France Follows The U.S. Blueprint While The U.S. Budget Awaits One
/In The News...
The political landscape has been relatively quiet, but that won't be the case for much longer due to two looming events sure to have lasting impressions.
U.S. budget deadline: First, the U.S. government has until April 29th to agree on a spending bill to fund government expenses through its September 30th fiscal year-end. The biggest unknown is whether certain major budget matters, particularly those promised during President Trump's election campaign, will be included in this negotiation or pushed out as part of the 2018 budget talks.
This type of thing is not new, but it is unique. Congressional infighting has threatened to shut down the government before, as well as risk default on certain financial obligations. However, Republicans have leverage due to control over both the executive and legislative branches. What makes this truly different is that these talks will occur on the watch of a new president who is intent on playing hardball. Interestingly, if a government shutdown does occur on April 29th, that happens to be President Trump's 100th day in office.
Do I think the government will shut down? No. There are too many outs that Congress can use to postpone certain decisions. These kick-the-can-down-the-road methods are part of the bigger problem preventing true budget reform, but that is for another day (and platform). But this is the first glimpse into Trump's deal-making, should he engage himself into the process this week as most believe.
France channels the U.S.: Meanwhile, France is taking a page from the U.S. playbook with its own presidential election. The two finalists for the French presidency are outsiders. Far-right candidate Marine Le Pen and political newcomer Emmanuel Macron will face-off in a final vote on May 7th. Le Pen has a Trump-esque populist approach to immigration and border protection. Macron is a former investment banker with virtually no political experience, whose focus is economic development and socially liberal policies. Current President Francois Hollande chose not to run for a second term, which opened the playing field for an array of candidates.
Among many differences between the two finalists, what makes this a big deal is that one candidate (Macron) wants to remain in the European Union while the other (Le Pen) wants to secede and tighten up French borders. Macron is the heavy favorite, but as recent history has shown, don't assume anything. Should Le Pen win the election run-off, the short-term market reaction could rival the volatility that occurred when Great Britain voted to leave the European Union last summer. France is the 6th-largest economy in the world, so this matters.
In The Market...
The S&P 500 rose +0.9% last week. Let's look under the hood:
(data source: Yahoo Finance)
Stock bounce-back? The majority of stock sectors rebounded. Consumer Discretionary (a current holding of ours) continues to look like the strongest sector. Utilities (another holding of ours) still looks bullish, despite the relatively flat week. The S&P 500 index is still floundering around a value of 2,350, where it has resided since late-February.
Earnings wave: Nearly 40% of S&P 500 companies report first-quarter results this week, including some of the big-boys like Google, Amazon and Exxon-Mobil. That will spark some market movement, one way or the other. More on earnings in the Opinion section below.
Bond-breakout? Conservative bonds such as long-term treasuries and investment-grade corporate bonds look primed for a rally, but we're not quite there yet. Both TLT (treasuries) and LQD (inv-grade corporates) were flat last week, which is positive considering the collective rebound within the stock market. As I often write, "safe" bonds like LQD and TLT often tumble when stocks rally, and visa-versa. The fact they held their ground amid a stock bounce is constructive. We are not quite ready to pull the trigger and buy just yet, but those bond ETFs are of interest.
In Our Opinion...
Stop me if you have said or heard this before...
"I don't understand. It was a great quarter for the company. So why is the stock price down?"
This confusion is common. Companies often exceed their earnings estimates or hit revenue targets, only to see the stock price react in an unexpected negative manner. There is no pure positive correlation between a company's share price and recent financial performance.
The best explanation for this is because it is impossible to know the motivations of every individual buyer and every individual seller -- those who make up the supply/demand for that stock. In the case of earnings season there are often catalysts within a company's results that may hurt its share price, contrary to our expectations. For example:
- The company beat its earnings estimate, but not by enough to invite new buyers
- The revenue target was reached, but total sales still declined compared to prior quarters
- Overall, the financials look good but customer growth is leveling off
- A management shake-up is announced that investors dislike
- During the earnings call, the outlook for future performance is revised lower due to unfavorable business conditions
These are just some reasons that might taint an otherwise rosy quarter. The opposite holds true too. Here are some reasons that might actually boost a stock price despite reporting a poor quarter:
- A quarterly profit loss was reported, but the loss was less than anticipated
- Total sales fell short of expectations, but a new opportunity or partnership is announced that will boost sales in the future
- A business unit is being dissolved or a layoff is announced. As tough as these events are on those affected, the right type of restructuring helps the business run more efficiently and profitably moving forward
The common theme here sums it up best: Quarterly earnings reports reflect on a company's past whereas its stock price reflects its future prospects. Investors care more about where they think a business is headed than where it has been. This is also why savvy investors refrain from buying/selling around earnings season. It is because of the wildly unpredictable nature of a) earnings reports, and, b) how stocks react to earnings reports. For these reasons, investing turns into gambling when buying or selling a particular stock near its earnings date.
In Our Portfolios...
Stocks: No changes last week. The Industrials sector is showing some opportunity, although it is unlikely we would yet sell either our Consumer Discretionary or Utilities positions to purchase Industrials.
Bonds: No changes last week. We may add investment-grade corporate bonds in the near future, at which point all accounts would be 100% allocated again.
Q&A / Financial Planning...
Are income taxes coming to a 401k plan near you?
As the federal budget negotiations heat up you will hear suggestions of ways to fund certain initiatives. These initiatives include reducing the corporate tax rate from 35% to 15%, paying for health care and building the border wall. One target in the budgetary cross hairs is the enormous amount of money sitting in tax-deferred investment accounts (401k, IRA) as well as the enormous amount of money that will be pumped into these plans in the future.
Here is an article that touches on one proposal to tax annual 401k gains at a nominal 15% rate. I have heard of other ideas ranging from lowering the yearly 401k contribution limits to replacing tax-deferred salary contributions with after-tax contributions only. All of these ideas would boost tax revenues in the short-term.
Let me be clear though: Do not lose sleep over this. Do not adjust any long-term plans based on these rumors, but it is worthwhile knowing what is being considered. I think it would be insane for the government to muck with the current 401k structure. It is our only form of retirement savings that is both universally understood and used. To revise it in a way that hurts retirement savers would potentially set us back an entire generation. Employers would scale back their plans and employees would stop utilizing them. The odds are slim that anything significant will happen to these tax laws, but it is worth mentioning.
What's New With Us?
You will receive an email from Docusign this week requesting your electronic signature to set up your TD Ameritrade account. Once your TDA account is established I will send a follow-up email (also via Docusign) to transfer your existing Scottrade account to TDA. If you have multiple accounts we will complete this process for each of them. The good news is that it only takes a minute or so to complete the e-sign process. Please call me if you have any questions along the way.
Have a great week everyone,
Brian E Betz, CFP®
Principal