Daily Comment (December 20, 2017)

by Bill O’Grady and Thomas Wash

[Posted: 9:30 AM EST]

(Note to readers: The Daily Comment will go on hiatus after Friday; commentary will resume on January 2, 2018.)

Markets are showing more of the same—U.S. equities are rising and bond yields are also rising.  Here is what we are watching this morning:

Tax bill update: It’s essentially a done deal.  The House will need to vote again on the tax bill due to procedural issues in the Senate that required a vote late last night.  The vote was strictly by party line, 51-48.  We expect a similar outcome in the House.  The president will have the bill no later than tomorrow; although there is some talk he might sit on it for a few days, we suspect he will sign it immediately.

Some thoughts on the tax bill: First, this bill got finished at record speed.  Kudos to the GOP congressional leadership.  Whether one likes the outcome or not, the fact that it was done so quickly is remarkable, especially given the disarray evident this fall.  Second, don’t expect durability.  In the hyper-partisan political environment in Washington now, both parties are looking for retribution when they get power.  Look how hard the GOP worked to unwind the ACA.  Universal healthcare is a totem for the Democrat Party.  And, even though a full “repeal and replace” failed, the GOP has undermined the ACA with various measures, including removing the insurance mandate as part of this tax legislation.  One should fully expect the Democrats to try to unwind this tax bill if they gain political power in 2018 and 2020.  Why?  Because tax cuts are a totem for the GOP.

Compare the current tax reform bill to the last one.  The 1986 Tax Reform Act only had 12 Democrat senators vote against it in its final form.  It passed 74-23; 11 Republicans opposed the measure.  Three decades ago, party discipline was clearly not as strong as it is today.  To get that degree of bipartisanship, legislators from both sides had to work in concert to craft the bill.  When bills have that degree of bipartisanship, they tend to remain unchallenged by future administrations.

This is a key point.  We are rapidly reaching a status where households and businesses can only rely on the current regulatory and legislative environment to endure as long as the party in power remains in place.  Once the government shifts, one should expect a wholesale reversal to occur.  This fact will make it increasingly difficult to invest and plan.  The current tax bill’s support is completely partisan, which means a new environment will develop if and when the opposition gains power.

The other issue to remember is that this tax bill has all sorts of surprises embedded in it, due in part to the haste in which it was fashioned.  The sunset provisions, which “everybody” knows will be extended, won’t be if the Democrats are in power.  An interesting sidelight is a provision that will eliminate the ability of cryptocurrency holders to transfer their holdings into another similar instrument and defer taxes.  Before this legislation, cryptocurrencies were treated as property, allowing tax deferral for like-kind exchanges.  In the media, there is lots of talk about how other, lesser known cryptocurrencies are jumping in value relative to bitcoin.  This buying may be tied to the tax legislation.

We will have more to say on the tax bill next year.  But, for now, it will boost corporate earnings, anywhere from 5% to 10%, and is clearly bullish for equities.  That fact will support stocks into Q1.

The EU rules on Uber: The EU’s top court says Uber is a transportation company, not a platform company, and thus is subject to EU regulation on livery companies.  This is a huge blow to the company, which was mostly built on regulatory avoidance.  If this ruling becomes precedent, other platform firms may find themselves subject to similar laws in their markets.

The shutdown: Although the GOP leadership in Congress is celebrating its tax win, the looming spending bill has to be passed by Friday or the government will run out of spending authority.  We expect a shutdown will be avoided but we will likely only get a short-term extension.  This issue will probably return by mid-January.

Catalan vote tomorrow: Catalonia will hold regional elections tomorrow.  Current polling shows that separatists and unionists are in a dead heat, with nearly 20% of the electorate undecided.  The most likely outcome is an indecisive election and weeks of jockeying before a regional government is formed.  However, if the separatists win decisively, a constitutional crisis could develop in Spain.

China blinks (again): The WSJ[1] is reporting that the Xi regime is dialing back its deleveraging program to support economic growth.  This has been a consistent pattern from the CPC; although the need to deleverage is obvious, the restructuring necessary will lead to a slower growth economy, something the leadership fears.  That is good news in the short run because China is an important component to global growth.  However, the debt level is clearly unsustainable and the safest way to address it is to slow growth and shift resources to the household sector.

Cryptocurrency woes: Two cryptocurrency exchanges had issues yesterday—one in South Korea was forced into bankruptcy after a cyberattack and another in the U.S. is investigating the potential of insider trading.[2]  These issues highlight the security problems of the new currencies.

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[1] https://www.wsj.com/articles/china-seeking-growth-softens-focus-on-cutting-debt-1513700557

[2] https://www.ft.com/content/aa9fdd64-e536-11e7-97e2-916d4fbac0da?segmentId=a7371401-027d-d8bf-8a7f-2a746e767d56