Daily Comment (October 3, 2016)

by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] Politics mostly dominated the weekend news flow, although Deutsche Bank (DB, $13.09, +1.61) was in the news, too.  German markets are closed for a holiday (it’s Unification Day, the holiday that commemorates the official day when East and West Germany were reunited), so we haven’t seen a full overnight session for the bank.  Shares rallied on Friday following a report that the DOJ and the bank were nearing a settlement, with a fine well below the initial $14 bn indicated.  However, the WSJ has quashed these rumors in a weekend article suggesting that no deal is imminent; in fact, talks haven’t even reached the point where a proposal has been fashioned that could be presented to the U.S. government and bank officials.  Thus, the issues with Deutsche Bank will continue.  We are also hearing that Sen. Clinton will speak today about making it easier to bring private lawsuits against corporate “bad actors,” which may bring selling pressure against some large U.S. banks.

In Colombia, voters narrowly rejected a peace deal between the Revolutionary Armed Forces of Colombia (FARC) and the government.   The vote was 50.2% against, 49.8% for; turnout was only 37%, partly due to torrential rainfall.  President Santos has indicated that the ceasefire will remain in place.  Although the low turnout may have been critical, we note that pre-referendum polls showed the “yes” vote winning 2:1.  This is yet another example of polls failing to capture an adverse outcome; we saw something similar with Brexit polls.  It isn’t clear what Santos and FARC will do to move forward, but we don’t expect a return to war and would not be shocked to see another vote.

In other major political news, British PM May has set a deadline of no later than March 30, 2017 to invoke Article 50 of the EU charter, which will begin the process of Brexit.  We are still not sure if Britain can leave the EU without an act of Parliament (a vote in the House of Commons to leave the EU would probably fail to pass), but it does appear that PM May is set to leave.  It also appears that Britain won’t be able to hold informal talks in advance of the Article 50 declaration as May had wanted.  Ideally, the U.K. had wanted to hammer out an agreement before declaring Article 50 so that negotiations would be smooth.  However, because France and Germany are facing elections next year and it won’t be politically popular for either to make it easy on Britain, it looks like they are going to do this the hard way.  The GBP fell on the news; meanwhile, as we note below, U.K. PMI data came in much better than forecast, likely helped by the currency’s depreciation.

The other big political news was Mr. Trump’s 1995 tax returns that were apparently leaked to the NYT.  This story is quite interesting on a number of levels.  First, it does appear to be a leak—according to reports, three photocopied pages arrived in NYT reporter Susan Craig’s mailbox a few days ago.  The letter’s return address was “The Trump Organization” and the postmark was from New York City.  The source appears to be unknown and could be a hoax, although his tax attorney from 1995 did confirm the paperwork as legitimate and noted that the first two digits of the eye-watering $916 mm loss had to be hand-typed because the tax preparation software of that era couldn’t handle a number that large.  Second, the loss is substantial, but not implausible.  The Trump Empire was under great strain during that time period as there were serious problems with the Atlantic City casinos.  Third, and perhaps the most critical unknown part of the story, is what happened with the losses?  When a household renegotiates a loan, if any part is forgiven then the amount forgiven becomes income and is subject to tax.  So, speculation that Trump has these massive tax losses that could shield his income for years may not be true.  At the same time, there are ways to avoid this issue.  A practice called “debt parking” can hold the discounted debt and Trump gets to keep the tax losses to offset future income as long as it never requires Trump to service the debt.  It could be illegal if Trump has any ties to whatever body is holding the parked debt.  We are not sure that this occurred, but the steadfast refusal to release his tax returns could be to protect the entity—a family member or a shell corporation—that may have bought the deeply discounted debt from the original debt holders.  Suddenly becoming liable for the income from the original debt forgiveness could be very costly for Trump.  Again, we are not tax accountants but the way the documents were leaked suggests a disgruntled employee or something of the like.

How serious is this news to the Trump campaign?  We doubt it will sway his hard core supporters.  This is the part that pundits seem to miss.  Trump’s policies on trade and immigration offer hope to a band of the electorate that sees these two issues as the primary reasons for their woes and thus Trump’s personal behavior is immaterial.  That group, by itself, won’t win Trump the election, but it probably means that he has a solid 35% to 40% of the electorate that is almost unshakable.  Taxes, ill-advised tweets and personal behavior will sway the undecided away from Trump and so they do matter.  However, unless Sen. Clinton can offer the undecided a reason to vote for her, they may simply stay home or vote for a third party.  Brexit and the Colombia vote showed the unreliability of polls.  The tax issue does matter but probably not as much as the pundit class is suggesting.

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