Emergence of the Swamp Thing?

And so the Trump era begins. I don’t like to talk about politics in these pieces much as I want readers to get an unbiased view on the economy or the financial markets. However, activist governments and central banks can’t be ignored. The U.S. government has enacted few impactful policy changes over the last several years as the political swamp continued its growth in Washington DC. That will change in 2017 as the new administration wants to make changes to healthcare, corporate taxes, infrastructure spending, immigration and personal taxes. That is a lot.

In fact, we did see the first change this weekend as the President signed an order that lays the groundwork for Congress to dismantle the Affordable Care Act (ACA). The most impactful change regarding the ACA will be a repeal of the many taxes that are imbedded within the law as well as reducing the regulatory burden on small business owners regarding labor. We will need to wait until February to see the “Replace” part of “Repeal and Replace” before we dive deeper into how such sectors as healthcare and biotechnology are affected.

Corporate tax reform is on deck. It looks like we may get a reduction to a 20% tax rate from what I can tell from my research. The changes should make the U.S. tax rates competitive within the international stage but details on taxing by territory, for example, may be more important to the financial markets. I am already seeing the street recommend companies that could could benefit from changes to the tax laws such as Apple and General Motors.

Other changes to personal taxes, immigration and infrastructure spending are likely addressed in the second half of 2017 (or later) so its best not too speculate too much, for now.

One major change to Washington will be how special interests behave after being in the driver seat all these years. Will they step aside or will there be a battle behind closed doors to create roadblocks and mazes to preserve their say in legislative matters? The swamp will not be drained easily, so don’t be surprised if we see a Swamp Thing emerge that protects his swampy home from humanity (the people) and supernatural threats (Trump). Will a Swamp Thing emerge to protect the special interests or is change just that easy to vote out of Washington?

Economic & Central Banking Snippets Snippets

  • The European Central Bank (ECB) has maintained its benchmark interest rates this week at record lows and left the pace of its bond purchases unchanged. The no change decision comes after policymakers announced they would be scaling back their €80B quantitative easing program.
  • In a public appearance this week, Janet Yellen has warned that the US risks a “nasty surprise” if it waits too long to continue raising interest rates. This remark comes as China recently cut its holdings of US Treasuries by $66B. (FT)
  • Steven Mnuchin, nominee for US Treasury secretary, may have caused surprise and disappointment on Wall Street on Thursday when he said that although he favored the Volcker rule, it was overly complex and needed refinement. Mnuchin also suggested that a “21st-century Glass-Steagall” Act might be worth considering.
  • Housing starts in the US shot up 11.3% in December compared with November, marking the strongest monthly growth since 2007. Despite the surge, starts are at only 62% of the long-term average for home construction, said Trulia Chief Economist Ralph McLaughlin. Overall housing starts rose 11.6% in December to a 1.226 million unit annual rate.
Housing starts
  • The Philly Fed manufacturing survey was also quite strong, a positive early sign for the next ISM. The headline business sentiment gauge rose to 23.6 in January from 19.7 in December, a two-year high. An ISM-comparable average of the main activity gauges we calculate jumped to 57.7 from 54.7 on big gain in the orders (26.0 v. 14.9) and employment (12.8 v. 3.6) components, also a two-year high and second highest since the recession.
Current general activity
  • There was a 0.8% gain in overall industrial production for the past month. Hard data has not yet reflected much of the surge in business sentiment since the election, resulting in a second year of close to zero growth in manufacturing output. Most of the gain in December was accounted for by a 6.6% rebound in utilities after a 9.7% drop in the prior three months, as more normal winter weather arrived after an unusually warm fall delayed heating demand.
Manufacturing sector: real output
  • Headline CPI inflation rose 0.3% in December for a 2.1% year/year gain this past month. Inflation is starting to accelerate for 2017.
  • Next week’s reports include: Q4 GDP, leading indicators and durable goods orders.

Chart Time!

You will see from the charts that most of the market is in a consolidation mode aside from the technology sector (NASDAQ). I expect we will see new highs across the board soon before we make any kind of top later in Q1. I do see some retail stocks underperforming so that is something to keep an eye on as the retail sector acts as an early warning detector for economic headwinds.

S&P 500 (SPY)
S&P 500 (SPY)
Dow Jones (DIA)
Dow Jones (DIA)
Russell 2000 - Small Caps (IWM ETF)
Russell 2000 – Small Caps (IWM ETF)
10 Year Treasury Yields - TNX
10 Year Treasury Yields – TNX

Market Snippets

  • Morgan Stanley continued an upbeat earnings season for the big US banks on Tuesday morning, posting a near-90% rise in net income. The earnings were attributed to a sharp rise in bond-trading and a solid showing in investment banking.
  • British American Tobacco has agreed to a $49.5B deal to take over Reynolds American in a move that will create the world’s largest listed tobacco company by sales.
  • The creators of Snapchat are expected to retain more than 70% of voting power following the group’s planned IPO. Other investors won’t get any voting power with shares purchased in Snap’s float which should be one of the biggest in 2017. (WSJ)
  • It looks as though the internet may resurrect the business it almost killed. Thanks to growth in Spotify and Apple Music, music streaming has passed the milestone of 100 million paying subscribers worldwide. (FT)
Streaming services
  • A SpaceX rocket successfully launched 10 Iridium Communications’ satellites into orbit following a fiery launchpad explosion that halted operations since September. This is “the beginning of one of the biggest tech refreshes in history,” Iridium CEO Matt Desch declared. The company has a seven-flight contract with SpaceX worth $468.1mm and intends to replace its entire global network with 70 new satellites.
  • Deutsche Bank may withhold bonuses from as many as 90% of its bankers and traders, according to the NY Post. Only the top 10% are expected to receive a bonus for 2016, and those payments may be spread out over the next five years. Deutsche recently settled a mortgage bond probe with the DOJ for $7.2B.
  • Goldman Sachs has capped an unusually bright earnings season for the big US banks, delivering a tripling in fourth-quarter profit that handily beat analysts’ forecasts. Like other banks on Wall Street, Goldman saw a big pick-up in trading activity in Q4.
  • Citigroup produce its first rise in profit as revenues from Citi’s fixed income division rose 36%.
  • The federal control board overseeing Puerto Rico’s finances might accept a revised fiscal plan and extend a debt moratorium until May 1, which would allow for more time to restructuring debt.
  • Credit Suisse recently agreed to a $5.3B settlement with the DOJ over toxic crisis-era mortgages.
  • A billion-dollar global coalition will create new vaccines to protect the world against emerging viruses that could cause catastrophic epidemics. Bill Gates, one of the coalition’s biggest backers said he hoped to cut the time between identifying and deploying a vaccine from as many as 10 years today to less than 12 months. (FT)

International Snippets

  • UK prime minister Theresa May has promised a clean break with the EU, saying that Britain would not “seek to hold on to bits of membership as we leave”. Mrs May said that Britain would seek “a new and equal partnership” with the other 27 countries in the EU — not “anything that leaves us half-in, half-out”.
  • Airbus plans to test a prototype for a self-piloted flying car as a way of avoiding gridlock on city roads by the end of the year. In 2016, Airbus formed a division called Urban Air Mobility that’s exploring concepts such as a vehicle to transport individuals or a helicopter-style vehicle that can carry multiple riders. The aim would be for people to book the vehicle using an app on their smartphone.

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.