November 17, 2017

Stocks rebounded yesterday after a week of losses. Strong earnings from Wal-Mart# and Cisco were two catalysts. Another was the passing of the tax reform bill in the House. Getting reform done in the Senate will be a tougher task, but investors still believed, and rightfully so, that one step forward was worthy of a celebration.

Interestingly, the dollar weakened and so did oil prices. Oil has been weak for several days on inventory concerns. U.S. production is back to all-time highs, currently running at about 9.6 million barrels per day. Some of the other areas where there have been noticeable volume slowdowns, notably Nigeria, are seeing production rise again. Barring a severely cold winter, it would appear that inventories will be ample into the summer driving season. Broadly, a $40-60 range for the price of oil seems like a prudent forecast unless weather, terrorism or a pointed effort by a major supplier to curb production (e.g. Saudi Arabia) intervenes. OPEC meets in December and most likely will stay at current production caps. Add in net growth from non-OPEC producers (notably the U.S.) and you can understand why the recent rise in prices, in reaction to political changes in Saudi Arabia, is not sustainable unless issues in the Middle East result in actual production cutbacks.

As for the dollar, it seems to be acting like an uncoiling spring. It made a sharp move up right after the Trump election, but then reversed course early this year as the promise of much stronger U.S. growth faded. It then rebounded a bit on rising hopes for tax reform and some better U.S. economic data, but then fell back again as better data started to come from Europe and Japan. Furthermore, as details of U.S. tax reform began to be analyzed, it became apparent that most of the benefit would go to corporations and high net worth individuals, not the lower and middle class who would be the more likely catalysts for increased consumption. With that said, the Senate bill looks quite a bit different than the House bill, and the final bill, assuming Congress gets that far, is likely to be different yet. While the core seems set (lower corporate tax rates, elimination of certain deductions, etc.) the devil is always in the details. Parts that are in the two bills today may fall by the wayside in conference negotiations, and little goodies that don’t exist yet could pop up in the final bill. One should realize that Congress has a way of sneaking in final goodies at the last minute to gain key support and individual votes. The devil is always in the details. Because of the way this bill is going to be accelerated through Congress, I have no doubt that there will be last minute provisions passed that many members won’t even know about.

But back to the market. Let’s not lose sight of the factors that impact stock prices, namely earnings, the dollar, and interest rates. Earnings are solid and the outlook will only improve with tax relief. The dollar has backed off of recent strength, and longer-term interest rates remain within a tight range. Until either the dollar strengthens in a meaningful way or rates spike higher, there is little reason to suspect that stock prices are going to fall meaningfully. Yes, there could be a bout of profit taking either early next year or after the full details of the tax bill become evident, but that would be just temporary. While stocks are and have been expensive historically, they still are more attractive than bonds or cash. Again, that could change if and when rates rise but under current circumstances, they remain the best game in town.

The Senate is not scheduled to vote on tax reform until after the Thanksgiving holiday. Public opinion between now and then could sway a few key Senators. The Republicans have only two votes to lose. Some, like Ron Johnson (R-Wisconsin), are pressuring for pointed changes. Others will do the same between now and then. It is possible that the repeal of the ACA individual mandate won’t survive if it costs more than one vote. Thus, expect some changes between now and the time the Senate votes. But it is clear that Republicans feel a collective urgency to get something done. In Obamacare repeal, they were taking coverage away from millions. Under tax reform, most get some more money in their pockets. That makes it a much easier sell. This may not be the best bill ever, for all the reasons I delineated lately, and it may accelerate the day of reckoning for exploding debt and entitlement reform. But in Washington, that is always a tale for next year, the next Congress or the next Administration. In other words, those problems aren’t likely to be tackled until there is a crisis. That won’t be 2018.

Today, Danny DeVito is 73. Martin Scorsese turns 75.

James M. Meyer, CFA 610-260-2220

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