Stocks took a beating yesterday, led by sharp declines in technology shares that fell, on average, by about 1.5%. Republicans kept working on a health care bill, but no solution seemed close. News that tax cuts related to capital gains might not be enacted could have affected investor moods, but most of the selling appears to have been technical and end-of-quarter in nature.
It became clear to many that the health care bill Republican leadership was trying to ram through Congress was facing stiff and increasing opposition. The Affordable Care Act, popularly referred to as Obamacare, wasn’t about making care more affordable. Rather it was about increasing the number of Americans insured. The Republican repeal and replace version, the Better Care Reconciliation Act, wasn’t about improving health care either. It was about lowering taxes for higher income and investment class individuals and reining in burgeoning entitlements. While both are admirable goals, the level of Medicaid cuts necessary to offset the tax cuts would leave gaping holes in coverage for many frail and elderly. Republican leadership is now revisiting its options. As of now, one possible result will be less tax cuts and reduced cutbacks in Medicaid. Another is to separate repeal from replace, repealing as much of Obamacare as politically possible and doing the replacement at a later date. To insure ongoing coverage, a repeal of the ACA wouldn’t take effect for a prescribed period of time, perhaps a year. President Trump endorsed such an approach (via Tweet, of course) this morning. From either approach may come a solution that will enable Republicans to gather the 50 votes needed to get a new law passed. Politically, the Republicans know that failure to do anything would be catastrophic. Thus, before this saga ends, we are likely to get something. What it looks like remains unclear. It almost certainly won’t be the BCRA.
From an investor perspective, a bill that either simply repeals Obamacare or strips out the tax cuts could complicate future tax reform efforts. By using the reconciliation process, Congress has to work off of a baseline budget. A deferred implementation, or the lack of tax cuts within any ACA replacement, may lower the bar for future tax cuts. It has been our base conclusion all along that robust tax reform was unlikely with a thin and divided Republican majority. It is still quite possible that corporate tax rates can be reduced along with repatriation of foreign profits at a nominal cost. But the odds for significant reform beyond that remain low.
Today is the last day of the quarter. So far, it has been a good one for stocks, although some of the leadership names, particularly some of the leadership tech names, have had a tough few weeks. There are moments when we think stocks move in a straight line, but more often than not it is two steps forward, and one step back. Many leadership names were up 40%, plus or minus, by the end of May. Giving back 15-20% at some point, is logical. Maybe now is the time, maybe not. But based on the action of leadership names like Alphabet# and Amazon, now may be as good a time as any. No fundamental cause is necessary. Simply the loss of momentum will move traders from these stocks to other pockets of strength like the banks. Even energy issues, the absolute laggards of 2017, have improved a bit over the last few sessions as money rotates. Money always rotates.
But don’t be fooled. The fundamentals of Amazon, Alphabet and their brethren are much better than those of energy stocks, for instance. The high flyers’ stocks can be guilty of moving too far, too fast, and a 20% correction would be constructive. However, over time, fundamentals win and the growth companies, unless they are wildly overvalued, should outperform listless companies that aren’t growing. Yes, there might be energy or staples companies capable of growing 2-5%. And they can do well in market environments when uncertainty is high or bond yields show increased volatility. But those stocks aren’t cheap today, and over the long term, growth matters. After a solid correction, I could be an interested buyer of these high quality names. A solid correction could be as little as 5% or as much as 15-20%. The key is that those corrections aren’t long lasting. If you can catch an opportunity anywhere near a bottom, you should be well rewarded.
Given yesterday’s sharp selloff, today may be a key indicator. It is the last day of the month, and a lot of traders do a lot of repositioning. Indices also get revised, setting off a flurry of late day activity. Monday will be a half day of trading with most investors off on extended holiday. That could mean a nothing day or one of high volatility. I have seen both many times in the same situation. What seems appropriate is to have a list of great companies you want to own except that the price has been too high. Set your buy point. It could be hit by early next week. Or maybe not. Be disciplined, and the worse that happens is that you buy nothing. But if you are fortunate, you might pick up a bargain or two. That is what happens with great companies. Once or twice a year there is a sale, just like in the department store. You know when department store sales occur; you don’t know when stock market sales happen. What we do know is that we are not at the cusp of a recession and euphoria, isn’t in the market. Therefore, we aren’t at the precipice of a bear market. That gives equity investors confidence to buy the dips.
Also remember my two-day rule. We have had days like yesterday with no follow through. That doesn’t mean I suggest complacency. One of these days there will be two nasty days in a row, and we will all have to hunker down for a brief storm. In a storm, the first thing one must do is protect. It isn’t the time to be on the offensive. Let the storm pass before you get bold. Sometimes the nastiest part of the storm is right at the end. But in the end, the sun always shines and life is restored to normal. If there is no pending recession, life will be good once again.
The last few weeks could be a setup for a correction or nothing at all. We can’t sit back and just wait for a correction. They happen at random times for unpredictable reasons. There are seeds out there. Stocks have had a good run. Europe may be close to tapering its expansive monetary policy. Trump’s fiscal plans could go up in flames. Growth in the U.S. is a bit weaker than first believed. Interest rates are rising. Any or all of these could suddenly create fear. But they can be ignored just as easily. The key for investors is to stay disciplined, keep to your asset allocation, and take periodic advantage of excess fear or euphoria. It has been a very nice first six months of 2017. One shouldn’t expect such a smooth ride in the second half. But there is no reason to expect us to go over the cliff either. Just because there might be a few bumps ahead doesn’t mean we should run and hide. Stay the course.
Today, Michael Phelps is 32. Mike Tyson is 51. It is also the 100th anniversary of the birth of Lena Horne.
James M. Meyer, CFA 610-260-2220
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