Federal tax collections data gives us a leg up on the market, because it tells us what to expect when the lagging economic data indicators are released later. That puts us ahead of the crowd, which is waiting for biased Wall Street pundits to interpret already stale, manipulated data, when it’s finally released. Meanwhile we already know what the facts are.
Tax data has told us whether the lagging economic indicators are promoting a false narrative. Thanks to statistically massaged data, and deliberate, or unknowing misinterpretation by the talking heads, that can go on for months. But we know the facts.
More importantly perhaps, the tax data has told us what the Fed will be seeing when it gets the lagging economic data. That helped us to know whether incoming economic data will keep the Fed on track or not.
Now, however, the picture has gotten fuzzy. The big tax cuts enacted into law at the end of 2017 have begun to impact tax collections. That makes it virtually impossible to analyze year to year changes on a like versus like basis. It will be several months, and perhaps the whole year, before we can make these year to year comparisons in a way that reflects the actual trend of the US economy.
In other words, Trump’s tax cuts are hiding the “big picture” right now when it comes to market predictions.
But fortunately, there’s another “bonus” indicator that tells us what’s going on…
Total Federal Revenues Indicate A Coming Market Downturn
Here’s what we do know right now. Total tax collections in January were UP, despite the tax cut. We can deduce from that the US economy was going gangbusters, at least in the upper echelons of the US income strata. This will only encourage the Fed to continue to tighten, REGARDLESS of how far stocks fall over the intermediate term.
Initial data on monthly tax collections comes via the end of month Daily Treasury Statement, available to us one day after month end. This is unmanipulated, hard data that can give us a clear, real time understanding of the direction of the US economy weeks before the lagging economic data is reported. We merely need to compare year to year growth rates by month to see whether the trend is slowing, heating up, or stable.
A few days later, the Monthly Treasury Statement provides us with a little more detail on several important categories of data. This statement is issued 8 business days after the close of the month. It is useful because it breaks out Social Security taxes from total income tax collections, and provides a breakdown on different types of excise tax collections. This is very helpful in understanding both employment trends, transportation trends, and trends in various sin taxes, which are always an interesting item for understanding personal spending trends.
BUT, thanks to the massive tax cuts enacted at the end of 2017, we’re now handicapped in understanding the year to year differences until next January. The comparisons are no longer like to like and the tax law changes are so arcane, it is virtually impossible to make accurate adjustments to account for the different tax rates.
Even though year to year comparisons will not be valid until next January, when the tax law will have been in effect for 12 months, there is still a good reason to watch the data closely. We can still track how total Federal revenues are impacted. That’s critical information because it directly impacts the amount of Treasury supply that the US government will bring to market. The greater the supply, the greater the downward pressure on bond prices, and secondarily on stocks as well.
And the TBAC has just told us that Treasury supply for the first half of 2018 will be gargantuan. Then over the past week we saw the first actual impact as the Treasury brought $186 billion in net new supply to the market for settlement by the end of the month. We haven’t seen a deluge of supply like this since the TARP financial bailouts in 2008. And we know what happened then.
Source: US Treasury
A Booming Economy Ensures The Fed Will Continue to Tighten
In December I said that “the data told us that the US economy top line growth numbers should remain positive, as those in the upper income strata continue to skew the numbers toward the plus side. Meanwhile, the evidence shows that the bulk of the American people are barely treading water. While top line growth will keep the Fed on track for tightening, ultimately the long term health of the US economy and US business profits will depend on broader participation.”
“In the shorter run, a tightening Fed will soon result in the end of this rally, and the beginning of a bear market later this year. There’s nothing in this data that would deter that.”
We now know that tax collections were also up in January, despite the tax cuts. A calendar anomaly boosted that, but even without that, collections still were up. Employers had apparently yet to implement the changes in withholding tax tables in employee paychecks. That’s coming. The bottom line is that the US economy was still booming in January, and that will keep the Fed on track.
Monthly Treasury Statement
Meanwhile, the trend toward larger deficits since 2015 continues. Government forecasters and the TBAC project that deficits will increase for the foreseeable future. The Joint Committee on Taxation of the US Congress says that the new tax cuts will add $280 billion to the deficit this year. That would result in an increase in an already heavy Treasury supply forecast, which will pressure all markets.
The TBAC just released its estimate of new supply for the first and second quarters of 2018. It calls for $618 billion in net new supply in the first half of 2018. That would put the US on a pace for average deficits of more than $100 billion per month.
They even expect to need to issue $84 billion in new supply from mid-April to mid-May when the Treasury normally pays down debt due to the April tax collection windfall. This is a sea change from the history of big paydowns over those four weeks that typically goosed the stock market. There will be no such benefit this year.
The forecast calls for approximately $190 billion in new supply between now and the end of March. This will add to the pressure that that the Fed is causing by siphoning money from the system under its balance sheet “normalization” program.
Remember, in the bad old days of QE, the Fed printed and pumped enough money into Primary Dealer accounts to fund every dollar of new Treasury supply. Today, they’re not only funding zero new supply, they’re actually taking money out of the system and forcing the Treasury to borrow even more, to raise the cash to pay off the paper that the Fed is redeeming.
It’s downright ghoulish.
The new tax law will cut receipts for the rest of this year. The current annual growth rate is 4.9%, but part of that was due to the extra calendar filing day this January and part of it was due to employers not adjusting the tax withholding to the new tables yet. This will probably be the last month that we’ll see a material year to year increase until at least January 2019.
There’s nothing here to suggest that the Fed will suddenly reverse course and move back toward ease. With the tax cut acting as economic stimulus economic data will probably strengthen over the next several months at least. That should make the Fed even more determined to stay the course of tightening.
Tax receipts as a percentage of outlays have been stable since 2014. On the basis of a 12 month moving average they have stabilized at approximately 85% for the past 24 months. It means that the US is borrowing 15 cents of every Federal Government dollar spent. That’s stimulus. And it has been required just to generate an average 2-2.5% GDP growth rate. Now we’re getting even more stimulus from the tax cut, so we could see much stronger economic numbers in the months ahead.
The tax cut will increase the deficit substantially this year. It will goose the economy, but will also add to Treasury supply at the same time as the Fed is removing money from the system. It is likely to create a classic scenario where the economic data heats up but stock prices begin to fall.
I still see the market as a calling for a systematic program of selling to raise cash, especially if the economic news continues to report stronger growth. It will only mean that those at the top are doing far better, pushing the total growth numbers higher, while the broadest segment of the population merely stagnates at best. Meanwhile the Fed will continue to tighten, which will cause a bear market.
The stock market is currently in a rally phase. If you have not already gotten to your cash target, which I recommended to be 60-70% of your portfolio, more or less depending on your circumstances, then this is a perfect opportunity to move in that direction. The next downdraft will probably carry below the recent lows, and I expect more of that over the next year or two.
The patterns that I see both in the liquidity data and the stock charts still suggest that the stock market is topping out and heading into a bear market. If the bear market hasn’t started already as I think, it’s likely to do so in the second quarter. So I’d still want that hefty cash cushion by March. There will be plenty of buying opportunities to come in the months that follow.