First things first – I hope you’re having a splendidly festive time with your friends and family.
I recently enjoyed a holiday party with my colleagues at Money Map Press, one highlight of which was a vigorous conversation with Shah Gilani about the impact of Trump’s tax cuts on the markets. I have deep respect for Shah’s analysis (and his excellent track record). He actually has an uncanny knack for finding bearish trades in a bullish climate, which the contrarian in me appreciates, and his writing is always incisive and entertaining.
However, on this issue, he is a confirmed bull, while I am a confirmed bear.
We enjoyed our argument immensely.
Then – after taking a bit of a break for some eggnog – I visited my comments section on Sure Money and lo and behold, a smart reader named Jesse had asked me the very same question…
Kismet! It was meant to be.
So without further ado, here’s my response to Jesse (and to Shah), followed by several other incisive reader questions as a nice holiday round-up.
Jesse: Hi Lee. Enjoy your articles. Your views about tax cuts and the market still tanking seem to conflict with what Shah Gilani says. Can you expound on how a tax cut will be bearish? Here is a cut and paste:
“What’s going to happen next is that tax cuts will flood already flush corporations.
They’ll enjoy a 10-year run of record low capital costs, record profit margins, and record profits (especially at giant tech companies) with even more ways to raise cheap capital, fatter profit margins, more profits, and more cash to plow back into their pockets.
By pockets, I mean their stock options packages, the price of their stocks, and the dividends they throw off. It will create more and more momentum, lifting markets higher and higher.
That’s the “miracle.”
Riding the market higher is the only way middle-class Americans are going to get their share. Now and moving forward, if you aren’t in the market, you’re losing money.”
Thanks — Jesse
Lee: Hi Jesse. I have no doubt that Shah will quickly adjust his outlook when the market proves him wrong on this issue (INSERT BIG SMILEY HERE). But all kidding aside, when views are this far apart, it’s obvious that one of us will be proven wrong, and we will need to make the adjustment in outlook as soon as it become apparent that our considered outlook isn’t playing out as expected.
Of course, we might both be proven wrong and the market could trade in a range for a few years. In that case we would both be positioned to take advantage of both declines and rallies.
So here’s how and why I think that a tax cut will be bearish.
There’s no doubt in my mind that tax cuts will goose the economy for a time. But eventually the corporate CEO and CFO class will find ways to divert the extra cash into their own pockets, just as they did with QE. Ultimately, the long run beneficial effect to the economy is questionable, and more importantly, irrelevant. They are second order effects.
The first order effects are these.
Federal tax revenues will decline and the deficit will grow. The US Treasury will be forced to sell more debt to cover the shortfall. That will put supply pressure on both the bond and stock markets.
Remember, at the same time the Fed will be pulling money out of the system. Instead of the Fed essentially buying or funding the purchase of Treasuries as it did under QE, it will now be reducing the amount of cash available to absorb the massive amount of new Treasury debt that will hit the market every month.
By next October the Fed will be draining $50 billion in cash from the market. That will force the buyers of new Treasury debt to liquidate something at the margin. It could be either other Treasury paper, or stocks or both. This will only add to the supply pressure. As stock and bond prices fall, margin calls will follow. That will both destroy cash as it is used to retire the margin loans, and it will also add to supply pressure.
So the tax cuts may well boost GDP a bit, and might even prove a one-time boost to corporate profits. But any acceleration in the top line economic numbers will only encourage the Fed to remain on a course of credit tightening.
And that brings us to Rule Number 1. “Don’t fight the Fed.” If the tax cuts have the intended effect of boosting the economy for a while, then that will be bearish because it will encourage the Fed to stay tight.
Markets top out when the news is good. So I think that this tax cut will prove to be a quintessential case of sell the news. Markets don’t top out on a dime, however. We don’t have to sell everything all at once. That’s why I’ve been recommending selling small amounts of stock at regular intervals to reach 60-70% cash by the end of January, or the end of Q1 at the latest. If by then the market hasn’t signaled weakness, I’ll have to consider whether to redeploy cash. If my analysis is correct, it won’t come to that, and we’ll be well positioned to protect against and take advantage of the decline I expect to come.
Stay tuned right here for any change in that outlook as we chronicle the changing liquidity and technical picture of the markets.
And now another intelligent reader who has questions about the tax cut (and other things).
Steve: Lee, Hi. Your articles are always very informative and compelling. There are a few open items: 1) 2800 on SPY – could be. However, what happens if the Trump “tax bill” (intentionally put in quotes because it is a caricature) passes – doesn’t the market tend to sell the news? Are you simply counting on people simply and blindly buying the madness of a “Santa Claus” reality, and how much is a Santa Claus rally typically worth?
2) On a related point – who is actually buying bonds and why in light of your analysis. I noticed that when the debt ceiling came into place in March of 2017 the debt level was frozen at ~$19.8 trillion. Now we are circa $20.5 trillion in about 3 months! That is a ton of bonds. You said the ECB purchases at a rate of $60 billion per month. You indicated that the Fed has started Q/T albeit at a very slow pace. Even if you consider the BoJ – appears to be a shortfall. Who are the buyers and why? In short, yes – we could hit 2800-ish but just seems that that some numbers are not adding up from a Wall Street “Examiner” standpoint. There also seem to be several factors on the horizon (Q/T, Korea, China, Sell the News on the “Tax Bill”) that could roil the markets quickly.
Your choice on responding – just trying to get a congruent view. Thanks Lee and good luck.
Lee: Hi Steve! There are many questions there and I have a simple answer. Markets float on a sea of liquidity. As liquidity rises so do prices and vice versa. There’s also a cyclical component to price motion, which I attempt to measure and forecast via Cycle Analysis.
One thing I do not do is get into hypotheticals, or “reasons” why. As Alfred, Lord Tennyson famously told us in The Charge of the Light Brigade, “Ours not to reason why, ours but to do and die.” This is what successful traders do. They religiously follow the trading discipline imposed by their method of reading the charts. They don’t concern themselves with news very much at all, except when the news creates countertrend entry and exit opportunities.
But yes, I would not be surprised to see the market sell the news when the tax bill passes. Whether that will be the final top or not, I’ll guesstimate when the charts tell me so. My analytical framework tells me to expect a top in January, or at least in the first quarter, based on liquidity analysis. And my technical work suggested a top somewhere in the 2750 area, perhaps 2800. We’re almost there. When I see sell signals on intermediate indicators, I’m prepared to believe them, and act on that.
I am, if possible, even more bearish on bonds than stocks. I cover the Treasury market in my Wall Street Examiner Pro Trader Treasury Supply and Demand Reports. As the Fed pulls cash out of the system, and the Treasury issues more debt to replace the lost revenue from the tax cuts, the supply/demand equation for Treasuries will grow increasingly unfavorable. As liquidity shrinks that will also affect stocks.
So, yes, I am bearish on both stocks and bonds for 2018. But first, as for stocks, Rule Number 2, “The trend is your friend. Don’t fight the tape,” is running the show. Cycles and trends point to a likely high in the 2750-2800 range. So far, the S&P has reached 2695. We’re less than 2% away. I’m very much alert to the possibility of technical sell signals at any time.
TA is like your GPS. If you take a turn that wasn’t in the plan, it recalculates. So it is for TA. We’re headed to the destination, but the route may vary and we’ll respond accordingly.
And finally, a kind compliment from Rhea, which I much appreciate.
Rhea: Your picture is perfect. You look like you’re ready to take on the world and win, and you look excited to do so… And your picture is right. The information is wonderful. NO ONE is calling a top, with a time frame, except you, at least no one I’m listening to.
Lee: Thanks for the kind words, Rhea. I am truly excited to be able to communicate directly with you and with millions of individual investors like you. It’s my honor and privilege to share my analysis and thoughts about our financial system with you from this great platform.
My analysis melds together liquidity analysis with cyclical/technical analysis. Liquidity analysis includes what the policy makers literally tell us about what’s coming in terms of the macro funds that will be available to fuel demand for stocks and bonds. Cycle analysis, based on the groundbreaking theory of JM Hurst in the late 1960s and early 1970s, also provides us with the ability to estimate both price targets and time windows.
Combining those two approaches enables me to forecast likely turning points in the markets with greater specificity than most analysts who rely on more traditional, individual approaches would attempt.
Thanks to all for your comments. They help me to question my own analysis as I always must, and to understand clearly the issues that you consider most important.
There were more great questions than I could answer in a single issue, so watch out for a part 2 very soon.
Have a happy New Year!