Mid Year Review - Slow but Steady?

In our December 2016 year end review we wrote, "No forecast now, no forecast until April.  We can't recall another time in the last 30 years that we were so uncertain about what to expect from the US government, and how that would affect the key drivers of stock market returns - revenues, earnings and interest rates.

Other analysts put out price targets for the S&P 500 of 2300-2450, which would imply gains of 3-9.5% from the current level of the S&P 500 at 2239.  The consensus for 2017 is that:

  • Inflation will rise from the current 2% annualized
  • Interest rates will continue to rise, with the Fed raising rates perhaps 3 times this year
  • The dollar will remain strong, depressing the value of overseas earnings and promoting imports over exports
  • A combination of deficit spending and new spending on infrastructure COULD enable the US economy to grow faster than the 2% annually of the last 8 years.
  • Wages will rise as labor markets tighten
  • Earnings in general will rise, particularly if corporate taxes are lowered"

From year end through July 14th, the S&P 500 made 24 record highs and currently gains 9.85% YTD, so already above the most optimistic forecast at the start of the year.  

  • Inflation remains under 2% (helped by a 20% slide in energy prices)
  • The Fed raised rates in March and June, may well raise a third time later this year
  • The US dollar hit a 15 year high in December, sold off 7% through July, but remains in a long term uptrend.
  • US GDP growth was 3.6% in the last quarter of the Obama administration, 2.1% and 1.4% in the first two quarters of the Trump administration, with 2.6% projected for the third quarter
  • The rate of job creation is slowing, and rate of wage increases is falling
  • No chance of a corporate tax cut this year, but the S&P 500 earnings drought of 2014-15 gave way to robust growth in 2016 and the first half of 2017:

Net, the US stock market is doing well because corporate revenues and earnings are doing well, while interest rates remain low in a lower than expected inflationary environment.  Even with the unemployment rate at 4.4%, there remains considerable slack in labor markets, so strong corporate profits are NOT translating into wage gains.  Overall, good news for Americans who own stocks, not good news for Americans who have not seen real income growth since the 1990's.

In our December 2016 year end review we wrote, "No forecast now, no forecast until April.  We can't recall another time in the last 30 years that we were so uncertain about what to expect from the US government, and how that would affect the key drivers of stock market returns - revenues, earnings and interest rates.

Other analysts put out price targets for the S&P 500 of 2300-2450, which would imply gains of 3-9.5% from the current level of the S&P 500 at 2239.  The consensus for 2017 is that:

  • Inflation will rise from the current 2% annualized
  • Interest rates will continue to rise, with the Fed raising rates perhaps 3 times this year
  • The dollar will remain strong, depressing the value of overseas earnings and promoting imports over exports
  • A combination of deficit spending and new spending on infrastructure COULD enable the US economy to grow faster than the 2% annually of the last 8 years.
  • Wages will rise as labor markets tighten
  • Earnings in general will rise, particularly if corporate taxes are lowered"

From year end through July 14th, the S&P 500 made 24 record highs and currently gains 9.85% YTD, so already above the most optimistic forecast at the start of the year.  

  • Inflation remains under 2% (helped by a 20% slide in energy prices)
  • The Fed raised rates in March and June, may well raise a third time later this year
  • The US dollar hit a 15 year high in December, sold off 7% through July, but remains in a long term uptrend.
  • US GDP growth was 3.6% in the last quarter of the Obama administration, 2.1% and 1.4% in the first two quarters of the Trump administration, with 2.6% projected for the third quarter
  • The rate of job creation is slowing, and rate of wage increases is falling
  • No chance of a corporate tax cut this year, but the S&P 500 earnings drought of 2014-15 gave way to robust growth in 2016 and the first half of 2017:

Net, the US stock market is doing well because corporate revenues and earnings are doing well, while interest rates remain low in a lower than expected inflationary environment.  Even with the unemployment rate at 4.4%, there remains considerable slack in labor markets, so strong corporate profits are NOT translating into wage gains.  Overall, good news for Americans who own stocks, not good news for Americans who have not seen real income growth since the 1990's.

Healthcare and Tax Reform

On June 22nd, Majority Leader Mitch McConnell spoke from the Senate floor, "Seven years ago, Democrats imposed Obamacare on our country. By nearly any measure, it has failed and no amount of 11th hour reality-denying or buck-passing by Democrats is going to change the fact that more Americans are going to get hurt unless we do something."

The problem with this statement is that is objectively not true.  Obamacare is far from ideal, but tens of millions of Americans are dependent on the program.  Philosophically, conservatives oppose Obamacare because they don't like the government telling people they need insurance, and they despise the 3.8% net investment income tax on interest, dividend, rent, royalty and passive business income of high-income (over $250K/year) taxpayers - the 2% of richest Americans.

Many of our clients are paying this tax, and yet we oppose the Obamacare repeal.  Prior to the 2009 Affordable Care Act, the number one reason why average families ended up in bankruptcy or foreclosure was because of unplanned medical expenses.  Even young, healthy adults are just one snowboarding accident away from catastrophic medical bills.

In a recent presentation, we framed the debate as, healthcare is

  • a right
  • an entitlement
  • an investment

 Progressives see healthcare as a right (and a good thing.)  Conservatives see healthcare as an entitlement (and a bad thing.)  Pragmatists see healthcare as an investment (and a necessary thing.)  Factory owners typically spend annually 10% of the purchase price of an industrial robot on maintenance.  At Heron Wealth, health insurance expenditure equals 12% of payroll cost - money well spent to retain our excellent team.  We have the advantage of having few, highly paid employees.  We understand how healthcare spending would cripple small businesses with many, low paid employees, who resolve that problem by shifting employees to part-time schedules of less than 30 hours/week, which is not good for the business, the employees or the company's customers. 

McConnell announced last week that Congress would remain in session for an extra two weeks into the traditional August recess while the Senate attempts to corral 50 votes to repeal Obamacare - tough sledding given that 61% of polled Americans, 1/3 of Trump voters, most state governors, the AARP, the American Medical Association, and the American Hospital Association oppose the current measure. 

As of Sunday, July 16th, a vote to repeal is on hold while Senator John McCain, potentially the 50th vote, recovers from surgery to remove a blood clot.  John and Cindy McCain have a net worth of about $120 million, so no doubt McCain's medical expenses were paid through private (or self) insurance.  Staffers in his office generally would be enrolled in DC Health Link, an ObamaCare exchange where the insured pay 28% of the cost and the Federal Government pays 72% of the cost.

The most recent iteration of McConnell's bill retains the Obamacare taxes.  Removing these taxes frees up $900 billion over 10 years, which in the calculus of congressional procedures would allow for tax cuts to the wealthy including the elimination of the inheritance tax and cuts to corporate taxes as well (taxes for middle and low income tax payers would probably rise.)  It seems unlikely that tax reform will occur this year, in particular because Congress still has to approve the budget for next year and raise the debt ceiling. 

In principal, the Republicans control the House, Senate, Presidency and Supreme Court.  In practice, the government is divided between 4 minority parties - moderate Republicans, conservative "Freedom Caucus" Republicans, Democrats and Trump, whose only allegiance is to himself.  No group can command a majority without support of at least a few actors from the other groups (and such support is not forthcoming.)  As a result, the ONLY significant accomplishment of Republicans since January is the confirmation of Supreme Court Justice Neil Gorsuch, accomplished only by dismantling the super-majority rule.

And yet, stocks are doing well!  Corporations and investors dislike uncertainty.  The status quo suits investors just fine.  Investors would like tax cuts (who wouldn't) but in our last commentary we observed that tax policy and economic growth are poorly correlated.  The economy and stock market soared after President William Clinton raised taxes and balanced the budget.  Both were clobbered after President George W. Bush slashed taxes, deregulated the banking system and exploded the deficit.

The Trump Show

The most gripping reality TV show of all time (and we cannot avert our eyes!). As we know, the frustration of average Americans with economic conditions was the tipping point issue in last fall's election.  We don't feel like adding more commentary to the millions of pages already written about Trump.  We observe that a third of Americans think Trump is a hero, a third pay no attention, while the remaining third think he's a blithering idiot (and a danger to all.)