in the Senate, where moderate Republicans are hearing from constituents who don't want any change in coverage of pre-existing medical conditions.

THIS IS A PRESIDENT who doesn't like to lose, and his debacle on the budget has prompted him to suggest that the Senate filibuster rules are "archaic" and "unfair." But there aren't enough Republicans to change the rules. Likewise, supporters of tax reform floated a trial balloon yesterday to widen the budget window to 15 or 20 years, which theoretically would allow for a tax bill that would lose trillions in the first few years. That won't fly with GOP deficit hawks.

SO WHAT ARE THE LESSONS FOR THE MARKETS? One very clear one: there is no stomach for any spending cuts, especially among Democrats, who have just enough votes to prevail. This is the strongest evidence thus far that the budget deficit is headed much higher, beginning within a year. As for tax cuts, Trump can get one if he wants to negotiate with Democrats – which they relish.

TRUMP'S VERY ROCKY STRETCH: In addition to getting fleeced on the budget deal, Trump has said the following in the past 48 hours: it would be an "honor" to meet with Kim Jong-un. Glass-Steagall should be resurrected. Andrew Jackson, who died 16 years before the Civil War began, could have prevented it. He seemed to praise Philippine thug Rodrigo Duterte. Trump showed a total misunderstanding of what's in the GOP health bill. He suggested raising the federal gasoline tax without consulting with Republicans in Congress, who hate the idea.

IT'S GOING TO BE LIKE THIS for the next three years and nine months, get used to it. Corporate earnings can soar, the economy can improve, tax reform can pass, the markets can surge. But take it from the Republicans we talk with – the President is a loose cannon, easily capable of going off message with an outrageous remark; generating headlines is his specialty. And, Republicans are saying in private, Trump isn't a very good negotiator – Chuck Schumer took him to the cleaners on Sunday night.


May 1, 2017 

Why Last Night's Budget Deal is Important; Guess Who's Running for President?

ONE SMALL STEP:  Those of us who still think a tax reform bill can pass (not until winter) got a bit of positive news late last night: a budget deal, keeping the government open through Sept. 30, was reached on Capitol Hill –  a sign that both parties actually can work together.

BOTH SIDES GOT THINGS THEY WANTED:  The Republicans got a $12.5 billion hike for the Pentagon and an extra $1.5 billion for border security, while the Democrats got $2 billion extra for the National Institutes of Health, with no cuts for Planned Parenthood and no money for a border wall. Chuck Schumer and Nancy Pelosi were crowing last night, which surely will inflame the GOP's conservative base.

THE THREAT OF A CRISIS  motivated this deal, and this threat could return by mid-summer when the debt ceiling has to be raised, and as the 2018 budget comes into focus.  But the major message was clear: despite his bombast, Donald Trump will compromise when necessary with the Democrats.

SO – IS A HEALTH DEAL IMMINENT?  House Republicans are hinting that a vote could come later this week to pass an Obamacare replacement bill, but our optimism over the budget deal has its limits. Even if the House moves, we don't see this health bill passing in the Senate; too many moderate Republicans consider the bill radioactive.

BUT THE TAX BILL IS NOT DEAD:  House hearings begin this week, and Treasury Secretary Steven Mnuchin will begin a barnstorming campaign to drum up support for what promises to be the dominant domestic issue of Trump's presidency. Changes are inevitable – Trump will have to scale back his proposal to kill the state and local tax deduction, for example. But we still think both houses could pass a tax bill by year-end, setting up a conference committee debate in early 2018.

JOE BIDEN FOR PRESIDENT?  We're not making this up – he was in New Hampshire last night for a campaign-style event amid signs that Biden will run in 2020. He's enormously popular with the Democrats' base, but he's 74 and has had two brain aneurysms. But Biden feels a need to move soon – Bernie Sanders, 75, looks like he's running, as is Elizabeth Warren, 67. No word yet on whether Mike Dukakis, 83, or Walter Mondale, 89, might run as well.


April 28, 2017 

Timing of Trump Tax Cuts – Why There's No Rush; Who's the Most Likely Yellen Successor?

TIMING OF TRUMP TAX CUTS:  There's a widespread misconception that delaying passage of tax reform until next winter would somehow be a disaster for the White House. Au contraire – even if enactment is delayed until a year from now, there's a crucial upside angle for the White House:

YOU WANT THE ECONOMY HUMMING  ahead of mid-term elections, and if tax cuts don't take effect until, say, next April 1, there would be a huge dose of stimulus injected into the economy to boost second and third quarter GDP growth just in time for the Nov. 6 elections. This actually could become the White House goal.

WE THINK THE EFFECTIVE DATE  of any tax cuts would not come before Jan. 1, 2018, because ironing out all of the differences will take at least 8 or 9 more months; perhaps passage could occur before the holiday recess in late December, but it probably will take longer than that. In any event, the GDP impact won't come until next year, perhaps in time to jump-start an economy that seems mired in a 2% growth rut (this morning's first quarter GDP report will be dismal).

IF THE ECONOMY IS ROARING,  with the labor market tightening and wages rising in mid-2018, that could provide quite a surprise for the Republicans in the elections. Based on our take on vulnerable Senators, we think the GOP could gain an additional 3-to-5 seats; they currently have 52. The Democrats might gain 12-to-18 seats in the House, but they would need a net of 24 to take control.

THE DEMOCRATS STILL HAVE SOME CLOUT, OF COURSE,  because filibuster rules can tie up Trump's agenda – as we'll see in the next 24 hours. A government shutdown probably will be avoided with a one-week extension, but the Democrats agreed to a stop-gap bill only after Trump made remarkable concessions – no cuts to Planned Parenthood, no money for a wall with Mexico, no cuts in federal subsidies to health insurers.

ASTONISHINGLY,  Democrats apparently have prevailed with their demand that the House not even vote on an Obamacare replacement bill, which will stay in limbo for months to come. So the Democrats will maintain some clout, but a Senate with a few more Republicans after the 2018 election will make a difference – especially as two or three Supreme Court justices prepare to leave.

JANET YELLEN'S SUCCESSOR:  Washington seemingly has settled on the clear frontrunner to replace Janet Yellen – Trump economic adviser Gary Cohn, the former President and co-Chief Operating Officer at Goldman Sachs. We agree that he's the favorite, but the White House might not want him to leave until the tax bill is finished, and that fight might still be raging on next Feb. 3, when Yellen's term as chair expires.

WHAT ABOUT YELLEN STAYING?  As part of his transformation, Trump now speaks highly of her and has even indicated that he might keep her. But what about the flip side of this equation? What if Yellen, who turns 71 this summer, decides that retirement is preferable than working at a Fed filled with Trump appointees? Winding down the Fed's balance sheet doesn't sound as enjoyable as retirement...


April 27, 2017 

The Goldman Sachs Takeover of the Trump Administration

WHAT WE SUSPECTED ALL SPRING  became virtually certain yesterday – the pro-market, pro-business Goldman Sachs faction in the White House has won and is calling all the shots on economic policy. It's not just on taxes, it's on numerous fronts:

A POTENTIAL LAST-MINUTE SNAG  on a fiscal 2017 budget deal was avoided last night, and a government shutdown looks unlikely. President Trump, who already caved on funding for a border wall, agreed to keep paying subsidies to health insurers. A one-week extension is still possible tomorrow night but this crisis – which could have rattled the markets – has been avoided. A clear victory for the Goldman Sachs faction.

A POTENTIAL U.S. DEPARTURE FROM NAFTA  was avoided at the last minute. The President is still looking for action in his first 100 days, but he backed away from a NAFTA exit; surely his Goldman Sachs advisers told him that such a radical move could have worried the markets. There will be individual trade spats, such as the U.S. fight with Canada over its lumber subsidies, but all-out protectionism looks unlikely.

RELATIONS WITH CONGRESS HAVE A DIFFERENT TONE:  Trump has been advised to abandon his "my way or the highway" stance with Congress. So yesterday he invited the entire Senate to the White House for a briefing on the threat from North Korea. Even though little was revealed, the symbolism was important: Trump wants Congress on board. Likewise, he is subtly encouraging – not demanding – that Congress resurrect the Obamacare replacement bill.

AND THEN THERE'S THE TAX PROPOSAL:  The President's most visible Goldman Sachs advisers rolled out a rough outline yesterday that was a Wall Street dream – pro-growth tax cuts that focus on boosting perplexingly weak business fixed investment; individual cuts that should stimulate GDP; and no protectionism like a Border Adjustment Tax. This is great for equities, although the implications for fixed income investors are less bullish.

IT'S NOT JUST GOLDMAN:  Many Wall Streeters have Trump's ear, including Blackstone's Stephen Schwarzman, and Trump relies heavily on Wilbur Ross, the Commerce Secretary. These advisers have routed the Stephen Bannon faction that takes a populist – almost hostile – view toward crony capitalism and Wall Street.

THIS BATTLE HAS BEEN WON:  After eight years of generally adversarial relations between the Obama Administration and Corporate America, there's a new pro-business climate in Washington. And a Reaganesque supply side tax policy is firmly in place (which of course has no support among Democrats on Capitol Hill and quite a few detractors among Republicans who worry about budget deficits).

THE MANTRA IS CLEAR:  Avoid protectionism, shutdowns, tax hikes, criticism of Janet Yellen and other negatives for business – keep the markets happy and the gains will flow down to investors and consumers, which will boost the overall economy and lead to more jobs.

THERE'S A LONG SLOG AHEAD  on tax reform, which could be a year away, but for a White House known for deep divisions there's surprising unanimity on the direction of economic policy – Wall Street will call the shots. Is there any wonder why the stock market is close to record highs this morning?


April 26, 2017 

Three Ways to Look at Trump's Tax Reform Rollout

AMID THE AVALANCHE  of leaks and trial balloons, how should we analyze today's unveiling of President Trump’s tax goals? There are three ways to look at it:   

1. A campaign-style stunt,  designed to keep the stock market rally roaring, with few specifics. President Trump apparently will not attend the 1:30 p.m. rollout; Steven Mnuchin and Gary Cohn, who aren't ready to get deep into the weeds, will attempt to explain the rough outlines.

2. The beginning of a protracted fight with Congress,  where lawmakers are lukewarm at best at the likelihood of a budget-busting bill that will be difficult to pass under budget reconciliation rules. We keep harping on the increasingly sour relationship between Paul Ryan and the White House; mutual suspicion is growing as Ryan seeks a revenue-neutral bill while the White House aims higher – the deficit be damned.

3. Let the bargaining begin,  as the White House starts a negotiating process on dozens of key issues. The top corporate and pass-through rates may not be as low as Trump wants; details on the repatriation of foreign earnings have to be hammered out.  For the financial markets, all that counts – for now – is that the tax reform process is alive, and it most certainly will be alive after today's announcement.

THE UNIFYING GOAL:  As Republicans prepare to fight among themselves – a central theme in 2017 – one key goal will dominate: boosting U.S. GDP growth,by a lot. To understand how the White House views this goal, we highly recommend a column in this morning's Wall Street Journal by supply-sider Stephen Moore, who believes the best way to reduce deficits is to focus in much stronger revenue growth.

THE BOTTOM LINE:  We have rarely seen so many moving parts on a key issue, but our base case is unchanged:

Significant rate cuts are coming for for corporations, individuals and pass-throughs;

There will be no Border Adjustment Tax;

Repatriation of profits stashed abroad is nearly certain – a huge plus for U.S. drug and tech companies;

There will be a much higher standard deduction with curbs on individual tax breaks.

The much-hated Alternative Minimum Tax will die, and the estate tax could die as well.

TRUMP WILL GET MUCH OF WHAT HE WANTS  but his opening bid will get scaled back because Congress simply cannot afford all that he wants. This still looks like a great story for stocks, but fixed income investors have to ask – will the final measure be credibly paid for? No way.

TRADE WAR WITH CANADA?  Perhaps overlooked amid this week's furious debates is the Trump Administration's assault on Canadian lumber and dairy policies. Going after a key U.S. ally and trading partner will play well with Trump's base, and besides – Canada doesn't have the weapons to retaliate like China has. But this does not bode well for negotiations on a revised NAFTA, and it makes us worry that we were too hasty in dismissing the threat of trade protectionism.


April 24, 2017

Big Week Ahead as Showdown Looms Between Donald Trump and Paul Ryan

IT'S THE BIGGEST WEEK  in Donald Trump's young presidency, and he faces a serious obstacle: he's not on the same page as many Congressional Republicans, who believe Trump has over-promised – and doesn't have the votes to prevail on a border wall or an Obamacare replacement. As for a tax reform tease, apparently coming on Wednesday, a consensus may be months away.

TRUMP NEEDLESSLY UPPED THE ANTE  this weekend, making fresh demands on funding for the wall, which raises the possibility of a shutdown on Friday at midnight. He wants victories to coincide with his first 100 days, so he will issue several executive orders this week – but legislative progress, which looked possible last week, still seems elusive.

THIS WEEK'S CONFUSING SIGNALS  and potential setbacks requires a scapegoat, and the obvious candidate is House Speaker Paul Ryan, who is increasingly exasperated with the White House, where the feeling is mutual. Ryan and his skittish troops face three issues:

1. Government shutdown:  We still think there's a 40% chance of a shutdown; many Democrats, in private, are itching for one. Ryan and his allies were closing in on a deal, whereby funding would be increased for immigration enforcement, but funding for a wall is a non-starter with Democrats. We envision an ultimate deal that will fund border security and boost outlays for the Pentagon, but a White House attempt to kill federal payments to health insurers would be a deal-breaker.   

Trump probably will maintain a hard line until Friday, then compromise. But as we have stressed, Washington is far different from New York; you can't turn on a switch and get a quick deal, not when legislative language is involved. So we think there will be a last-minute extension, perhaps for a week, that would keep the government open. There simply may not be enough time to finish a deal by Friday night, because Ryan needs votes from Democrats, who are in no rush.

2. Obamacare replacement:  Ryan made it clear this weekend that there isn't enough time this week to move quickly on a health reform bill. He has nearly enough votes in the House, but this measure is unlikely to move in the Senate. The sooner the GOP puts this albatross on the back burner, the better.

3. Tax reform:  Trump's boast that a tax proposal will be released on Wednesday stunned Ryan and many of the President's advisers; there's no consensus in the White House on key elements of a bill. In fact, there's not even a consensus on whether there should simply be a big tax cut now or a tax cut combined with fundamental reform of the tax code, which would require up to a year to complete; we think the White House leans toward the latter option.

Tax cuts have real sizzle and Trump knows this, so the promises will be lavish on Wednesday. But the details won't come into focus until summer, when House passage of a bill is possible. Once again, Speaker Ryan has big differences with the White House – should there be a Border Adjustment Tax, and how would the bill be paid for? Treasury Secretary Steven Mnuchin seems to think the cuts will pay for themselves – still another potential source of friction with Ryan.

THE BOTTOM LINE:  The big story this morning obviously is in Europe, where the center is holding and the EU is still intact. Eventually the center-right will hold in the U.S., but this could get messy for the next week as Trump grapples with a glaring weakness: an inability to get along with his own party.


April 21, 2017 

Don't Get Fooled Again  –  Trump and Health Reform

ENOUGH ALREADY – LET IT GO!!  With geopolitics heating up, with a government shutdown looming, with tax reform entering a crucial phase, President Trump is still obsessed with a losing cause: getting Congress to agree on an Obamacare replacement bill. We've said it before and will reiterate – health care is an albatross for the party in power, a waste of time and political capital for a new president who probably doesn't have enough votes in his own party to pass a bill.

BUT TRUMP WANTS A SIGNATURE ACCOMPLISHMENT  in his first 100 days, other than the Neil Gorsuch confirmation. So he and his aides have been applying extreme pressure on House Speaker Paul Ryan to pass the Obamacare replacement. One problem: there still aren't enough votes for the bill in the House and almost certainly not enough in the Senate.

SHELL-SHOCKED REPUBLICANS  will return to Washington on Monday after a battering in town halls, where activists and ordinary citizens ripped into the health reform package that failed in March. In private, many GOP lawmakers say health reform is radioactive; they want to move on to other issues. In any event, a House vote next week looks very unlikely; there simply isn't enough time to whip votes for the bill until the week of May 1.

HEALTH BILL BOTTOM LINE:  Only three scenarios, none of them to Trump's liking: 1. The latest bill fails to win enough support in the House; 2. It narrowly squeaks through in the House only to die in May in the Senate; 3. Different bills pass in both houses, leading to long and ultimately fruitless conference committee deliberations. No quick win for Trump with those scenarios, just a high-risk/low reward quagmire.

THE NEXT ISSUE: IT'S TIME FOR TRIAGE ON THE BUDGET,  that's the real issue that Trump needs to focus on in the coming week. Incredibly, Democrats – in the minority in both houses – have real leverage as a government shutdown looms next Friday. They will not agree to fund a wall with Mexico and they will block deep spending cuts.

WE THINK A BUDGET DEAL  will come into focus within a week – including more money for the Pentagon and infrastructure – but this deal probably can't be finished in time to meet the Friday deadline, so a temporary extension is likely. Kicking the can down the road is a Washington specialty.

TRUMP VERSUS CONGRESS:  He can prevail with regulatory reform and executive orders, he can show U.S. resolve militarily, but he cannot bulldoze his way through Congress. The new president doesn't get it – Congress is glacial and maddening, not willing to negotiate like New York City developers. So there must be someone to blame, and the increasingly unpopular Ryan is a convenient target.

EVENTUALLY TRUMP WILL FIGURE OUT  how to deal with Congress; Mike Pence and other insiders will steer him in the right direction, so we continue to believe it's premature to give up on tax reform – it may be a year away, but there's strong support for the concept of reform, if not the details. In the meantime, Trump won't get health reform any time soon and he's headed for a draw, at best, in the budget fight.

RECOMMENDED READING:  Check out this morning's Wall Street Journal editorial on steel tariffs, a politically seductive concept that brings nothing good – higher inflation, lost jobs, the threat of retaliation. The key issue – is Trump's bark worse than his bite on trade? Is his recent bombast against Canada simply hot air? Probably, but trade protectionism suddenly has returned as an issue to watch.


April 20, 2017 

You Want Tax Cuts? Two Huge Clues Are Coming Next Week

THE FINANCIAL MARKETS  are getting impatient; investors want to see progress on a tax reform bill that slashes rates. The markets can handle a delay – but if there are clear signs that the bill is in trouble, that would be a major negative. So we have two important clues – perhaps market-moving – coming next week as Congress returns from the long spring recess:
1. Obamacare reform: We're hearing that House Freedom Caucus rebels are close to a deal that could jump-start the stalled Obamacare replacement bill. House passage doesn't mean that the Senate would go along; many moderate Republicans think the new measure is radioactive. But any kind of movement, after last month's debacle, would be a sign that the dysfunctional House is starting to coalesce – which would be a positive signal for tax reform.
2. Government shutdown: This will be closely watched for signs of whether Congress and the White House can work together for the rest of the year. Democrats will never agree to a bill that kills Planned Parenthood or funds a border wall, and advisers to President Trump are prepared to dig in for major new defense outlays and new spending for immigration enforcement. A shutdown next Friday looms if there's no agreement.
To be blunt, if there's a shutdown it will so poison the climate that prospects for tax reform will slip well below 50%. On the other hand, if there's a deal between the two parties, that could bode well for progress in other areas. Our guess is that there will be a budget extension for a week or two, keeping the government open until there's a new crisis in early May.  But an ultimate deal is still the best bet.  
ONCE THERE'S A BUDGET DEAL, the focus will shift to the complicated tax issues – whether the bill should be revenue-neutral, whether a Border Adjustment Tax will be included, etc. But it's still premature to write off a tax bill – Gary Cohn and Paul Ryan can get a measure passed in the House by July, in our opinion. It's still a long slog in the Senate,  but if Congress can avoid a shutdown next week there will be hope for a tax bill. 
STEEL IMPORT CURBS COMING? Trump wants to add to his modest list of accomplishments in his first 100 days; his assertion that this is the most productive first three months in the history of the presidency is absurd, especially when compared to FDR's breathtaking first 100 days in 1933. But give Trump credit – he's methodically checking the boxes on his campaign promises, and will pledge today to crack down on steel imports.
TRUMP REPORTEDLY WILL SIGN AN EXECUTIVE ORDER today that will direct the Commerce Department to investigate whether the U.S. should curb or block steel shipments into this country. This is a key promise he made in Pennsylvania and elsewhere; we recall meeting people in Bethlehem, Pa. last spring who swore that Trump would revive the U.S. steel industry – a long-shot, in our opinion, but it's a promise that he's determined to keep, even if it smacks of trade protectionism.


April 19, 2017 

The Interest Rate Plunge – A Fake Out?

SOMETHING ODD HAPPENED  on the way to a 3% yield on the Treasury 10-year bond. After surging to about 2.6% a few weeks ago, yields have plunged, and now are below 2.2%. We fully agree that you don't fight the tape, but this move looks like a fake out; the three major reasons why interest rates have dropped seem transitory.

1. The economy is soft? Not really.  For the fourth successive year, first quarter GDP growth will be tepid, probably no better than 1% – something is clearly wrong with the seasonal adjustments. Will slow growth persist into the second quarter? Maybe, but we'd bet on GDP growth of roughly 2% for the rest of 2017 – a slight disappointment, but there's still no recession in sight, not with unemployment at 4.5%.

The bigger economic story is that this soft patch has not significantly changed attitudes at the Federal Reserve, where officials are committed to gradually raising rates and reducing the Fed's balance sheet. With inflation close to the Fed's target and the labor market in very good shape, we still expect two second half rate hikes – but the Treasury market seemingly is dismissing that likelihood.

2. Geopolitical tensions? They may subside:  Kim Jong-un may be unstable but he's not stupid; he is not prepared to endure 21,000 pound U.S. bombs. So this crisis may subside a bit. The next crisis – French elections this Sunday – could intensify fears over a breakup of the European Union, but even if one of the two Euro-skeptics make it to the runoff on May 7, they do not have enough support in the French parliament to pull out of the EU. In any event, we think Emmanuel Macron, a moderate, is likely to prevail in the end.

3. Trump is imploding? We don't see it:  As we suspected, last night's Georgia House results failed to produce a 50% total for a young Democrat insurgent, who now faces a more difficult runoff in June. So – two special House elections this spring, and two failures by the Democrats. We don't see an anti-Trump wave developing, although Democrats clearly are angry and well-funded. (Of course, their biggest draw, Bernie Sanders, proclaimed yesterday that he isn't a Democrat.)

As for Trump's agenda hitting a wall, there's no doubt that it will take longer to enact than he – or the markets – anticipated. But his agenda is not dead; hearings begin next week in the House on a tax reform package. As long as tax cuts still look likely – even if it takes another year – the markets will be patient.

BOTTOM LINE:  By early summer, economic growth will be well above the lame first quarter pace. The labor market will be tight, with wages moving higher. The threat of geopolitical crises may have subsided. President Trump, still controversial, will continue to benefit from a weak opposition. And the long slog toward tax reform will be underway.  Is this a prescription for rock-bottom interest rates? We don't think so.


April 18, 2017 

Go Figure – Trump Shows Promise on Geopolitics, Stumbles on Domestic Issues

AS DONALD TRUMP  approaches his first 100 days, it's becoming clear that he won't back down on geopolitics – a strike on Syria, a 21,000 pound bomb in Afghanistan, and an unyielding stance against North Korea that may force Kim Jung-un to back down. This is not what Trump's supporters expected; they were looking for legislative victories from a Republican Congress.

NORTH KOREA MYSTERY:  Perhaps a tell-all book years from now will spill the beans on why North Korea's missile test fizzled last weekend. We would not be surprised if there was a U.S. cyberattack that planted a virus in Kim's weapons, and there undoubtedly are back-channel threats from China, probably at Trump's urging, that are giving North Korea a reason to back off.

THIS COULD BE A PLUS FOR THE MARKETS,  but the sorry state of Trump's domestic agenda may begin to worry investors. We've argued for weeks that tax reform won't win enactment in 2017, and now Treasury Secretary Steven Mnuchin has dialed back his widely-panned forecast of passage by the August break. He tells the FT it will take much longer, and he conceded that there are stumbling blocks: there's no consensus – even within the White House – on whether the bill should be revenue-neutral or whether there should be a Border Adjustment Tax.

WE STILL THINK A TAX BILL  can come into focus by late fall, with Gary Cohn making a big difference, and it might win enactment a year from now – but this enormous task has encountered two fresh obstacles: the growing call for Trump to release his taxes, and the public opposition to the GOP Obamacare replacement bill, which is increasingly radioactive; Republican lawmakers are sprinting away from the measure. Without the revenues from this health bill, tax cuts are less likely.

IT'S BEEN A ROUGH SPRING  for Republicans, who aren't feeling the love back home, but we think there's a reasonable chance that an upstart Democrat in Georgia will fall just short of 50% tonight, thus setting up a one-on-one with a GOP candidate who would be favored in the June 20 runoff. We don't see a tidal wave threatening Republicans, but tonight's vote will be significant and a nasty budget fight – with 40% chance of a government shutdown – looms as another GOP distraction by late next week.

ARE REPUBLICANS SUDDENLY LESS POPULAR?  Yes, largely because of the Obamacare fiasco, but Trump's numbers among his base are surprisingly solid; his core supporters are still willing to give him time. The least popular GOP lawmaker, by far, is Paul Ryan – who has a 29% approval rating among all voters as he fails to win anything in the House. Who's the most popular politician in America? Bernie Sanders, with a 61% approval rating.

SO IT'S DOMESTIC ISSUES  that Trump has to worry about – including the likelihood that the economy has lost momentum, a major reason why interest rates have slipped. Trump needs another victory; Neil Gorsuch wasn't enough. It appears, at least for now, that Trump's emergence as a global tough guy may bring him more successes than his sputtering legislative agenda.


April 13, 2017 

Two Skunks at the Picnic; Why Donald Trump Needs Janet Yellen

ON MONDAY WE WROTE ABOUT "THE TRANSFORMATION OF DONALD J. TRUMP,"  and sure enough, there have been breathtaking reversals this week by Trump on NATO, Janet Yellen, trade deals, etc. We continue to believe that the Goldman Sachs faction in his administration has won, reinforcing a pro-business climate that the markets will continue to enjoy. But there are two skunks at this picnic that could threaten an otherwise bullish climate:
1. A NORTH KOREAN NUCLEAR TEST appears to be imminent, perhaps coming this weekend, amid an escalating war of words with the U.S. This is the greatest threat to world stability; we continue to believe a U.S. strike at North Korean missile sites is on the table. Can China really exert pressure on Kim Jong-un to dial it back? Trump seems to think so, but we're not sure. The most likely outcome is even tougher U.S. sanctions, but this is an increasingly serious wild card.
2. A GOVERNMENT SHUTDOWN at midnight on April 28 just got more likely, as the Trump Administration threatens to kill subsidies to health insurers in an effort to drive Democrats to the bargaining table on an Obamacare replacement. The Republicans will capitulate on other issues like Planned Parenthood funding and deep spending cuts, but the sudden emergence of the health subsidy issue makes a shutdown a 40% probability, which would further delay progress on tax reform. Stay tuned.
JANET YELLEN, RECONSIDERED: Everything Trump said in the campaign about the economy – the real unemployment rate is 40%, U.S. has to get tough on trade, crony capitalism has to end, etc. – apparently was for show (and it worked, he won). He has changed his tune on all of these issues, and the most startling reversal is Trump's suggestion yesterday that he might re-appoint Janet Yellen as Fed Chairman.
WHO KNOWS IF YELLEN, who turns 71 in August, would want to stay as Chairman when her term expires next Feb. 3? We'd guess she might want to stay and preserve her legacy by gently letting the air out of the balloon as the Fed's $4.5 trillion balance sheet is trimmed. It could be a marriage made in heaven: a president who needs easy money and low rates to pay for his ambitious spending plans also needs a dovish Fed,  and most of the alternatives to Yellen on the right wing would hike rates more aggressively than she will. 
SOME HISTORICAL PERSPECTIVE, PLEASE: Politicians and pundits are proclaiming that U.S.-Russia relations are at an "all time low." Really? What about the Berlin blockade and airlift in 1948-49? What about Moscow’s brutal suppression of the Hungarian Revolution in 1956? What about the Cuban missile crisis in 1962, when a nuclear war was not unthinkable? Yes, relations are rocky now, but to claim they're at an all-time low ignores history.
EDITOR'S NOTE: We're off for the long Easter-Passover weekend, such a glorious holiday, rich with the promise of renewal. We'll be back on Tuesday.


April 12, 2017 

A Head-Scratcher from Trump on Taxes; French Election Wild Card; Can the GOP Keep to the House?

HEAD-SCRATCHER:  In an interview to be aired later this morning, President Trump tells Fox anchor Maria Bartiromo that he wants to pass Obamacare reform before moving on to tax legislation. We don't get it – what a waste of time and political capital to return to the quagmire of health reform.

HOUSE REPUBLICANS  have made the measure more palatable to the unyielding Freedom Caucus – and even less appealing to the public – by seeking to abolish popular provisions like those dealing with pre-existing conditions. There's virtually no chance the new measure could pass in the Senate. Health reform is clearly a no-win issue for the Republicans; tax cuts and infrastructure have some sizzle.  Most Republicans we talk with on Capitol Hill view another health bill as radioactive, and Trump eventually will agree.

FRENCH ELECTION WILD CARD:  Perhaps the markets have been worrying about the wrong candidate in France. The fear, for supporters of the Euro, was that hard-liner Marine Le Pen would finish first or second in a crowded field on April 23 and squeak to a win in the finals on May 7.  But here comes a dark horse from the far left,  a Bernie Sanders-type populist, Jean-Luc Melenchon. He's gaining against centrist Emmanuel Macron, who was the frontrunner until recently.

WHAT A CHOICE:  A runoff on May 7 could pit Le Pen against Melenchon, almost unthinkable for the markets, since both favor a referendum on exiting the European Union. Melenchon also favors huge tax hikes on the wealthy, more confiscatory than anything in recent decades in France, which is saying a lot. We think the moderate Macron or conservative Francois Fillon will emerge to run against Le Pen, and either would beat her. That's what the markets want, but in light of recent polling debacles and voter volatility, this election suddenly looks like a nail-biter.

A VERY OVER-HYPED U.S. POLITICAL STORY  is that Democrats are on a path to reclaim the House in 2018 – wishful thinking, in our opinion. Last night's special House race in Kansas, a GOP victory, was no great surprise. Another special election, on April 18 in Georgia, has been super-hyped as a race "to make Trump furious." The Democrats have a well-funded young challenger who needs 50% of the vote in a field crowded by Republicans, but we think he will fall just short – and then lose a one-on-one race on June 20 to the GOP winner.

TO BE FAIR,  the Democrats – angry and organized – and should score significant House wins in 2018. They will need a gain of about two dozen seats, net, and have a decent chance of winning 15. But odds are only about 40% that the GOP will lose the House, because the districts are drawn (or gerrymandered) in a way that keeps incumbents very safe. As for the Senate, that's an easy call in 2018 – Republicans will add a seat or two to their majority; there simply are too many vulnerable Democrats in states that Trump won last fall.


April 11, 2017 

Business Confidence is Back

THE STOCK MARKET GETS IT:  Why is the market so strong, with geopolitical tensions rising, the Fed taking away the punch bowl, and President Trump having trouble with his own party? A key factor is business confidence – solidly higher as regulations are relaxed, as the White House aggressively lays the groundwork for tax and infrastructure legislation.

A GAGGLE OF TOP BUSINESS LEADERS  will meet with Trump today at the White House, and he'll ask them, as he always does: what do you need? Trump seemingly has abandoned his populist attacks on business; still another new player is Kevin Hassett, the new head of the Council of Economic Advisers – a highly regarded pro-business economist, an advocate of tax reform, and an outspoken critic of trade protectionism.

HASSETT WILL JOIN A TEAM  dominated by Goldman Sachs veterans who know that business confidence is crucial. That's why they immediately went for regulatory reform early in the Trump Administration. "People overlook the importance of these regulatory reforms," a source told us yesterday. "They give business a sense of optimism after eight years of an adversarial relationship with Washington."

SO THIS IS A MAJOR REASON WHY THE STOCK MARKET IS HAPPY,  in addition to decent corporate earnings, plus the expectation of stronger GDP growth after still another soft first quarter. What could derail this market? Other than a geopolitical crisis, the only negative that could make a difference would be a clear signal that tax reform is in trouble; the markets are counting on it, even if it doesn't come until early next year.

UNLIKE THE OBAMACARE REPLACEMENT FIASCO,  which was mismanaged by House Republicans, the White House will play a much more aggressive role on tax reform. Gary Cohn, Steve Mnuchin, Hassett and others will push hard for a top corporate rate of around 20%, with repatriation of earnings from abroad – still another huge positive for U.S. business.

MEANWHILE, TRADE PROTECTIONISM  has faded as a fear; perhaps there will be some new tariffs on China and others, but it's not like Smoot-Hawley is returning. Crony capitalism is back in vogue; even the Export-Import bank – hated by populists – may survive.  But the key for now is an exceptional change by the regulators; just watch M&A activity, sure to surge as antitrust policy is relaxed.


April 10, 2017 

The Transformation of Donald J. Trump

WAKE-UP CALL:  Heading for decidedly mixed reviews when he hits his first 100 days on April 29, Donald Trump has come to a startling conclusion: he needs votes from Democrats on several issues, because he cannot rely on his Republican troops.

TRUMP WON SOME BADLY NEEDED SUPPORT from mainstream Republicans and many Democrats for his strikes against Syria, and we expect polls later this week will give him a bump. But Democrats – in the minority in both houses – are on the offensive. They will seek major concessions for cooperating with him; follow the money – that's where things get interesting later this month.

HARD-LINE CONSERVATIVES in the House will not provide the votes Paul Ryan needs to pass a budget deal, keeping the government open, by April 28. So Ryan and Trump will have no choice – they have to lure Democrats with promises to fund Planned Parenthood, reject money for a wall with Mexico, and abandon the idea of deep spending cuts for domestic programs. (Defense is still headed for a big raise.)

CHECKMATE: Mitch McConnell said late last week that Democrats will have to be part of a budget deal, raising this issue: where else will the mainstream in both parties strike deals? Infrastructure is still the low-hanging fruit, and Democrats are already making demands for urban spending, higher worker wages, etc. Even on taxes, Democrats are talking about what they want: no big tax cuts for the wealthy, revenue neutrality, etc.

THE NEW TRUMP: What a turnaround – three dozen House Freedom Caucus rebels, who don't believe in compromise – have forced Trump into dealing with Democrats. There are no alternatives – seek Ryan's ouster? There's no logical successor. Shake up the White House staff? Maybe, but that will just hasten Trump's move to the center.

A SOBERING REALITY FOR TRUMP'S BASE: It's sinking in – he's willing to get involved in a Mideast civil war; he can't build a wall; his bark was worse than his bite on trade; he can't fix Obamacare; the impact of tax reform is a year away; and he needs Democrats to get anything done.

WHAT THIS MEANS FOR THE MARKETS: This is starting to look like a center-right administration; the Goldman Sachs faction has won, and a pro-business climate is a good thing for the markets. But the sizzle Trump brought to the office – radical change, unabashed populism, massive tax cuts, no foreign wars – has faded, as he realizes how daunting it is to deal with Congress and geopolitics. He never, ever knew it would be this difficult...


April 7, 2017 

New Sheriff in Town – A Defining Moment for Donald Trump

A FRESH START FOR DONALD TRUMP:  We think public opinion will sharply pivot; polls this weekend will show overwhelming support for U.S. air strikes against Bashir al-Assad. There are enormous ongoing issues about what comes next, but the political implications are clear: this is a huge win for President Trump.

THE AIR STRIKES WON OVERWHELMING BIPARTISAN SUPPORT  last night, with only a handful of critics, mostly on the far right. Rand Paul gets far more media ink than he deserves; he's an outlier. Democrats who were bashing the Supreme Court "nuclear option" just 24 hours ago were praising the air strikes last night.

A MESSAGE TO THE WORLD:  One clear signal was to North Korea; in effect, Trump said "you're next." There are risks, obviously, to playing policeman to the world, but Kin Jong-un has to think twice before lobbing more missiles toward Japan.  After eight years of relative passivity, the U.S. suddenly is a force to be reckoned with.

THIS COULD LEAD TO A COOLING OF RELATIONS WITH RUSSIA,  but even this has upsides for Trump. It sends a message to Russia's allies that the U.S. is prepared to counter Vladimir Putin in the Mideast. And it sends a message to Americans that Trump is not Putin's lapdog, as Democrats have alleged. Putin respects strength, and he did not respect Barack Obama; all that has suddenly changed.

SO – WHAT DOES THIS MEAN FOR THE MARKETS?  Geopolitical risk is impossible to quantify, and it can't be dismissed if the U.S. gets sucked into other global hot-spots. But a bigger story is that Trump just won some badly-needed political capital; his job approval numbers will rise in the next week,  and this has positive implications for his agenda.

TRUMP'S WINNING STREAK:  We wrote earlier this week that he was headed for an upswing: a Supreme Court victory, a convenient new foil in Susan Rice, and the beginnings of some movement on tax and infrastructure legislation. Perhaps most importantly, he may be growing into the job; foreign crises will do that to a president.

TRUMP IS MOVING TO THE MAINSTREAM:  His infatuation with Steve Bannon may be over, and the pragmatist conservatives like Mike Pence and Reince Priebus have won. And the Goldman Sachs faction will call the shots on economic policy. The losers are the alt-right and the House Freedom Caucus; Trump is evolving into a center-right hawk, not an angry isolationist populist.

THE SYRIAN AIRSTRIKES  have transformed the Trump presidency; previous mis-steps will be forgiven as rookie mistakes. The U.S. will re-emerge as a force to be reckoned with, so here's the key issue: can Trump take advantage of this turnaround? He finally has some bipartisan support, and if he can capitalize on it there could be a re-set for his entire presidency.


April 6, 2017 

Markets Can Handle Janet Yellen – But Maybe Not Paul Ryan

THE FED'S BALANCE SHEET, A WORK IN PROGRESS:  The Federal Reserve has sent signals that it probably will begin winding down its $4.5 trillion balance sheet later this year, so the FOMC minutes yesterday shouldn't have been a big surprise. There's more internal debate to come, since the central bankers have not resolved key details of the program, but they seem to be adroitly communicating their goals.

NOTHING IN CONCRETE:  We enjoyed an exchange yesterday with old friend Don Kohn, the brilliant former Fed Vice Chairman. Don wasn't surprised by the Fed announcement, but he added: "it's important to keep in mind that the Fed will always be very data/forecast dependent. If the labor market and inflation don't follow the Fed's expectations, they will adjust. They emphasized that their expectation for all aspects of policy were derived from their forecasts; if the forecasts change, so will they."

SO THE MARKETS DIDN'T OVER-REACT YESTERDAY  to a policy change that may be eight months away, with key details unresolved. A nice stock rally was snuffed out, but the Dow Jones Industrials fell by only 41 points, hardly a rout. Moreover, while the Fed announcement was expected, comments from House Speaker Paul Ryan caught some investors by surprise.

JANET YELLEN CAN CONTROL HER TROOPS, RYAN CANNOT:  While the Fed cautiously moves on the balance sheet, Ryan has been a huge disappointment this year, generating more confusion than clarity. He proclaimed yesterday that the tax reform bill may take even longer than getting an Obamacare replacement (that process took seven years, and failed). The White House, Senate and House "aren't on the page on taxes," he conceded.

THE MARKETS CAN HANDLE  a couple more rate hikes this year and a gradual reduction of the balance sheet, because it will be accompanied by a strengthening economy.  But the markets cannot handle any hint from a top player that tax reform is in   jeopardy.  A lengthy delay, which we anticipate, would be grudgingly accepted on Wall Street as long as tax cuts look likely within a year or so.

SO WE THINK THE MARKET HICCUP YESTERDAY  was based on anxiety that Ryan – who's always optimistic – may see trouble ahead on taxes. He surely knows that there are huge issues, including the likely death of his pet idea, a 20% border tariff that has become politically radioactive. Ryan has already proved that he can't unify his GOP troops, and his relations with President Trump have cooled.

WE STILL THINK TAX REFORM IS COMING,  but comments like Ryan's inject an element of doubt. At the least, this will be a much longer process than the markets anticipated, probably dragging well into 2018. And if uncertainty over fiscal policy persists, it's possible that Yellen will go slow on rate hikes, waiting until the second half to move again. Do we worry about Yellen? Not really. Do we worry about Republicans like Ryan who can't get their act together? Yes indeed.


April 5, 2017 

Raising Our Odds of a North Korean Strike; Susan Rice Controversy; Tax Reform Trial Balloon Shot Down

DOES NORTH KOREA WANT AN ATTACK?  Firing a ballistic missile just two days before U.S.-China talks seems unusually provocative, even for the erratic Kim Jong-un – unless China, in the ultimate spy novel double-cross, urged North Korea to fire the missile, thus giving Beijing negotiating leverage with Donald Trump, who wants China to curb Kim.

IN ANY EVENT,  the U.S. essentially said this was the last straw – and at some point words have to be backed up by action. The U.S. is furiously injecting "worms" and other computer viruses into the North Korean missile sites, and has placed hundreds of THAAD missiles in South Korea; Lockheed Martin is the prime contractor. But these moves may not be enough – a nd we think odds have risen to at least one-in-three that the U.S. will launch pre-emptive strikes; Trump may state as much to Xi Jinping later this week.

AS FOREIGN CRISES PERCOLATE  in the Korean Peninsula and in Syria, Trump faces his greatest challenge as president. His generals are opposed to the military option against North Korea, but Trump sees the world in personal terms – he loathes being humiliated – and we suspect Kim (and Bashir al-Assad) may have gone too far.

THE SUSAN RICE DIVERSION:  We got some push-back yesterday from readers who think Susan Rice did nothing illegal, or even provable. But that's not the point. Trump now has a diversion from the Russia probe; he can claim that he and his advisers were targeted for surveillance for political purposes. Whether that's true is largely beside the point; there's some plausibility in the claim, which is all he needs to rally his supporters.

TAX TRIAL BALLOON SHOT DOWN:  How to pay for tax cuts? That's a dominant issue without a clear answer. Trump aides floated a trial balloon yesterday – perhaps a value added tax or a carbon tax could pay for lower individual and corporate rates. This trial balloon was almost immediately shot down by House Republicans, who absolutely, positively will not accept either idea.

THIS HAS TWO IMPLICATIONS:  First, the need for revenues to pay for tax cuts is acute, especially as the unpopular border adjustment tax continues to lose support (it would raise about $1 trillion over ten years). What are the other options? Find new sources of revenue like a VAT tax; kill tax breaks and use very optimistic assumptions to make the bill revenue-neutral; or pass a bill that loses a ton of money. We'd bet on the latter.

THE OTHER IMPLICATION  is that Trump aides are scrambling to come up with their own bill, not one written in the House. Speaker Paul Ryan continues to lose support in the White House; his attempt to resurrect an Obamacare reform bill has virtually no chance of winning moderate GOP support, especially in the Senate. "Ryan would support a health bill that would kill the pre-existing conditions provision?" an incredulous Trump ally asked us yesterday, adding: "Does he want us to lose the House next year?"


April 4, 2017 

A Reversal of Fortune for Donald Trump – Thanks to Susan Rice

IN A DEEP SLUMP  since his Feb. 28 speech to Congress, Donald Trump suddenly is on the verge of a turnaround – perhaps reversing market anxiety that his presidency had stalled.

SUSAN RICE, BACK IN THE NEWS:  The key player, incredibly, in this Trump turnaround may be the former Obama national security adviser, Susan Rice. Was there surveillance of Trump advisers during the election? Yes. Were Trump officials "unmasked" by Rice? Possibly. This is the hot new story – and it so muddies the water on the Russian probe that the President can persist with his narrative that he was the victim of surveillance.

WE'RE NOT SURE RICE DID ANYTHING ILLEGAL,  but as the Wall Street Journal argues in a scathing editorial this morning, her testimony under oath could be illuminating. Of all people – the fiercely partisan Susan Rice, the right wing bete noir, whose initial reaction to Benghazi was disingenuous at best.

TRUMP NOW HAS HIS FOIL,  and the public may lose interest amid an eye-glazing "he said, she said," on surveillance. Even partial vindication for Trump is a big deal; it could let him off the hook – assuming, of course, he can refrain from any more self-inflicted wounds.  Actually, he's on the verge of more positive developments.

NEIL GORSUCH WILL WIN CONFIRMATION SOON,  and that unifies the entire Republican Party, which is thrilled with him. Trump is close to a House breakthrough on an Obamacare replacement (the Senate is another issue). And there are signs of movement on tax reform and infrastructure.

WHY THIS MATTERS FOR THE MARKETS:  As one of our regular readers said a couple of weeks ago, it was starting to look like Trump was in over his head after the Obamacare vote. Investors were beginning to wonder if any of his proposals could pass. As we said then and reiterate now – it's premature to conclude that Trump's agenda is dead; it simply will take longer than expected to prevail.

THE PRESS WILL NOT RELENT,  there's a new story in this morning's Washington Post about a Seychelles meeting between a Trump ally and Russians seeking a back-channel arrangement. There will be more stories, but Trump has been handed a gift from Susan Rice – and there's no question he will exploit it.


April 1, 2017 

Five Huge Stories This Week

DESPERATELY IN NEED OF A VICTORY,  President Trump is likely to get one this week, but the Neil Gorsuch nomination isn't the only high-stakes development. There are five big ones:

1. Trump and Xi Jinping:  The Chinese President's visit on Thursday to Mar-a-Lago has two enormous implications – first, are the countries headed toward a trade war? Perhaps, but not now. The two leaders will make their case; tariffs and other action would come later.

Second, the big issue is North Korea, as whispering grows louder in Washington that the U.S. is preparing a strategic strike. That may be posturing, designed to pressure China, but Xi has little influence over the erratic Kim Jong-un. There's a minority view that the U.S. and China could reach a "grand compromise" on trade and Korea, but we'd put odds at no better than 25%.

2. Supreme Court Win for Trump:  One way or another, it looks like the Gorsuch nomination will prevail on Friday. Changing filibuster rules is a huge issue in Washington, but most Americans will view this as a Trump win. A sidebar is the crude threats by left wing activists to defeat moderate Democrats who vote for Gorsuch – a strategy that makes no sense. If Joe Manchin, a Gorsuch supporter, loses the Democrats' primary in West Virginia, his Senate seat almost certainly would go to a Republican.

3. Obamacare Bill Revived:  Trump stated the obvious this weekend – he hates to lose – so he has resurrected efforts to pass an Obamacare replacement. And it just might pass in the House – only to be rejected by the Senate. Why Trump would spend time fighting for a hugely unpopular bill is a mystery; he needs to move on, this bill can't pass – it simply highlights GOP divisions, including opposition by Paul Ryan to any compromise that involves Democrats.

4. Tax Reform is Percolating:  Get ready for a leak a day on how the tax bill is shaping up. The New York Times, weeks behind the curve, reported on Sunday that the border adjustment tax is in trouble. No kidding. There's a more fundamental issue – the White House doesn't trust Congress on a tax bill after the Obamacare fiasco, so Trump aides are preparing their own tax bill. Congressional tax writers want their version – still another example of distrust between the two branches. Nevertheless, a bill will begin to move this spring, a positive story.

5. Unemployment Friday:  A March blizzard, and a typically soft first quarter (blame the seasonal adjustments), could produce a so-so jobs report on Friday; consensus is 177,000 nonfarm payroll jobs. But the longer-term outlook is good, and the Fed has finally hit its 2% inflation target. We still think Janet Yellen is in no rush and will wait until the second half to raise rates twice; talk of winding down the balance sheet is still in the trial balloon phase.

THE TWO ONGOING STORIES:  Democrats are determined to get their way on the budget (no money for a wall, no cuts to Planned Parenthood), and they will prevail because the divided Republicans need their votes, or else a government shutdown on April 28 is possible. And there's no end to the Russian scandal; watch the Senate Intelligence Committee – members are convinced there was collusion between the Trump campaign and Moscow, and the focus soon may shift to the Russian mob.


March 31, 2017 

What We Learned in the First Quarter

The first quarter ends today, and what a quarter it's been. Several major themes have emerged – themes that may persist for the year or longer. Here's our take on the key first quarter themes:

No one can crack the Washington gridlock:  Donald Trump thought he could, and maybe he can. But the No. 1 theme of the first quarter is that it will take twice as long as Trump thought to get his agenda enacted. Washington is glacial, always has been and always will be.

Trump will stay outside the box:  Starting with his bleak Inaugural address, Trump has defied the consensus – he's well outside the box – he's an angry populist who's not afraid to break some furniture. You don't like his tweets, or his threats to conservatives, or hints that he may seek tougher libel laws? Get used to it – Trump is 70, he's not gonna change.

Democrats in the wilderness:  They cheered when the Obamacare bill failed but they had nothing to do with it. Democrats may overplay their hand on Neil Gorsuch and perhaps a government shutdown, but Chuck Schumer has little choice – he's on a very short leash, his base is furious.

No one cares about the deficit:  Not only is no one in Washington talking about deficit reduction, the trend is tilting toward more spending and higher deficits – and both parties are equally complicit. Only one clear winner in this profligate climate: defense stocks.

Worst first quarter:  Paul Ryan, in the penalty box because he misled Trump about the extent of House support for the Obamacare bill. Best first quarter:Gary Cohn, the new power player in the White House – and he's a nominal Democrat!

Biggest first quarter surprise:  It now appears that the 2018 mid-term elections may actually be exciting. The Democrats have an outside chance of taking the House, and the GOP's hopes of adding several seats in the Senate have slipped.

Least surprising first quarter themes:  Bipartisanship is a dead end, it's sounds nice but won't happen. And the least surprising story by far – the party that owns health care always regrets it; health care is a policy albatross.

Russia – a cloud over everything:  The House Intelligence Committee is bogged down in a partisan farce, but the Senate panel – serious and bipartisan – will be worth watching this year. How blatant was Russian involvement with the Trump team? The Senate committee will find out.

Europe back from the brink:  The most strident candidates may have peaked, and the Euro may survive after all. And the economy there has gone from terrible to mediocre – that's real progress.

The Fed is still dovish:  Another couple of rate hikes are likely in 2017 – later rather than sooner, perhaps in response to an economic pickup in the second half. Janet Yellen will go slow, even though the "Taylor Rule" would require a fed funds rate of about 2-½% now. We might not get there for another two or three years.

And in the real world:  Consumers and businesses are increasingly confident, the labor market is booming, the public is not concerned about the House Intelligence Committee or North Carolina bathrooms. The swamp hasn't been drained? Well, most people don't seem to care.

Has Trump been a disappointment?  Of course, but 70 days is not a true test. He's got 40% of the public behind him, and no other politician or party is close to that level of support. Can Trump figure out how to use his political capital? The jury is out – he faces a steep learning curve with no margin for any more unforced errors.

Finding Perspective on Volatility

While my goal when I communicate with you is to convey complex topics simply, once in a while, it’s helpful to go a bit deeper to drive home an important concept. But please stay with me. I’ve had a few discussions lately that made me realize that a reminder like this is helpful.

Since 1965, the annual total return for the S&P 500 Index has averaged 11.2%, with the best return of 37.2% occurring in 1995 and the worst return of -36.6% occurring in 2008. On a side note – while 2008 was a wretched year and nearly all asset classes took a temporary hit, stocks did bounce back nearly 26% the following year.

Over those 50 years, 39 were in the green (78%) and 11 were in the red. So far, this is pretty straightforward and supports the argument that stocks have a place in most portfolios, assuming at least a medium timeframe.

Now it’s time for a slightly deeper dive before I pull it all back together.

Since 1965, the standard deviation (a common measure of how variable returns of a particular asset are) of the annual 11.2% return has been 17%, which means that about 67% of all annual returns should fall between 11.2% plus or minus 17%. Or a range of -5.8% and 28.2%.

If we go out two standard deviations, about 90% of all annual returns should fall between -22.8% and 45.2%.

In reality, we experienced only two of the 50 years outside the range, with both years coming in below -22.8%.

What does all of this mean?

Time to get practical and extract ourselves from the numbers.

This is a high-level review of S&P 500 stock returns and volatility that surround the average annual returns. Some investors easily look past such volatility while others experience sleepless nights at the thought of their portfolio losing “two standard deviations” in one calendar year, even if the odds are low.

Only you know how you will react. That’s why I counsel – Investor, know thyself!  We have had more discussions around the new technologies of risk scoring of portfolios to try to make sure that client’s portfolios match up with their understanding of their situation.

When we are young and may not need any cash for decades, it is usually wise to focus on growth, which carries more risk.  But as we age, preservation of capital, quick access to our funds, and regular income become equally if not more important for many.

The current correction has had less impact on those who have reduced exposure to stocks, but these portfolios trade a reduced long-term expected return for a smoother ride of returns.

Bottom line

Benjamin Graham, known as the “Father of Value Investing” and a favorite of Warren Buffett, once said, “Individuals who cannot master their emotions are ill-suited to profit from the investment process.”  Diversification and an investment roadmap that takes the emotions out of the investment equation have typically been the surest path to financial success.

While it’s easy to adhere to the investment plan when times are good, some investors find it difficult when the road gets a bit rocky.  It’s during times like these that detours tempt the investor. In most cases, however, you’ll wind up in an unfamiliar neighborhood, and the delay will cost you precious time.

In closing, I trust that you have found the September summary and this big picture view to be beneficial and educational. As always, I am humbled that you have placed your trust in my firm. It is something I never take for granted.

I always emphasize that as your financial advisor, it is my job to partner with you. If you ever have any questions about what I’ve conveyed in this month’s message or want to discuss anything else, please feel free to reach out to me.

Data Source: Horsesmouth October client letter

September Review - The Fed Blinks

The September meeting at the Federal Reserve was eagerly anticipated by analysts, economists, and short-term investors because there was the real possibility that central bankers would finally boost the fed funds rate for the first time in almost 10 years.

In case you missed it, the Fed chose not to raise rates in September, but left open the possibility we might see an October or December move. At the press conference that followed the Fed’s decision, Fed Chief Janet Yellen said the economy “has been performing well and impressing us by the pace at which it is creating jobs…” Still, that wasn’t enough for the Fed to pull the trigger.

Instead, worries about what’s happening in China and emerging markets were the primary reason the Fed chose to stay on hold.  In recent days the jobs report came out and did not look very good at all, giving most people the expectation that the Fed may not raise them now this year.  This made for a nice recovery off of a big decline last Monday (currently up about 5% off of those lows this past week), but doesn’t paint a great picture for the current US economy.  Click here to read more insight on the current outlook.

While I believe it is important to monitor various economic indicators and events that have the potential to impact various asset classes, it’s also important to filter out “the noise” that only the shortest-term traders might find of value.


In other words, let’s put the last Fed meeting into perspective. Will it really matter one year, or five years, or 10 years from now that the Fed chose to raise or not raise interest rates at the September 2015 meeting? It won’t.

It’s the long-term that really matters, not the day-to-day or month-to-month gyrations in the market.

While rollercoaster rides can be fun for some (think the short-term or day trader) and unsettling for others, a more mundane approach is usually the best.

As the influential economist Paul Samuelson once said, “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.” It’s why I counsel that it is sometimes best to skip the financial news channels that focus on the ever-changing crisis of the month.

If we properly understand your tolerance for risk, then even those volatile days won’t be very unsettling.

Market Performance through 9-30-15

MTD* %YTD %3-year** %

Dow Jones Industrial Average-1.47-8.63+6.62

NASDAQ Composite-3.67-2.45+14.03

S&P 500 Index-2.64-6.74+10.05

Russell 2000 Index-5.07-8.63+9.54

MSCI World ex-USA***-5.29-8.69+1.90

MSCI Emerging Markets***-3.26-17.18-7.56

Source: Wall Street Journal, MSCI.com, Horsesmouth October client letter

*August 31, 2015 – September 30, 2015


August 2015 - Market Volatility

The markets have had a welcome small bounce back so far today.  To follow up on my email yesterday, I’ve assembled some various thoughts regarding this market volatility from various market sources I receive updates from.  This could get worse before it gets better, but most of my sources still view it in the context of a normal pullback that has been overdue, but without the main structural concerns here in the US like there were in 2008 where we had really weak banking and lending fundamentals and overheated markets and credit (especially with the impact of housing).  Although our markets have been up for the last 6.5 years there has never been a feel of excessive optimism driving prices to unrealistic levels (like what we did see in Chinese stock markets this past year).

Dr. David Kelly from JP Morgan emphasized on a conference call yesterday that short term selloffs are largely about psychology, mid-range market results are about economics, and long-term results are about valuations.  Psychology is going to be what determines what happens in the next days and weeks.  Fear can cause panic selling to continue, but at some point those investors looking at economics and fundamentals will be looking for good buying opportunities.

Mid-range US economics have actually looked pretty good lately (especially with housing, employment, autos etc.) with definite talks of the feeling that the Fed could finally raise interest rates in September (something that seems much less likely now) and valuations are obviously more attractive now than at the beginning of last week (where they were moderately high to fairly valued depending on the metrics used) as we look forward.

China is clearly the big concern (and primary cause of this recent global decline) and I do have concerns that data from China can be less reliable and it’s hard to know the extent to which these market declines can have on the psychology of the Chinese consumers as well as those countries and economies who have had a major reliance on supplying the major Chinese demand over the last 10+ years.  We have seen commodities (from oil to gold, copper, aluminum etc.) all decline significantly affecting many emerging markets.  China devaluing their currency a couple of weeks ago has led to more skepticism regarding central banks around the world being able to sustain their monetary policy decisions without leading to unintended consequences.  There are certainly plenty of intertwined concerns that could be exposed and lead to bigger issues.  For long-term investors I believe that a policy of staying the course (or modifying allocations to be more conservative if you feel uncomfortable with current volatility) is appropriate.  For those with shorter term goals, let’s make sure that your portfolio is in a position you are comfortable with.

PMC – Is this the big one?

Edward Foy – Deja vu (more a reflection of the most recent decline last fall and the nature of how quickly things can turn)

Blackrock – As Markets Plunge some Value surfaces

PFG Market Update

July 2015 Market Update - Greece again.

Before discussing Greece I wanted to briefly hit on the U.S. economy. We previously discussed the slow climb we’ve had out of a deep hole from 2008-09 and we had another speed bump earlier this year. But there has been some good news – the economy seems to be exiting the funk it entered just a few months ago.

You can see it in the pick-up of job creation in April and May, according to data provided by the U.S. Bureau of Labor Statistics. You can see it in the faster pace of housing sales in the all-important spring selling season (National Association of Realtors, U.S. Commerce Department). And you can see it in willingness of consumers to spend (U.S. Bureau of Economic Analysis).

That’s a plus for S&P 500 company profits, which are forecast to rise a modest 2.2% in Q2 versus one year ago, compared to an estimated decline of 2.8% expected at the start of the quarter (Thomson Reuters).

Market performance

MTD %YTD %3-year* %

Dow Jones Industrial Average-2.17-1.1411.01

NASDAQ Composite-1.645.3019.33

S&P 500 Index-2.100.2014.84

Russell 2000 Index0.594.0916.23

MSCI World ex-USA**-2.992.698.23

MSCI Emerging Markets**-3.181.671.23

Source: Wall Street Journal, MSCI.com



But this month, I want to turn my attention to the international arena. In one word, it’s Greece. Greece is a small nation in southern Europe.  In 2014, the U.S. exported $773 million in goods to Greece. That compares with a U.S. economy that totals over $17 trillion (U.S. Bureau of Economic Analysis).

Greece is a beautiful country that is rich in history and culture.  However, simply from an economic standpoint, Greece is too minor to have any effect on thereal U.S. economy.  The worries that are bubbling to the surface are squarely focused on the credit markets, the financial markets, and the banking system. This could have an impact at home.

I’ll get to that in a moment, but before I jump in, a brief history may be helpful to those who aren’t sure what the headlines are about.

December 2009 Credit ratings agencies downgrade Greece on concerns that it could default on its debt.

May 2010 Europe and Greece reach a $146 billion rescue package, which is conditional on austerity measures – first bailout.

March 2012 Private-sector creditors agree to massive restructuring and some write-downs of debt, which frees up more funds – second bailout.

January 2015 Greek voters choose an anti-austerity party that resides on the far left. Alexis Tsipras becomes prime minister.

February 2015 Greece and eurozone creditors extend bailout agreement until the end of June; both agree that any new funds will include reforms.

May 2015 Greece quells fears of an imminent default, authorizing a big loan payment to the International Monetary Fund (IMF).

June 2015 Greece defers a series of debt payments to the IMF until the end of June; it misses a 1.5 billion euro payment to the IMF due June 30.

Sources: NY Times, CNNMoney

Should the latest blow-up be a surprise? Well, not for students of economic history. You see, since Greece became an independent nation in 1829, it has been in default or rescheduling its debt 51% of the time through 2006 (First Trust).

This most recent crisis started in 2009, so financial markets have had plenty of time to prepare. At least that is the prevailing wisdom.

What’s different this time around is that Greece no longer has an independent currency – the drachma. Instead, it is part of the 19-nation European bloc that shares the euro.

No nation that has traded in its old currency for the euro has ever torn up the contract or has been forced to give up the euro. Such an event, if it were to occur, creates a heightened level of uncertainty because markets are woven together.

Short-term, stocks do not like added uncertainty and that accounts the nearly 2% selloff in the Dow on June 29 (MarketWatch).

But let’s put that into perspective. A 350 point daily loss in the Dow does grab headlines, but it is modest when compared with the 4.4% drop registered the day after Lehman Brothers collapsed in September 2008 (Wall Street Journal). Furthermore, the dollar, which we might have expected to surge on safe-haven buying, was little changed against the euro. That could change in the days ahead as this is good short-term barometer of risk.

The June 29 drop in stocks may have just been an excuse to sell, since the decline was preceded by an inordinate amount of complacency in markets over the last couple of months. While Greece has been in the headlines, there had been a general expectation that we’d eventually get some type of “kick-the-can-down-the-road” deal.

Put another way, it would have been a cleverly crafted headline that offers modest progress but fails to address the fundamental issues. It just buys more time.

The financial plans we recommend take into account bumps in the road. Because no knows the future with certainty, it sometimes surprises us when we get big daily moves. Stepping back and taking a broader perspective, it really shouldn’t.

As I’ve counseled on repeated occasions, look past the daily gyrations and keep your focus on the financial plan. The long-term, disciplined investor is the one who has historically been rewarded. The childhood story of the tortoise and the hare comes to mind.

Let’s get back to the central issue – credit markets  

Economically speaking, remember that Greece is too small to impact the global economy. But if it can create significant tremors in credit markets – think the fallout from the collapse of Lehman Brothers in September 2008 – it can leave its mark.

Unlike the Greek crisis of 2010 and 2011, the private sector holds very little in the way of Greek debt – eurozone banks hold about $6 billion (MarketWatch, JP Morgan). Most of it is held by the IMF, the ECB, and European governments Therefore, it is less likely a Greek default would spread across Europe and roil credit markets.

Skeptics, however, would argue that we’re set to enter uncharted waters, raising the possibility of something more serious.

In the aggregate, about $350 billion of Greek debt is at risk, but only around $40 billion resides in commercial banks. Out of that $40 billion, $14 billion is owed to U.S. banks (Guggenheim Investments, MarketWatch).

It really isn’t very much, unless a large bank or hedge fund is overexposed to Greece. In 1998, the collapse of the hedge fund Long Term Capital Management nearly created a financial crisis, which was averted with a hastily arranged rescue package.

Where do we go from here?

For now, the situation is tense and extremely fluid in Europe.

Greek Prime Minister Alexis Tsipras surprised markets when he called a July 5 referendum on creditor demands. A ‘yes’ vote would likely keep Greece in the eurozone and soothe investor anxieties. Still, a deal has to be inked that releases more aid. A ‘no’ vote creates more uncertainty and could force Greece from the eurozone.

Previously, there was the automatic assumption that a default would result in a return of the drachma (its former currency), but that’s unclear at this juncture. A number of possibilities exist, including a parallel currency in Greece.

Or Greece may acquiesce and agree to creditor terms prior to the vote, as reports suggested early in the month. Again, the situation is fluid.

The general consensus suggests that, (with their relatively minor global production & consumption) while it would certainly be difficult short term for the Greek people, a default by Greece should not create treacherous conditions for global financial markets on its own. That would not have been the case in 2010 or 2011 but it is probably the case today since markets have had time to adjust. The bigger concern long-term could be the domino effect on countries like Spain and Portugal, who are similarly vulnerable with far more sizable economies, as well as the impact that it could have on global credit markets and banking systems.  It is obviously something that we will continue to keep a close eye on and will discuss further in a few weeks during our 2015 Mid-Year market outlook webinar as things develop further.

May-June 2015 Market Update

Here are a few interesting facts related to the markets so far this year (source: BTN Research).

The S&P 500 is up +3.2% YTD (total return) through the end of May. The stock index has set 10 all-time record closes this year even though the split between “up” days and “down” days through 5/29/15 was 46/54, (i.e., more “down” days than “up” days).

The best performing individual stock YTD in the S&P 500 gained +83% through the end of May. The worst performing individual stock YTD in the S&P 500 lost 38%.

The # 1 performing stock in the S&P 500 during 2014 has fallen 12.4% YTD through May, while the # 500 performing stock during 2014 has gained +2.8% YTD.

The 3 summer months (June-July-August) have produced an average loss of 0.3% (total return) for the S&P 500 stock index over the last 25 years(1990-2014). However, the stock index has been up the last 3 summers (2012-13-14), gaining +7.9% during the summer of 2012, +0.7% during the summer of 2013 and +4.7% during the summer of 2014.

As always, please click on the Economic & Market Commentary of our site for links to more in-depth updated outlooks.  I thought I would summarize some thoughts from some of the links available there.

From JP Morgan’s “Asset Allocation Views” (highlighting and underlining are mine)

“Selecting a theme that encapsulates the year so far is an unenviable task. The financial media may delight at the tempo of news flow—the sharpest U.S. dollar rise in 50 years, large-scale quantitative easing in Europe, the (now traditional) first-quarter slump in U.S. data and a sharp slide followed by a rebound in oil. But for investors, the sheer multitude of market-moving events might explain the prevailing tone of caution.

For all the frenetic pace of market developments in early 2015, global asset market returns proved remarkably resilient. Developed world equities delivered 4.2% in the year through May 6, and G4 10-year bond (U.S., UK, Japan and Germany) returns were flat. Meanwhile, the VIX—the Market Volatility Index and the often quoted “fear gauge”—actually declined from 19 to 15. So why the palpable sense of foreboding?

In our view, three factors account for the pervasive market skittishness: extrapolation of the soft patch in the U.S., fear over the impact of higher U.S. rates and lingering skepticism over the global recovery. We also believe that many find the length of the current business cycle disorienting.

Notwithstanding soft first-quarter U.S. data, most macro data points show the U.S. economy in mid-cycle. It would be extraordinary for the U.S. to move from a prolonged early-cycle phase directly to late-cycle before the Federal Reserve (Fed) raises rates, but this fear of “policy error” haunts investors. The impacts of the recent European crisis, and the long-term experience of Japan’s underperformance, are cut deep in investors’ memories.

There remains a divergence in growth and policy around the world, and while we expect this to persist through 2015, we also have faith that the world economy is improving. Rising wages and a slower pace of U.S. dollar appreciation should limit the fallout from the Fed’s expected tightening in the third quarter. Meanwhile, European and Japanese policy stimulus is coming in tandem with better data trends.

We expect both data and policy to reinforce the notion that the U.S. economy is in mid-cycle. Paradoxically, the very fear that the economy will lurch to late-cycle or slide into recession will probably restrain the exuberance that is common at the peak of a cycle.

This presents a supportive backdrop for equities. U.S. stocks lagged in early 2015, but cuts to earnings expectations leave a low hurdle for positive surprise. Meanwhile, higher beta markets—Europe and Japan—continue to deliver on earnings as currency weakness boosts output.

The downside risks of overzealous policy tightening or a currency crisis in emerging markets remain; on the upside, a more synchronized global recovery would give a powerful boost to risky assets and send bond yields higher. On balance though, we believe that the themes of divergent global policy, a gradual recovery in Europe and a rebound in U.S. economic strength will dominate the middle part of the year. The growth scare from the first quarter should abate, and while we anticipate some volatility around the first Fed hike, we see a U.S. economy in mid-cycle and a supportive backdrop for risk taking.”


From PIMCO’s “Secular Outlook May 2015 – The New Neutral Revisited”

“Six trends driving global markets

  • Converging to New Normal potential growth rates in developed and emerging economies.
  • Evolving to a re-regulated, better capitalized global banking system.
  • Moving from energy scarcity to energy abundance unlocked by the shale revolution.
  • Accelerating from deflation and toward targeted 2% inflation in the major economies.
  • Shifting (a nascent trend) from a global savings glut supported by lower commodity prices and toward narrowing global imbalances amid stronger global demand, which will depend to some extent on whether China can succeed in making the middle income transition
  • Implementing (another nascent trend) better economic policy in key emerging economies (China, India) as well as key developed economies (eurozone, Japan) with at least the possibility of future breakthroughs in U.S. economic policy (immigration, oil exports, trade promotion authority).

Six key tail risks to the secular trends

  • With trend growth rates and inflation modest, policy rates low, public balance sheets bloated and public debt high, few countries would have room to maneuver to deploy countercyclical policy were the global economy to go into recession within the next five years.
  • The re-regulated, better capitalized global banking system allocates little of its balance sheet to making markets, resulting in greater likelihood of flash crashes, air pockets and trading volatility.
  • The trend away from energy scarcity and toward energy abundance creates big losers as well as winners and is only a net positive for global demand if the winners’ boost in consumption offsets the losers’ cut in consumption and capital spending.
  • Geopolitical conflicts have thus far been taken in stride by markets, but “disaster risk” is to some extent priced into financial assets today and is a source of volatility and downside risk to equity prices and credit spreads   and upside potential to Treasury and Bund prices.
  • The distribution of global inflation outcomes has a right tail as well as a left tail; over our five-year horizon, a breakout of inflation to the upside of central bank inflation targets is not as unlikely as many seem to assume.
  • A trend is called nascent for a reason – there is a risk it does not develop – and there is risk to our optimistic baseline that foresees better economic policy in key emerging and developed economies and the possibility of future breakthroughs in U.S. economic policy over our secular horizon. There remains a tail risk of political polarization in the eurozone and/or a British exit from the European Union. In China, the planned reforms are ambitious, but success is not assured, and capital account liberalization in particular will be challenging to accomplish in the time frame announced. “

From Oppenheimer’s “You Can’t Have One Without the Other

“In this context, we believe global equities would still outperform global bonds. The key point to remember is that on a global basis, top equity performers will likely rotate on a virtually semi-annual basis. U.S. equities were top performers until they gave way to Europe in the past six months, but we’ll probably go back to seeing U.S. equities outperform their European counterparts once again. However, since these short-term turns are so difficult to predict, a diversified global equity portfolio has been and remains our mantra for the time being.”


Finally, I also was interested in this piece by American Funds that talks about the incredible advances of “disruptive technology” and the investment opportunities related with them.  The piece looks at the turnover of companies represented in the S&P 500.  Companies that were represented in the index in 1958 had an average length of representation in the index for 61 years.  Companies currently will average about 18 years.  At the current pace, 75% of the companies represented will be replaced by 2027.  Rapid changes in cloud technology, mobile payment systems, biotech, and music technology are creating major shifts in our everyday lives.  I think it’s valuable to remember as we often hear about the many global, political, and economic concerns that there are a lot of people putting their heads down and focusing on creating business value.

Market Update March 2013

Market updates from JP Morgan & Envestnet PMC

Here are some thoughts (below) from pages 7 & 8 of the most recent JP Morgan Market Bulletin.  For more insights, go to their Market Insights website for good current information.  The Envestnet summary also provides good weekly insights.  Weekly updates can be found by clicking here

“Earnings hand the baton to multiples:

Despite the recent rally, equity valuations remain below their historic averages as seen in Table D (of the attached JP Morgan Market Bulletin from 3-14), which in our view, leaves room for multiple expansion going forward. Nearly every valuation metric in the table still appears lower than its 10 and 15 year average, suggesting there’s still some room to run before we need to concern ourselves with stocks beingtoo expensive. In addition, as highlighted in Chart L, earnings growth has been the sole driver of the post-recession rally, with sentiment-based multiple expansion only contributing during the last two quarters.  In other words, the multiple expansion-led bull market has only just begun. Historically speaking, once earnings growth stabilizes in the single-digit range, we see multiples expanding on average by 4% per year (Chart M). This is significantly more than the -2% average contraction in multiples that has been experienced during robust, albeit unsustainable, double-digit earnings growth. To be clear, by no means do we expect the outsized, +100% market returns that investors have experienced over the past four years to repeat themselves. These returns were driven by a substantial market displacement in 2008, and fortunately, equities have now finally recovered the lost ground. However, as seen in Chart N, an improvement in consumer sentiment to pre-crisis levels in light of less macro uncertainty should help multiples expand. Coupled with stable dividend yields and sustainable earnings growth, these forces should provide mid to high single-digit annual returns, outpacing the traditional alternatives of bonds and cash.

Investment Implications:

–          Despite weak headline numbers, fourth quarter EPS may have been stronger than reported given accounting methods for pensions. Controlling for these changes, fourth quarter growth remained consistent with a moderately healing U.S. economy.

–          Going forward, earnings estimates are clearly too high. While these estimates should fall as the respective quarter approaches, we do not expect markets to be materially affected.

–          Companies remain the leanest they have been in decades, leaving very little room for additional cost cutting and placing the burden of future earnings growth on stronger revenues.

–          As equities surpass their previous peaks and approach historical average valuations, this is not necessarily indicative of negative returns going forward. The removal of macro uncertainty combined with low, albeit sustainable, earnings growth should result in moderate equity market performance for long-term investors.”

Are You Up To Date on College Planning?

I got this article (below in quotes) from a blog from Vance Howard of Howard Capital Management who always has good insights. This in my mind highlights a few important things that I talk with my clients about for those of you have kids planning to go to college:

1) Have an understanding of your Expected Family Contribution (EFC) for various schools well in advance of filling out FAFSA forms in their senior year. Use all appropriate strategies you can to get those numbers as favorable as possible. These are areas I can now provide insight for you on atwww.sandiegocollegeplanning.com. Contact me and I will have you complete the Data Form on that site to get that information.
2) Make sure you talk with your kids (by middle school or early high school) so they have realistic understanding of the costs involved and your ability to help cover costs based on your situation (and as it relates to your retirement, etc.). Along those lines try to avoid debt as much as possible (see the chilling chart below).  I know many kids are coming out with degrees with low pay potential and student loans that will be with them for years and years.  I recently spoke with a couple with $175,000 in student debt.  That’s a tough hole to dig out of.
3) As they get closer to college (ideally in Junior year) invest in working with an organization that can help your kids identify their strengths and career objectives and match them up with an appropriate school that can match up well with them in those areas as well as financially. Minimizing the likelihood of a 5th or 6th year of college due to changing majors is a huge cost saver, but also the whole experience should be more effective for them with that work done up front. Too many kids seem to go to the wrong schools for the wrong reasons. I can help you get connected with a quality organization for that.
4) Make sure you begin saving & investing appropriately as soon as you are able. I have a great College Planning & Savings resource guide that I can email you if you would like me to send it. Email me at jeff@phase4fs.com

“Below is an excerpt from a press release form the New York Federal Reserve from November 27, 2012. We found it very interesting and thought you might also. We have included a chart showing the growth in the cost of a college education against the average earnings of graduates with bachelor’s degrees in real terms. The cost and benefits of a degree have really gotten out of sync. The cost of a college degree is going through the roof while wages have actually fallen in real terms.


NEW YORK – In its latest Quarterly Report on Household Debt and Credit, the Federal Reserve Bank of New York announced that in the third quarter, non-real estate household debt jumped 2.3 percent to $2.7 trillion. The increase was due to a boost in student loans ($42 billion), auto loans ($18 billion) and credit card balances ($2 billion).

The Quarterly Report on Household Debt and Credit is based on data from the New York Fed’s Consumer Credit Panel, a nationally representative random sample drawn from Equifax credit report data. During the third quarter of 2012, total consumer indebtedness shrank $74 billion to $11.31 trillion, a 0.7 percent decrease from the previous quarter. The reduction in overall debt is attributed to a decrease in mortgage debt ($120 billion) and home equity lines of credit ($16 billion), despite mortgage originations increasing for a fourth consecutive quarter.

“The increase in mortgage originations, auto loans and credit card balances suggests that consumers are slowly gaining confidence in their financial position,” said Donghoon Lee, senior economist at the New York Fed. “As consumers feel more comfortable, they may start to make purchases that were previously delayed.”

Outstanding student loan debt now stands at $956 billion, an increase of $42 billion since last quarter. However, of the $42 billion, $23 billion is new debt while the remaining $19 billion is attributed to previously defaulted student loans that have been updated on credit reports this quarter.1 As a result, the percent of student loan balances 90+ days delinquent increased to 11 percent this quarter.2

Other highlights from the report include:
• Outstanding auto loans ($768 billion) are the highest in nearly four years.
• Auto loan balances increased for the sixth consecutive quarter.
• Mortgage debt at $8.03 trillion is at its lowest level since 2006.
• Delinquency rates for mortgages decreased from 6.3 percent to 5.9 percent.
• HELOC delinquency rates remain high by historical standards (4.9 percent).
• New foreclosures are returning to their pre-crisis levels, as about 242,000 consumers had a new foreclosure added to their credit report, the lowest in nearly six years.
• Mortgage originations, which we measure as the appearance of new mortgages on consumer credit reports, rose to $521 billion, the fourth consecutive quarterly increase.
If you would like to learn more, you can go to the New Federal Reserve’s web page to view the report.”

2012 Mid-year market review and outlook

The first half of 2012 was a tale of two quarters. The first quarter represented the strongest start for the U.S. stock market since 1998, with Japan turning in its best first-quarter gains in 24 years. This was largely driven by a reduction of fears about Europe, as well as stronger economic data in the U.S.  The second quarter gave many of those gains back. Of note in the second quarter was that markets were driven by escalating concerns about the future of the European currency union and slowing global growth, accompanied by discouraging data on employment and renewed focus on the capitalization of European and some American banks.  We’ve also seen a slowdown in China and India, putting downward pressure on the prices of oil and other commodities and stocks in general.  There were signs of the European situation stabilizing; after being off 7% in May, markets around the world did recover with a 4% gain in June.

Here’s a summary of global market performance in the first half of 2012, all in dollars. Of note, the global “flight to safety” over the past year has led to a stronger dollar, depressing returns outside the U.S. when denominated in the dollar.

2012     U.S.        Europe     Emerging mkts     Global returns

Q1        +13%          +11%                   +14%                     +12%

Q2        (3%)            (7%)                    (9%)                       (5%)

YTD      +9%           +3%                     +4%                       +6%

12 mo.  +5%             (16%)                   (16%)                    (6%)

On the surface, investors today face a range of unattractive choices.  While stocks appear fairly valued by most measures, the second quarter saw volatility well above historical norms. Holding stocks has always been risky if your time frame is short, but geopolitical uncertainty and market swings can make owning stocks feel especially dangerous today.  There is considerable debate about whether stocks are expensive, cheap, or fairly valued. Some observers express doubts about the sustainability of today’s record corporate profit margins and the enduring impact of debt problems and slow growth around the world. U.S. stocks also show up on the pricey side using models such as the valuation approach advocated by Yale’s Robert Shiller, comparing stock prices to average earnings over the past 10 years, adjusted for inflation.

On the other side, a fair number of reputable analysts view stocks as historically cheap, pointing to attractive ratios of stock prices to book values and measures like multiples of earnings and cash flows. Indeed, using Shiller’s multiple of average 10-year earnings, Europe is inexpensive by historical standards. My view: for long-term investors, stocks globally today provide fair value.

Bonds pose different risks. We’re seeing historically low interest rates, as central banks around the world keep interest rates down to stoke economic growth. Given current inflation, in normal times we would expect to see interest rates about 2% higher than today, but of course these are not normal times.

And, of course, holding cash to eliminate risk from stocks and bonds virtually guarantees depreciation of purchasing power, and for many investors, cash gives them no chance of earning the returns they need to achieve their long-term goals.

Clearly, every client is different and every portfolio is different. That said, even given short-term uncertainty in stocks, I am recommending that most clients move to the upper end of the equity allocation in their risk tolerance profile. That decision is supported by perspectives from two respected investment veterans with long experience on Wall Street, Dan Fuss and Bob Farrell.

Dan Fuss: Replace market risk with company risk

Dan Fuss is vice chairman of Boston-based Loomis, Sayles & Co. With over 50 years of fixed-income experience, he is one of the most highly regarded bond managers of all time. Still actively running money in his mid-70s, Fuss manages a bond fund with over $20 billion in assets that over the past 20 years has been a top performer in its category.

In an April interview with Investment News, Fuss made an unusual recommendation for a bond manager: to sell bonds and buy stocks. The reason relates to the risk of rising interest rates. “We’re in the foothills of a gradual rise in interest rates,” he said. “Once they start to rise, you’re probably looking at a 20- or 30-year secular trend of rising interest rates.”

He went on to say that when the unemployment rate falls to between 6% and 7%, it’s likely that Ben Bernanke and the Federal Reserve Board will alter the policy that has been keeping the interest rate on the 10-year Treasury bill artificially low. “Once that happens, you need to get out of the market risk that’s in fixed income and into the company-specific risk you can find in stocks,” Fuss said.

Bob Farrell: Market rules to remember

In the 1950s, Bob Farrell attended the same masters program at Columbia as Warren Buffett, studying under Benjamin Graham, the father of value investing.  In 1992 after many years in the investment business, Farrell penned 10 rules on investing. Two of those 10 are particularly pertinent today and give me encouragement about stock returns in the mid- and long-term period ahead.  We always hear “this time it’s different” and it can always feel like that in the moment, but we have to try to avoid being too distracted by short term disturbing noise that would have us make decisions that are not in our best long term interest.

Rule 1: Markets return to the mean over time

“Returning to the mean” is another way of saying that over time, performance on stocks will revert to historical averages. The long-term annual return in the U.S. stock market going back to 1926 is 9.8% before inflation and 6.6% after inflation, what’s called the real return. Whenever you have an extended period in which returns exceed the long-term average, chances are a period of underperformance will follow. And the opposite applies as well; a long period of underperformance will be followed by a period of above-average returns.

The 1990s saw average real returns of 14.9% annually, the best decade on record. Then reversion to the mean kicked in, and the following 10 years saw an average annual loss after inflation of 3.4%. Add the two decades together and you get a real return that’s 1% below the long-term average. In essence, it’s taken the last decade to rectify the valuation excesses of the previous 10 years—but with that behind us, history (and Bob Farrell’s rule on reversion) suggest that long-term real returns going forward should be closer to the 6.5% average.

Rule 5: The public buys the most at the top and the least at the bottom

Since the financial crisis, total assets in U.S. fixed-income funds have more than doubled to over $2 trillion, up from $1 trillion at the start of 2008. At the same time, we’ve seen record outflows from U.S. equity funds. To me, this is further indication that, provided you have a time frame of five-plus years and can tolerate the kind of volatility we’ve seen of late, investing in a broadly diversified stock mutual fund portfolio is likely to serve you well.

Implications for your portfolio:

For retired clients, I believe in maintaining secure, liquid funds to cover two to three years of expenses. Having that buffer means that we reduce the risk of having to sell holdings at depressed levels; this also lessens the stress and anxiety for us both.

Given stock valuations and the risk in bonds, for some clients we have recently increased equity weights to the upper end of their range. Of course, market reversals from current levels are always possible; however, taking a long-term view, at current levels there is a strong case for stocks over bonds.

When building equity portfolios, I’ve always advocated strong diversification outside the U.S. This has helped my clients through most of the 2000s and hurt them in other times, such as the past year. Going forward, I have no idea whether the U.S. dollar and market will do better or worse than global markets, but I do know that we represent less than half of investing opportunities around the world and need to stay geographically diversified as a result.

Cash flow from investments continues to be a major focus for many. In an uncertain environment for immediate economic growth and equity returns, we continue to place priority on the cash yield from investments, especially for those in or nearing retirement. In my view, the returns on some REITs, investment-grade corporate bonds, the better-rated high-yield bonds and dividend stocks in selective sectors continue to make these attractive relative to many available alternatives.

February Market Update

It has continued to be a rocky start to 2016 in the financial markets.  The main culprit at the beginning of the year was China and data that suggested a continued slowdown in manufacturing and overall economic output.  This is partially intended as they have been in a continued focus on transition from such a full manufacturing economy to a more consumer-based society, but the numbers have been more negative than hoped for.  In addition to that there was further devaluing of their currency and the markets were spooked there influenced heavily by traders with short term emotional selling, which triggered emotional selling here in the US as well.  As it was in August when China related concerns were also at the forefront, there are so many unknowns regarding Chinese data and also the theories on how a slowdown there will continue to impact commodities, oil, emerging markets (who supply many of the commodities, metals, and natural resources), and ultimately the developed economies of the US and Europe.  China is not going to be in a true recession (at least 2 quarters of negative GDP growth), but their slowdown from double digit growth in the 2000’s to projections in the 6-7% range this year that now some say could go even lower, makes it feel like a recession by their standards.

In general this Chinese trigger has spooked assets globally.  Investor confidence is fragile and this has led to declines in all categories of stocks and other “risk assets”.  Oil has continued to see declines as global supply continues to surpass global demand.  For all of the complaints about falling oil prices and their obvious negative impact on oil companies and certain countries, it seems overlooked that lower oil prices are a big benefit to consumers and other industries, such as airlines.  Savings at the pump over time should lead to some increases in consumer spending.  US exports to China represent only about 1% of US GDP, so a Chinese slowdown is not catastrophic for our growth by itself, and generally US economic data, including housing prices, auto sales and employment, have been pretty strong (Federal Reserve Economic Data).  The broad US stock market is down a little over 11% YTD with large company stocks holding up a bit better than small ones like last year, but with growth stocks doing a bit worse than value, unlike last year.  All sectors are negative, except for utilities, with financial stocks and tech hit hardest.  Foreign markets have generally performed worse than the US to start the year, with the MSCI World (not including US) down 12.43% through February 11.  Bonds have generally been slightly positive (with the exception of High Yield).  Commodities also continue to suffer.  (Morningstar Indexes, Will China’s malaise spread to the U.S. economy? – Morningstar).  For more market updates at any time visit the Market & Economic Updates section of our website.

As always, the temptation to sell in declining markets is understandable.  Headlines, like “Sell everything”, make us question our long-term focus and bring painful memories of 2008.  This piece, from American Funds, reminds us just how frequent 5-20% declines have been historically and how robust the recoveries have been for those who stuck to their long-term plan.  I like the Warren Buffet quote “The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people.”  The biggest challenge with dramatic moves away from your long term allocation plan is the difficulty with knowing when to get back in.  Market recoveries are historically quick and come before everything “feels right”.  I remember March of 2009 with the Dow around 6600 and reading predictions of people saying it could go to 4000 and below.  The temptation to cut losses and sell out was strong.  From the bottom on March 9th, the Dow was up over 10% within a week, 23% within a month, and 33% within 3 months (Yahoo Finance charts).  What I remember most were articles telling people that it was a short term rally that would lead to a double dip recession.  That drop back never came and many investors who should have been long-term investors sat on the sidelines missing out on the significant gains we have seen the last 6 years.

That being said, there are certainly concerns that I have that the fragile nature of investor sentiment could lead to further short-term declines.  For those of you who are having difficulty stomaching the volatility, let’s discuss your accounts in the context of your long-term financial plans.  An allocation shift to more conservative positions or increased use of risk-reduction types of accounts may be worth a conversation, especially if you feel that your goals, time horizon, or something else about your situation has shifted meaningfully.

As always, please let us know if we can help in any way.  All the best, Jeff