Week In Brief: March 24

March 27, 2017

Stocks had their worst day in months last Tuesday. The S&P 500 Index retreated more than one percent for the first time since October. And small caps lost more than two percent for the first time since September. As of yesterday, the Dow Jones Industrial Average has been down ten of eleven days.
Volatility via the VIX Fear Index was jolted from its peaceful slumber. Driven up to 13.39 after having been range bound since December.
Why? Investors could see the healthcare-reform failure coming like a 68-mile-per-hour fast ball.
Arch-conservatives blocked passage of the bill by trying to strip it of "essential health benefits" like coverage of preexisting conditions, and the ability for children to stay on parents' insurance until age 26. Ripping out these provisions would result in losing a majority of GOP moderates. And force the president to break his campaign vows. So ensuring the bill's death in the Senate.

Republican swept all three government branches on the premise that they'd retool the Affordable Care Act. Well, 29 insurgent Republicans couldn't see past the ends of their own noses. And so the effort failed. And contrary to popular belief, the next swipe at reform could be a long-time coming.
Which means that the GOP's Freedom Caucus could be left holding the bag at the 2018 midterms when the party is forced to explain why they failed.
As Otto Van Bismarck said, "Politics is the art of the possible, the attainable - the art of the next best."
The Freedom Caucus ideologues forgot that maxim. And they'll likely pay the price.
Following the death knell dealt healthcare reform, Bloomberg published an article exclaiming, "Trump's retreat on healthcare deals a blow to the rest of his agenda." The commentary was fairly representative of the consensus media view.
It is not, however, a view with which we agree. And representative of the media's narrowcast thinking.
The healthcare failure means Trump will move on to tax reform. And as Teddy Roosevelt would have said, bully for him.
This represents good news for investors. As tax reform remains the single most important item on th agenda. Money managers and institutional investors are counting on U.S. corporate tax reform. Because P.E. multiples are too high. Earnings estimates are too high. And equity markets are too high. But tax reform's manifestation provides a rational basis for the elevation of all three.
For anecdotal evidence of tax reform's importance to equity markets, take a gander at stock performance when the headlines turn towards Obamacare versus tax reform. Obamacare discussed? Stocks fall. Tax reform on the docket? Stocks rise.
Many pundits argue that healthcare's failure portends bad omens for tax reform. We disagree. As tax reform represents a more bipartisan issue. One around which conservative and moderate Republics, as well a moderate Democrats, will likely coalesce. Not saying it will be a cakewalk. There will be many special interest groups fighting to maintain hard-earned turf. But the desired outcome -- lowering and simplifying the personal and corporate tax rates and codes -- remain widely sought after objectives that healthcare reform's opponents cannot so easily oppose
Big picture, the economy derives more benefit from tax reform than fixing Obamacare. Stocks will better respond to corporate and personal reforms and deductions. More so than bailing out an unsound healthcare program.
Down the road, when the pain of Obamacare's coming failures mount? Then Congress will acquire the will to fix the healthcare system.
So don't fret too much. For non-partisans interested only in the betterment of the nation and its economy? This could be a positive development.
One last comment as we circle back to the rise in the VIX index. Remember: widely perceived fear does not predict a severe market decline. A peak in the business cycle (recession) does. So keep your eye on the economic indicators. Which, per the graph below, continue to show strong trend lines.
In economic news, the most important development was a big beat for new home sales: February came in at a 592,000 seasonally adjusted annual rate, which was better than January and well ahead of consensus at 565K. It was highest reading since July 2016. Sales were strong in the Midwest, but down in the Northeast. The median sales price slipped to $296,200 from January's $312,900 level.
The U.S. dollar appears to be weakening. Threatening the dollar's bull market begun in 2009. Thus far, Fed rate hikes have failed to strengthen it. And if that doesn't change, the dollar bull is over.
Which is important to you because two of the asset classes that benefit by a weaker dollar are international bonds and domestic equities. So, a weaker dollar could help to propel stocks higher.
So, what's around the corner? Nobody knows.
Stocks could continue to rise like the phoenix. Or like Icarus, perhaps they've already flown too close to the sun. Which underscores the need for proper asset allocation. And not simply to stocks, bonds and cash. But to an array of alternative investments.
Consider this.
According to Nobel Prize winner Robert Shiller, stocks returned 7.7 percent per year from 1950 through the end of 2016. Which is why you often see investors using eight percent as the expected return for large cap stocks over long periods. However, pull the microscope back a bit and the nuances come into perspective.
From 1871 to 2016, stocks returned just four percent per year (Shiller's data). And there have been long stretches where stocks have returned nothing. Like 1929 to 1954. Or 1973 to 1985. Even more recently. From 2000 to 2013. Stocks returned, well, nothing.
Disconcertingly, today's cyclically adjusted price-to-earnings (CAPE) ratio on the S&P 500 sits at 28. Historically, buying stocks when the CAPE ratio was 28 signified annual returns as meager as 1.9 percent for the next five years.
Meanwhile, interest rates are rising off historic lows. Spelling the end of the 30-year bond bull market.
Last Friday, renowned technical analyst Tom McClellan published a note regarding his Dow Jones Industrial Average Price Oscillator, a diffusion index that considers the behavior of each member of a group in order to generalize the direction of the group. Accordingly, McClellan's Oscillator tells us that the near term direction for stocks is lower.
Hardly surprising. Here we sit, roughly two percent below January's all-time high. Following last year's 12 percent rise. And the historic leap following the surprise election outcome. Volatility has been too low for too long. And increasingly bullish, lackadaisical investors needed a slap upside the cranium.
So expect stocks to drift sideways to lower for a few weeks. Until the tax-reform legislation begins in earnest. And investors become excited over its long overdue benefits.
In Asia, Hong Kong selected a new Chief Executive. No surprise that the choice, veteran civil servant Carrie Lam, won the majority of the 1,200 votes cast by an election committee stacked with Beijing loyalists.
Will Ms. Lam have the desire and ability to stem Beijing's assault on Hong Kong's autonomy and rule of law? Unfortunately, her record does not inspire confidence. Ms. Lam will be tasked with convincing Chinese President Jinping that the 'mainlandization' of Hong Kong is neither in the best interest of China or its province. The world will be watching.
Finally, a suggestion.
I recently watched the HBO documentary, "Cries from Syria." From the opening scene, when a three-year old boy's body lay passive on a beach as waves wash over his face, I knew it would be difficult viewing.
That's an understatement.
Evgeny Afineevsky's documentary serves as a primer on this continuing catastrophe. Graphically chronicling how Syria's quest for liberty in the wake of the Arab Spring forced a confrontation between President Bashar al-Assad's army and a fragmented patchwork of resistance groups.
The crisis evolves from one gruesome stage to the next. As the Free Syrian Army battles al-Assad's blind brutality. And then Islamic State appears. Administering their brand of Sharia Law, which brings nothing but additional death and tumult. And finally, the documentary captures the barbaric intervention by Russian forces. And the mass devastation wrought by the indiscriminate dropping of barrel bombs from jets and helicopters. Eventually spawning the widely covered Syrian mass migration.
Through it all, the Syrians contend with one wave of atrocities after another. Chemical weapons. Russian fighter jets. Street-to-street combat. All adding up to one of the worst humanitarian crises in modern history. All told through the phone videos and voices of Syrians. Many of them children.
"Cries from Syria" is not an easy watch. As it portrays a depressing tapestry of the middle-aged brutality humans still inflict on one another.
But it's also an amazing film in that its protagonists, who could have easily given up, never do. They fight. Hope. Love. Empathize. Rebel. Mourn. And most of all, endure.
I implore you. Watch this documentary when you have two hours to devote. Very likely, it will impact your worldview.
Weekly Results
Major indices finished lower last week. The DJIA dropped 1.52%. The S&P 500 fell 1.44%. The Nasdaq dropped 1.22%.10-year Treasury bond yields fell 3.44%. Gold futures closed up 1.50%.

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