Market Update

Posted on October 20, 2017 by Gemmer Asset

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A 30-Year Anniversary


Has it really been 30 years??!! The biggest percentage decline in the Dow ever is hard to forget. After all, you don’t often see almost a quarter of an index’s value wiped out in a single day. Some speculative biotech stock maybe, but the Dow??




But contrary to almost everyone’s expectation, a global depression didn’t come hot on the heels of the crash. Actually, the bull market ran through 1990, and in some ways through 2000. If anything, October 19th, 1987 breathed life into the idea that the Fed had the market’s back. The day after the crash the Fed issued the following statement:


“The Federal Reserve, consistent with its responsibilities as the Nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.”


While only 30 words long, the statement packed a punch. It signaled the Fed’s willingness to fulfill its function as the lender of last resort and may also have prodded skittish banks into fulfilling their responsibilities as intermediaries. And as Bank Credit Analyst notes, it was the start of the Greenspan Put:


“…but Black Monday can be viewed as a policy watershed. After it, the Fed’s conduct of monetary policy has become transparent to the point of oversharing. More meaningfully for investors, it marked the origin of the ‘Greenspan Put,’ the widespread notion among market participants that the Fed would do its best to ward off or mitigate financial market downdrafts.”


Lowest in 44 Years


Not much in terms of new economic data this week. Existing home sales were up a touch in September, but really the story in housing is one of falling inventory levels. Inventory decreased 6.4% year-over-year (blue line below). The number of months worth of supply is right around 4, close to the lowest level since January of 2002.




The other key report for the week was something of a milestone. For the week ending October 14 initial unemployment claims came in at 222,000, down 22,000 from the previous week. This is the lowest level for initial claims since March 31, 1973. Yes, 1973.




At the same time, the number of job openings in the U.S. economy is at the highest level since 2001 (see yellow line in the chart below).




This should be good news for wage growth in the months to come.


I Wish I Could Dynamically Score my Checking Account


Really the big news this week came Thursday night. The U.S. Senate passed a budget vote that lawmakers expect will pave the way towards the tax overhaul plan floated by the administration a few weeks ago. The Senate voted 51 to 49 in favor of a resolution that bakes in the ability to cuts taxes by $1.5 trillion over 10-years with a simple majority vote. The next step will be for the Senate to work with the House to sync up their budget documents. Most analysts think this can happen by early November.


Rand Paul was the notable Republican who voted against the bill, but he has come out publicly saying he will support tax cuts. On Friday he tweeted “”I’m all in for tax cuts @realDonaldTrump, The biggest, boldest cuts possible – and soon!” Somewhat surprisingly, both McCain and Corker voted for the plan as well.


The Thursday agreement also requires Congress to use dynamic scoring when evaluating the upcoming tax proposal. This is a big deal. Look at the table below.




The plan floated a few weeks ago would cost $2.7 trillion over 10-years assuming nothing else changes. However, this needs to fall to $1.5 trillion if it is to pass the Senate with a simple majority vote.


Republicans argue that the tax cuts will partly pay for themselves because growth will go up and tax receipts will increase commensurately. By requiring dynamic scoring this means Congress can make some sort of growth assumption when assessing the cost.


The academic support for this is nebulous at best. But would anyone be shocked that dynamic scoring happens to add, oh, I don’t know, maybe about $1.2 trillion of additional revenue over the next 10-years. That just happens to be the difference between the $2.7 trillion net cost in a static world and the $1.5 trillion number in the budget resolution.


The Possible Earnings Bump


Love it or hate it this thing is going to get pushed pretty hard in the weeks to come. Obviously, the Republican’s feel like they need a win in early 2018 so they can go into the mid-terms with something. What the final proposal looks like is anyone’s guess, but the biggest component will be the corporate tax cut. This is what the market is fixating on at least. As you can see below, analysts think S&P 500 earnings will be $139/share next year.


Goldman Sachs estimates that the earnings boost under the tax plan would be anywhere from $9 to $17 a share. The bulk of this comes through the cut in the corporate tax rate, but the change in how foreign earnings are taxed would also add to the bottom line under an optimistic scenario. They think 2018 earnings could be boosted to between $148 to $156 a share if a plan is actually approved.




This is a big boost and goes a long way towards explaining the robust market the last few weeks. Are there downsides? Without question. But for the now the market is fixating on the earnings growth story. And as we know, the market is like a small child. It can only focus on one thing at a time!!


A Real Time Experiment


So take an economy with the lowest level of unemployment claims in 44 years. Throw in a bit of tax stimulus that might not boost the economy much, but comes at the point in the cycle of full employment. Mix it all together and we have an interesting experiment taking place. Can we push the unemployment rate down below 4% without inflation ticking up? Or will this cycle resemble that out from the 1960s. As you can see below, inflation was tame during the early and mid-60s as unemployment fell from roughly 7% to below 4%. However, starting in early 1966 inflation started to pick up as the economy reached full capacity.




Is this time different? Or does history rhyme? Such will be the dilemma for the next leader of the Fed, whoever that might be.


Have a good weekend.


Charles Email Sig



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