The Way To Profit From Suddenly Soaring Tax Collections Is Not What You Think

Withholding tax collections soared in the second half of November after a very weak start. Is the surge an anomaly, or is it a sign of a final explosive blowoff in the US economy? Maybe it’s both. We’ll need to watch the data in the next few weeks to see how quickly this surge dissipates. They always do.

Over the years that I have been tracking withholding tax collections I have noticed that just as JP Morgan said about stock prices, “tax collections will fluctuate.” There’s a regular cycle of increases and decreases that typically runs 2 to 4 months. The surge that we just had is much larger than normal, but typical time wise. The next pullback is due to start any day now.

Now, you may be wondering what these withholding taxes tell us about Friday’s employment report, coming soon to a TV screen or web browser near you. Unfortunately, there are too many conflicting signals in the data to draw conclusions about the November jobs report.

With apologies to Hall and Oates, it doesn’t really matter any way. You can rely on the Fed’s less money, you can rely on the less Fed’s money.

With that in mind here’s what we can learn from this data that is absolutely critical to the health of your portfolio.

There’s No Change In The Trend And That’s Bad News

There’s no sign of any meaningful change in the trend of withholding tax collections that would presage weaker economic data.  So there’s nothing on the horizon that would deter the Fed from staying its course of reducing the amount of money in the system. In fact, if this withholding tax collection spike sticks, it would make the Fed even more determined to keep tightening.

And the market won’t like that.

Despite this pickup in withholding in the second half of November and the first few days of December, tax collections were still down for the whole month. Revenues continue to trail the year ago periods by about $25 billion or so per month. That’s cash that the government must raise in the market by selling debt. And those debt sales suck capital out of an ever diminishing pool of cash, thanks to Fed bloodletting.


I’ve long observed that in the big picture economic cycles, business people seem to take their hiring and firing cues from stock prices. Are companies now even micromanaging workers according to the shorter term swings in the stock market? In the beginning of the month, withholding tax collections were extremely weak. When stocks plunged in October, withholding collections fell. Employers may have cut back a little on hiring or hours in response to the plunge in stock prices that month.

But then stocks rallied from the end of October until November 9. They sold off mid month, then rallied hard after Turkey Day. Did employers take the cue from those rallies to ramp up again? If so, boy have they gotten whipsawed over the past 2 days!

Should It Matter To You That Employers Are Following The Stock Market?

Now if big employers really are doing that, it still wouldn’t help our trading at all. Even in real time, it’s a lagging indicator. The stock market leads because it responds virtually immediately to changes in liquidity. Everything else follows.

The media spends countless hours trying to convince you that you must follow the economy to understand the market and trade it successfully.

In fact, it’s the other way around. If the market leads, and the economy lags, then what possible use is there in trying to divine what the economy will do next? There is none. The only things that matter are what the Fed and Treasury are doing right now to impact liquidity.

That’s where tax collections come in. And miracle of miracles, the government gives us the raw data virtually in real time every day with but a one day lag. All we need to do is collect it and chart it. The Treasury isn’t so kind to do that for us, but I’ve been doing it for a very long time, so you don’t have to.

Falling Revenues Mean Money Will Tighten, Here’s How To Profit

The crucial point is this. US government revenue is still falling well below the same period of 2017, as the tax cuts continue to bite. That means that Treasury supply will remain at crushing levels, pushing interest rates higher as the Fed relentlessly pulls money out of the stock market.

Despite all the bleating and moaning from Wall Street that the Fed will slow rate rises, the money markets will continue to tighten. The Fed will not be deterred until there are signs of real economic contraction, and there are none in this month’s tax data.

As I wrote back in early November:

“The Fed will continue to tighten, pulling $50 billion per month out of the banking system and retiring it. And the market will continue to suffer under the weight of that, plus the increases in Treasury supply from the revenue shortfall and budgeted Federal spending increases. Both bonds and stocks will be hit in successive waves until the Fed is forced to relent and reverse policy.”

“With Powell pronouncing the doctrine that the Fed will only react to a significant and sustained drop in the market that causes a downturn in consumer spending, that intervention is likely to be a long way off, with a lot of pain to come before it happens.”

In view of the latest tax data my opinion remains the same. Cash is king. Stay away from stocks and bonds. Roll T-bills instead.

A small portion of your cash can be set aside as risk capital. Profits can potentially be made by buying barely in the money SPY puts with about 4 weeks to expiration when the market rallies to near a key resistance level. Have a mental stop on the S&P 500 or SPY just above that resistance level. Sell half the position when the market drops to a key support level. Let the other half ride, and roll it over at expiry. Wash, rinse and repeat and watch your profits pile up!

Good Trading!

Lee

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