MACA (competitive)! Go big or go home and a 15% corporate tax rate will certainly make that happen. I’ll leave it to others to figure out if and how we get there (it will obviously be tough) but the implications will have to also be measured by any change in interest rates in response in gauging the impact on corporate earnings and for other obligations. In other words, we can’t just do an ‘all else equal’ analysis. If the administration is going to rely heavily on dynamic scoring and thus assume a higher economic growth rate to ‘finance’ the tax cut, well then we have to assume too that interest rates will go higher both on growth possibilities and budget deficit ones. By the way, for a while deficits didn’t matter but nothing negative does in a bull market. If we are no longer in one, maybe this time it matters. We still need buyers for all this paper and the foreigners have said ‘no mas’ and the Fed might just do the same by year end. Also with respect to corporate earnings, lowered interest expense was a huge boost since the earnings trough in ’09.
So let’s put numbers around all this. The CBO forecasts the government will take in $320b of corporate income taxes in fiscal year 2017. Let’s assume this gets cut in half and companies receive $160b (will likely be less because of offsets but let’s assume). As of Q4, total business debt in the US was $13.47 Trillion. Thus, if interest rates rise 100 bps, we can add about $135b in higher interest expense. For households, we can $147b of higher interest expense on mortgages, credit cards, auto and student loans, etc… and for government at all levels we can add about $200b. Now there are certainly timing issues here in that there is plenty of fixed rate debt with maturities that stagger in coming years but you can see my point how important any interest rate response might be to a growth enhancing and budget busting tax cut. I want to be clear, making US companies more competitive from a tax perspective is crucial and I am all for this. We just can’t analyze it though in a vacuum and must acknowledge the potential response in the bond market with the large amount of debt, particularly on the corporate side, and the artificially low level of interest rates that fed that beast over the past 10 years.
For those borrowers not locked in to fixed rates, such as LIBOR based borrowers, 3 month LIBOR has already gone up almost 100 bps over the past two years and if the Fed follows thru on its rate hike plan, we will see another 100 bps rise over the next year. See 3 month LIBOR chart:
US 3 Month LIBOR
Stock market sentiment according to II got more bullish w/o/w. Bulls rose to 54.7 from 51.9 last week where most came out of the Correction side that saw a 2.4 pt drop. Bears remained in a tight, albeit very low range as it fell to 17.9 from 18.3. Bottom line, the S&P 500, DJIA and Russell 2000 peaked on March 1st when sentiment got to its most extreme in 30 years and I still feel that in order to achieve another leg higher of substance, sentiment has to cool first.
Mortgage applications to buy a home fell 1% w/o/w and that’s after a 3.4% drop last week. The y/o/y change is essentially unchanged and the index level is at a one month low. We are smack in the middle of the important transaction season and I would have preferred to see some better gains in this gauge. This is with the average 30 yr mortgage rate which fell to a 5 month low at 4.20%. Instead, refi’s got a boost of 7.2% w/o/w but they are still down 34% y/o/y as rates are 35 bps higher than a year ago.
Peter is the Chief Investment Officer at Bleakley Advisory Group and is a CNBC contributor.