At 2pm est yesterday the two biggest risks to the market were highlighted in their different forms. Firstly, nothing new was revealed in the minutes, especially after hearing from a slew of Fed members over the past few weeks but maybe market participants need to get slapped a few times before they pay attention. I’ll say again, I have a bridge to sell you if you think a rate hike cycle combined with a shrinking balance sheet will go smoothly. Also, I can’t get over the irony of Fed members acknowledging high equity valuations, that artificially set interest rates spawned, at this stage of the bull market where valuations have only been exceeded twice in history. Where were they years ago on this outside of Yellen talking about biotech stocks. I raise an important question generally on monetary policy, if the exit process ends up turning messy (defined as a recession and bear market in stocks) was all this easing worth it?
“Like a river that don’t know where it’s flowing, I took a wrong turn and I just kept going” wrote Bruce.
Secondly, after being reminded how complicated our healthcare system has become, Paul Ryan woke all up to the fact that fixing our tax code is so damn difficult too. And, the market and corporate America doesn’t want to wait until 2018 to see its benefits because it will freeze behavior in 2017. In a market that is priced for perfection, there is no room for policy mistakes.
Be bullish if you think both news stories will turn out just fine. Be very worried if they don’t. I’m going to be hopeful that some tax reform takes place but I believe any benefits to the stock market will be overwhelmed by monetary tightening when valuations are as extreme as they are at the same time we are late cycle in the economy. Just ask the auto makers on the latter. Also, remember 2013. We entered that year with a ton of tax increases on income, capital gains, medicare, payrolls, estates, medical devices… and the elimination of a bunch of deductions. GDP growth still managed to rise by 2.2% and S&P 500 corporate earnings were up about 10% even though sales were higher by just 3%. Why was the S&P 500 up 29.6% before dividends? Thank you QE infinity along with QE elsewhere. Monetary policy certainly Trumped fiscal policy that year and throughout this bull market.