Dear Valued Clients and Friends,
This was a pretty amazing week in the news cycle as we had a big special election, significant movement in conference (where the House and Senate are trying to reconcile their tax bills), and the Fed moved on interest rates. Bitcoin began trading on the futures market. It reached 25 degrees in New York City. And yes, through it all, the world continues to turn. This week’s Dividend Café is going to cover all of these news cycle items and look at some of the credible fears of a market reversal. So with all that said, let’s get into it …
Reforming tax reform
The rather significant development in tax reform this week is that the conference presently under way to reconcile the House and Senate bill has apparently concluded, or is set to successfully conclude, and produced some meaningful improvements. I am so exhausted by all the moving parts here that I really am tempted to just wait until the final bill comes out of conference, but the following modifications appear to be set for the final bill:
- A 37% top rate on income rates (instead of the 39.6% current rate and 38.5% in the Senate rate)
- A 21% corporate rate instead of 20% previous plan (and vs. the 35% current rate). This is presumably the “pay for” relative to the reduction in top marginal income rate
- A 750k level for mortgage interest deduction in future home purchases (was 500k in House plan but $1 million in Senate)
- The corporate rate will kick in 2018 instead of 2019
- The stealth increase on capital gain tax whereby they were going to force investors to sell their first purchased shares first vs. giving investors custom choice on tax lots is being scrapped
- Corporate AMT is now scrapped all together
Some details are still forthcoming around final decisions on pass-through entities but more or less the reconciled House/Senate bills appear ready for vote, and Presidential signature. The changes listed above add to the market-friendliness and pro-growth capacity of the legislation. There appears to be on the horizon a historical event set to take place before the end of the calendar year.
Anything else to say on Bitcoin?
The questions are not likely to stop because the hype around this maniacal move higher is so violent, so some talking points are in order:
– There is no need for people who wouldn’t touch this mania with a ten-foot pole to predict when it will drop or how far it will drop; the avoidance is not and should not be based on any such fake crystal ball reading – it should be based on the violent lessons of history
– What are those lessons? That any time hordes of people begin buying something they don’t understand for no other reason than speculative hope, it eventually ends in tears. There are always lucky souls who have the good fortune to sell Pets.com at $140 or flip out of their Vegas condos in 2007 before a 100% drop in the former and 75% drop in the latter, but trying to be that person is gambling, not investing. And it is delusional
– This is not a comment about bitcoin as a future medium of exchange, which is also something we think will end badly. It is a comment about the history of manias, for which there are NO EXCEPTIONS – the most naive and uninformed becomes the greater fools in a vicious exercise of greater fool theory, and unspeakable economic value deterioration is done
– Sorry – but there has almost never been a substitute for diligent and fundamental investing – and there likely never will be
– They give free cocktails in Vegas
With jobs like this, who needs tax cuts?
It actually saddens me to think anyone may read that headline and not read the paragraph I am presently typing. Yes, there is a school of thought that says with the economy at near full-employment, tax cuts are a bad idea as they risk overheating the economy. This school of thought (often Keynesian, traditional Phillips Curvers) fails to recognize the difference between inflationary growth (monetary driven) and productive growth (the heart of a free enterprise economy). And of course, the presupposition in the belief is that the purpose of tax cuts is merely economic stimulus, and not returning to taxpayers what is rightly theirs, and that the most optimal allocation of capital exists where there is profit motive and private enterprise.
But yes, the employment picture is truly strong, as the 228,000 new jobs in November far outperformed expectations, and past month revisions netted an additional 30,000 (1). Average hourly earnings are up 4.8% from a year ago (a key metric and one very relevant to how the Trump administration will be judged). Three rate hikes seem inevitable next year, with four now on the table. And of course, all of that (meaning Fed rate scenarios) are subject to change at any time.
In non-news, the Fed raised rates this week
Yes, the Fed raised rates again 25 basis points (one-quarter of one percentage point), as expected.
Note what the futures market was telling us about a Fed rate hike in advance of their actual announcement:
* CME Group, December 11, 2017
It isn’t very common that the market would price in a 85% chance of something and it not happen.
Now what is the market saying about the likelihood of a rate hike in March? Roughly 65% odds, and that is before tax reform has passed.
* Bloomberg, December 11, 2017
Energized for 2018
Are we perma-bulls on the energy sector at The Bahnsen Group? Not at all. In fact, we have always been highly selective in our energy sector weightings and preferences. We have been rather long term energy infrastructure bulls, particularly around midstream assets (pipelines for transportation and storage), but that has a lot more to do with commodity price agnosticism, dividend yield (and dividend growth), and then the secular story behind it all. We became bulls on the integrated energy plays (those with business in the upstream, midstream, and downstream spaces) in early 2016 due to the value offered us in that oil price downturn. We have been richly rewarded in that decision. So as value investors, it is true that energy has been a focus for some time due to its value characteristics since the 2014 oil collapse, but as is always the true with value investments, timing is a different story altogether.
We are quite bullish across much of the space entering the new year. We have had a fantastic equity year in 2017, and yet energy has not participated. The commodity prices have recovered more than the stock prices, and that affords us some degree of margin. Strong companies have persevered extraordinarily well through the rough times, and positioned themselves for greater competitive advantages in the next cycle. Global economies are all growing, leading to more fossil fuel consumption. And as we have written about all year, the current Presidential administration is extremely friendly to the sector in terms of new project approvals and deregulation. The full expensing of capital expenditures written into the tax bill is a game changer, in our opinion.
An old foe coming back to fight
I firmly believe that inflation will be the conversation of 2018, drastically changing the major conversation investors have been having for many years. This does not mean we will see it, or see it in significant levels. And it does not mean other countries will be celebrating a complete victory over deflation. But it does mean that inflation threats will be the story of 2018, as people shift portfolios to deal with a paradigm shift in risk management. More to come on this crucial issue!
Can the Fed tighten their way to a bear market?
Of course, they could! Most bear markets start with central bank tightening, meaning, higher rates and the contraction of money supply and liquidity to cool down heated economic forces. But will they? We have been so accustomed to perma-dovishness from the Federal Reserve that it has created too many false alarms to count that Fed activity was about to pour water on the bull market. Our view is that current Fed “tightening” (small incremental interest rate hikes and painfully slow roll-off of the balance sheet) is really better called “normalization,” and that for the central bank to pop the bull market they would have to tighten in excess of the natural interest rate that inflation levels warrant. Could they get ahead of themselves? Sure. But right now those warnings have proven highly premature.
Fixing our eyes on Fixed Income
Emerging markets debt has had an extraordinary run in 2017, and a blip higher in the last few weeks as well as emerging currencies have largely moved higher relative to U.S. dollar. Many credit instruments appear over-valued or best case fully valued. Municipal bonds enjoyed a strong 2017, but have flat-lined lately as interest rates have inched higher vs. earlier lows, and questions have surfaced as to what the tax reform bill will mean for muni investors, but also muni issuers. Securitized credit has had a strong year, but also leveled out in Q4.
We enter 2018 believing rates will finally move up a bit between Fed policy and genuine economic growth (the kind that has been lacking for so long). But we also enter 2018 believing credit is frothy if not dangerous. Those who believe the stock market offers a lot of questions right now would really get their brain tied in a knot by the bond market.
Protection from Protectionism
When President Trump was elected, our thesis was that the big benefit to markets would be in tax reform and the big risk to markets would be in anti-trade policies. A year later, tax reform appears ready to pass, and yet anti-trade policy has not come close to matching anti-trade rhetoric (the old bark/bite distinction common in politics). But has the stunning move up in stock prices since President Trump was elected really been about tax reform? If one were looking for an explanation within the Trumpian-political list of possibilities, deregulation has been a far lower hanging fruit. But one could also argue – the fortunate avoidance of implementing anti-growth protectionist policies has been a very good thing as well. Sometimes the bad news that doesn’t come moves markets as much as the good news that does.
Chart of the Week
There is too much negativity in the world today to not point out some of the truly amazing things happening in the world. The Chart of the Week we offer in this Dividend Café is perhaps more important to human flourishing, AND markets, than any chart we have ever put forward.
Quote of the Week
“Sometimes the first duty of intelligent men is the restatement of the obvious.”
~ George Orwell
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We have a lot of very exciting announcements coming as far as new additions to The Bahnsen Group team coming as we enter 2018. We plan to enter the new year with the strongest team of investment advisors, analysts, and service and operations personnel we have ever had. We have no less than three new people joining the team (all in service and operations) and have hired a new analyst already. I’ll wait for the finalization of these hires to send details, but we are very, very excited, and it is a serious indicator of how determined we are to be the top service and operations wealth management business in the country.
We also want to be the top investment services practice in the country. That does not mean each and every month our stocks going up more than someone else’s stocks; it means each and every second we operate under a thoughtful philosophy and diligent commitment to executing it proficiently. It means understanding the economy, understanding markets, and resisting the great distractions put in front of mature investors from time to time.
And we want to be thought leaders. We want our clients to be smart investors, and we create a lot of content to help facilitate that. We are completely revolutionizing plans for our 2018 podcast, and our Dividend Café properties will remain as robust as ever!
So to all these ends we work. Enjoy your weekends. And if you are looking for a Christmas idea, feel free to consider Crisis of Responsibility (www.CrisisOfResponsibility.com)! =)
David L. Bahnsen, CFP®, CIMA®
Chief Investment Officer, Managing Partner
(1) First Trust, Data Watch, Brian Wesbury, December 8, 2017
The Bahnsen Group is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.
This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.
All data and information reference herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary, it does not constitute investment advice. The team and HighTower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.
This document was created for informational purposes only; the opinions expressed are solely those of the team and do not represent those of HighTower Advisors, LLC, or any of its affiliates.
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