One week ago, Jan Loeys - the person who wrote "The JPMorgan View" for 15 years - announced his exit, as he transitioned from tactical asset allocation to longer-term strategy, and that he would be handing over the authorship to John Normand, and soon Nikos Panigirtzoglou and Marko Kolanovic, but not before summarizing what he has learned in 30 years of investing in a must-read bulletin which he published last week.
In any case, this weekend it was Normand"s turn to regale JPM"s countless retail and institutional clients with a preview of the upcoming key "spoilers" which according to Normand boil down to 3: a reality check on US tax reform, weaker-than-expected China data, and a Russian rethink on extending oil cuts. Not surprisingly, JPM focuses on the first issue, because as Norman writes, "tax overhaul seems the most complicated market driver given its fluid composition and tortuous legislative process."
By contrast, China’s slowdown looks familiar and was already part of our economists’ baseline; hence, our neutral recommendation on base metals ex aluminum. The November 30th oil producers’ summit is not a drop-dead date for extending their year-old agreement, but we took profits anyway on a long Brent trade last week because oil’s geopolitical premium looked excessive.
For those curious what the largest US bank thinks will be dominant events over the balance of the month, here it is straight from the horse"s mouth.
How much tax reform is priced?
Readers of The J.P. Morgan View may realize that this edition is the first in 15 years without Jan Loeys as lead author. Jan has transitioned from tactical asset allocation to longer-term strategy. The View will now be authored by a different team, which hopefully maintains Jan’s succinctness and relevance while introducing complementary approaches to cross-asset strategy.
The growth trade that has dominated markets since late summer – higher yields, equities and commodities; tighter credit spreads and lower volatility – has stalled for a third-consecutive week, depending on one’s benchmark. US small cap stocks, probably the best barometer of US tax reform hopes, peaked in early October. Base metals began moving lower a week later. Most major stock indices are flat-to-down over the past week while credit spreads have widened (US high-grade +5bp, US high yield +20bp) and volatility has rallied (VIX +2%, VXY +0.5%) To be sure, these retracements are trivial relative to what risky markets have delivered year-to-date: returns are still running at least twice their long-term average for most equity markets, and in some EM sectors (local bonds, FX carry).
Multiple spoilers are converging in November, such as a reality check on US tax reform, weaker-than-expected China data, a Russian rethink on extending oil cuts. We’ll focus on the first issue, because tax overhaul seems the most complicated market driver given its fluid composition and tortuous legislative process. By contrast, China’s slowdown looks familiar and was already part of our economists’ baseline; hence, our neutral recommendation on base metals ex aluminum. The November 30th oil producers’ summit is not a drop-dead date for extending their year-old agreement, but we took profits anyway on a long Brent trade last week because oil’s geopolitical premium looked excessive.
The central question around tax reform should be What’s priced? Obviously the higher the expectations, the less upside on stocks and maybe bond yields and the dollar into year-end if Congress meets its somewhat unprecedented timetable of passage by Christmas. Conversely, another stalemate as befell healthcare reform could trigger a decent correction. We call Congress"s schedule somewhat unprecedented because proper tax overhaul like Reagan"s involving both lower rates and simplification required over 10 months to agree, as measured from the first House vote to Presidential signature. Just cutting taxes has been easier: Clinton’s initiatives in 1997 and Bush"s in 2001 and 2003 only required two months.
The Trump Administration has proposed Reagan-like reform, but our economists’ view has been that Congress will probably only manage Bush-like cuts. This means $1.5trn of gross unfunded tax reductions over 10 years, but more like $1trn net due to expiring provisions. These sums translate into little growth impulse once considered in annual increments, then discounted further to account for household and corporate tendencies to save some portion of tax givebacks. JPM Economics didn"t raise 2017 or long-term growth estimates after Trump"s election, nor after his tax proposal emerged in October. We’re still at 2.2% yoy for 2018.
Strangely given surging news trends around the tax topic, most survey and market-based measures suggest limited optimism. For example, consensus growth expectations (Blue Chip survey) have barely moved since the election. In January 2017, forecasters expected 2018 US growth of about 2.4%; that projection only risen to 2.5% since. It’s true that the S&P500’s forward P/E multiple has risen by about two points since the election, but EPS projections for 2018 (IBES basis) have not – they’ve been in a $146-$148/share range since November 2016. The implied 10% year-on-year growth in earnings next year would match 2017’s pace, even next year should deliver stimulus. By contrast, our Equity strategists think that just lowering the statutory corporate tax rate from 35% to 20% would add $12/share boost to any baseline.
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