Month: March 2017

InnOvation Capital & Management, LLC

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MARCH 29 , 2017

Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

 

Before we continue a discussion of Tax Reform here in IntelDigest, we’d like to offer a sobering assessment from David Stockman.  You will recall that Stockman was the budget chief in the Reagan Administration, who often found himself at odds with the Republican establishment.  After government service, he spent two decades on Wall Street, and is now a raconteur and contrarian pundit.

Stockman’s opinions on the state of things:

“There is no Republican “majority” on Capitol Hill.  There’s only a gang of factions that will form a circular firing squad around President Trump.  The Republicans will bring Trump’s legislative agenda to a thundering halt before it even gets launched.

“The immediate case in point is the campaign pledge that Obamacare would be subject to “repeal and replace” within days of the inauguration.  That didn’t happen.  And it’s not going to happen within these vaunted first 100 days.  Or even this year or next.  Instead, the so-called Republican majority will splinter.  They’ll bog down the legislative process in prolonged maneuvering and wrangling ….

“The plain truth is that if Ronald Reagan couldn’t drain the swamp way back then, how in the world can Donald Trump do it now, after 36 years of massive growth in government and debt?

“The implications for the Great Disrupter could not be any clearer.  His predecessors have used up the nation’s public balance sheet  ….  Reagan inherited a debt-to-GDP ratio of 30%.  He had wide-open space to accidentally implement giant deficits.  But Donald Trump has no running room at all with debt-to-GDP at 106%.”

We are not as pessimistic as Stockman;  but, it is important that Our Leaders address all these matters.  For our part, we will continue to focus on issues of economics, finance, law, and policy on a weekly basis in IntelDigest.

The Republican Plan – A Better Way?

Last week, we set out the Tax Reform proposals of the House Republicans, as published by House Speaker Paul Ryan in a document titled “A Better Way.”  If Congress can form a consensus over many of the business-related incentives contained in that plan, we can be encouraged that Tax Reform can contribute to kick-starting the economy.  Tax Reform actually has the interest of Congresspersons across the political spectrum, so (unlike healthcare) there is a much better prospect of garnering enough Democrats and Republicans to pass a Tax Reform Bill.

We have deliberately not addressed a much-discussed feature of the Republican plan, the proposed Border Adjustment Tax (BAT) … primarily because the chance of adopting this provision is slim.  If its chances improve markedly over the next few months, we will analyze the proposal and the underlying reasons for it.

Today, we discuss WHY Tax Reform is important.  Over the coming weeks, we will study matters which relate to American Taxation, such as the state of Work (Employment) in the U.S., the size of government, budget deficits, etc.  For today, we reduce the question to one simple truth.

 

 

The Importance of Tax Reform in 2017

Success at passing Tax Reform this year could set the tone and direction of the U.S. economy for years to come.  A comprehensive package … reached by consensus in the Congress … will affect jobs and healthcare, as well as taxes and the economy.

Here is an essential argument for lowering taxes:

Spending  by governments in the United States … federal, state, local … now amounts to 35% of the American Economy!  Governments provide a small amount of their own support.  They rely on taxes paid by the private sector. In past decades, the private sector comprised 80% of the economy, so it was four times the size of the government. Now, the private sector is barely two times the size of government.

Every private Dollar which goes to paying taxes and supporting the government is a Dollar that cannot be invested in new businesses or creating new jobs.  On the other hand, greater tax-saving by Americans who are capable of re-injecting those savings into U.S. businesses is a boost to the U.S. Economy.

Capital feeds entrepreneurial activity, which is the biggest creator of new jobs in the United States.  If lower taxation frees up more Capital to create more jobs, that is a good thing.

This is why Tax Reform is so important.  We are at a Tipping Point.  Over the last 40 years, under both Republican and Democratic Administrations, the size of government has grown relentlessly, putting greater burdens on taxpayers. And the National Debt has exploded over the last seventeen years.

Since the Financial Panic of 2008, the American economy has been growing at a rate of 2% per year (after inflation); but, the Debt increase has grown at DOUBLE the rate of the economy!

We need the Economy to grow faster than the Debt, and growth in the Economy … like the growth in employment … comes primarily from the entrepreneurs and other business owners who put Capital to work every day.

If Tax Reform can release more Capital into the Economy, allowing businesses to grow and create the jobs of the future, we have a much better chance of working our way out of the hole which our politicians have dug over these last few decades.

 

 

 

InnOvation Capital & Management, LLC

IntelDigest

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MARCH 22 , 2017

Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues. Material may not be reproduced, forwarded or shared without express permission.

This week in  IntelDigest, we continue a discussion on Tax Reform, a vital factor in the strategy to grow the American economy out of the very-deep-hole known as the National Debt.  As we stated two weeks ago, the new Administration … in its zeal to overturn All Things Obama … is making a serious tactical error in tackling healthcare ahead of all other matters.  Nothing is more important than using Tax Reform to begin the process of growing the Economy faster than the Debt.

The Republican Plan – A Better Way?

So, we turn to the initial proposals to use the Internal Revenue Code to spur American business … the tax proposals of the House Republicans.  The Republican Agenda, issued by House Speaker Paul Ryan, is titled “A Better Way.”  Although it addresses a number of policy areas, we will spend the next few issues solely on the tax proposals.

We will look at both Corporate and Individual tax provisions.  Most large American businesses are incorporated;  the majority of businesses are organized as proprietorships, partnerships, or limited liability companies taxed as partnerships and subject to the Individual tax rates and rules.

If Tax Reform is going to provide the impetus to kick-start the economy, business owners among all these organizations must be able to benefit from Tax Reform and plow their tax savings into growing their own businesses and the U.S. economy.

Before we begin, we should acknowledge that it’s very difficult to calculate how much effect each of the tax proposals would have in the end.  Not only because we are very early in the process, and even the most basic tax reforms will not pass the Congress before the end of the year.  But also because of the innate ability of the American businessman/woman to “game” whatever tax rules exist in order to reduce his/her company’s exposure to taxation!

 

 

 

Corporation Tax Proposals

The Congressional plan includes the following tax changes:

• Reduction of top Corporation income tax rate from 35% to 20%

• Elimination of the Alternative Minimum Tax (AMT) on corporations

• Immediate deductions for capital investment expenditures (Depreciation)

• Indefinite carryforward of net operating losses

• Repatriation of foreign cash holdings at an 8.75% tax rate (limited time offer)

• Exemption of foreign-subsidiary dividends from U.S. tax

The following changes would partially offset the new breaks:

• No Interest Deduction on future loans

• Elimination of many deductions (except Credit for research and development costs)

The overall effect, if all these changes were to be signed into law, would be significant tax savings for large and small corporations alike, and simplification of tax compliance.

Lowering the top Corporation tax rate will benefit mostly large corporations;  they would cumulatively save many  Hundreds of Millions of Dollars, which could be re-injected into the economy.  The ability to “expense” capital expenditures in the year of purchase … rather than depreciating or amortizing over a number of years … would profit companies across-the-board.  Businesses of all sizes expend capital on plant-and-equipment … from computers and furniture and vehicles in small businesses to large-scale construction and factory equipment and fleets of vehicles in bigger companies.

Among the winners:  technology and biotech firms which would still be able to write off Research and Development Costs;  manufacturing and industrial firms which can immediately expense large capital expenditures.

A minority of businesses would benefit from a repeal of the Alternative Minimum Tax, but many more would make use of Loss Carryforward provisions, which would reduce taxes in future years.  Multinational companies stand to gain from the proposals pertaining to foreign operations.

One of the most important factors would be the potential repatriation of funds held overseas.  We have addressed this issue in  IntelDigest on several occasions.  The largest American multinationals have held large amounts of Cash overseas, estimated cumulatively at approximately Two Trillion Dollars, for several years.  The U.S. Corporation Income Tax on that sum would be about 35%;  hence, a reluctance to bring that Cash back to our shores.

However, most companies would jump at the chance to pay 8.75% on repatriated funds, and the remainder would be a welcome addition to the U.S. Economy.

 

 

Individual Tax Proposals

The Congressional plan includes the following tax changes for individuals and families, some of which apply to the small business sector:

• Reduction of the top Individual tax rate to 33% (many prosperous taxpayers can have an effective top rate close to 40% for federal income taxes alone)

• Possible reduction of top rate to 25% for self-employed and business owners

• Elimination of the Alternative Minimum Tax (AMT)

• Repeal of the Estate Tax and Gift Tax

Other proposals have less impact on the economy, but would be important to individuals and families which could benefit or be affected:

• Elimination of itemized deductions (except mortgage interest, charitable donations)

• Larger standard deductions and child/dependent care tax credits

• Streamlined education tax benefits

• Improved Earned Income Tax Credit (EITC)

Regarding the business-related proposals and their impact on the economy, a large portion of the American economy … and the largest creator of new jobs … is Small Business. Most Small Businesses are owned by people who pay Individual tax rates.  So, Small Business owners will arrange their organizations and tax reporting to take advantage of lower tax rates and expensing capital investments.

With a top tax rate of 25% applying to proprietorships and pass-through entities such as partnerships, limited liability companies, Subchapter S corporations, we will see a form of “Musical Chairs” as business owners and investors and self-employed individuals reorganize to take the most advantage of tax law changes.

But, this is NOT a bad thing.  More tax-saving by Americans who are capable of re-injecting those savings into the U.S. Economy is a very good thing.

 

We will be writing about Tax Reform for the rest of the month … outlining proposals, burrowing into details, and analyzing the probabilities for passage and implementation in the near future.

 

 

InnOvation Capital & Management, LLC

IntelDigest

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MARCH 15 , 2017

Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

To complete our recent discussion of the Debt Ceiling, the recent “suspension” of the Debt Ceiling (negotiated 17 months ago) ends today.  So, the hard work begins between the Congress and the Trump Administration.  The Republican President intends to spur the American economy by way of a massive federal stimulus program aimed at rebuilding the U.S. infrastructure.  However, there are significant numbers of Republicans in Congress who would oppose raising the federal Debt Ceiling in order to provide the funds for such a program.

We will see this issue increasingly in the news as Winter turns into Spring … the conflict is likely to come to a head by sometime in June.  So, look for early “fireworks” this year.

In other news, The Federal Reserve raised short-term interest rates this afternoon by another 25 basis points (0.25%).  Tomorrow, the Trump Administration will release its first Budget Proposal, which contains significant cuts to federal spending across the board, but particularly at the State Department and Environmental Protection Agency. And, elections in The Netherlands have taken place today. By tomorrow, we’ll know whether the far-right candidate … referred to as the “Dutch Trump” … has succeeded in gaining power in that country.

Keep in mind that the Netherlands vote is the first major European election of the year, to be followed by elections in France and Germany.  Later in the year, we will take stock of developments in the European Union, movement on the Brexit from the E.U., and determine if the wave of populism in Western nations is growing or petering out.

This week in  IntelDigest, we turn to Tax Reform … the discussion will begin in this issue and continue over the next two weeks.  Tax Reform is so important because it is a vital factor in allowing the U.S. to “grow” its way out of our Debt quagmire.  Even if the government is successful in doing so, it will certainly take ten years to accomplish.  But, it simply will NOT happen unless the American tax system provides the impetus to kick-start the economy.

In the December 7 issue of  IntelDigest, we published our own line-by-line policy recommendations to the incoming administration.  Congressional Republicans have recently put out their first draft of a Tax Reform program, which we begin to review, below.  Some provisions are in line with our thinking.  However, as we wrote three months ago, at the very least …

“The new administration MUST prioritize getting the national debt and annual deficit under control. It doesn’t have to be done immediately; the process can stretch over several years or even a decade. But, there must be a process in place to show The American People that this dangerous situation is being addressed ….

Allowing the Debt to grow further will just make it harder for our economy to grow out of the problem. Since the Financial Panic of 2008, the American economy has been growing at a rate of 2% per year (after inflation); but, the Debt increase has grown at DOUBLE the rate of the economy! These trends must be reversed, at minimum.”

Difficulties of Tax Reform

Government is a necessary instrument for maintaining a civilized society.  Some of you may disagree with that basic premise, but we believe that an orderly government is the middle ground between totalitarianism and anarchy.  So, for the sake of argument, let’s agree that an orderly Government is Necessary.  And, Taxation is the price we have to pay in order to pay for Government.

Everyone has reason to complain about the American tax system, but we all get something out of it.  Most people have apprehensions about making significant changes to the system … fear of losing whatever tax benefits currently accrue to them, or a more general fear of the unknown.  As a result, Tax Reform is extremely difficult to accomplish, so most Reform efforts fail.

The basic goal of any policy of taxation should be to simply raise sufficient revenue to make Government work.  But, the American Government … as it has developed over approximately 230 years … has become enormously complicated.  As has the system of taxation used to fund Government.

Some will say that our Federal Government is too large, trying to accomplish too many varied goals, with fingers in too many different pies.  If that is your view, or even if you believe that Big Government is necessary, we should all acknowledge that our tax system has evolved to the point where tax policy is used to encourage/reward certain behaviors and interests, and discourage/punish others.

As a result, the tax system has become obese, unwieldy, incomprehensible.  It creates incentives which may be counterproductive and/or out-of-alignment with rational, reasonable policies and practices.  Overbearing taxation, on one hand, or generous tax incentives, on the other, actually determine whether certain industries can exist in our society.

Tax Reform is so difficult because Tax Policy is interwoven with decades and decades of economic, social, environmental, and political initiatives, promulgated by liberals and conservatives, Democrats and Republicans alike.  One may argue that the ideal tax system would be neutral, providing a level playing field for all citizens … businesses and individuals … to deliver their goods and services, to seek their own prosperity.  But, we don’t have that … our starting point is a complex, convoluted mass called the Internal Revenue Code (Tax Code).

It would take decades for Congress to walk-back a significant amount of the Tax Code.  Constant, incremental reform should be required of our legislators.  However, an absolutely necessary first step … in the current financial circumstances … would be adopting a basic level of Tax Reform, certain measures which would help to kick-start the economy.

Both Congress and the Administration have acknowledged as much.

The Republican Plan – A Better Way?

In the next two installments of  IntelDigest, we will analyze the tax proposals of the House Republicans.  The Republican Agenda, issued by House Speaker Paul Ryan, is titled “A Better Way.”  Although it addresses a number of policy areas, we will spend the next two issues solely on the tax proposals.

So, we will end here, and dive into the plan next week.

 

 

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
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MARCH 8 , 2017

Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

 

 

This week in IntelDigest, we will have the first of several weekly discussions on the subjects of Legislation and Policy, as the Trump Administration goes to battle with Congress on issues of vital importance to the nation.  The American economy is at stake in this conflict, and the actions of the White House and Congress will determine if we, as investors, finish the year on a sweet or sour note.

As we wrote in November, in the weeks following the election, the Dollar and stock markets were rallying ..

“… on the expectation that a Trump presidency will be good for business. The President-Elect has vowed to lower taxes (especially on corporations), commit Hundreds of Billions of Dollars to infrastructure spending, and reduce government regulation.”

The stock market has continued to advance since Donald Trump assumed the Presidency, on the same hope that these business-friendly policies will come to pass. However, the market strength will have to subsist on hope until the President and Congress prove that they can work together and move forward on two major issues:  (1) the Debt Ceiling, and (2) Tax Reform.  These are the topics for our discussions in  IntelDigest during the remainder of March.

In our opinion, the new President has started with some counter-productive moves.  In his zeal to overturn the Obama Legacy, he is making the same mistake that President Obama made in his first term:  focusing too much on healthcare.  As President Trump stated (without a hint of irony) in a speech to the nation’s governors on February 27, “nobody knew that healthcare could be so complicated.”

So, the hard work of governing begins …

The first draft of a Republican replacement for the Affordable Care Act has stoked criticism from both mainstream Republicans and right-wing Republicans (not to mention opposition from Democrats).  Arguments over healthcare policy threaten to impede progress on more important matters affecting the economy.

 

In addition to Healthcare, the Trump Administration is seeking to vastly reduce federal government regulation, cut the budget for many government agencies and departments, and spend a whole lot more on the Military and Infrastructure.  Tax Reform is a major issue, which we will discuss in detail over the next couple of weeks.  But, the first major battle of vital importance to the nation comes up next week … the Debt Ceiling.

 

 

The First “Speed Bump” for the Trump Administration

It is likely that two events will occur next Wednesday which will directly impact the U.S. Economy.  It is expected that The Federal Reserve will raise short-term interest rates by another 25 basis points (0.25%), as The Fed tries to put monetary policy back on an even keel (as we discussed last week).  And, the President and Congress will begin to battle over raising the Debt Ceiling.

The U.S. Debt Ceiling is a legislative limit on the amount of federal debt which can be issued by the U.S. Treasury.  As the federal government has been regularly spending more money than the Treasury takes in over the last few decades, the government must borrow to help fund operations. When borrowing pushes the national debt up to the Debt Ceiling, conflict arises.

The government must choose among cutting programs and spending, or defaulting on the Debt, or raising the Ceiling. Political conflicts have led to government shutdowns.  In 2011, a crisis arose over a threatened default of government debt … leading to a downgrade in the credit rating of The United States … when political wrangling delayed an increase in the Debt Ceiling.

In October, 2015, President Obama and Speaker Boehner negotiated an agreement to suspend the Debt Ceiling until March 15, 2017, allowing the national debt to keep piling up.  As of next week, the new President and the Republican-controlled Congress will have to come to terms on a new Debt Ceiling, or otherwise agree on federal spending limits.

 

 

History of the Expanding National Debt

We wrote, in the September 28 issue of  IntelDigest, that:

“… the state of our official National Debt … stands at approximately $20 Trillion.  Additional future unfunded government liabilities … Social Security, Medicare, Medicaid … would increase the true National Debt to hundreds of Trillions of Dollars over the coming decades.

The official Debt can only increase, as the federal government continues to spend much more than it brings in.  Boston University professor Laurence Kottlikoff has written that over 90% of federal tax revenues go to cover entitlement programs plus interest on the Debt.  ALL other federal government expenditures … including the cost of the largest military in the history of the world … has to be funded from the remaining 8-9% of revenues, PLUS more and more borrowing.”

Our national debt is close to $20 Trillion, while our national Gross Domestic Product (GDP) is approximately $19 Trillion, resulting in a debt-to-GDP ratio of 105%.   How did things get this bad?

In the first 200 years of the Republic, such peaks in the debt-to-GDP ratio occurred during major wars … the Revolutionary War, Civil War, World War I, World War II. After the wars were finished, the country worked to re-establish sound financial footing, so that the debt-to-GDP ratio always came down to reasonable levels.  As recently as the Nixon, Ford, and Carter administrations, the ratio stood at approximately 33%.

The Era of Expanding Debt began in the Reagan Administration in 1981, and has grown through Democratic- and Republican-controlled governments alike. After decades of strong economic growth and stable “real” interest rates, Reagan entered office in a time of high inflation, high interest rates, and a major recession.  He had, in his favor, a low debt-to-GDP level and sound American credit.

After Fed Chairman Paul Volcker successfully brought inflation and interest rates under control, the recession ended and the Dollar was strong.  President Reagan wielded American fiscal strength as a weapon to win the Cold War … using deficit spending and borrowing power for a huge military expansion, including the Strategic Defense Initiative anti-missile program (dubbed “Star Wars” by the press).

Reagan’s first-term tax cuts and second-term military spending ballooned the Debt and federal deficits;  the debt-to-GDP ratio rose to 55%.

The fiscal conservatives in the Reagan Administration (some of whom now advise Donald Trump) expected that tax cuts would reduce government income, and the government would be forced to cut spending in order to reduce deficits.  But, it didn’t work out that way.  Higher and higher government spending became a way of life.

Under the administration of George H.W. Bush, the deficit grew, and the debt-to-GDP ratio rose to 60%.  So, the Bush Administration negotiated a budget compromise, including some tax increases, with the Democratic-controlled Congress.  This was contrary to his “No New Taxes” pledge, which damaged his re-election chances.  Ross Perot entered the race as a third-party candidate, and Bill Clinton won the 1992 election.

The Clinton Administration was able to enjoy a period of relative peace in the world;  through lower military spending, sound monetary policy by The Federal Reserve, and a small rise in income taxes (which are at roughly the same levels today), President Clinton presided over the longest peacetime expansion of the economy in American history, and produced a small budget surplus for the first time in 30 years.

At the time of the election of George W. Bush (and Dick Cheney) at the end of 2000, the federal budget was again in deficit and the debt-to-GDP ratio was at 58%.  Although his predecessors had succeeded in holding the line on the debt level, it was still close to the highest level in history to that time.

Bush/Cheney pushed through major tax cuts in 2001 and 2003, and increased federal government spending across the board.  They adopted additional increases in federal spending for military and intelligence in response to the 9/11 attacks, and prosecuted wars in Iraq and Afghanistan, as well as military actions in several other countries.

At the same time, The Federal Reserve continually lowered short-term interest rates, encouraging speculation in banking and real estate.

By the end of the Bush Administration, the debt-to-GDP ratio was up to 63%, the national debt had grown to $10 Trillion, and the world economy was in full-blown Financial Crisis.

Barack Obama entered office during the worst financial panic since The Great Depression … the economy was crashing and jobs were lost by the millions.  The Administration’s attempts to stimulate the economy with government deficit spending succeeded, but at a slow rate of less than two percent per year.  The 2009 American Recovery and Reinvestment Act provided little “shovel-ready” infrastructure spending, and went primarily to protecting jobs of municipal workers, teachers, healthcare workers.  The Republican-controlled Congress blocked further stimulus programs.

 

 

The Way Forward

The Trump team believes that Growth is the answer to leading the American economy out of our Debt Crisis over the next decade.  Although mathematically possible, it will be a long and difficult journey, even in the best of circumstances.

But, that long journey begins next week.  In order to have the financial flexibility to pursue the Trump Agenda, the Administration will require the cooperation of the Republican-controlled Congress to increase the Debt Ceiling.  There are factions within the Republican Party which are not likely to cooperate.  So, we can expect a battle to be raging at this time next week.

 

 

 

InnOvation Capital & Management, LLC

IntelDigest

LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR

MARCH 1 , 2017

 

Contact Richard Power with comments or questions. IntelDigest is intended for the use of our clients and colleagues.  Material may not be reproduced, forwarded or shared without express permission.

 

 

Over the last few issues of  IntelDigest, we have set out our analysis of the investment markets going forward.  Our forecast for 2017 can be summarized as follows:

 

Small-cap stocks will benefit … over the course of this year … from an expectation that the Trump Administration and Congress will succeed in lowering business taxes, reducing government regulation, and increasing federal spending on infrastructure

The U.S. economy will continue to expand … as it has over the last eight years … but at a stronger pace;  if Trump and the Congress succeed, the expansion could approach three percent (3%) per year

Fundamentals are improving in Emerging Markets, and the BRICs countries (Brazil, Russia, India, China) should do well this year

Precious Metals (particularly Gold and Silver) are expected to rise, and should be a staple (up to ten percent (10%)) of an investor’s portfolio

Historically low Interest Rates are the dominant factor in the U.S. Equities Bull Market … stock prices are reasonable when low interest rates are factored in;  even though three modest rate increases are expected from The Federal Reserve this year, rates will still be extremely low, supporting a continued rise in stock prices

U.S. Real Estate remains a very attractive investment while interest rates are at such low levels

Excellent opportunities still exist in some mature foreign markets, such as Japanese equities

These are the precepts supporting an optimistic viewpoint, at least as far as this year is concerned.  Stock markets will have occasional spurts up, such as the increases today following the President’s address to Congress last night. And, there will likely be corrections … where equities slide by 5-10%.  However, the basic assumption of a rising stock market should hold for 2017.

Taking a Cautious Stance

Having an optimistic outlook does NOT mean that we should keep our eyes closed to potential problems.  And, it does NOT mean that ALL investments will do well in the current environment.

In the weeks prior to the Election, we warned investors that the value of corporate bonds will fall as The Federal Reserve raises rates;  that the stocks of companies with substantial indebtedness or unsustainable dividends should be culled from portfolios.

An investor who has reduced exposure to bonds and the stocks of problem companies should be left with a strong core of equities (both American and international), precious metals, and U.S. tangible property.  Owning such formidable assets should carry you through 2017.

Update on Short-Term Interest Rates

Mohamed El-Erian is the Chief Economic Advisor at Allianz, and a former officer at PIMCO investments.  Writing in Bloomberg, El-Erian sees a likelihood of a modest rise in interest rates in March, and a possible change in “tactics” by The Federal Reserve going forward.

The Fed is more likely to raise rates in March if the February jobs report is strong.  El-Erian believes that “… a green light from the wage data would do more than significantly increase the probability of a March rate hike. It also would allow the Fed to slowly evolve away from its tactical posture and toward one that involves more strategic consideration.”

After the 2008 Financial Crisis, The Fed had adopted a “data-dependent” approach to policymaking, with poor results.  Not only were the experts at The Fed surprised by the crisis, their analytical modeling was insufficient or out-of-date, and the policy of dragging short-term rates down to ultra-low levels has been a catastrophe for Main Street.

El-Erian believes that a positive jobs report will motivate The Fed to step up in March, and return with confidence to its historical proactive strategic stance … one which will be necessary moving forward, as policy battles between Congress and the Trump Administration threaten to derail the expansion of the American economy.

 

 

The “Goldilocks Market”

Louis Navallier, famed investment advisor, has a different take on rate hikes.

Navallier describes the current economic conditions as a “Goldilocks” environment … meaning that the economy is running at exactly the right temperature.  There is sustainable growth, but it’s not so “hot” that The Fed will be compelled to raise interest rates by much.

He believes that The Fed Open Market Committee will NOT likely raise rates at its March meeting because inflation remains in check.  He asserts that The Fed has a 2% inflation target;  if it exceeds that level, it’ll likely raise interest rates.  As it stands, the Fed’s inflation measure is running at 1.7%.

In recent testimony before the Senate Banking Committee, Fed Chair Janet Yellen implied that the FOMC will gradually raise key interest rates at its upcoming meetings.  Fed Vice Chair Stanley Fischer later reiterated Yellen’s comments … that The Fed is noting the strengthening economy and that it “is a little more confident about where we’re going and how soon we’ll get to full employment with stable prices.”

Translated from “Fed speak”, Fischer is hinting that the data-dependent Fed will most likely raise key interest rates at its June FOMC meeting. There is a small chance of a rate hike at the March FOMC meeting, but based on market rates, a June hike is much more likely.

The Strength of the Stock Market

Navallier believes that the accommodative policies of The Federal Reserve will continue, and will push down the yield on corporate bonds. If Congress passes corporate tax reform which includes an incentive for multinational corporations to repatriate Billions of Dollars held in foreign countries, Navallier believes that this would lower bond yields even further.

This goes against our own view of bond yields, so we will keep a close watch on these developments.

Navallier has a theory for the “persistent strength” of high-quality U.S. stocks:

“Between the stock buyback activity and the lackluster IPO market, the stock market is actually shrinking. So as money pours into the stock market, it flows into fewer shares.”

Looking at the short term, March and April tend to be seasonally-strong months in the markets as significant amounts of pension funding occur at this time. So, we expect the markets to continue performing well in the coming weeks.

Next week, we will update developments in the three major policy debates which will impact all our fortunes in the coming months … the Debt Ceiling, Tax Reform, and Infrastructure Spending.