Market Update

Posted on November 10, 2017 by Gemmer Asset

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The equity markets basically waxed and waned depending on the tone of the last tax related headline. This week the Senate introduced their own bill that differed markedly from the House plan, and investors started to question both the timing of passage and even passage itself. For the week the S&P dipped a fraction while small-cap stocks lost -1.3%. The international markets were similarly soft, but none of the declines were too dramatic. China stands out with a +1.8% gain for domestic shares and a similar gain for Hong Kong stocks.


Bond yields moved modestly higher and intermediate-term government bonds lost -0.5% for the week. High-yield struggled and lost -1.0%. The prospect of eliminating the deductibility of interest for some companies is filtering through the market and weighing on the debt of highly leveraged firms. Bank loans held up far better, losing only -0.3%.


Shaping Up for a Solid 4th Quarter


It was a quiet week on the economic news front. The major report was the payrolls number last Friday. October payrolls grew by +261K (chart below) and the unemployment fell a tenth to 4.1%. August’s number were revised up from +169K to +208K and September went from -33K to +18K.


Not bad. And growth in the fourth quarter is tracking at a 3%+ rate according to various surveys. The Atlanta Fed estimate (below) is running at 3.3% while the New York Fed is at 3.2% (not shown).


A lot to Get Done by Year-End


The tax reform saga rolls on. As we all know, the House floated their idea for tax reform a few weeks ago. But everyone knew at the time that the Senate plan would differ, but we just weren’t sure how much. On Thursday the Senate introduced their own bill that differs in some significant ways from the House plan. Key differences include:


– The Senate plan would delay until 2019 the introduction of a headline corporate tax cut from 35% to 20%.


– The Senate proposes keeping the current seven individual tax rates. The house collapses them into four.


– Perhaps the thorniest issue thus far has been how to handle the state and local tax deduction, which allows people to deduct their state and local income, sales and property taxes. The House bill limits the deduction to just property taxes and caps it at $10,000. The Senate plans eliminates everything.


– House Republicans would limit mortgage interest deductions to loans of $500K or less. The Senate sticks with the current $1MM limit.


– Finally, the House wants to eventually repeal the estate tax. The Senate bill doubles the exemption to $11MM but doesn’t kill the tax altogether.


Despite the differences, the core philosophy behind both plans appears similar. Whether we like it or not reconciliation seems likely. Debate on the Senate plan will begin among lawmakers next week.


Is Failure an Option?


Could the current push towards tax reform fail? Without question. Bank Credit Analyst had an interesting take on things this week:


“Will the plan fail? It could, if enough Republican voters turn against it. The latest polling from Pew research shows that Americans no longer think that they pay too much in taxes (chart below).



On the other hand, Republican and Republican-leaning voters do have a problem with the complexity of the tax code, and the proposed plan simplifies taxes for some middle-income households by doubling the standard deduction and repealing the AMT. The White House has already begun stressing this feature given that it polls well with voters. Polling (also) suggests that President Trump remains relatively popular with Republican voters despite his dismal polling with the general public (chart below)… As long as Trump remains more popular with Republican voters than his Republican peers in Congress, we think that he will be able to force the tax plan through both the Senate and the House.”



Of course, the situation with the Alabama Senate race could change the dynamics when it comes to the Senate voting. Time will tell.


Ignore the Noise!!


But should investors react to the tax plan by changing their investment strategy? We’d argue not. A few weeks ago the consulting firm Dalbar Group updated their study of ‘average investor’ returns. This study looks at actual investor statements to determine what they have earned on their accounts over the last twenty years. The chart below shows the ‘average investor’ return compared to different sectors of the market.


As you can see, the ‘average investor’ has earned a little over 2% per year through the end of 2016, only slightly better than inflation and behind 3-month T-Bills. This is largely due to the fact that investors chase fads and think they can time the market. And we are all guilty of this. I’d guess that 95% of us who look at the chart above momentarily think about buying the asset classes that have done well over the last twenty years. “Give me some Small-Cap Value or EM Sovereign Debt” is the refrain. But it is precisely that line of reasoning that leads to poor choices and sub-par returns.


So the tax debate rolls on and the financial media tries to sell magazines or generate clicks by telling investors how they should respond to the proposed tax changes. But Odysseus was probably right:


“Next, where the Sirens dwells, you plough the seas; Their song is death, and makes destruction please. Unblest the man, whom music wins to stay nigh the cursed shore and listen to the lay. No more that wretch shall view the joys of life His blooming offspring, or his beauteous wife! In verdant meads they sport; and wide around lie human bones that whiten all the ground: The ground polluted floats with human gore, And human carnage taints the dreadful shore. Fly swift the dangerous coast: let every ear be stopp’d against the song! ’tis death to hear! Firm to the mast with chains thyself be bound, Nor trust thy virtue to the enchanting sound. If, mad with transport, freedom thou demand, Be every fetter strain’d, and added band to band.”


Basically, ignore the nose!!


Have a good weekend.


Charles Email Sig


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