Carry On Wayward Son
Doug Walters
As Bitcoin came crashing down, legitimate investments like U.S. equities marched forward to new highs, despite mixed reviews on tax reform progress and continued North Korean tensions.
Market Review
Contributed by Doug Walters
The S&P 500 closed at a new high of exactly 2,500 this week, thanks to some big gains on Monday. As bad as hurricane Irma was, it did less damage than expected, and North Korea did not make good on its threat to launch a missile last Saturday (although they made up for it later in the week). While there was little progress made on tax reform, the market seems content that reform remains a major topic of debate among lawmakers.
Hatching a Plan
Corporate tax reform, which is seen by many as a key driver of the loftiness we have seen in U.S. stocks, took center stage this week. The so-called “Big Six” are attempting to craft a tax reform proposal for consideration. The corporate tax rate is one point of debate. President Trump has floated the idea of a 15% rate (down from 35%), with no detail on how the country could afford such a massive cut. Most see this as posturing and expect a final figure closer to 25%. Appealing to his populist base, Trump made clear that he did not support any tax cuts for the wealthy; a stance that aligns him (at least on this one issue) with Democrats.
Passing a tax bill will not be easy. Senator Hatch, the Senate Finance Chairman, sent a stern warning to the Big Six, making it clear that his committee would not be a “rubber stamp” for whatever they propose. Ironically, Senator Hatch is a member of the Big Six (the others being, House Speaker Paul Ryan, House Ways and Means Chairman Kevin Brady, Treasury Secretary Steven Mnuchin, National Economic Council Director Gary Cohn, and Senate Majority Leader Mitch McConnell).
There will be winners and losers in the quest for tax reform. Overall, we see this as a positive for corporate America (and thus U.S. stocks), with Small Cap stocks likely to reap the most direct benefits.
| Indices & Price Returns | Week (%) | Year (%) |
|---|---|---|
| S&P 500 | 1.6 | 11.7 |
| S&P 400 (Mid Cap) | 2.0 | 5.6 |
| Russell 2000 (Small Cap) | 2.3 | 5.5 |
| MSCI EAFE (Developed International) | 0.5 | 16.6 |
| MSCI Emerging Markets | 1.0 | 27.8 |
| S&P GSCI (Commodities) | 2.2 | -0.6 |
| Gold | -1.9 | 14.5 |
| MSCI U.S. REIT Index | 0.3 | 2.6 |
| Barclays Int Govt Credit | -0.5 | 1.1 |
| Barclays US TIPS | -0.6 | 1.2 |
Economic Commentary
The Burst of a Bubble
In April of this year, we wrote on Strategic Insights that the Bitcoin price might be forming into a bubble: “A Bit of a Bubble”. This past month, we saw that bubble burst, as the Bitcoin price collapsed 28%. The crash was caused by:
- A lack of intrinsic value,
- Increased negative sentiment, perhaps due to the JP Morgan CEO’s comments, and
- China cracking down on crypto-exchanges and platforms.
On Tuesday, JP Morgan’s Chief Executive Officer Jamie Dimon described Bitcoin as a “fraud” and that he would fire his employees caught trading the cryptocurrency “in a second” because of their “stupidity.” He is not a fan of Bitcoin and has made similar degrading comments in the past including: “Bitcoin is a terrible store of value”, “will not survive”, and “is going nowhere.” Bitcoin’s price largely shrugged off his previous comments, but could not ignore the actions of the Chinese government.
The People’s Bank of China decided this week to ban Bitcoin trading platforms and prevent Chinese speculators from buying or selling the digital asset. The week before, China announced it was banning Initial Coin Offerings, which so far this year have been used to raise significant sums of money (see “Initial Coin Offerings“). China is taking these steps due to fears of money laundering as well as tax evasion, and they may simply not want an alternate currency of any form to their national Yuan.
We often get asked, “how can I invest in Bitcoin?” We hope this week’s actions make clear what we have been saying all along. You cannot “invest” in Bitcoin, because it is not an investment. It is a gamble.
Week Ahead
HEFT-y Market Expectations Building
Housing Starts for the month of August is expected to remain nearly flat versus July at 1,170,000 new housing starts.
- Between 1990 and 2005, new housing starts averaged at 1.5 million units per month.
Eurozone inflation data for August will be released on Monday.
- The European Central Bank president, Mario Draghi, has stated the importance of inflation to reach their 2% target rate.
- Inflation data above analyst’s expectations can rattle the markets as it provides ammunition for the central bank to start tightening.
FOMC meeting is scheduled for Wednesday at 2 pm, followed by Fed Chairwoman, Janet Yellen’s, press conference.
- No rate hike is expected at this meeting.
- Investors will be looking for any details on plans to reduce the $4.5 trillion balance sheet.
- The U.S. Federal Reserve has expressed an interest in unwinding its balance sheet, but details have been sparse.
Trade data in the form of Import and Export price indexes will be released on Tuesday. The export prices are expected to decline while the import prices are expected to increase.
- The decline in the U.S. dollar against major currencies makes U.S. exports more attractive abroad.
- The U.S. dollar is at a 20-month low.
- We discussed the dollar’s decline in more detail in our previous issue of Insights “Three’s a Crowd”.
Strategy Updates
Contributed by Max Berkovich ,
STRATEGIC ASSET ALLOCATION
Technical Dislocation
The Russell 1000 Growth Index is up over 19.8% year-to-date, while the Russell 1000 Value Index is up only 6.3% over the same period. The run-up in the Technology sector and the decline in Energy are a big reason for the gap. FAANGs (Facebook (FB), Apple (AAPL), Amazon (AMZN), Netflix (NFLX), and Google (GOOG, GOOGL)) are the top contributors to outperformance but some smaller technology companies also made giant strides.
- Almost a quarter of the Russell 1000 Growth market capitalization is attributed FAANG names. Yet Technology stocks make up only 6.5% of the Russell 1000 Value, while Energy makes up 9%.
- The performance gap was inverse in 2016. The Russell 1000 Growth Index was up 7.1%, while the Russell 1000 Value Index was up 17.3%. Since December 31, 2015 the gap between the two indexes is about 1.9% in favor of Growth.
- Active asset allocation allows us to take advantage of this dislocation and we are reviewing a rebalance between value and growth for our portfolios.
STRATEGIC GROWTH
Lowered Expectations
The Energy sector received a boost from another activist investor recommending a value-adding plan for natural gas driller EQT Inc. (EQT). Health Care was the laggard on the week. In other strategy news…
- Oracle Corp. (ORCL), the software giant, reported consensus topping results, but weaker guidance and elevated expectations dragged sentiment lower on the stock. Last quarter Oracle looked like it had a solid inflection point where cloud revenue was surpassing traditional software, finally illuminating a long-awaited growth story. The less than expected guidance took some of that enthusiasm down a notch.
STRATEGIC EQUITY INCOME
Cutting the Cord as Well
The Energy sector had a stellar week thanks to crude’s move back to near $50 per barrel. Interest rates notched up a bit and unsurprisingly Utilities were the laggard sector. What was surprising is that Telecom did not follow Utilities’ lead…
- Telecom goliath Verizon Inc.’s (VZ) CEO, Lowell McDowell, revealed at an investor conference that he was ready to cut the cord in his search for a cable network. The company has been involved in numerous rumors of an acquisition of Comcast (CMCSA) and Charter Comm. (CHTR), as well as content providers like Disney (DIS), but could not reach a deal. The company now will shift its focus on fiber and 5G network deployment. The company will also cut $10 Billion of cost by 2022, which adds a little more safety to its big dividend.
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