No market goes up in a straight line, and so the US stock market was due a pull back at some stage. The question that you have to ask at this point is whether this is a typical market retreat following a 4 month almost straight line rise or is it something more sinister?
The Past
First, it is worth revisiting the reasons for our overweight US. Following the US election, both H&H and I took the view that Trump was going to engineer a boom. While the boom would probably be followed by a bust, leaving the US in a worse debt position with a mostly destroyed tax base, it is hard to come up with an argument to sell US stocks because the boom that hasn’t yet started will one day burst. The view was that the US would see a confidence jump, mainly in small businesses, which will drive short term employment and tide the US economy over until the tax cuts and infrastructure spend can take over in late 2017. The big dangers to the view: the USD rallies too quickly and US domestic growth slows, trade wars breaking out or other policy errors.
Since then consumer confidence is up, inflation has made a re-appearance (although most of this is transient oil and the flow on effects), the Fed has raised rates and employment has been strong.
The US stock market has rallied hard. So hard that we have taken profits twice – happy to be overweight but don’t want to be too far overweight.
The Present
Fast forward to today and the fears seem to be:
- The Republicans couldn’t get healthcare reform over the line and so they are destined to fail at anything they try.
- The cost savings from healthcare reform were needed to pay for the tax cuts/infrastructure spend and so the tax cuts won’t occur.
The Future
I agree the Republicans are going to struggle to govern because of competing views. I’m actually relying on it. One key assumption is that Trump’s trade war rhetoric won’t see the world in a global trade war – and the events of the last week around healthcare give me some comfort with that view. There is going to be Republican opposition to trade wars.
Tax cuts are a different beast though. Republicans universally want them. There is a component of the hard right that demand budget balance, and so at least a few of them are going to need a fig leaf of fiscal coverage.
At the moment that fig leaf looks like being:
- increased growth assumptions – i.e. the economy will grow so quickly that it will raise additional tax
- the cost of government will be cut and this will provide savings.
Neither of these arguments hold much weight if you look too closely – a lot of the government cuts are the Abbott/Howard type where you sack people and then find you have to hire consultants at higher rates to do their job. But, I’m not expecting the Republican hard right to look too closely – detail is not their strong point. The arguments should be enough of a fig leaf for at least some of the tax cuts.
The tax cuts themselves are somewhere around 0.25-1% of GDP per annum in the early years depending on what gets through. Then you need to add a fiscal multiplier of say 0.5-1x to that effect.
So, in a low growth world, the tax cuts are likely to be somewhere between big and massive for growth.
The Risks
- Republicans are too diverse in philosophy to pass legislation.
- A trade war or a real war with a major power.
- A stronger USD or higher interest rates snuff out growth.
Should you buy the dip?
What dip? If the market pulls back 4-5% then let’s talk about a dip.
Overweight the US was never about healthcare reform. Now that healthcare is off the table we can move to the key plank in Trump’s engineered economic boom – tax cuts.
The first risk has increased. But the second has reduced.
At the moment I’m staying the course. If the Republicans do prove too inept to pass tax legislation then we will be executing a sharp pivot. The US market is getting expensive, and so we aren’t inclined to chase too hard at this point – keep taking profits to make sure your position doesn’t get too large, but it is not yet time to be defensive.
These are volatile times – it is not a buy and hold market.
Damien Klassen is Chief Investment Officer at the MB Fund launching in April 2017. Register your interest now (if you haven’t already):