Is The Fox In The Hen House?

The Trump Administration's proposed tax reform plan was released this past Wednesday (with great fanfare).

In comments on Wednesday while in Indianapolis, specifically relating to his Administration's tax proposal, President Trump said: "Our framework includes our explicit commitment that tax reform will protect low-income and middle-income households, not the wealthy and well-connected," Trump promised. "They can call me all they want. It's not going to help. I'm doing the right thing, and it's not good for me. Believe me!"

Wow! Given the details of the tax "reform" proposal that was actually released to the public on Wednesday, we can only assume that there was some sort of "last minute switch"! If we are to give President Trump the benefit of the doubt, which we must, then this is the ONLY explanation possible given the following analysis of Mr. Trump's tax proposal as completed by the Tax Policy Center:

1. Taxpayers in the top 1% (incomes above $730,000) would receive approximately 50% of all proposed tax cuts, and their average after tax income would increase by 8.5%.

2. Taxpayers in the bottom 95% would see their average after tax incomes only rise between 0.5% and 1.2%.

Other proposed tax cuts in the Trump Administration's "Unified Framework" for tax reform include the following:

1. Elimination of the Inheritance Tax (Donald Trump's family could save as much as $4.0 billion on this proposed tax cut alone given his claim that he is worth $10.0 billion)

2. Reduction of the tax on "pass-through" business entities to a maximum of 25% as compared to the current maximum of 39.9% (Donald Trump and his family are known to have multiple "pass through" business entities)

3. The so-called "Alternative Minimum Tax" (AMT) is to be repealed completely in the Trump Administration's framework (according to the NY Times, the AMT is known to have cost Donald Trump $31 million in 2005, the only year that we an actual Tax Return for President Trump)

"It's NOT good for me! Believe me!"

According to the Tax Policy Center, the Trump Administration's tax reform proposal will reduce the Federal Government's net revenue by $2.4 trillion over the first 10 years and $3.2 trillion over the second decade. These numbers could be substantially worse if the proposed elimination of multiple tax deductions is NOT included with the actual tax cuts!

Stock investors cheered President Trump's tax plan last week! They believe him when he says that this will be the biggest tax cut ever for business and that he has the votes to pass this legislation in Congress. And maybe he does (but not likely)!

The Republican Party has the majority in both the Senate and the House of Representatives, but there are "factions" within the party that can be considered "deficit hawks". My view is that the Trump Administration's tax reform "framework" has no chance of passage in its current form!

So when does reality set in? Perhaps there is no time like the present! The sobering reality is that tax reform is complicated! And stock investors may very well wake up Monday morning and feel that it may be a good time to take some chips off the table!

Let's take a quick look at the Russell 2000 Index, which closed at a record high last week and jumped almost 2% on Wednesday alone (in response to the Trump Administration's Tax Reform framework)!

If you go to the iShares website (www.ishares.com/us/products/239710/ishares-russell-2000-etf, and search for the Russell 2000 ETF (symbol IWM) you will see the following information:

Cool Stuff! The P/E ratio looks very reasonable at just 20.87.

However, what I found most interesting was the information tag (i) on the P/E Ratio line. If you click it, here is what it says:

What? "Negative P/E ratios are excluded from this calculation" !!

So the P/E ratio for the Russell 2000 is NOT really 20.87! In fact, it's nowhere even close to that "reasonable" value. In the latest weekly edition of Barron's Magazine, the P/E ratio for the Russell 2000 Index is 97.96 as calculated by Birinyi Associates using the trailing 12-month earnings for each company. 

Wow! 

If we were just coming out of a recession, when corporate earnings were just starting to recover, maybe valuations of 97 P/E could be rationalized, but not after 8 1/2 years of recovery. When the next U.S. economic recession begins early next year, you can be sure this P/E number will get a lot worse! And if owners of this popular ETF ever want to liquidate, what kind of bids will they receive when scores of component stocks are in free fall because they just aren't worth anything (negative P/E ratios)!

Beside the overwhelming evidence that the U.S. Federal Reserve is now in "tightening mode", and beside the fact that the next Chairman of the Federal Reserve will probably be Kevin Warsh, a well known monetary hawk, here are just a few exogenous variables which could negatively impact U.S. and global stock markets immediately ahead:

1. The Iraqi Kurds have voted for independence. Will there be a military confrontation in this key oil-rich area of  northern Iraq?

2. Catalans will vote on an independence resolution tomorrow, Sunday, October 1st. This vote comes without sponsorship from Spain's central government in Madrid. The potential consequences of a YES vote here are significant to the future of Spain (and may disrupt financial markets).

3. The U.S. Justice Department's Special Council Robert Mueller has been fairly quiet despite the enormous political (and economic) ramifications of his investigation into Russian interference into our last Presidential election. How will the financial markets respond if Mr. Mueller reports that the Trump Administration colluded with the Russians in support of Donald Trump. And what if Mr. Mueller's investigation finds information "beyond a reasonable doubt" that individuals within the Trump Administration, and maybe even President Trump himself, obstructed justice (among other potential charges)?

4. It is being well reported today that North Korea is moving missiles out of its development area. Will the North Koreans launch these missiles? And more importantly, what will be the target of these launches? Last Monday, the North Koreans claimed that President Trump's recent comments represented a declaration of war against North Korea!

5. The U.S. has threatened trade sanctions against China and also threatened to renege on the Iran Nuclear Deal, but the more interesting trade squabble right now is with Canada. The United States has said it will impose tariffs of up to 200% on goods imported from Bombardier, a major Canadian aircraft and defense contractor. Canada is our second largest trading partner!

6. Among the most crowded derivative trades in the financial markets right now is the "short volatility" bets (which have been giant winners). If and when markets actually return to "normal" volatility levels (or worse), how will stock prices respond? Is it possible to see another "flash crash" like we saw on May 6th, 2010? The Dow Jones Industrial Average fell almost 10% in just minutes that day! And many big name stocks actually had NO BIDS! Could that happen again?

Here are some interesting statistics relating to volatility:

1. In the year ended September 30, 2016 there were 23 days when the S&P 500 fell 1% or more, 6 days when the SPX fell 2% or more, and 1 day when it fell 3% or more.

2. In the year just ended September 30, 2017, there were just 5 days when the S&P 500 fell by more than 1%, and there were NO days when it fell by more than 2%!

You can see why the "short volatility" trade has been so successful and continues to be so popular now! However, it appears to me that no one is really sure of the potential impact on the overall stock market if volatility suddenly upticks significantly in response to some unexpected event. In late 1987, implied volatility in the S&P 100 Index options (more popularly known as the OEX) surged to 250 as the stock market crashed on October 19th that year and naked out-of-the-money put options suddenly went deep into the money. The implied volatility of the S&P 500 Index options now (as measured by the VIX) is just 9.51 as of Friday's close, 9/29. Friday's close in the VIX was the lowest weekly close, lowest monthly close, and lowest quarterly close ever! And here is the latest CFTC weekly report on VIX Futures (courtesy www.zerohedge.com):

VIX Futures - Net Speculative Positioning
(per latest weekly CFTC report)

Official monthly chart sell signals have been triggered in my computer trading system at Friday's close (9/29) in the following stocks and ETFs:

ADBE, CCL EQIX, ICF, IEF, IYR, KO, NI, ORCL, PG, TLT, VALE and XLU

Bottom line: We haven't heard the phrase "liquidity squeeze" in a long time. However, all the pieces are in place now for a surprising liquidity squeeze that will soon take its toll on financial asset prices, with U.S. stocks leading the way down! "Cash" will soon be king again!!

Russell 2000 Index Monthly Chart with Computer-generated Buy & Sell Signals

Adobe (ADBE) Monthly Chart with Computer-generated Buy & Sell Signals 

Recent Action In Utilities Shares: Warning Sign Of Trouble Ahead For Stocks

The Utilities Select Sector SPDR ETF is now down 5.96% since its record high as posted on September 11th, 2017! Utility stocks are supposed to be among the most conservative groups and also have a reputation for stability and low "volatility". 

Utilities Select Sector SPDR ETF (symbol XLU) Daily Chart

Could the negative action in the Utilities sector be a warning sign of trouble ahead for the broader market? This group just plunged 5.96% in the last 13 trading days!

The proposed Trump Tax Cut has bolstered U.S. stock prices over the last three days, but this major tax reform is not likely to be passed in Congress in its current form anytime soon. While Republican budget deficit hawks seem few and far between in this "age of Trump", there are still a proud few who will rightly see the fiscal disaster ahead if President Trump's tax cuts see the light of day. Massive budget deficits as far as the eye can see will be the obvious result here, which translates into complete legislative failure to pass anything even resembling the original plan as Democrats side with true conservative Republicans (i.e. Bob Corker) to defeat the measure.

For stock market investors, who should you trust? Do you trust President Trump who claims that he "has the votes" to pass the "largest tax cut in history"? Or do you believe Chairman Janet Yellen who says that the Federal Reserve should not wait to normalize (raise) interest rates despite lower than projected inflation. The Federal Reserve is expected to begin liquidating its bloated balance sheet this coming month (October) and the odds now favor another 1/4-point hike in the Fed Funds rate before year end 2017. And some Federal Reserve officials are already talking about three more 1/4-point interest rate hikes in 2018! And one more footnote here: Kevin Warsh is being considered by the Trump Administration to replace Janet Yellen when her 4-year term as Chair ends on February 3, 2018. Mr. Warsh is considered relatively hawkish and has often criticized the Federal Reserve for its accommodative monetary policy and its quantitative easing (QE) programs during the current 8-year economic expansion which began in 2009.

Equity investors should NOT fight the (hawkish) Fed! While proposed initial tax cuts from the Trump Administration look "business friendly", final tax reform legislation is far from certain. If tax reform efforts are successful, which is no guarantee, then the final package enacted will almost certainly be dramatically different and also much less friendly to business than what's on the table right now. 

Charts of the benchmark U.S. Stock Market Indexes will soon look like the bearish chart of the Utilities SPDR ETF (symbol XLU) where multiple sell signals have been triggered by my computer trading system. The old axiom "Buy Rosh Hashanah (9/20) and Sell Yom Kippur (9/29 at sundown)!" looks like a winning strategy this year. A major correction in U.S. stocks appears imminent!

Utilities Select Sector SPDR ETF Monthly Chart (symbol XLU)

U.S. Stock Market - Are There Any Real Bears Left?

Most major U.S stock market indices posted record highs last week, including the Russell 2000 Index of small-cap stocks which lagged the overall market for most of August.

While some technical analysts are pointing to relatively low volume as a reason to be skeptical of this latest advance into record territory, one observation is abundantly clear and without reservation: Bearish traders and investors have been mauled because there have been no meaningful corrections in the stock market since Donald Trump was elected President in November of last year!

Those is the bullish camp are apparently "fearless" right now, and not even hawkish rhetoric from the U.S. Federal Reserve in recent weeks can get them to sell their precious stocks! The Fed is now indicating that it will begin to liquidate its $4.5 trillion balance sheet in October, hike short term interest rates again in December, and then hike interest rates three more times next year! Wow!! Some uninformed Wall Street pundits are actually now claiming that these normally bearish pronouncements are actually bullish for the stock market! While I have to give the bulls credit for hanging tough here, I will NOT buy into the idea that liquidation of the Fed's balance sheet is bullish for stocks, and I will definitely not buy into the idea that 4 expected interest rate hikes over the next 14 months is bullish for stocks!

Besides the argument that stock prices may be over-valued on a historical basis, is there anything that can even be considered remotely bearish right now?

Potential "black swans" on the international front look more than interesting to me here. The German election results this past weekend MUST be considered negative for the European Union given the German AfD extreme right wing party's surprisingly strong performance at the polls (+13.5% of the vote). In Spain, despite Madrid's complete lack of sponsorship, the Catalan separatist movement looks bound and determined to move ahead with an October 1st Independence Referendum. While I doubt there will be a civil war, this CAN'T be good for Spain! And largely under-reported is tomorrow's independence vote by Iraq's Kurdistan region. Unlike in Spain, there is no guarantee that civil war won't break out again in Northern Iraq as Kurds fight for their independence! The Trump Administration is actually talking about the possibility of breaking the Iran Nuclear Deal (as negotiated by President Obama). This may result in catastrophic consequences. Of course, I haven't even mentioned that small problem on the Korean peninsula, where Kim Jong-un, the Supreme Leader of North Korea, has threatened to set off a hydrogen bomb in the Pacific Ocean and maybe even launch a nuclear preemptive strike against Guam!

Closer to home, the negative price action in the following key stocks last week could be considered support for any bearish case in the U.S. equity market immediately ahead:

Tesla (TSLA)                        -7.6%

Apple (AAPL)                      -5.0%

Amazon (AMZN)                 -3.2%

Johnson & Johnson (JNJ)    -2.3%

Microsoft (MSFT)                -1.2%

FaceBook (FB)                     -0.6%

Nasdaq-100 (NDX)              -0.9%

Weekly chart sell signals were triggered by my computer trading system at Friday's close in NDX, TSLA, MSFT, JNJ, IP, and PG.

Monthly chart sell signals were triggered by my computer trading system in ORCL and XLU (Utilities ETF).

Monthly chart buy signals were triggered in the 10-year T-Note Yield and also the 30-year T-Bond Yield (see charts below).

Bottom line: The next major move in the U.S. Stock Market will be to the downside! Higher short term interest rates, pressure on corporate profit margins, renewed recessionary fears, and less accommodative central bank monetary policies on a global basis will contribute to the end of this incredible bull market in stocks that has now lasted 8 1/2 years!

10-Year Treasury Note Yield Monthly Chart with Computer-generated Buy & Sell Signals

30-Year Treasury Bond Yield Monthly Chart with Computer-generated Buy & Sell Signals

Tesla Weekly Chart

Apple Weekly Chart

Amazon Weekly Chart

Johnson & Johnson Weekly Chart

Proctor & Gamble Weekly Chart

Nasdaq-100 Index Weekly Chart

Microsoft Weekly Chart

U.S. Stock Market - Outside The Box

Most major U.S. stock market indices posted record closing highs this past Friday, September 15, 2017. And many pundits on Wall Street and most investors on Main Street now see even higher prices for stocks ahead.

According to the latest University of Michigan survey, 65% of investors surveyed now think that U.S. stock prices will be higher a year from now. As you can see from the chart below, this 65% figure is a new all-time record high.

Latest University of Michigan Consumer Sentiment Survey

In my computer trading system, weekly chart sell signals were triggered last week in key stocks like Adobe (ADBE), Coca Cola (KO), McDonalds (MCD), Oracle (ORCL), and Yum Brands (YUM). However, new found strength in the energy sector helped the broader market indices to record high ground.

Oracle (ORCL) Weekly Chart with Computer-generated Buy & Sell Signals

So where do we go from here?

The Federal Reserve meets this coming week to discuss significant potential changes to its monetary policy. It is now widely believed that the Fed will begin to unwind its massive balance sheet immediately ahead. And the Fed may even telegraph another interest rate hike between now and year end! While tighter monetary policies are normally considered a negative for the stock market, investors don't seem to believe the steady stream of recent hawkish rhetoric from Fed officials ahead of this week's key meeting.

Massive hurricane damage throughout the South over the last several weeks is being viewed as bullish for stocks as reconstruction funds provide much needed "fiscal stimulus" for the economy. While 3rd quarter GDP results may take a minor hit as a result of this hurricane damage, it is widely believed that a rebound in GDP will soon follow in the 4th quarter and early next year as fiscal stimulus takes hold.

So what's not to like? Here are three potential negatives for stock prices:

1. Three major global central banks appear poised to tighten monetary policy immediately ahead (the U.S., the UK, and the ECB).

2. Corporate share buybacks are significantly lower this year, down about 20% from last year

3. According to the latest weekly report from the American Association of Individual Investors (AAII), investor allocations to stocks are near a record high while cash reserves are near a record low (see chart)

Latest AAII Weekly Survey

An interesting story is beginning to get more attention in the media. There appears to be evidence of vote tampering in several key swing states in the last Presidential election when Donald Trump won a surprise victory over Hillary Clinton. Influential former Vermont Governor Howard Dean thinks there may actually be credibility to the story that votes were "flipped" in major key Democratic strongholds like Milwaukee and Detroit. Since Donald Trump won Wisconsin and Michigan by the slimmest of margins, potential vote tampering could easily have changed the electoral results in those two key swings. Voter result irregularities are now being investigated, and the early evidence of potential hacking into electronic voting machines is compelling, at least on a statistical basis. For your review, I have listed three URL's that highlight some of the early investigations into this issue. Could Hillary Clinton have actually had the Presidential Election stolen from her? Was the "system actually rigged" as Donald Trump claimed it was almost every day from the moment he entered the Presidential race in June 2015?

www.unhackthevote.com/

www.votesleuth.org/

www.bluedotdaily.com/howard-dean-evidence-suggests-russia-falsified-votes-for-trump-victory/

My own view is that the "Russian Connection" to the Trump Administration will soon become as dominant an issue on Wall Street as it is now on Main Street. Special Prosecutor Robert Mueller's investigation of Russia's interference in our November 2016 National Election appears to be moving forward rather quickly now, and investors should not be surprised to see actual indictments handed down before the end of this year! Investors hoping for major tax reform (tax cuts) before year-end 2017 are likely to be disappointed, despite recent positive comments on this issue from Treasury Secretary Mnuchin.

Bottom Line: A major stock market correction is long overdue! While equity prices could easily retreat on the basis of valuations alone, my educated guess right now is that a "black swan" event or a surprisingly hawkish Fed proclamation will serve as the catalyst for the next market decline. President Trump is scheduled to speak before the United Nations this coming Tuesday. I personally doubt that President Trump will be the picture of diplomacy in his UN speech which will almost certainly address the ongoing crisis on the Korean Peninsula.