The markets shook off Thursday's worries about the tax bill and rallied on positive comments Friday morning.

Weekly Statistics

Friday Statistics

On Thursday, there were multiple concerns about getting enough votes to pass in the senate with multiple senators either undecided or definite no votes. Further tweaking occurred, promises made and early Friday there appeared to be enough votes to pass it. In addition, as details leaked out the FIFO provision had been removed, corporate AMT was removed and the cuts are effective January 1st. The market gapped open on multiple positive rumors but representative Kevin Brady's comments at 11:AM lifted the Dow to 24,674 and slightly above prior resistance. The markets remained positive the rest of the day as further details appeared and rallied again just before the close as Rubio and Corker said they would vote yes. There was some option expiration selling at the close but the markets remained strongly bullish. The Dow rebounded 277 points from Thursday's closing low to Friday's intraday high.


Here is the skinny details of the tax plan:

Corporate tax rate cut from 35% to 21%.

Individual tax rates with 7 brackets, 10%, 12%, 22%, 24%, 32%, 35% and 37%. The current top rate is 39.6%.

CNCB Table for New Rates

CNBC Table Current Tax Rates

The standard deduction rises to $12,000 or $24,000 for a family.

Pass through businesses will receive a 20% deduction for the first $315,000 in income.

Obamacare lack of insurance penalty removed starting in 2019.

Corporate AMT eliminated. Individual AMT threshold raised significantly.

Estate tax remains but the $5.5 million exemption before taxation was doubled.

Child tax credit doubled from $1,000 to $2,000.

SALT deductions up to $10,000 for local sales, income or property taxes.

Current mortgage interest exemptions remain. New mortgages are capped for loans up to $750,000, down from $1,000,000.

Tax deductions for charitable contributions and retirement savings plans remain.

FIFO, first in, first out, stock sale provision removed.

The last hurdle is getting it passed by both the house and senate. In the senate that means John McCain and Thad Cochran, both currently in the hospital, will have to show up to vote. The only senator still on the fence is Susan Collins and she is leaning towards a yes vote after three amendments she backed were included. In theory McCain and Cochran would not have to show up if republicans were sure the other 50 GOP senators were going to vote yes. Vice President Pence could cast the tie breaking 51st vote. However, I am sure they will not want to take that risk. There is always the potential for an unexpected event so those two should be there if they have to arrive by ambulance and rolled in on a gurney.

The House is planning to vote on it on Tuesday. The Senate vote depends on when they expect McCain and Cochran to show up. That is more than likely on Wednesday.

With all the major warts out of the bill and corporate cash flows expected to grow by 15% to 20% next year as a result, the market "should" be positive into the end of December. Without the FIFO worries there is no reason to sell stocks that would have given you an higher tax bill in 2018. That threat is gone.

While nobody knows how much of the tax reform expectations for 2018 have been pulled forward into 2017, there should still be some gas left in the tank.

The S&P is up +590 points (28%) since the election without any material pullback. There was a 3.1% decline in March but we normally have two 5% declines and one 10% decline every year. There is a lot of uncaptured profit in the market and that means January could see some strong volatility.

Friday's economic reports were positive but far from bullish. The NY Empire State Manufacturing Survey for December declined from 19.4 to 18.0. That was not a big month-month decline but the high was 30.2 in October and December was a 5-month low so it is material. Anything over zero represents economic expansion so it was still positive. New orders declined slightly from 20.7 to 19.5. Back orders also declined slightly but from -4.6 to -8.7. That was the worst component in the report. Employment declined slightly from 11.5 to 5.1. The capital expenditures component rose sharply from 25.4 to 34.1 and the highest reading since 2010. Technology spending rose from 10.8 to 22.5 and a five-year high.


Industrial production for November declined from +1.2% to +0.2%. The majority of the decline came from a drop in utility output due to unseasonably warm weather. Overall, industrial production is up +3.4% since November 2016. Remaining outages from hurricane damage to the supply chain were also a factor.

The economic reports for the week lifted the Atlanta Fed's real time GDPNow forecast for Q4 back to 3.3% growth, up from 2.9% on December 8th. Spending growth estimates rose from 2.5% to 3.2% after the Consumer Price Index.


The final revision for Q3 GDP will be released on Thursday. Expectations are for 3.3% and unchanged from the prior revision.

This is the week for the housing reports with the Housing Index, existing sales and new home sales. The Philly Fed Survey is also on Thursday and the most important economic report for the week because it is a proxy for the national ISM.


The biggest challenge for the week is still the government funding deadline for midnight on Friday. The republicans are adamant about getting defense funding done for the rest of the fiscal year, reauthorization of the Children's Health Insurance Program or CHIP and increased funding for immigration enforcement. The democrats are equally firm on subsidizing premiums for Obamacare, authorizing citizenship for "dreamers" and various other funding for social issues. Both sides have said multiple times they will not support the funding for the items on the other side. The house wants to submit a defense funding bill for the full year and kick everything else into January with another continuing resolution. Democrats have said absolutely not and even some republicans are against that tactic.

There will be a fight and there will be negative headlines about a potential government shutdown. If that causes a market meltdown, it could be a buying opportunity but there is still risk of a minor correction in January.

Earnings actually pickup some next week with an active schedule on Tue/Thr. FedEx and Micron will highlight on Tuesday and Dow component Nike on Thursday.


The three big cap tech stocks that reported earnings after the bell were moving on Friday. Costco (COST) posted a $6 gain after beating on earnings by 2 cents. Revenue rose 13.3% to $31.12 billion. Expectations were high because of their recent release of blowout sales numbers for November. Same store sales rose 10.5% and e-commerce sales rose 43.5%. Membership renewals were 90%, which is in line with the historical average, so no drop offs. Member households rose from 49.4 million to 49.9 million and cardholders rose from 90.3 million to 91.5 million. They plan to add 20-25 stores in 2018. I challenge anyone to show me the impact of the Amazon/Whole Foods acquisition. I have pointed out many times the two stores are not related.


Adobe Systems (ADBE) reported earnings of $1.26 beating estimates for $1.16. Revenue rose 25% to $2.01 billion and beating estimates for $1.95 billion. They guided for the current quarter for earnings of $1.27 compared to estimates for $1.24. Revenue of $2.04 billion was in line with current estimates. Adobe said they were raising the subscription fees for various creative cloud products in March. They said they were seeing aggressive renewals by enterprise customers ahead of that price increase. Bank of America reiterated a buy with a $220 price target. Barclay's raised the price target to $193. Morgan Stanley reiterated a neutral and $186 price target. BMO reiterates a buy and raised their target to $205. Pivotal Research maintained a hold and $162 target. Shares closed at $177.


Oracle (ORCL) reported earnings of 70 cents compared to estimates for 68 cents. Revenue of $9.62 billion beat estimates for $9.57 billion. Cloud revenue rose 44% to $1.52 billion with software as a service revenue rose 55% to $1.12 billion. Analysts were expecting $1.56 billion and $1.14 billion respectively and a miss on both metrics. It was a good quarter and surprising when revenues can grow 44% and 55% and still miss estimates. Shares were punished despite the good quarter.


Teva Pharmaceutical (TEVA) announced on Thursday they were cutting 14,000 workers from their 56,000-person workforce. They expect to reduce costs by $3 billion by the end of 2019, with $1.5 billion in cost reductions in 2018. The company also suspended its dividend for ordinary shares and will eliminate bonuses for 2017. They are planning on closing a "significant number" of R&D facilities, offices and other locations around the world. They are going to consolidate offices in the US from 7 locations to only one campus. Teva incurred a lot of debt when they purchased the Allergan generic pharmaceuticals business for $40 billion last year. That was poorly timed just as generic prices were crashing. The company is also reviewing its asset base in order to sell noncore assets. Apparently, the new CEO, Kare Schultz, is determined to turn the company around sooner rather than later. Shares are bouncing back from a 17-year low in November. Shares were upgraded by Morgan Stanley, Goldman Sachs and Credit Suisse on Friday.


Foot Locker (FL) was upgraded from hold to buy at Canaccord and they raised the price target from $42 to $64. Part of the thesis was the move by Nike (NKE) to reduce their retailers from 30,000 to only 40. Foot Locker was one of the 40. Those 30,000 retailers have more than 110,000 locations. Nike said it was not going to remove product from those locations but it was going to focus future efforts on marketing and exclusive product offerings with those top 40 partners. Nike is going to prioritize "direct to consumer" e-commerce sales rather than a major network of small retailers. Nike wants retailers to create a unique "branded" Nike space within their stores. Foot Locker has already put that plan in motion.

Nike will supply trained and experienced sales and marketing people to assist with sales. More than one-third of Nike offerings will be exclusive to Nike.com e-commerce sales. The company is also cutting available styles by 25% starting in January. Canaccord sees Foot Locker as the major Nike retailer with more than 3,350 stores. Foot Locker shares were up 3% but the real winner last week was Nike with a $5 gain to a new 52-week high.



Fitbit (FIT) fell -8% after Stifel Nicolaus cut the stock from hold to sell. The analyst said, "With the stock market near all-time highs, no visibility to monetization of healthcare opportunities, and no opportunity for Fitbit to benefit from corporate tax reform, we cannot advocate owning Fitbit shares. There are no sightlines to profitability" with demand weak for fitness trackers. Earlier in the week, Morgan Stanley said inventory was continuing to build despite the holiday season.


Bitcoin had a rocky week after the CBOE began trading futures last Sunday evening. The coin fell from $18,000 to nearly $13,000 and then rebounded back to $18,000. Volume declined as the week progressed. Volume peaked on the 8th at $22.3 billion traded with Friday's volume at roughly $5 billion in trades according to WorldCoinIndex.com.

The CBOE began trading bitcoin futures last Sunday evening and their website was very slow to down completely for most of the first 6 hours. The CME will begin trading bitcoin futures Sunday night with a 5-bitcoin contract. Several brokers announced on Friday they would allow customers to begin trading and shorting bitcoin futures next week. Up until now, there were only a limited number of traders able to actually buy bitcoin futures. The faster new investors are allowed to trade the futures the less volatility will be seen. Volume reduces volatility as an actual market is created.


Crude prices continue to be dormant. The price has fluctuated between $56-$58 for the last two weeks. There has not been a material move since the OPEC meeting. There have been some daily moves but they were reversed almost immediately. Inventories should continue to decline over the next two weeks then rise again in January after the property tax deadline passes on December 31st. Refiners do not want oil in inventory on the 31st, but there will be a surge of imports beginning the next week. As inventories rise, prices should decline, assuming there are no additional outages. The 450,000 bpd Forties pipeline in the North Sea was shut down last week because of cracks and could be down for a couple weeks. This will help reduce the global inventory levels by about 3.1 million barrels a week until restarted.




 

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Markets

If conventional wisdom ruled the markets, we could expect several more months of stellar gains as investors priced in lower taxes, cash repatriation, higher dividends and more stock buybacks. Unfortunately, the markets are controlled by fear and greed and they tend to look forward months into the future.

That means some portion of the 590 S&P points (28.3%) gained since the election was in anticipation of reduced regulations and tax reform. How many of those points were pulled forward is unknown. Analysts have said that corporate tax cuts to 20% would add 10% to 15% to S&P earnings and that would equate to about 225-275 S&P points. The S&P has already gained 590 in the Trump bump so we have to assume a lot of those 225-275 points have already been pulled forward.

This does not mean the market is not going higher but it does mean we should not expect to see S&P 3,000 by March. Now that FIFO is no longer a threat to holding positions over December 31st, we could see continued gains for the rest of the year. Investors will now want to hold over and not sell until 2018 so they can get the benefit of the lower tax rates.

I continue to believe we could see some increased volatility in January as investors in "low tax rate" stocks like tech stocks, dump those shares in favor of high tax rate sectors where the impact of lower taxes could be dramatic.

Sectors with the highest tax rates according to Goldman:

Energy 35%
Telecom 33%
Industrials 32%
Utilities 31%
Consumer Discretionary 30%
Consumer Staples 30%
Finance 28%
Materials 27%
Healthcare 27%
Technology 24%

The S&P is only 25 points from 2,700. That seems to be a given at this point even though it could produce a minor sell the news dip. With two normally bullish weeks left in December, I have no idea how much higher the index could run. Conventional wisdom would suggest 2,800 could be a target since selling should be limited. Bearish analysts have been predicting tops for weeks and I am sure they will target 2,700 and 2,750 as easily discernible selling points. Personally, if I were bearish, I would take the rest of the year off and sell the open on January 2nd.

Support is now 2,650 with 2,675 as initial resistance.


The Dow broke out to a new high and even with the -31 point drop at the close, it posted a nice gain of 143 points. Resistance was 24,666-24,672 and the Dow traded just over that intraday but fell back at the close. I do not see this as material. I do expect higher highs and the 25,000 level would be the obvious target and a highly visible selling target if there were any shorts left in the market.



The Nasdaq was significantly responsible for the market gains on Friday. The Nasdaq and the Russell 2000 had been lagging. The Nasdaq big caps have been weak for the last three weeks since the sector rotation virus hit the index. The big cap stocks woke up on Friday and the index surged to a new high well over 6,900. The Nasdaq 100 blew out over 6,400 to a new high. I doubt this run is over. These stocks have been lagging so badly that Fridays short squeeze in tech stocks probably has room to run.




The Russell 2000 closed at a three-week low on Thursday with a -1.16% decline. They spiked over two weeks of resistance on Friday with a +1.55% gain. Since small caps are normally favored in December and the tax cut will be beneficial to small corporations, I am surprised the index has not been stronger. It may have been fears the tax bill was going to fail and investors were taking profits. Once it appeared to be a sure win, they raced back into the sector. That is one theory.

Financials were up strongly on Friday and that is 17% of the index. Biotechs were also up strongly along with semiconductors, also large index components. Everything was working in the Russell's favor.


Investor sentiment surged 8% to 45.0% and the first time in five weeks it is over the historical average of 38.5%. This survey closed on Wednesday so sentiment should be higher again next week with all the major indexes at new highs and the tax bill passed.


New market highs tend to produce additional new highs. We are not in a euphoria stage yet and there is just enough weakness every few days to give investors new entry points and keep the party rolling. While there is nothing on the horizon to hold the market back other than the potential for a government shutdown on the 23rd, there is always the risk of profit taking. The market has a million moving parts and it only takes a few to cause a hiccup.

The potential for a government shutdown does not carry as big an impact as in the past. Everyone knows it will only be temporary but the negative headlines could provide a buying opportunity. Just be aware of the potential for some portfolio restructuring in early January.

Enter passively and exit aggressively!

Jim Brown

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"All truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident."

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