Looking for a Catalyst

An activist government is hard at work for the first time in many years. It will be several months before we see traction with regard to trade, GDP or jobs as the President continues his efforts to rebuild the middle class by cajoling the private sector to build in America. February should bring more clarity regarding the healthcare law and corporate taxes which will frame out government deficits and spending for the next several years.

By the way, its earnings season so don’t forget that among all the political headlines. However, it does seem that the market is looking past this earnings season given the potential outcomes for trade and tax policy. So far, I haven’t seen much of a disappointment in earnings (except for retail) so I don’t see much downside risk for the general market from what’s been reported. A disappointment in policy outcomes may be a catalyst for a move lower but the equity markets still look poised to move higher, in my opinion (see the Chart Time! section below).

For the first time in several years the markets are not wound up regarding every little word from the Fed. If growth picks up in 2017 then we all know they will raise interest rates and begin efforts to reduce their balance sheet. The first meeting of the year is this week so our President may be robbed of a few hours of air time on Wednesday. I don’t expect any surprises and neither does the market as policy changes are taking center stage, anyway.

I have included a new section for the time being to keep track of the policy changes that may affect the performance of the financial markets. It will likely be a part of the Market Update for the next several weeks or months.

Economic & Central Banking Snippets

  • U.S. existing-home sales fell in December, suggesting that limited inventories, climbing prices and higher mortgage rates will hold back the market in 2017. Mortgage rates have risen over 50 bp since the election, and mortgage credit availability remains a problem, but the largest restraint on home sales last year according to the National Association of Realtors was lack of homes for sale.
  • Business activity in the Eurozone fell in January as measured by the Purchasing Managers Index reading which fell to 54.3 from 54.4 in December. The reading was one of the highest over the past five years. It signals respectable GDP growth.
  • Following sharp falls in the lira, Turkey’s central bank hiked its overnight lending rate by 75 bps to 9.25%. The lira is the worst performing currency of the year (-7%) as investors have been unnerved by political uncertainty, a slowing economy and the potential for a central bank becoming less than independent from its government.
  • In line with decline in the pending home sales index to a ten-month low in November, existing home sales (which are counted at closing) declined 2.8% in December to a four-month low of 5.49 million units annualized.
  • Japanese exports were stronger than expected in December, growing for the first time in 15 months as exports to Asia rose and a weak yen helped lift trade surplus.
  • The UK economy continues to grow as the economy grew at a rate 0.6% in Q4. Growth for the year as a whole was 2.0% which was in-line with a growth rate of 2.2% in 2015.

The Trump T(i)rade

  • This week, President Trump formally withdrew from TPP, promised to renegotiate NAFTA, placed a hiring freeze on federal employees, discussed slashing business regulations by 75%, reinstated the Mexico City policy and vowed to stop the seizure of South China Sea islands.
  • Corporate Taxes: The average corporate tax rate paid by the S&P 500 companies is 22.8% (effective cash tax) while the Russell 2000 (small caps) is 32%. Therefore, the smaller U.S. based companies get a more substantial tax benefit out of a lower corporate tax rate. (Bear Traps Report)
Effective tax rate per sector
  • Treaties & Executive Agreements: Many believe agreements such as the North American Free Trade Agreement (NAFTA) are legal treaties under U.S, law – they are not. Under the U.S. Constitution, treaties must be ratified by a 2/3 vote in the Senate and are subsequently only repealable by a subsequent 2/3 vote. Treaties like NAFTA are instead called “Executive Agreements,” out of which the Executive has unilateral authority to withdraw. In addition to NAFTA and other agreements, the same goes for the participation of the United States in the World Trade Organization (WTO). (Bear Traps Report)
  • Under The Trade Expansion Act of 1962, the President may impose tariffs or quotas as needed in order to counteract a national security threat posed by imports. The definition of “national security threat” rests with the President.
  • The Trade Act of 1974 gives the President the power to withdraw from trade agreements and authority to impose tariffs of up to 15% (or quotas) for 150 days against countries with large trade imbalances. The President is also empowered to retaliate against countries which the Executive deems not to be living up to their free trade agreements.
  • The U.S. currently runs a trade deficit of $58B with Mexico. As 80% of Mexican exports go to the United States, Mexico has a vested interest in maintaining their current trade relations with the U.S. Trump’s threat to cut off Mexican investment by American companies has large consequences that go beyond just Mexico. Many countries have been enriched by the cheap wages offered by Mexican workers. Including benefits, the average auto worker in the U.S. takes home $58 an hour, in Mexico it is closer to $8 (cheaper than China). (Bear Traps Report)
U.S. exports as % of GDP
  • Building a Border Wall: U.S. Senate Majority Leader Mitch McConnell said Jan. 26 that he expects President Donald Trump’s proposed border wall with Mexico to cost between from $12 to $15 billion, CNN reported. Estimates about the final cost of the wall have varied widely and will depend on a variety of factors, including terrain, the presence of necessary infrastructure such as roads, and the acquirement of land in the wall’s path. (STRATFOR)
  • TransCanada has re-submitted its application to build the controversial Keystone XL oil pipeline. The Canadian company is seeking approval for an $8B pipeline that would carry oil from Alberta to refineries in the US.

Chart Time!

Markets made new highs this week and looked poised to continue the trend. See the charts below:

S&P 500 (SPY)
S&P 500 (SPY)

The Dow Jones Industrial Average on Wednesday rose above 20,000 for the first time this week!

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

  • Quicken Loans is coming under increased regulatory scrutiny as it has become the second-largest retail mortgage lender after originating $96B in loans last year. (NYT)
  • This week McDonald’s reported earnings and that global comparable-store sales increased 2.7% in Q4. Total revenues were down 5%, however, impacted negatively by eight percentage points from foreign exchange swings (ouch).
  • Chinese manufacturer, Foxconn, is considering a joint $7B investment with Apple for a highly automated display facility in the U.S. The production site would eventually create 30,000 to 50,000 jobs, Foxconn CEO told the press, according to Nikkei. While American manufacturing is typically more expensive, Foxconn claimed that growing demand for larger display panels made U.S. production a better option than importing parts from China.
  • U.S. District Judge John D. Bates blocked the proposed $34 billion merger between Aetna and Humana due to antitrust issues. The DoJ proved that a merger of the healthcare companies would pose a threat to competition.
  • Executives at some of the biggest Wall Street banks have sold nearly $100 million worth of stock since the presidential election. At Morgan Stanley, for instance, chief executive James Gorman sold shares three days after the presidential election, the first time he has done so in six years. (WSJ)
  • American Airlines is getting rid of seat-back screens in its new fleet of domestic Boeing aircraft. The carrier reasoned that with over 90% of passengers bringing their own device on board these days, the screens are unnecessary. “We’ve committed to investing in fast satellite-based Internet access and power at every seat,” American Air said in a statement.
  • So much for the first tech IPO of the year. In a move that may signal a hot IPO market, Cisco bought AppDynamics for $3.7B, one day before the company was scheduled to IPO at a valuation near $2B. AppDynamics develops software to help businesses monitor their mobile apps and websites, and generated revenue of $158.4M in the first nine months of 2016, up 54% from the prior year.

International Snippets

  • Theresa May intends to visit China to shore up Britain’s trading arrangements with the world’s second-largest economy. The visit will represent an attempt to strengthen Britain’s global trading links.
  • The UK’s highest court ruled on Tuesday that the government must hold a parliamentary vote before triggering Article 50 to leave the EU.
  • UK telecom company BT increased the scale of its write-downs in its Italian business over “improper behavior” to £530m from an earlier estimate of £145m. BT appointed a new CEO for its Italian business and suspended a number of the senior management team in the country.
  • Jose Cuervo is planning a Feb. 8 pricing for its delayed Mexican IPO listing in an effort to raise $1B. The company put its IPO on hold twice last year after the election of Donald Trump sent the peso to record lows and spurred fears of an economic slowdown. Jose Cuervo traces its roots back to the early 18th century.
  • Egypt raised $4B of debt on Tuesday in the country’s first public bond offering since it devalued its currency and turned to the International Monetary Fund for assistance last autumn. The offering had 5/10/30 year maturities and attracted orders of roughly $13.5B showing a healthy demand for high-yielding emerging market debt. The 5 year notes priced with a yield of 6.125% while the 10 and 30-year bonds priced with a yield of 7.5% and 8.5%, respectively. (FT)
  • Royal Bank of Scotland has set aside $3.8B to cover a potential penalty from US authorities regarding the sale of toxic mortgage securities which helped to fuel the 2008 market meltdown. The provision takes the total amount that RBS has earmarked to pay the impending fines to $8.3B.

Paul McCarthy

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