This Week in Barrons – 4-23-2017:
“…Closed today due to government shutdown.”… Smithsonian Institution
Why does everything in our government ALWAYS come down to the last minute? The above is a picture of the sign posted on the gate of the National Zoo in Washington, D.C. – advising visitors that the institution was closed due to the partial government shutdown on October 15, 2013. If the U.S. Government fails to avert a shutdown next week, investors should hope that Wall Street treats President Donald Trump like it did Barack Obama and not Jimmy Carter. According to LPL Financial, markets have shown modest weakness during government shutdowns (falling an average of 0.6% over the period of the closure), but show more dramatic shifts when a single political party controls the executive and legislative branches of government.
A 0.6% retreat would hardly be catastrophic for the markets (which remain a few percentage points from all-time-highs), but the single-party control of the current government could mean the market is more vulnerable and its reaction more severe than normal. In the 5 instances where there was single-party control, the markets were decidedly weaker in 4 of them, including a 4.4% drop during an 11-day closure in 1979. A single-party government shutdown does signify ‘rough waters to come’ surrounding passage of any major legislation – something markets are particularly attuned to right now. This rally (that was sparked by Trump’s election) has started to unravel with the pulling of the health-care reform act. The prospect of continued difficulties passing other economic agenda items such as tax reform, infrastructure, and regulation reform – will cause the markets to believe that their rise was unwarranted.
Federal government operations are currently funded through April 28, next Friday. Without a new spending bill, the government would ‘partially’ shut down for the first time since 2013. Many federal employees would be furloughed, but others (FBI agents and air-traffic controllers, for example) would stay on the job. National parks would close, but the U.S. Post Office would remain open. That was the situation from Oct. 1-16, 2013, the last time the federal government partially shut down, due to a battle over the Affordable Care Act. Washington flirted with a shutdown in September 2015 over funding Planned Parenthood, and again in December 2016, over health-care benefits for miners – but last-minute deals (in both cases) kept the government open. During the 2013 shutdown, 850,000 federal employees were furloughed immediately. However, most civilian employees went back to work after a week.
Congress is currently on vacation, and when lawmakers return they’ll have only days to head off a government shutdown. Senators are due to return Monday, April 24, with House members scheduled to come back a day later. Before leaving, leaders signaled that they were likely to exclude the most contentious provisions from legislation needed to keep the government running past April. For example, House Speaker Paul Ryan suggested that they would not eliminate funding for Planned Parenthood, and Sen. Roy Blunt suggested that the April bill would likely EXCLUDE President Trump’s request to start the U.S.-Mexico border wall and any boost to military spending. Isaac Boltansky of Compass Point Research & Trading expects lawmakers to return from recess and quickly pass a short-term funding extension (Continued Resolution) before passing another funding package that would postpone the entire budget to the fall.
In terms of funding Trump’s $30B to $54B increase in military spending, the first step is to eliminate the sequestration verbiage surrounding the current defense budget. This keeps current spending limits at Fiscal Year 2016 levels minus 10%. Some in Congress want Defense to remain on ‘Continued Resolution’ (CR) status. After all, CR is an easy way to maintain the status quo, and cut the Fiscal Year 2017 budget without having to address any specific programs. Until they fix the sequestration verbiage, no increases will occur and Defense will be forced to take the pre-negotiated 10% cuts. Many of our military think that our own internal sequestration verbiage is a much greater threat to homeland security than anything outside our borders. I think that there will be a few days of government shutdown – then President Trump will ‘blink’ and agree to extend the CR past April 28th. This will be followed by another short-term CR until the end of August – at which time a real budget will be worked out. I think we will eventually fix the sequestration verbiage but it will be at the 11th hour. Right now, with healthcare, tax reform, building the wall, and infrastructure still all up in the air – an adjusted August deadline is just another 11th hour decision.
We have a military war raging in Afghanistan, Syria, and maybe N. Korea, but we have a ‘war of truth’ being fought within our own borders. So much so that this past week Steve Ballmer (former CEO of Microsoft) opened a new data mining site: www.USAFacts.org that attempts to put all of the governmental data in one place. But even with this, there is a renewed escalation of tension within the U.S., and recently the ‘gloves have come off’. One recent video documented Yale students signing a petition to repeal the First Amendment - the part of the Bill of Rights that guarantees their own right to freedom of speech, religion, the press, assembly and, ironically the right to petition. The world continues to have difficulty telling fact from fiction. Last week Bank of America’s Michael Hartnett noted: “Central Banks (ECB & BoJ) have bought $1 trillion of financial assets just in the first four months of 2017. This amounts to the highest buying on record. This Liquidity Supernova is the only explanation why global stocks & bonds are showing annualized double-digit gains year-to-date despite Trump, the French elections, and N. Korea."
This quest to ‘prop up the stock market’ began after the great crash of 1987, when President Ronald Reagan created his ‘Working Group on Financial Markets’. This group was tasked with ways to prevent market crashes before they happen. Wall Street coined them: the ‘Plunge Protection Team’ (PPT). This past week Dr. Pippa Malmgren (a former member of the PPT) said: “It’s not conspiracy theory, it is conspiracy fact. There's no price discovery anymore by the market because governments impose prices on the market." When you have a group designed to keep an orderly market, and a member of that group admitting to setting prices – we have now confirmed our government’s direction, ability, and intention. At least we know why the market is over-priced – yet it holds up and continues to push higher.
So, where do we go from here? Factually, the data is eroding: (a) retail sales are soft, (b) the FED is still threatening to raise rates, (c) housing starts are falling, (d) automobile purchases are cooling off, (e) the Purchasing Manager’s Index (PMI) and the Consumer Price Index both missed their targets, (f) GDP has been revised downward from 3% to almost nothing (0.4%), and (g) earnings (and even ‘adjusted doctored-up’ earnings) are mixed. But more importantly, there is a lot of speculation surrounding what the global markets will do based upon the results of the first round of the French elections. The common thinking is that if Le Pen wins, the market might get soggy – as she's in favor of leaving the EU and ending their immigration nightmare. However, didn't we hear that very same thing about the market prior to Trump winning? And also on Friday the Trump people came out and said that next week they would be announcing the biggest tax cut plan "maybe in history".
Therefore, next week we have (a) the initial outcome of the French election and (b) the possibility of an announcement surrounding an upcoming tax plan. It’s my guess that the market will push higher no matter who wins in France and irrespective of the validity of Trump’s new tax plan. Why, because the Central Banks are in control. If they want the market up – the market will go up no matter who wins. After all, they’ve already purchased over $1T worth of financial assets in just the first 4 months of 2017. It doesn't sound like they're ready to let markets fall or ‘be free’ just yet. So, it’s my guess that they poke and prod this market to (a) regain their 50-day moving averages and then (b) trade sideways as we have for the past month.
With the French election and the new tax proposal, there is a tremendous amount of volatility priced into the market this coming week. Currently the 2,350 level in the S&P has been the center of trading since the start of the year. For example, at the beginning of last week the S&P was at 2,332 and had a $28 expected move. The high for last week in the S&P was 2,360 – matching the expected move to the penny (2,332 + 28). Algorithms and investors are trading the expected move as if they are guarding a castle – with the borders of the expected move not being allowed to be penetrated.
Looking forward, this week’s expected move is $47, which puts the S&P potentially touching down as low as 2,300, and as high as 2,395. This level of volatility has not been seen since prior to our U.S. Presidential election. This means that traders are worried and covering their ‘tail-risk’. Currencies, emerging markets (EEM), and our own financial markets (XLF) are also looking at extremely high sector levels of volatility.
A few recommendations:
- EWY (the South Korean ETF) = If you believe N. Korea’s rhetoric about launching a “super-mighty preemptive strike that will send the U.S. back to the Stone Age”, then expecting the S. Korean market to go down in the coming weeks would be a natural. A May monthly call credit spread in EWY (selling the $62 Call and buying the $63 Call) expiring in 28 days is a defined risk bearish strategy with a 70% probability of making 50% of its max profit prior to expiration.
- XLY (the U.S. Consumer Discretionary ETF) = If XLY opens around $87.50 on Monday, look into buying the ETF as well as a couple of the largest stocks in the sector: Home Depot (HD) and Comcast (CMCSA). Both HD and CMCSA are in ‘squeezes’, coiled to fire to the long side – and should move both stocks nicely higher next week.
- IWM (the Russell 2000 ETF) = IWM has a weekly squeeze forming, and has all its averages (8-day, 21-day, and 50-day) in alignment. I’m looking for this period of congestion to resolve itself and move higher. Consider buying the $147 IWM monthly Calls for August, 2017. IWM is currently trading at $137, and as IWM would gain steam and move higher – the $147 (out-of-the-money) calls should dramatically gain in value.
- Google (GOOGL) and Priceline (PCLN) are both in daily squeezes and looking to fire long. Given GOOGL has earnings on the horizon, selling Put Credit Spreads on both should be good for the coming weeks.
- Chipotle (CMG) is setting up to have another good opportunity to the long side for trading this coming week.
To follow me on Twitter.com and on StockTwits.com to get my daily thoughts and trades – my handle is: taylorpamm.
Please be safe out there!
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