Before You Book That Vacation, JPM Warns Multiple Spoilers Are Converging In November

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.

CANADA: 2008 all over again?

A major issue arising in Canada hasn’t received too much attention lately. Year after year, quarter after quarter, the level of the household debt is increasing both in absolute and relative numbers:

Source: tradingeconomics.com

The net debt versus disposable income tells you the total amount of debt in a household versus that household income and is a bit comparable to a net debt/EBITDA ratio on a company basis. A ratio of 170% means a Canadian household would have to spend 21 months of its (entire!) disposable income on debt repayment before being debt free. If a repayment capability is for instance just 20% of the disposable income, you’re talking about a repayment period of 10 years – excluding the additional interest expenses.

Did you want to see another perspective? The next chart shows the net debt versus Canada’s GDP. As you can see, this ratio has increased sharply, indicating Canadians are outspending.

Source: tradingeconomics.com

And finally, a third chart which should worry you; the total amount of car loans.

Source: globalnews.ca

One of the ‘arguments’ from those who consider the elevated debt levels ‘not too bad’ is the argument the asset value of the households is increasing as well, predominantly due to increasing real estate prices. Technically, one is correct when assuming the increasing asset prices keep the debt/equity ratio in balance despite an increasing debt level.

However, the real estate market is actually a major part of the problem in Canada, and that’s also something the Bank of Canada has pointed out in a recent update. The total indebtedness of the Canadian households actually increased exactly due to the increasing real estate prices, increasing the need for its citizens to apply for larger mortgages.

Canadians seem to think the only way the real estate prices are going, is up. Does this sound familiar to you? Because it definitely sounds familiar to us, as inflated real estate prices and ‘over-borrowing’ homeowners were the main culprits of the global financial crisis in the USA in 2008.

Back then, the Canadian banks were seen as some of the safest banks in the world, but the stability of the main banks is now being threatened by losses related to loans to oil companies and a negative shock in the real estate market might have very negative consequences. Even if we wouldn’t expect the housing prices to drop but to level off, the expected increases in the benchmark interest rates will make a mortgage much more expensive.

Source: globalnews.ca

Whereas the average cost of a mortgage is currently approximately 3%, this could easily increase towards the 5% level by the end of the current decade. If you’re a Vancouver- or Toronto-based homeowner who borrowed $1M, your interest expenses will increase by $20,000 per year or $1,500 per month. That’s a pure cost increase and doesn’t reduce the principal payments on your loan.

According to the Bank of Canada, the total amount of mortgage debt increased by 6% in the past year to C$1.45T. A 2% increase in the average cost of debt would increase the total annual payment by C$30B. To put this in perspective (as the C$30B will have to be funded by slashing other expenses), that’s approximately 2% of the country’s GDP so you can be pretty certain the trickle down effect will be substantial.

Source: Bank of Canada

And the higher mortgage rates will have another negative consequence. Exactly because the cost of debt is increasing, fewer people will be able to afford a mortgage, and banks will tighten their conditions. This by itself will cause the real estate prices to stall, and very likely to decrease. After all, unless the foreign buyers are filling the gap, there will be fewer buyers in the market for the available properties. The central bank is absolutely right when it says the ‘household vulnerabilities have moved higher’.

A low oil price, low (hard) commodity prices, an ‘over-borrowing’ population and an overvalued real estate market. Oh, what could possibly go wrong?

> Protect yourself with HARD assets. Read our Guide to Gold right now!

Federal Bureaucrats To The Public: Be Afraid!

States have always thrived on the fear of the taxpayers, and states have always justified their existence in part on the idea that without the state, we"d all be overrun by barbarians, or murdered by our neighbors. Charles Tilly, a historian of the state, frequently noted that the modern state as we know it, was born out of war, and was created to wage war. War and the state are inseparable. 

Moreover, support for the state is so central to maintaining continued funding and deference to the state"s monopoly power, that Randolph Bourne famously went so far as to say that "war is the health of the state."  

By extension, agents of the state — whether elected officials or bureaucrats — fancy themselves as guardians of prosperity and civilization. Without them, they apparently believe, life would be barely worth living. 

Thus, one should hardly be surprised when government bureaucrats spread fear as a means of self-promotion. 

Keeping this tradition alive is Department of Homeland Security John Kelly who recently claimed that people would "never leave the house" if they "knew what I know about terrorism." 

This, incidentally, introduces a new variation on the time-worn they"re-coming-to-get-us propaganda that the state has relied on for centuries. Nowadays, we"re not even allowed to know what the threat is.

"It"s a secret, so just trust us." is the refrain. "They"re coming to kill us. We swear it"s true."

Kelly then punctuated his comments with an advertisement for the federal government, concluding  

The good news is, for us in America, we have amazing people protecting us every day, DHS, obviously, FBI, fighting the away game is DOD Department of Defense, CIA, NSA, working with these incredible allies we have in Europe and around the world.

What counts as "protecting us every day," is apparently a bit different for Kelly than for more astute observers. 

James Bovard recently described how the FBI has been doing such a great job keeping us safe: 

Before the 9/11 attacks, the FBI dismally failed to connect the dots on suspicious foreigners engaged in domestic aviation training. Though Congress had deluged the FBI with $1.7 billion to upgrade its computers, many FBI agents had old machines incapable of searching the Web or emailing photos. One FBI agent observed that the bureau ethos is that "real men don’t type. ... The computer revolution just passed us by."

The FBI’s pre-9/11 blunders "contributed to the United States becoming, in effect, a sanctuary for radical terrorists," according to a 2002 congressional investigation. (The FBI also lost track of a key informant at the heart of the cabal that detonated a truck bomb beneath the World Trade Center in 1993.)

"Everyone makes mistakes!" Might be what the FBI"s-backers claim. True enough. But few organizations get paid 8 billion dollars per year of the taxpayers" money to not stop terrorists.

So, it"s unclear what Kelly is referring to in how we"d all be dead were it not for federal agents. 

Perhaps he"s referring to the CIA. The same CIA that planned the disastrous Bay of Pigs invasion, and then spent decades paying spies to report on how the Soviet economy was growing impressively, estimating the Soviet economy to be three times the size of what it actually was. The implication, of course, was that the USSR was a powerhouse that could defeat the US in an arms race. 

One can guess what CIA agents were saying at the time: "If you knew what we know about the Soviet economy, you"d never leave the house!" 

Kelly also refers to the NSA. This is the same NSA that allowed Edward Snowden to walk off with countless numbers of their own top-secret documents. And its lack of control over its own information enabled this month"s malware attack that infected computers in 99 countries. The attack was not stopped by the NSA, of course. 

These are those "amazing people" that keep us safe, according to Kelly.

And then there"s the Department of Defense. The centerpiece of a military establishment that hasn"t won a major conflict since 1945. The "victory" in Iraq in 1991 wasn"t even complete enough to end the economic sanctions imposed on Iraq before the war started. Those sanctions persisted until 2003. 12 years after the first "victory" the US then attacked Iraq again, thus promoting the spread of Islamic extremism and causing a civil war that led to the near-destruction of Iraq"s few remaining Christian communities. 

"Before the United States invaded Iraq, Al Qa’ida was on the ropes..." the Brookings institution concluded in 2007. "The invasion of Iraq breathed new life into the organization."

Meanwhile, the Pentagon doesn"t know what it did with six trillion dollars. 

Fortunately for us, the US"s most implacable enemy today is ISIS, which has no air force, no navy, and is composed largely of depressed outsiders whose deadliest weapons outside of Iraq and Syria are delivery trucks. 

It doesn"t take an army, or an FBI, or a CIA to stop crazies from driving trucks into crowds on Bastille day, as one did in 2016. It requires that police keep unauthorized trucks off pedestrian malls during festivals. 

Nor are secret police required to keep people from carrying bombs into crowded theaters. Competent security guards can do the trick. The same might be said of maniacs carrying semi-automatic rifles into night clubs. 

But of course Kelly would likely claim that the government is preventing far greater attacks than these. He just can"t tell us what any of them might be, or give any details at all. 

Nevermind that in situations like this, the burden of proof is always on the government agency that  wants more tax dollars and more power to keep doing what they"re doing. The claim of necessary secrecy offers a convenient excuse from having to provide an evidence at all. 

But, there"s always enough violence and mayhem in the world to try to convince people that the world is falling apart. Although the chances of being murdered in an American city are at a 50-year low (unless you"re in certain neighborhoods of Chicago and Baltimore) many Americans believe crime is worse than ever. Pew has noted that at the homicide rate was cut in half over the past 20 years, Americans persist in the idea that crime is getting worse. 

Moreover, under the Obama administration, the feds claimed that mass-shootings were sweeping the country. In fact, the odds of dying in a mass shooting are so low that they might as well be zero. 

The hysteria over shootings, however, was a convenient justification for the federal government"s ongoing attempts to regulate firearms. 

"If you knew what I know about gun violence" Obama might have said. "you"d never leave the house!" 

Creative arithmetic is also being used to justify public fear over terrorism. Kelly"s comments invoked this week"s massacre in Manchester where 22 people (not including the attacker) were murdered. But, if you"re worrying about homicides in England, you"d might want to look to street crime instead. After all, in England and Wales, homicides increased by 121 (21 percent) from 2015 to 2016, largely fueled by stabbings and shootings of the traditional variety. 

Unfortunately, many Americans have been trained to believe whatever they"re told by higher authorities. The specifics vary according to one"s politics. Leftists appear ready to believe whatever some federal bureaucrat says about global warming — provided it fits into the leftwing narrative. 

Rightwingers are primed to believe whatever some government agents says that confirms their narrative about national security.

To illustrate the skepticism one should bring to comments such as those made by Kelly, let"s use the same format, and apply it to claims that might be made from across the ideological spectrum:

"If you knew what I know about the state of our lakes and rivers, you"d never drink any water!" said the director of the EPA...

"If you knew what I know about our economy, you"d never trust private industry!" said Senator Elizabeth Warren...

"If you knew what I know about kidnappings, you"d never let your children out of your sight!" said FBI director...

"If you knew what I know about global warming, you"d never drive a car again!" said President...

And so on. 

When confronted with a blanket claim that it"s obvious to those "in the know" that hysterical fear is warranted, we might be inclined to demand more convincing evidence. But, if what is said just supports our existing biases, then no evidence is necessary. The self-serving opinion of a government bureaucrat is all that"s required.

CEOs Begin to Warn of the Damage the USD's Strength Will Cause

The market is about to wake up to something bad.

That something is the fact that the $USD’s strength is going to crush corporate profits in 1Q17.

You see, companies begin to issue guidance for their results during the last week of the quarter. So the warnings are about to start hitting. Indeed, we’re already beginning to see this.

Safra Catz is CEO for Oracle, a $160 BILLION tech company. And she just issued a major warning of what"s coming this way.

This quarter, the effects of currency movement were more than what I had included in my guidance, mostly because of the strengthening U.S. dollar after recent elections in U.S. and Europe, resulting in currency headwind of 1% in total revenue, 2% in some revenue categories and one penny to EPS.

Here"s a Fortune 500 CEO warning that the $USD"s strength is already going to shave 1% off of revenues. Lest you think that 1% isn"t a big deal, consider that it comes to $371 MILLION.

As we head into quarter end, we’ll be hearing more of this. Indeed, Coca-cola, Restoration Hardware, and other companies are all already warning about the impact of the $USD post election.

After all, if the $USD"s bull market since 2014 has already crushed corporate earnings to 2012 levels... this current rally to new highs will be ANNIHILATING profits going forward.

And this is happening at a time when investors are RECORD bullish on stocks.

Everyone and I mean EVERYONE is "all in" on stocks. Hedge funds, commercial traders, even individual investors have piled into the market.

This will end badly as all manias do. We believe the market is primed for a 10% drop... possibly more.

THIS WILL HIT BEFORE THE END OF JANUARY.

Another Crisis is brewing… the time to prepare is now.

If you"ve yet to take action to prepare for this, we offer a FREE investment report called the Prepare and Profit From the Next Financial Crisis that outlines simple, easy to follow strategies you can use to not only protect your portfolio from it, but actually produce profits.

We made 1,000 copies available for FREE the general public.

As we write this, there are fewer than 19 left.

To pick up yours, swing by….

http://phoenixcapitalmarketing.com/Prepare1.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research