Home Morning Commentary

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There has always been a group of people who are fearful of a market getting “too hot.”  Some people just want to make a fearful warning in order to gain credibility and fame, in order to sell books in the future.  Most, however, never offer a warning of any kind – especially major Wall Street banks…and central bankers.  What’s rather odd, is that these two sectors of The Street did indeed offer a fresh warning that the markets are too high.

J.P. Morgan’s analyst, Jan Loeys, recently wrote a note to clients titled “Financial Overheating a Problem Yet?”

“The speed of these upgrades and asset price rallies is both exhilarating and scary. The faster we rally, the greater the joy, but the more one should be worried about the eventual reckoning. How far from now is that and what should we do about it?

“We stay in the Growth Trade as we believe that the steady upgrading of growth prospects and asset price moves is still benefiting from greater positive feedback loops and that the negative feedback from economic and financial overheating are both still too weak or too far off. At the same time, the speed of the rally is inducing us to start trimming slowly, through going neutral on HY.”

“The signs of financial overheating in the US can be seen from elevated equity multiples, which for the S&P500 reached 24 on a trailing reported GAAP basis, the same as in 1997; new cycle lows on HG spreads and lower than the last cycle lows when adjusted for maturity and ratings changes; HY yields below 6%, which cannot be called high yield anymore; US Households with a higher share of equities in their financial assets than anytime except 1999-2000; and US household confidence back to the highs of the 90s, and their unemployment rate back to the lows then.

What’s even more interesting is that the governor of the People’s Bank of China (PBoC) made a similar warning, yet they are the very people blowing financial bubbles!

“If we are too optimistic when things go smoothly, tensions build up, which could lead to a sharp correction, what we call a ‘Minsky moment’. That’s what we should particularly defend against.

“The nation should toughen regulation and let markets serve the real economy better, according to Zhou.

“High leverage is the ultimate origin of macro financial vulnerability,” wrote Zhou, 69, who is widely expected to retire soon after a record 15-year tenure.

“In sectors of the real economy, this is reflected as excessive debt, and in the financial system, this is reflected as credit that has been expanding too quickly.”

And yet, when there is a slightest hint of the stock market falling; what do the central bankers do?  They create even more excessive debt to expand credit even faster.  Nevertheless, it is interesting to hear an actual central banker complain about the outcomes of their own meddling in the markets.  

What will come of it?  Probably nothing.

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Fairly early in the Thursday trade, the GOP released the details of its tax plans.  The initial reaction was very bearish for the market, and therefore great for everyone who was short, or simply likes to short the market. The slide in the markets didn’t last very long, however, as they all reversed course enough to be positive at the close.  The Dow actually rallied so much that it was able to notch ANOTHER record high.  I guess the initial knee-jerk reaction lower was way off base.

Here are many of the Bill’s highlights…

  • Lowers individual tax rates for low- and middle-income Americans to Zero, 12%, 25%, and 35%
  • Trying to appease Democrats, the tax rate for those making over $1 million stays at 39.6%
  • Increases the standard deduction from $6,350 to $12,000 for individuals and $12,700 to $24,000 for married couples.
  • Establishing a new Family Credit, which includes expanding the Child Tax Credit from $1,000 to $1,600
  • Preserving the Child and Dependent Care Tax Credit
  • Preserves the Earned Income Tax Credit
  • Preserves the home mortgage interest deduction for existing mortgages and maintains the home mortgage interest deduction for newly purchased homes up to $500,000, half the current $1,000,000
  • Continues to allow people to write off the cost of state and local property taxes up to $10,000
  • Retains popular retirement savings options such as 401(k)s and Individual Retirement Accounts
  • Repeals the Alternative Minimum Tax
  • Lowers the corporate tax rate to 20% – down from 35%
  • Reduces the tax rate on business income to no more than 25%
  • Establishes strong safeguards to distinguish between individual wage income and “pass-through” business income
  • Allows businesses to immediately write off the full cost of new equipment
  • Retains the low-income housing tax credit


Of course, not everyone will be happy with what’s outlined above, and of course other details.  There will be a huge fight between the two parties, and surely between the House and the Senate.  There is so much wrangling that will need to be done that the current Bill as proposed won’t have a chance as being the final bill.  Moreover, there is so much discord in D.C. —- they may not pass a tax cut at all.

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There was big news from (for) the Federal Reserve bank today.  The FOMC ended a 2-day meeting and gave it’s outlook for the future.  There was also news “for” the Federal Reserve today as well: It will have a new Chairman very soon – Jerome Powell.

As was widely expected, the FOMC didn’t say much that was new or otherwise surprising.  Because of this, rate hike odds for the December meeting moved up from 85% to 87.5%.  There’s no need to go over the whole statement, as the following three sum it all up.


  • “Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize”   
  • “Near-term risks to the economic outlook appear roughly balanced”   
  • “The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate”

As mentioned above, what was new for the Fed was Wednesday’s Wall Street Journal’s story of a new Chairman to replace Janet Yellen, which will be Jerome Powell.  From their story https://www.wsj.com/articles/trump-to-tap-feds-jerome-powell-for-fed-chairman-1509568166 we read the following highlights.

On Interest Rates

Mr. Powell, 64 years old, has backed Ms. Yellen’s policy of gradually raising interest rates if the economy improves as projected. In recent public remarks he has sounded an optimistic note, saying he expects inflation to move up to the Fed’s 2% target, economic growth to remain steady and the unemployment rate to fall further. “I would view it as appropriate to continue to gradually raise rates,” he said in June.

On Shrinking the Fed’s Portfolio

Mr. Powell in September voted in favor of beginning the yearslong process of winding down the central bank’s $4.5 trillion portfolio. Like Ms. Yellen, Mr. Powell has said the Fed could resort to new rounds of asset purchases in another crisis if the economy needs more stimulus. Putting new assets on the Fed’s balance sheet should be an option “only in extraordinary circumstances,” he said in February.

On Dodd Frank

Mr. Powell has expressed willingness to ease some of the burdens imposed on financial institutions from the 2010 Dodd Frank law, a position that could appeal to the Trump administration.

Speaking before lawmakers in June, Mr. Powell said he was looking into softening the Volcker rule preventing banks for making overly risky bets with their own money. He also said it might be appropriate to ease some of the annual stress tests that big banks must perform.

He has also called for revisiting new supervisory requirements imposed on bank boards of directors after the crisis. In his view, a board’s role “is one of oversight, not management.” That, he said in a 2015 speech, means boards should not be saddled with “an ever-increasing checklist.”

Jerome Powell will be the first former investment banker to become Fed Chair (and first non-economics PhD in 40 years).

Powell, a Princeton graduate, was a lawyer in New York before he joined the investment bank Dillon Reed & Co. in 1984. He stayed there until he joined the Treasury Department in 1990. After he left Treasury, he became a partner in 1997 at The Carlyle Group (CG), the private equity and asset management giant. He left Carlyle in 2005.

Since change is a good thing, we are anxiously awaiting the change in the Chairman’s leadership.

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The US equity markets clocked in another slow, narrow range day on Tuesday as participants were unwilling to make major moves ahead of the GOP tax proposal which is scheduled for release on Wednesday. As I mentioned earlier this week, the bill will mark a major milestone for possible tax reform that will lower the corporate tax rate substantially, provided that the bill that is revealed on Wednesday is not a sharp departure from the rough draft presented earlier this year. It is possible that modifications to the individual tax brackets will be proposed whereby a fourth category will be introduced for the upper class, but otherwise I expect that side of the bill to remain mostly the same as in the rough draft.

However, I do expect that the corporate rate will be phased in over a period of at least 5 years, which will be somewhat of a disappointment to the markets but still a positive development provided that there is little chance of that being cancelled after 2020 in the event the President Trump is not re-elected. Also, if the phase in starts next year with a significant cut, then this should spur equity prices somewhat higher, although I will expect initial volatility as the market has been stagnant at the recent highs for some time. Only a clean and clear cut to the corporate rate that begins next year will probably surprise the markets enough in order to induce a renewed surge in buying. Let’s keep an eye on the proposal to see just what’s in store.

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US equities markets were more volatile than they have been recently on Monday after it was rumored that significant changes were likely to be revealed on Wednesday for the new GOP tax bill. The primary concern for the markets still is whether (or not) the corporate tax will indeed be lowered to 20%. This proposed reduction is certainly helping to keep the markets near all time highs in the absence of any other substantial news. However, it now seems probable that the GOP will propose to phase in the lower corporate rate over a five year period or longer. This of course leaves the markets questioning if a phased lowering of the corporate rate over such a long period might ultimately mean that it is vulnerable to being repealed down the line. Therefore, if that is the path chosen by Congress, it will need some kind of guarantee that the lowered tax will not be repealed. To that end, we will await the unveiling of the new tax bill on Wednesday.

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One of the most important areas of focus this week will be on the proposed release of the new GOP tax bill. Currently the bill is scheduled to be revealed on November 1st, which is Wednesday of this week. Of primary interest to the financial markets will be if the proposed reduction in corporate taxes will still be included. Currently, the proposal is to reduce the rate down to 20%, a proposal that has garnered disdain by left-leaning Senators such as Bernie Sanders. It seems certain at this point that no Democrat will vote in favor of the bill provided that the corporate rate is slashed. Rather, it seems fairly clear that many in the DNC as well as some Republicans would prefer to see the corporate rate stay the same or potentially be increased. There is also likely to be substantial pushback by congressional Republicans who serve states with higher taxes since it has been proposed to cut the deduction of state taxes on the new tax bill. Regardless, if the GOP proposal remains similar to the rough draft released weeks ago, then this would seem to confirm that the party is united in its resolve to reduce taxes across the board, including for corporations. We’ll focus on any new details that might emerge between now and then.

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So the “big day” for the markets has come and gone, with a whimper.  If there was ever a dullard at a party, it would be Mario Draghi.  He did everything in his power to make some changes, that we highlighted, and nothing else.  Moreover, he made it clear that he would extend this (seemingly) forever so there was far less volatility Thursday than the previous few days.

The Eurosystem will reinvest the principal payments from maturing securities purchased under the APP for an extended period of time after the end of its net asset purchases, and in any case for as long as necessary. This will contribute both to favourable liquidity conditions and to an appropriate monetary policy stance.

At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:

(1) The interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00%, 0.25% and -0.40% respectively. The Governing Council continues to expect the key ECB interest rates to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases.

(2) As regards non-standard monetary policy measures, purchases under the asset purchase programme (APP) will continue at the current monthly pace of €60 billion until the end of December 2017. From January 2018 the net asset purchases are intended to continue at a monthly pace of €30 billion until the end of September 2018, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim. If the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the APP in terms of size and/or duration.

(3) The Eurosystem will reinvest the principal payments from maturing securities purchased under the APP for an extended period of time after the end of its net asset purchases, and in any case for as long as necessary. This will contribute both to favourable liquidity conditions and to an appropriate monetary policy stance.

(4) The main refinancing operations and the three-month longer-term refinancing operations will continue to be conducted as fixed rate tender procedures with full allotment for as long as necessary, and at least until the end of the last reserve maintenance period of 2019.

Said another way, with stocks at ALL-TIME HIGHS, “emergency” level rates must continue.  Said yet another way —> the ponzi finance scheme of the central planners must continue.

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A few days ago we touched on the fact that Thursday is a big day for Europe and the ECB in general, and Mario Draghi specifically.  Said another way, if the changes to the current ECB policy do not go over well with the markets, Mr. Draghi alone will be blamed.  We said, “The main predictions as of today are for a large slash in its current bond buying from to go from €60BN per month to €30BN per month and last another 3 quarters.  When this time period is over, the ECBs balance sheet is expected to have swelled to €2.5 trillion.”

So the day is upon us and the markets have seen increased volatility, especially on Wednesday.  The Forex market and currency futures in Chicago will probably see mad volatility Thursday morning; so if you’re not used to it, you probably should not trade it.

Following are a few of the major bank predictions on the looming event…

  • Barclays – Think that QE will be extended for a longer period (nine months) but at a lower pace of EUR 30bln per month, and do not rule out a 12-month extension at an even lower pace of EUR 20-25bln. Do not expect the ECB to commit to tapering towards zero at the end of the extended programme as the GC will likely want to keep all options open in case economic or market conditions deteriorate in the meantime.
  • Deutsche Bank – Now expect a larger reduction in the pace of QE – from EUR 60bln to EUR 30bln (not EUR 40bln). To compensate, expect (i) a longer extension of QE – nine months rather than six months – (ii) a commitment to not changing the sequencing of exit and (iii) the introduction of conditionality into the definition of “well past” within the rates guidance.
  • HSBC – Expect six months of asset purchases at a reduced pace of EUR 40bln per month to start in January. Although, it is hard to have huge conviction given the near infinite possibilities. Do not think the ECB will set an end-date for purchases given concerns that underlying inflation pressures are still insufficient.
  • UBS – Expect the ECB will cut its monthly asset purchases from EUR 60bln to EUR 30bln as of January, with a commitment for nine months, i.e., until end-September 2018. UBS think the ECB will leave open whether it will extend QE after September and hint that this decision will be taken in a data- dependent fashion, closer to the time.

In addition to the early mention of this major event coming and the fact that volatility should increase in general, we were also rather specific a day ago with this comment: At this point, I’ve already noticed that the media is noting the fact that this might signal an end to the rally, and perhaps the beginning of a strong decline. While I think that these things might be true, it is crucial to note that for the moment it seems more likely that we are at a new consolidation area where a new all time high for the market is not likely to be made for a while. Put differently, things might be taking a breather.”

We certainly hope that all of it helped you prepare the what changes may lie ahead.

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The Japanese stock market received a significant boost after Prime Minister Shinzo Abe was re-elected to lead the country. This should be expected, since Abe’s economic policy for Japan included massive central bank stimulus, including doubling the money supply and eventually leading to the Bank of Japan adopting negative interest rates. And for those who aren’t aware, a negative interest rate essentially means that the BORROWER receives interest for borrowing money. The point of doing this is to discourage people from depositing money in banks, since they would be charged for the deposit rather than receive interest. Simply put, this policy turns the entire history of finance upside down, and it has become the new normal in some parts of the world, including Europe and Asia.

The Nikkei 225, which is the Japanese equivalent of the S&P 500, ended a 16 day winning streak today, after climbing before and then after the October 22 Japanese election. The fact that Abe is still in charge of the country means that Japan is most likely to continue its current economic policies, which are intended to create inflation and economic growth. However, with the Nikkei at 21,800, this if far from the all-time high set by the index in 1989 (which was 38,916). Since the peak in 1989, Japan’s stock market and it’s economy of struggled against persistent deflation. While the recent rally in the Nikkei seems to be pointing to an eventual return to those all-time highs, it is long way to that destination, and seeing how massive was the stimulation necessary to create this rally, it seems more than reasonable to ask just how it will be possible for Abe’s monetary policies to ever achieve the goal of getting Japan out of its near 30 year economic rut. We will find out soon, but I wouldn’t get your hopes up.

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While the “Trump Trade” has been the story of the last 11 months, and although the markets show few signs of considerable stress, it seems that clouds are beginning to form around the otherwise calm environment in the equity indexes. On Monday, we saw one of the relatively few down days in the market that have occurred recently. The S&P 500 declined -0.40%, a figure that before the current low volatility rally would have been considered as a mild decline. But in the present context, it stands out sharply against a backdrop of consistent incremental increases in the markets, day after day.

At this point, I’ve already noticed that the media is noting the fact that this might signal an end to the rally, and perhaps the beginning of a strong decline. While I think that these things might be true, it is crucial to note that for the moment it seems more likely that we are at a new consolidation area where a new all time high for the market is not likely to be made for a while. Put differently, things might be taking a breather.

The primary stress that I see is again with respect to legislative action. If the regulatory environment does not become more business friendly, and if tax reform is not forthcoming, then the markets will almost certainly shed most (if not all) on the gains of the last 11 months. Corporate debt defaults are down from the recent highs we saw in 2016 (the highest we had seen since the financial crisis), but these could rise as a side effect of the Federal Reserve unwinding its balance sheet of treasuries, a move which should push debt servicing costs higher due to rising interest rates. Since the FOMC created an environment of massive borrowing by corporations through its quantitative easing policies, we can expect companies to fall closer to default on their debts unless growth continues to pick up the pace. Therefore, all eyes in the market are on the US government to see what they can accomplish in the nearterm. For now, it’s a waiting game.