@theMarket: Markets Enter the Danger Zone
It has been a bumpy week for stocks, and it could get worse if you believe the headlines of the financial press. The issue I see is that just about everyone is expecting a nasty period ahead for equities. That makes me somewhat bullish.
Calling short-term market moves in this environment is akin to fortune-telling. It is short on analysis, and long on my gut feelings. Granted, I too, have been warning folks that the September-October 2021 time period has been a seasonally difficult time for equities. My column last week addressed the possibility of a 5-10 percent correction, and what investors should do about it.
The media has now proclaimed that we are entering a "danger zone" for stocks, which stretches from today through the end of the month. Today, Friday, September 17, 2021, is also widely expected to be extremely volatile. It is a "quadruple witching" day when derivatives of stock index futures, stock index options, and single futures expire simultaneously. This event happens once every quarter on the third Friday of March, June, September, and December.
It is usually a big volume day in the markets. Individual stocks and indexes sometimes see large price swings during the day and into the last hour of trading. The media has everyone worked up that somehow the "danger zone," combined with "quadruple witching," spells doom for the markets. I beg to differ. While volatile, these events have proven to have little impact on the markets after the one-day expiration. Losses are usually recouped throughout the following days.
The contrarian in me also wonders how useful it is to worry about the next two weeks in the market. When everyone else is on one side of the boat, I tend to lean the other way. Headlines like "investors brace for more September volatility" just adds to the noise, and leaves little left to discount on the downside, at least for now.
What could move the markets higher? Well, we have another FOMC meeting coming up on Wednesday, September 22,2021. I expect the Fed will wait until November before pulling the trigger on tapering. That will cheer up most investors. There was also some good news on the economic front.
As most readers are aware, U.S. consumer spending is a massive part of the Gross Domestic Product of this country (about 70 percent). Thanks to the pandemic, incomes were boosted by fiscal stimulus, while at the same time, spending was depressed amid the lockdowns. Economists believe that as a result, consumers' savings have accumulated to the tune of $2.4 trillion or more. That is a lot of firepower and leaves the typical consumer with a combination of extra cash and lower debt.
That thesis came home to roost this week. Consumers defied expectations and went shopping. Retail sales in August 2021 jumped 0.7 percent, which surprised the markets, since consumer confidence readings had been falling sharply in recent weeks. That led most economists to expect a decline of 0.7 percent. It seems that those rising incomes, employment, and accumulated savings kept the consumer shopping, despite fears about the Delta variant.
The S&P 500 Index is at an important level, hovering just below its 50 Day Moving Average (DMA). This has happened several times before since March 2020, and each time buyers appeared to "buy the dip." I suspect they will again, so, no, I won't get bearish quite yet. I will go the other way and predict that markets will bounce next week. But what if I am wrong? Technically, the downside risk could be another 80 points (1.8 percent) to around the 4,365 level on the S&P 500 Index.
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The Retired Investor: Moderates Winning on Tax Debate
For months, wealthy U.S. taxpayers and corporations have been living with the specter of higher taxes under the Biden administration. It is a pretty good bet that taxes will go up, but not as much as you might expect.
Throughout the week, Democrats in the House and the Senate have been horse-trading over the amount of spending versus the amount of taxes necessary to pay for President Biden's $2.3 trillion budget plan. Republicans are already on record that they will oppose any new tax hikes at all.
Since the Democrats hold such a slim majority in both the House and the Senate, any legislation will need to accommodate both moderates and progressives within the party in order to pass. The battle between the progressives and the moderates has already started.
It appears that Senate progressives, like Bernie Sanders and Elizabeth Warren, along with House liberals, such as Alexandria Ocasio-Cortez, will need to temper their expectations on how high the corporate tax rate (and other taxes) should be raised. Draft legislation, released this week, indicated that the corporate tax rate, which is at 21 percent, may rise to 26.5 percent (on anything over $5 million in income) and not the 29 percent that was first suggested in the president's initial proposals.
As for individual tax rates, there is some on-going discussion among moderates who might want to raise the top bracket for wealthy individuals and married couples by $50,000 or so.
The original idea was that those individuals earning over $400,000 per year (and married couples earning over $450,000) would be taxed at 39.6 percent, up from 37 percent starting in 2022.
However, the key battle will still-to- be waged is over changes to the capital gains tax.
Under current law, people who die with unrealized gains don't pay capital gains taxes. Their beneficiaries do pay, but only on gains dated after the prior owner's death, and only when they actually sell those assets. The Biden plan would treat a death in the same way the IRS treats a sale, that is, a capital gains tax would automatically be applied.
The initial proposal would also increase the capital gains tax from 23.8 percent to 43.4 percent. The House Ways and Means Committee has suggested limiting the capital gains tax to just 25 percent, which does not sit well with progressives.
Capital gains taxes are a sore point for many (but not all Democrats), who have complained for years that the present tax laws unfairly benefit the wealthiest Americans. Not so, say others. Moderates argue that there are plenty of small family businesses and farms that would be devastated by these changes.
The Biden proposal would offer a $1 million exemption to everyone and would allow farm and business owners to defer taxes as long as their businesses remain family-owned. A new
Senate Finance Committee proposal would ease the capital gains hit by raising the per-person exemption to $5 million, and up to $25 million for family farms.
Then there is a group of senators and congresspeople (regardless of whether they are progressives or moderates) from New Jersey, New York, and other high-tax states that are insisting that they won't back a budget deal without a relaxation of the limits on the state and local tax deduction, the so-called SALT tax passed in 2018 by Republicans. Progressives are just as insistent that the lion's share of these benefits would accrue to the rich and not the middle class. A compromise might be found in capping any SALT tax breaks to a specific middle-class income bracket.
As you can imagine, this debate is not over. I expect it will take at least two more months before a compromise will be hammered out between the opposing wings of the Democrat Party.
Investors can be almost certain that taxes will rise for some, but the sting will be lessened to some degree.
Fortunately, the chances of compromise are quite high, especially when one considers the stakes. The expansion of the U.S. social safety net, the critical need for a new climate policy, and the fact that mid-term elections are not that far away, indicate a deal will get done.
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@theMarket: Some Brokers Are Getting Bearish
For four days in a row, the markets closed down. That is in itself unusual. It has only happened four other times since the March 2020 low. Does this portend further downside in September?
On Friday, the markets tried to bounce back. The damage to the averages has been minimal thus far. But given how far we have come, more and more brokerage houses (Goldman Sachs, Deutsche Bank, and Morgan Stanley, among others) are warning that the September-through-October time frame could see a 10 percent correction. How much weight should you give these gloomy predictions?
If you are a short-term day, or swing trader heed their call, since we are probably overdue for such a downdraft. This has been one of the 15th longest stretches in market history where the S&P 500 Index has gone without even a 5 percent correction. Consider that the average time between 5 percent corrections since 1950 has been only 97 days. As of Friday, Sept. 10, we are pushing 316 days without such a decline.
As I have pointed out in the past, there are plenty of issues that investors are facing over the next two months. Any one of which could justify some profit-taking. We have the looming battle over the debt ceiling, and the beginning of the Fed's announced tapering of bond purchases, to name just two.
On Thursday, the European Central Bank (ECB) gave us a taste of what that might look like. Christine Legarde, President of the ECB, announced their own tapering of bond purchases under its pandemic emergency purchase program. The Governing Council kept interest rates the same, but noted that inflation was running at a 3 percent rate in August 2021, the highest in a decade. Markets in Europe took it well, but closed mixed, while U.S. markets fell on the news.
Other investor concerns center on the potential slowing of the U.S. economy during this third quarter, as well as the probability that corporations have already hit peak earnings for this cycle.
Of course, the pandemic is still with us and continues to cause dislocations. Supply chain issues, which were thought to be temporary, seem to be lengthening in durations in areas such as semi-conductors and consumer durable goods and parts. And economists are still arguing over what is transitory inflation and the other stickier kind. The U.S. Producer Price Index rose 0.7 percent in August bringing the year over year increase to 8.3 percent, the largest on record.
Now, none of the above information is new. It has been with us for quite some time, but it's that time of the year when investors for some reason start to focus on what could go wrong (rather than go right). Call it behavioral science, investor psychology, or simply "cup half empty." If this September/October turns out to be down months, then I am pretty sure that November through the end of the year will be up months for stocks. That is the rhythm of the markets.
The moral of this tale is that if you are a long-term investor the next two months are simply a tiny blip, or bump in the road that should be ignored. If you attempt to sell everything and then buy at the lows, you haven't learned anything from reading my columns. The best advice I can give is to ride it out, and if markets drop, just don't look at your portfolio (if you are the nervous type).
Another possibility is that we have a shallower pullback than the pundits are predicting, or none at all. Who says they have it right? As I wrote last week, history has been a poor guide in predicting the future of markets undergoing extraordinary circumstances.
As regular readers know, my target for the S&P 500 Index in the intermediate term was 4,550. On September 2, 2021, we hit an intraday high of 4,545.85, which is close enough for government work.
Right now, I see some downside, possibly to 4,448 on the S&P 500 Index, and then I will reassess. Make no mistake, I expect the markets to be volatile in both directions over the next few weeks. If we do see that 5-10 percent correction, I believe it will happen over the next two months, rather than a few days.
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The Retired Investor: Japan Is Worth a Look
It has been 30 years since the Nikkei 225 last touched the 30,000 level. However, many investors look beyond this island nation and focus instead on its Chinese neighbor. That may prove to be a mistake.
To some investors, it is the epitome of value investing. Warren Buffet's Berkshire Hathaway made some sizable bets on several Japanese trading companies last year. Japan's stock market is cheap compared to many other markets. But deservedly so, say the bears, since investors have had to put up with years of sluggish growth and perennial deflation.
Japan is home to many well-known companies, (think Sony and Toyota) that have balance sheets flush with cash. More than half of Japanese companies have net cash positions on their books, compared to just 10-20 percent of most companies in the Western developed world.
Over the past few years, an increasing number of activist's equity funds and private equity firms have lobbied these cash-rich firms to begin to share the wealth with shareholders. Japanese corporations are listening. As a result, dividend income is increasing. The dividend yield now tops that of the U.S. stock market. The average Japanese company is still paying out only a third of profits as dividends. there is a lot of room for growth in the years ahead.
Those trends tend to fall on deaf ears, however. That is understandable given the nation's aging population, insular business culture, and overwhelming national debt.
Japan is the developed world's most indebted nation with a debt to GDP ratio this year of 256.49 percent. It has been so for decades. What most investors fail to understand is that Japan, unlike many other nations, has little to no risk of ever going bankrupt. That is because it also happens to be the greatest creditor ration in the world. The Japanese are among the world's best savers. Their savings rate is about 20 percent, compared to just 5 percent in the U.S.
The fact is that its debt is entirely denominated in Japan's own currency, the yen. And about half that debt is owned by the Japanese Central Bank. In other words, the government is lending money to itself. It has no fear of default as a result. Of course, by creating too much money, the nation runs the risk of generating inflation. That would be ideal in the case of Japan. since inflation is currently stuck around zero. For years, Japan has been battling deflation, noy inflation.
Like all nations, the Japanese have been wrestling with the COVID-19 pandemic with varying success. After postponing the 2020 Tokyo Olympics, Prime Minister Yoshihide Suga, of the Liberal Democratic Party (LDP), despite opinion polls to the contrary, decided to risk holding the games in July 2021. At the same time, the Delta variant pushed COVID cases to a record high. On the economic front, massive fiscal and monetary spending has had only a modest impact on growth. Japan's economy is expected to grow by 2.8 percent in 2021. Public support for the ruling, market-friendly, Liberal Democratic Party has been waning as a result.
In response, Prime Minster Suga abruptly announced last week that he would not be seeking reelection after only a one-year tenure. His resignation likely improves the chances that the next leader will come from the LDP, which removes a major concern for equity investors. The clear winner of Suga's announcement has been the Japanese stock market. It has risen by more than 4 percent since the announcement.
There is a short list of prospective candidates from the LDP, but investors are expecting that whoever wins, improving the rate of vaccinations, and additional fiscal spending program of "tens of trillions of yen" will be in the cards. If so, investors should keep their eyes peeled for any downside in the Japanese stock market in September 2021and October 2021. It would be an ideal time to commit some capital to Japan.
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@theMarket: Investors Are Chasing Stocks Higher
The proverbial Wall of Worry provided plenty of foot holds for investors this week. The major averages continued to make new highs (or hovered just below them), despite bad news and focused instead on anything that could justified higher prices.
The belief that the Delta variant of the coronavirus may be peaking in the worst-hit states was enough to cheer investors. Not that the extremely contagious infection ever had much of an impact on the markets anyway. Still, the hope that Delta has peaked gave added umph to large cap growth stocks.
Helping this summer's move higher was almost $30 billion in fresh money that has come into the market since July. It appears that many retail investors with money on the sidelines caught FOMO fever. This "in at any price" behavior might explain why valuations continue to be stretched upward, despite the belief that we have already seen "peak" earnings in the stock market.
As I cautioned investors, last week's Jackson Hole symposium was a non-event with Fed Chairman Jerome Powell sticking to his story line that tapering would come, just not yet. That relieved some of the markets' anxiety around when the taper would begin, at least until the Sept. 22 FOMC meeting. Weaker employment data for last month, I expect, will postpone any tapering until more data is forth coming. That could mean no action from the Fed until November 2021. Readers should hear a lot of jaw boning by Fed officials leading up to the Sept. 22 meeting. Their frequent speeches, insights, and opinions are meant to give the markets plenty of time to adjust to a taper without (hopefully) causing a tantrum.
In the meantime, equity strategists are split between calling for even higher prices ahead or warning of an imminent correction during September, which historically has not been kind to the markets. But that is not necessarily going to be the case this year. In years where the stock market has had strong upside gains, like they have had this year, two-thirds of the time, stocks have had a pretty good month.
However, history, especially in a time of extraordinary events, such as the present pandemic, along with huge monetary and fiscal stimulus, has not been an accurate predictor of financial markets. Technical analysis is also less effective in determining market movements when stocks continue to make new historical highs week after week. Markets can perform like rubber bands that are stretched and stretched until they snap. The problem is that no one can gauge the strength of the rubber bands.
For instance, for months I have targeted 4,550 on the S&P 500 Index as a likely spot where we may see some consolidation, at least in the major averages. Traders have pushed stocks up close to this level several times this week only to back off by the end of the day.
At this time, the S&P 500 Index overall is extremely overbought, as is the NASDAQ, if less so. Momentum in many stocks is also bleeding off. Yet, the small cap, Russell 2000 Index, which has been in a holding pattern for most of the year, seems ready to catch-up to the main averages in the weeks ahead.
Precious metals also look to have room to run. Gold has broken out of an eight-year range, but there has been no follow through as of yet. The price just chops around in a tight range. The dollar, I suspect, will determine when and if gold moves higher. The greenback has been in a trading range for months. It is presently weakening against a basket of currencies. The weaker it gets, assuming interest rates remain low, the higher the price of gold, or at least that is the theory.
Bitcoin and Ethereum, two of the major crypto currencies, have responded to the weaker dollar. Bitcoin, after spending the last few months digesting its decline from more than $64,000 to $28,000, has been inching its way higher week after week. I said "inch" instead of leap, or spike, because the volatility around Bitcoin has quieted down.
Some analysts believe that the entry of a large number of institutions into the crypto currency market (as opposed to just retail money), has had a calming effect on price movements. Ethereum, on the other hand, has been outperforming Bitcoin, which may mean that crypto is no longer a one-horse Bitcoin show. That could be another sign that the crypto marketplace is maturing.
If Bitcoin can break through the $51,000 level (no easy task), says the chartists, then the chances of a move higher rise substantially. Some crypto bulls expect to see $100,000/coin by year end. On the downside, Bitcoin below $46,000, and Ethereum under $3,500 would indicate to me that this up move has failed.
As for the economy, supply chain disruptions, the end of stimulus payments, and higher unemployment checks are expected to have slowed growth in the economy this quarter, which could also be a headwind for the stock market. Unemployment claims continue to decline, but the number of unemployed workers is still quite high, despite the enormous number of unfilled jobs nationwide. Non-farm payrolls for August 2021 were a disappointment with the economy only gaining back 235,000 jobs — half the consensus forecast.
Let's stay the course on the investment front, even though we may experience a little turbulence this month. And have a great Labor Day weekend, everyone.
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