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Tax Burden: Washington Wrangling Takes Center Stage as Weekend Nears

December 15, 2017

(Friday Market Open) Corporate news and fresh data seem a little lacking today, meaning focus could turn once again toward a policy debate underway in a certain city along the Potomac. Meanwhile, markets fell overseas early Friday, but U.S. stock futures pre-market trading turned higher.

A new round of political squabbling in Washington appeared to interrupt Wall Street’s party Thursday, breaking a five-session streak of higher closes for the Dow Jones Industrial Average ($DJI). A lot seems in flux as Republicans try to get their tax reform bill to the finish line, with a few Republican senators telling the media they couldn’t support the bill as it currently stands.

While it’s impossible to predict how this might turn out, it does seem like confusion could continue as the weekend nears, putting some fear into the hearts of investors who might have thought a corporate tax cut could be penciled in. That’s not to say it won’t happen. It’s just that getting there looks a little less clear. That might be one reason that volatility woke from its slumber Thursday and the VIX popped back above 10.

Investors might want to keep a careful eye on Capitol Hill to see if Republican leaders start making changes to address concerns of some members. This might play out over the weekend and into Monday as well. At times like these, it’s important to tread carefully in the market, because news out of D.C. — whether it’s seen as positive or negative from a stock market perspective — has a chance of sending markets up or down rather quickly.

Child tax credits appear to be the current sticking point. Two Republicans want to expand these and might not vote in favor of the overall legislation if they don’t get their way. It’s unclear now how big a hurdle this could represent, but you might want to check your favorite political coverage site for more analysis and coverage of further developments.

In a separate Washington development, the Federal Communications Commission (FCC) voted 3-2 on Thursday to end net neutrality. The vote wasn’t a surprise, as it had been widely telegraphed. But it does have potential to hurt the info tech market, especially video streaming services that take up a lot of bandwidth.

Another possible reason for volatility as we approach the weekend is today’s quadruple witching, when stock index futures, stock index options, stock options, and stock futures all expire. Typically, this brings a higher volume of people trying to close or roll out positions, often leading to more volatility. The last quadruple witching of the year is normally very big and a lot of people like to get out of their positions so they’re clear for the year. However, if we don’t get clarity on taxes before the trading day ends, that could delay peoples’ plans and they might put off their decisions until 2018 when they hope to know more about the tax regime.

Looking at sectors, financials once again fell moderately on Thursday, with only materials and telecom doing worse. Financials had climbed going into the Fed’s meeting, but appear to have some “buy the rumor, sell the news” going against them at the moment. The Fed’s rather dovish predictions for next year might also be weighing down financials, and bond prices stayed basically unchanged Thursday while the yield curve between 2-year and 10-year notes flattened by one basis point as of the end of the day. A flattening yield curve tends to be seen as bearish for financials because it can sometimes indicate weaker economic performance ahead.

In corporate news late Thursday, tech giant Oracle (ORCL) saw shares fell in post-market trading despite beating Wall Street’s Q2 earnings estimates. Cloud growth and software-as-a-service both missed expectations, and that seemed to be the rub, so to speak. Also, Costco (COST) reported earnings per share that beat Wall Street analysts’ expectations, but missed the Street’s forecast for sales. Shares climbed slightly in pre-market trading, perhaps in response to the company’s solid online sales growth.

Crude oil climbed slightly in the early hours Friday, while Treasury bond prices hardly moved. The dollar fell a little vs. the euro and yen.



The Nasdaq Biotech Index (candlestick chart) peaked in October and remains well below its highs, trailing the S&P 500 Index (purple line) by a large margin since then. On Thursday, biotech was one of the weakest sectors, falling more than 1% after gaining some ground earlier in the week. Data source: Nasdaq. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

One Way To View Fed Move: The Fed’s rate hike and forecast this week could indicate that Fed officials think economic growth might continue without heating up the economy too much and raising the scepter of inflation. It’s what some people call a “Goldilocks” scenario, meaning just right for investors. While nothing is guaranteed, the Fed raised its gross domestic product (GDP) growth estimate for 2018 even as it kept its forecast for just three rate hikes. Sometimes when the Fed predicts higher growth, it also starts sounding more hawkish, but that wasn’t the case Wednesday. Furthermore, Fed Chair Janet Yellen didn’t repeat the Fed’s November analysis about potential overheating in the stock market, which had given some investors pause last month.

The Fed now expects 2.5% GDP growth both this year and next. That’s below a lot of analysts’ expectations, and we’ve just had two quarters in a row of 3% or better growth. The Q4 is almost finished, and next month we’ll get a chance to see if the economy topped the 3% mark once again. The Atlanta Fed’s GDP Now indicator on Thursday raised its Q4 GDP prediction to 3.3% from the previous 2.9%, basing that on this week’s strong consumer price index and retail sales data.

Thank You, Shoppers: The only sector making decent gains Thursday was consumer discretionary, which appeared to get a lift from continued booming holiday sales. Retail sales rose 0.8% in November and more than 6% year-over-year, the biggest year-over-year gain for the month in many years. Electronics and appliance store sales were among the big gainers, perhaps a sign of early holiday cheer among shoppers. While it’s doubtful holiday shopping season began as early as October, the government also updated October’s retail sales growth to 0.5% from the prior 0.2%. Retail sales are now up three straight months for the first time since the spring of 2016.

Russell Skids As Tax Uncertainty Looms: The Russell 2000 (RUT) index of small stocks seems to be closely tracking the tax debate in Washington, D.C. The index out-performed other indices on Wednesday and then slid further than the others on Thursday, falling more than 1% as uncertainty arose in Washington. Small businesses tend to have more of their sales in the U.S., meaning some of them could conceivably enjoy better benefits from a tax cut than larger, multi-national firms. Also, the planned tax repatriation and lower corporate rates have many analysts expecting a big year for mergers and acquisitions in 2018, meaning small businesses could potentially get more glances from big companies perhaps interested in adding to their assets. It looks like there’s a lot riding on this legislation from a small company perspective.

Good Trading,

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