@theMarket: Markets Gain on Hope & a Prayer
Investors remain cautiously optimistic that the wall of worry that has been plaguing us for months may now be crumbling. That's no sure thing, but at least we did have some good news this week.
While most investors were not expecting a repeat of last month's partial government shut-down, it was still a relief to see that issue put to bed on Friday. The president reluctantly signed the budget bill that Congress passed over his objections.
Granted, the president did not get his wall, although now he is threatening to get the funding by declaring a national emergency on our southern border. Whether there is or is not such an emergency, by declaring one, he bypasses Congress. That will establish a dangerous precedent for future presidents who may be frustrated with the constitution's checks and balances among the three bodies of government.
Another president could use that same tactic to circumvent Congress in order to secure his or her own objectives. Nancy Pelosi, the Democrat speaker of the House, has already indicated that, for example, that same tactic could be used in the future to restrict or even outlaw guns in this country. It could be used to balance the budget, or set term limits in Congress, or any number of things that a frustrated president might wish for.
But enough politics. As I have written many times in the past few months, the markets remain China-dependent. Earlier in the week, markets swooned when reports surfaced that some of the structural issues within the Chinese economy that we want changed have become a sticking point in negotiations. A few days later, the president said he "may consider" postponing the March 1 deadline, if there was progress on the trade talks.
Almost every other day, some administration official or another makes a positive (or negative) comment that sets the markets in a tizzy. Words such as "reluctant" or "constructive" can send the Dow up or down 200 points in the blink of an eye. From my point of view, it's all-day trading and won't impact the longer-term outcome of the markets.
I have been predicting from the outset of Trump's trade war, that there will be a resolution and a compromise on these issues between the U.S. and China. No, it won't be on the market's time table or terms. I believe it will be a series of incremental agreements on one or two issues at a time.
It also happens that it is a fortuitous period of time for the United States to address these decades-old issues. Not only is the Chinese economy faltering on several fronts, but China is also in the midst of a multi-year program of becoming a consumer-driven, rather than an export-driven, economy. As such, reducing exports and increasing imports dovetails with their own economic objectives through 2025. However, altering trade deficits and surpluses is the relatively easy part of the trade discussions.
The intellectual property debate is something that will require a substantial change within China and can't be done with a brush of the pen (or keyboard). Clearly, one of China's major objectives is to become the world's leader in technology advancements. If that means stealing our secrets in any way they can, then they will do it. Not only is this a clear and present danger to our own economy, but also has enormous ramifications for our military and national defense.
Next week, the trade talks move back to Washington. As such, we can expect a series of "leaks" as the days go by, which should guarantee more volatility on a daily basis. As for the supposedly "important" stuff like earnings, economic growth, employment, etc., all of it remains relegated to second or third place as the talks progress.
As the markets climb, there are more and more calls by strategists for another one of those 6-7 percent pull-backs (that could easily turn into a 14-15 percent decline on the back of all this computer trading). I have an interesting notion. What if the news is really good on the China front and, after a brief spike up, markets use the occasion to "sell on the news"? That would be the most inconvenient thing that could occur to the greatest number of people. That's what the markets usually do.
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The Independent Investor: Trump's War on Drug (Prices)
For the second year in a row, President Donald Trump called on Congress to do something about the escalating drug prices in America. The president is doggedly pursuing this campaign promise in the face of an army of special interest groups and big drug companies. Hurrah for you, Mr. President.
In his State of the Union address he said:
He wants our legislators to "deliver fairness and price transparency for American patients. We should also require drug companies, insurance companies, and hospitals to disclose real prices to foster competition and bring down costs."
Given that drug pricing is a complicated area and there have been various proposals and recommendations proposed, I will focus on just a few at a time. One of the president's proposed actions would reduce drug prices by allowing pharmaceutical companies to offer discounted prices to Medicare and Medicaid directly, bypassing the middlemen, called pharmacy benefit managers (or PBMs). Historically, these PBMs have been useful to insurance companies and large employers. They make their money by negotiating behind-the-scenes deals with Big Pharma acquiring discounts, called "rebates," for their big clients on certain "approved" prescription drugs.
These rebates are targeted to name-brand drugs that are covered by Medicare and Medicaid. Since this is a well-known system of back-scratching, drug companies simply hike prices high enough each year to cover these "rebates." This year, for example, despite the president's call to hold down prices, 60 drug companies increased prices on more than 300 products, and we are only in February of the new year.
Trump wants these discounts, instead, to flow directly to the consumer at the pharmacy counter, rather than the pockets of the PBMs. Since drugs paid through the Medicare system account for 30 percent or more of the country's retail drug spending, this would result in a sea of change to the prescription drug market.
This change would especially benefit those of us with really high prescription drug costs. The rebate system, you see, is usually focused on competitive drugs, such as two opposing blood pressure medicines. The really expensive drugs usually have no competition and therefore fall out of the rebate system.
I have a client, for example, with a fairly rare condition, who pays well over $100,000 a year for one drug. Under the current system, his deductible and co-insurance are sky high, because there are no rebates available to him. He pays the list price for his medication and is required to pay a percentage of the drug's cost himself. He could save as much as 30 percent on his drug costs.
For many of us, however, there would be a downside. Since insurers would no longer be able to apply the rebate money, they receive from PBMs to lower overall insurance premiums, the typical Medicare patient could see premiums go up by as much as $5 or more a month. Some experts think that about one-third of Medicare drug plans will benefit from the change, while two-thirds may not.
Another group to benefit would be those who suffer from the "doughnut hole" In Medicare Part D, which covers drug cost. These expenses can escalate until they reach what is called the "catastrophic phase" where out-of-pocket expenses tops $5,100. At that level, the government steps in and will assist in paying most of the bill. Lowering drug costs will reduce prices and provide some relief to we who suffer from the prescription donut hole on a yearly basis.
Although the Democrats have identified drug pricing as an area they would also like to attack, their solutions differ. In an almost knee-jerk fashion in today's partisan politics, anything one side proposes is immediately shot down by the other side.
"The Trump administration's rebate proposal puts the majority of Medicare beneficiaries at risk of higher premiums and total out-of-pocket costs and puts the American taxpayer on the hook for hundreds of billions of dollars," says Nancy Pelosi, the Democrat's speaker of the House.
It remains to be seen if the Democrats can come up with something better. In the meantime, one proposal I thought made a lot of sense was Trump's proposed change to Medicare B pricing. He wants a much larger set of drugs to be priced no higher than they are in foreign countries like Japan or nations in Europe. He also proposed that the secretary of Housing and Human Services (HHS) be allowed to negotiate prices and permit U.S. residents to purchase medicines directly from other countries.
Despite the partisan rhetoric, there seems to be some willingness to work together. Given the president's lead on drug pricing, I believe it is one area where we could see Congress and the White House come to terms and pass something useful and acceptable for all of us. Wouldn't that be great?
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@theMarket: Markets Are China Dependent
Profit-taking is a natural and expected part of the stock market. That's why no one should be surprised that this week we are witnessing a period of consolidation. It is actually a good thing.
Given that most investors need a reason to explain any market declines, this week's announcement that President Trump is postponing his meeting with Xi, his Chinese counterpart, was both a surprise and a disappointment. It shouldn't be.
Over the last few months, I have tried to reduce investors' expectations of an easy, one-shot, Chinese break-through on the trade front. The postponement is actually a positive, in the sense that both sides are taking the negotiations seriously. There is just too much to negotiate, which is why I expect that the March 1 deadline to institute additional tariffs will again be postponed.
Part of the problem is the president's insistence that he be the one to make most, if not all, of the decisions on the China front. That is difficult to do when his attention has been focused on getting his Wall money, fending off investigation after investigation, shutting down the government (or not), and feuding with Nancy Pelosi and Chuck Schumer.
There just isn't enough time in the day. To accomplish all of the above and move forward to solve an array of issues that have evolved over decades of trade with the world's second-largest economy is asking the impossible. I have to hand it to Trump for even attempting to renegotiate our long-standing China trade issues. No other president before him has tried.
As such, investors should take a more realistic view of what can and cannot be done between now and March. But try telling that to the machines that drive most of the daily trading. All they need is the word "postponement" and the selling begins.
Last week readers might recall that I expected this pullback.
"We have seen some good gains, however. So, I would expect to see a period of consolidation in the weeks ahead. Any dips in the market would be an opportunity to buy, not sell."
My target was 2,715 on the S&P 500 Index. We hit that level and a bit beyond before profit-taking began on Wednesday. Regardless of the reason, stocks were over-bought, in need of consolidation, and the China news provided the excuse.
I said last week that if you had sold out of the markets during the downdraft we experienced in the last quarter of 2018, you now have an opportunity to get back in the market. I am sure you will be wondering at what level. Short-term timing advice is purely a guesstimate. From a technical point of view, the S&P 500 Index could drop another 50 points easily from here to 2,646.
It could go lower, but I wouldn't worry about it. You see, all it would take is an encouraging tweet by the president to trigger a buying frenzy among the machines. Investors, please ignore the day-to-day noise. The economy, earnings and employment are still growing. The Fed is no longer tightening and that's all you need to know.
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@theMarket: The Fed Finds Religion
After two years of tightening monetary policy, the U.S. Federal Reserve Bank signaled this week that it was time to put their monetary tightening program on hold. The stock market soared in celebration.
As we closed out the month of January, stocks are gaining. The October-December declines that culminating in the "Christmas Eve Massacre," which were the worst in 80 years, are rapidly disappearing. Investors who were smart enough to hold fast should be made whole again by the end of this quarter, if not before.
That does not mean that the volatility that has beset the markets of late will fade away. Quite the contrary, I expect the wild swings in the stock market to continue. But for now, the Fed has once again provided a floor of support for equities. The question to ask is:
"Was the Fed's move justified, or did the markets (and Donald Trump) scare Chairman Jerome Powell and his committee into backing off?"
I would say there is a little of both in the Fed's actions. While the economy is still growing, "the case for raising rates has weakened somewhat," according to Powell, who spoke after the FOMC meeting on Wednesday. Of course, he reminded his audience that the Fed would still be "data dependent" in deciding when the next interest rate hike might occur.
That was a sea change in rhetoric from last quarter when the Fed chief said rate increases and sales of $50 billion a month U.S. Treasury bonds were largely on autopilot. President Trump threw a fit, making his own dissent from that policy quite clear. He believed that the Fed's actions were causing the economy to slow. He lashed out at the man he hired last year to lead the Fed and threatened to have him fired.
Whether it was his words or the fact that the markets threw a hissy fit, plummeting almost 20 percent in a matter of weeks, is debatable. Whatever the reason, the Fed did a 180 and has returned to the easy money religion that has galvanized the stock market since the financial crisis of over a decade ago.
Some of the key variables that the Fed studies in order determine monetary policy are wage growth, inflation, GDP, and unemployment (among others). None of them are flashing warning signs yet. Yes, economic growth is moderating but is still growing. Yes, we are seeing some wage growth, but it is not out of hand by any means.
Friday's employment report indicated wage growth is moderating, although jobs are still gaining. Nonfarm payrolls surged to 304,000 jobs versus estimates of 170,000. Evidently, the government shutdown didn't have that much impact on the data, although the official unemployment rate did tick up to 4 percent, which is where it was back in June of last year.
Granted, corporate earnings are slowing, but if this quarter's earnings season is any indication, many companies are still seeing good gains from the economy. So maybe, just maybe, all those Doom Sayers predicting an imminent recession are wrong. It seems to me that we are in an economic sweet spot that will support stock prices through the remainder of the winter.
Last week, I predicted the S&P 500 Index would touch 2,715. We hit 2,716 on Friday. That brought the gains for the three averages for the month of January to 8 percent for the Dow, 9.5 percent for the S&P 500 Index, and 12 percent for the NASDAQ. That was the best stock market performance in thirty years. For those of you who followed my advice and held on to your positions through the last quarter of 2018, you have now recovered the lion's share of your losses.
We have seen some good gains, however. So, I would expect to see a period of consolidation in the weeks ahead. Any dips in the market would be an opportunity to buy not sell. For those of you who sold last quarter, I am sorry, but you will probably get a chance to buy back in the months ahead.
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The Independent Investor: Europe, the World's Sick Sibling
The European Community is beset by worries. Brexit, trade threats, a slowing Chinese economy, and internal politics at home have all conspired to slow growth, employment, and positive sentiment.
This year, the EU will be lucky to see 1.5 percent GDP growth. In fact, the International Monetary Fund reduced their overall forecast this week for global growth largely as a result of poor performance out of Europe. Europe's powerhouse, Germany, saw its growth for 2019 cut by 0.6 percent because of anemic consumption and weak industrial production data.
Italy, one of the problem children of the EU, saw its growth forecasts cut by 0.4 percentage points as a result of weak domestic demand and out-of-control government borrowing. France did not escape the knife either. Its GDP was reduced by 0.1 percent, largely because of the continuous, production-stopping street protests.
Trade tensions top the list of obstacles afflicting Europe. While most of the news coverage tends to dwell on the slowing economy of China (because of the ongoing trade war), this issue is impacting businesses throughout the world. Automobile tariffs on EU exports, for example, have impacted growth, especially within Germany.
Brexit has also cast a dark shadow over Europe. Uncertainty has infected every corner of the 18-nation union ever since the UK referendum to leave the EU back in June 2016. The unsuccessful exit negotiations, which recently culminated in the British Parliament's rejection of the terms, brought to naught years of talks between Prime Minister Teresa May and her cabinet and EU negotiators.
Since then, both sides are grappling with the next step forward. Some believe another referendum will need to be called. Others hope new (and better) terms for the UK exit will be required, although the chances of the EU offering better terms is hard to believe. This issue will continue to weigh on investment and growth on both sides of the Channel until it is resolved.
No discussion of Europe would be complete without mention of Italy. This southern nation is already flirting with recession. Fourth quarter growth was already the weakest it has been in four years. Unwilling to adhere to the strict guidelines of EU lenders, the nation's voters insist on upping spending year after year, borrowing more and more, while digging itself deeper and deeper into a financial hole.
The nation has replaced Greece as the "Bad Boy of Europe" with a real risk of witnessing a collapse of their financial sector. The Italians, of course, are watching the exit negotiations of the United Kingdom. There is an implied threat if EU authorities lean on Italy too hard that what the UK can do, so can Italy.
Amid this unsettling backdrop, Mario Draghi and the monetary authorities of the EU's Central Bank (ECB) are walking a tightrope of maintaining some stimulus, while taking some away. Like our own Federal Reserve Bank, the EU has been slowing their purchases of government bonds, which should wind down to zero this year. This may or may not be followed by the ECB's first interest rate hike late in the year — if the data warrant it.
My own bet is that while the ECB is talking a good show, the economic worsening of conditions in Europe will postpone any rate hikes. If, on the other hand, a Brexit agreement can be reached, if a trade agreement with the U.S. can be resolved, and if Italy were to ‘find religion,' conditions may improve. But don't hold your breath.
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