Through a dream
I have come to an ancient door
Lost in the mist
I have been there a hundred times or more
Pounding my fists
Now inside, the fire of the ancient burns
A boy goes in and suddenly a man returns
-- "The Oath" Stanley, Powers, Ezrin (Kiss) 1981
The day, the month, the quarter all came to a conclusion on Wednesday night. So did baseball's off-season. That fact is a story all to itself and seems out of place here, but really is not, for seasons do come, and seasons do go. Seasons bring fortune, famine, success and failure. I have tasted them all, and yes, I did once take an oath with no expiration date that turned a boy into a man at an early age. Worth it? Of course it was. I never could have survived on Wall Street without the ability to be decisive, and right or wrong, to adjust on the fly. Without it, I never would have developed fully the codes of discipline and honor instilled by my exceptional parents that have shaped my lifetime.
How fortunate. To be raised in a good home by a woman who has personified the golden rule her entire life, and by a man who provided through example the literal blueprints for male adulthood. All I had to do was connect the dots and follow the trail. A senior drill instructor told us that yes, we were indeed the good kids who actually showed up, and for that we deserved praise. That was the last kind word we heard from him, for after three months of summer fun at Parris Island, the "kids" had been gone for quite a while. Some went home. Some turned into something else.
Then Wall Street called. This was something special. I could like this. A semi-organized mental brawl every day. A chance to win... or lose, or evolve. Every day. I loved the mental and back in those days, physical demands that the job placed on the human body. As I fondly recall those early days, I finger a coin with a bull's head on one side, and a bear's head on the other. The original token of the old auction market model. This one I carried with me every day that I wore badge number 986 on that beautiful playing field, also known as the trading floor of the New York Stock Exchange.
I look at my original certificate, framed on the wall, signed by Dick Grasso, proclaiming that I had become a member of the exchange. A seat at the table of opportunity. Forever we stand. Honor clean. For soon 'tis known from whence we came. Where'er we go, they fear the name... of garryowen in glory.
Did You See...
...The tech-heavy Nasdaq Composite move 1.5% higher on the last day of the quarter? The U.S. 10-Year Note's return to stability really since very early (pre-opening) Tuesday? Did you feel the heat, not of what had been a rather strong trading day for the most part, but the way the algorithms turned on equity markets late in the session? On very high trading volume.
There's a trick here. We expected some rebalancing... and we expected some window dressing. The fact that there was broad professional distribution late in the Wednesday session that appeared to be trying to take advantage of a pop possibly created ahead of the president's $2.25 trillion (or so) spending plan spoke to me. So did the fact that these professionals tried to take advantage of others trying to dress up their longs across "growthier" swaths of the marketplace on this day.
So did the fact that this whopping spending plan is just one part of a "two-parter," and this is the productive half. The second part, to be released later this month, may be just as expensive, but not nearly as productive. The next plan will be more about supporting families, or social structures. I'm not making a political argument. I'm making a markets/economic argument that the next shoe to drop will be more expense, less return.
Are you following here?
The Dow Jones Industrial Average closed out March 2021 up 8.5% year to date, the S&P 500 up 6.5%, the Nasdaq Composite now up 2.9% after Wednesday's rally. Getting granular, the Dow Jones Transportation Average now stands 15% higher than it had on New Year's Day, and the Russell 2000 has run 12% since. Forward-looking economic activity my friends is possibly fully priced in.
I will give that the Nasdaq Composite retook its own 21-day simple moving average (SMA) on Wednesday, and that will bring some of the slower swing traders on board this morning. I would not be surprised at all to see the Composite try to retake the 50-day SMA as well. The algos will do that. They are not sentient, at least not yet anyway. They are programmed to force overshoot.
Think with me here, because I am about to go out on a limb. Markets have priced in a lot of optimism, as well as incredible year-over-year comparisons going forward. Markets are pricing in 2021 (S&P 500) earnings growth of more than 25% on revenue growth of almost 10%. The S&P 500 after closing at a record last night, now stands at 22 times these projected 12-month earnings.
President Biden revealed a lot of planned goodness on Wednesday night -- $621 billion toward transportation infrastructure and electric vehicles; $561 billion toward green housing, schools, and upgrades to the electric grid, as well as public water works; $480 billion toward manufacturing subsidies and research & development projects; $200 billion toward increasing national exposure to broadband and job training. There are even provisions of $213 billion to build and renovate roughly 2 million homes that will build in a tax credit for lower-income households.
Now, for the bumps in the road. The plan would take federal corporate tax rates to 28% from 21%. This would push the average corporate tax rate, when adding in state and local corporate taxes, to 33%, which would place the U.S. in the ballpark of having the highest average corporate tax rate in the 37 member OECD. Does that sound competitive to you?
David Kostin of Goldman Sachs has told you that if the federal corporate tax rate were to go to 28% that you could lop 9% right off of expected aggregate S&P 500 earnings. Ed Yardeni was far more gentle. He only sees a 7% haircut. In addition, the minimum tax on profits that U.S. multinational corporations earn abroad would be increased to 21% from 13%. There will be penalties imposed on companies that offshore certain operations in order to avoid these higher tax rates.
Beyond that, this plan eliminates all tax breaks for fossil fuel industries, while forcing net polluters to pay into the Superfund Trust. Plans are also being made to repeal a number of loopholes for tangible income that could total well more than $200 billion.
Now, I am not saying that much of the planned spending does not look good. I think it needs to be said, though, that almost every one of those "bumps" in the road as I termed it, hurts someone, and in almost every case that someone will be a business.
Yes, the cost of doing business in the U.S. is going higher. There is no doubt about it. This means that at some point, capex has to drop off, and so will private demand for labor. This also means that the onus for driving economic growth is, or maybe already has shifted from what had been a robust private sector to public spending.
Can that work? I think it might. For a little while. I think it also creates an environment where there will be a never-ending need to come up with more and more spending.
Part two in April? How about Part six in April 2023? At some point with or without the Fed, the bond vigilantes will show up and what we saw earlier this year will be a walk in the park -- unless the Fed just buys it all. Can they? Will they?
How close are we to becoming an artificially managed economy, which by the way has failed on every attempt made in human history. You show me modern day China as an example of a managed economy becoming competitive. Is that what you want? Forget all of the human rights abuses, you better get used to building bridges and airports in the middle of nowhere just to keep the economy growing.
Organic growth that lifts people out of poverty? That used to be us.
Taking a Shower
Late on Wednesday afternoon and into after-hours trading, I took a lot of cards off of the table. Not that I know anything for sure, but I see an extreme period of volatility over at least a short-to-medium period of time. Perhaps long-term, but I would not bet the farm on anything.
As a hedge against volatility, I have returned cash levels to what is the highest they have been since last spring. It is now that the political season begins, and keyword reading algorithmic traders are going to pounce on every word.
House Speaker Nancy Pelosi expects to bring this spending plan in the form of a bill up for a vote across the full House by July 4. Expect that this will be partisan, but will pass. Then on to the Senate where the vote will still be partisan.
Remember the Democrats cannot lose a single vote in the Senate and certain senators will be put in a position of doing what is best for their constituents economically, and supporting their party. Think Senator Joe Manchin of West Virginia. Think he can support items that hurt the fossil fuel industry and still get re-elected? Me neither. Therefore, there will have to be compromise in the Senate that will anger the more progressive members of the Democratic Party.
Understand this. Something will pass this summer/autumn, but it may not exactly reflect what the president laid out on March 31.
That all adds up to, even in the best case, delays in infrastructure spending, which will hurt certain industries, while slowing down tax hikes. That could preserve corporate earnings for maybe one more year. Hopefully. It is for these reasons that I see the risk proposition for equities at this time tilted toward the downside. Keep in mind that the more and more artificial that the economy and price discovery become, the less accurate our most often looked at metrics for measuring risk assessment will also become.
I am not calling "game over,'" what I am doing is calling a timeout, as I do think that GDP of 6% plus, potentially beefed up even further by ever-looser fiscal policy, will require tough decisions moving forward.
The central bank either permits rates to rise, thus forcing the federal government into an awful position of servicing its debt as real rates go positive, and the public adapts to unwelcome inflation (damaging consumption) that may or may not be transitory. Either this, or the central bank turns to the calamity that is Modern Monetary Theory. Then it will be game over.
On The Bright Side
I could be wrong, but at least if I am, I have created immense flexibility.
My New Favorite Defense Contractor
I did not sell a share of Microsoft (MSFT) on Wednesday. Perhaps you noticed the $10 billion JEDI cloud-building contract awarded to the firm by the Pentagon in 2018. Perhaps you noticed on Wednesday that Microsoft has been contracted to deliver 120,000 HoloLens augmented reality headsets to the U.S. Army over a decade in a deal that could approach $22 billion.
This deal is the result of a $480 million agreement made between Microsoft and the U.S. Army back in 2018 to provide the Army with various prototypes of an Integrated Vision Augmented System. The version that the Army has decided upon will run about $3,500 a piece, and allow leaders to project information onto a soldier's visor in real-time.
Gone are the days of truly being out of touch or on your own out in the jungle until you could get the radio running well, and staying out of touch if radio silence had been declared. Gone are the days of pointing to a spot on a paper map to show a helicopter pilot where you needed to be, and watching the terrain pass from the side door of a Huey, hoping this guy understood his mission.
Readers will note that for the second time in 2021 Microsoft finds itself in the losing portion of what we in the industry refer to as a pennant formation. Pennants are named so because, well they look like pennants. They are basically symmetrical triangles that can last anywhere from a couple of weeks to a few months. When pennants close, they often create an explosive move in the direction of trend. Therefore, pennants are viewed as patterns of continuance.
The trend for MSFT has been upward for years. That upward surge that the closing of the last pennant created in January? That's called a "flagpole," and forms the foundation for the next move, which in this case appears to be another pennant.
I am increasing my price target at this time for MSFT to $285 from $278.
Economics (All Times Eastern)
08:30 - Initial Jobless Claims (Weekly): Last 684K.
08:30 - Continuing Claims (Weekly): Last 3.87M.
09:45 - Markit Manufacturing Index (Mar-F): Flashed 59.0.
10:00 - Construction Spending (February): Expecting -0.9% m/m, Last 1.7% m/m.
10:00 - ISM Manufacturing Index (Mar): Expecting 61.2, Last 60.8.
10:30 - Natural Gas Inventories (Weekly): Last -36B cf.
13:00 - Baker Hughes Oil Rig Count (Weekly): Last 324.
The Fed (All Times Eastern)
13:00 - Speaker: Philadelphia Fed Pres. Patrick Harker.
18:05 - Speaker: Dallas Fed Pres. Robert Kaplan.
Today's Earnings Highlights (Consensus EPS Expectations)
Before the Open: (KMX) (1.27)
After the Close: (ACCD) (-0.23)