Daily Comment (July 28, 2017)
by Bill O’Grady and Thomas Wash
[Posted: 9:30 AM EDT] Unlike the past few days, there was a lot of news overnight. Here’s what happened:
The Senate fails to “repeal and replace”: In the wee small hours of the morning, three GOP senators joined the full contingent of Democrats to kill any chance of ending the ACA. After seven years of opposing Obamacare, the GOP had no real replacement plan. Healthcare is hard. The Charlie Gard situation in the U.K. shows the fears Americans have over a single-payer system. On the other hand, medical care spending in the U.S. is very high and the outcomes we enjoy from that spending are not superior to what is seen elsewhere. The GOP, in retrospect, couldn’t figure out how to reduce costs and maintain coverage. The troubling part of the ACA is rising costs, which will continue to plague the law. At the same time, both the ACA passage and the failure of its replacement scream for some sort of bipartisan solution. Sadly, in our highly divided political environment, bipartisan actions are usually career-enders for politicians. Anyway, now that the healthcare situation is behind us, we can move on to tax reform.
Taxes? We expect the House and Senate to move on to tax reform. Financial markets were never all that concerned about healthcare but are keenly focused on tax reform. Unfortunately, there don’t appear to be any detailed tax proposals prepared. The White House, Treasury and congressional leaders issued a six-paragraph statement of goals yesterday. The only detail we received is that the beleaguered border adjustment tax (BAT) is now officially dead. Although controversial, the BAT actually resolved a couple of problems. First, it was a major revenue generator; using a BAT would have created enough revenue to allow for large marginal cuts. Second, it accomplished the president’s goals of improving America’s trade imbalance by raising import prices (although a stronger dollar would have offset some of this effect). It was terribly unpopular with retailers and refiners (who import oil) but quite popular with manufacturers. Our read is that the president found it too complicated and it reduced his ability to micro-focus on firms and industries to harm or help over trade. But, without it, we will probably see smaller cuts in marginal rates. Congressional Republicans want tax reform that is revenue neutral. The White House appears less concerned about deficits and may press for much bigger cuts than Congress can live with in the absence of offsets. Another sideshow we will be watching is Steve Bannon, who lobbed a proposal to raise the highest marginal tax rate to 44% on incomes over $5.0 mm. That idea will be an anathema to the establishment GOP but might actually be a powerful bargaining chip to attract Democrat votes. We will be watching to see how quickly the establishment GOP moves to kill this idea; Grover Norquist will probably be front and center on this issue.
The Mooch fires away: Anthony Scaramucci was in the press over the past two days expressing extreme displeasure with Chief of Staff Priebus and Senior Advisor Bannon, using colorful language that we won’t repeat here. Although interesting to watch, it could have an impact on financial markets if the tensions lead to resignations and firings in the White House. The White House appears thinly staffed as it is; this kind of tension may lead to exits which would exacerbate problems and reduce the effectiveness of the president.
The Russians respond: After the elections, President Obama forced the Russians to leave two facilities in the U.S. that had long been suspected of being listening posts. Obama made this move in response to evidence of Russian interference in the U.S. presidential election. Russia didn’t initially respond to the U.S. moves, likely in order to see how the incoming administration would act toward Russia. The recent sanctions overwhelmingly passed by Congress have triggered a Russian response; the number of people tied to the U.S. embassy in Russia will be reduced to 455 people, the same number of diplomatic staff Russia has in the U.S.
Iran has an ICBM, too: Iran launched a missile that is capable of reaching space and can carry a payload of 550 lbs. Although Iran still remains compliant to the deal it signed with the Obama administration, the Trump administration is clearly unhappy with the deal and is threatening to scuttle it. If the Iran deal is rescinded, we would expect Iran to rapidly move to finish the nuclear cycle and build a weapon. How the U.S. and Israel react to such a development will be clearly worth watching. It’s possible the U.S. could launch airstrikes against Iran’s nuclear facilities; a more likely outcome would be a nuclear arms race in the region.
Amazon disappoints: We usually don’t comment on individual stocks in this report but the tech sectors (and the NASDAQ) are lower this morning after Amazon (AMZN, 1046) earnings came in below expectations. Shares are off 3.6% in the pre-market trade. Given the dominance of a few tech stocks in driving the overall indices higher, an earnings disappointment might lead to a broader consolidation. At the same time, as we discuss in this week’s Asset Allocation Weekly Comment below, there is still enough sideline cash to likely prevent a significant pullback in equities.