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Tax Cuts and the US Stock Markets

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The stock markets rise or fall on sentiment, earnings, and economic data. While the initial boost following the US Presidential elections was sentiment driven, the markets held their own as the data flow stabilized and improved in the US and around the world. However, at the current levels, the US stock markets look pricey compared to historical averages.

Key points

  1. The markets are trading at rich valuations even after discounting a favorable tax cut
  2. Treasury Secretary Steven Mnuchin believes market will crash without a tax reform
  3. A few analysts believe that the markets will remain firm even without a tax cut
  4. We believe markets will be vulnerable for corrections if Republicans fail to pass the tax cuts
  5. Buy the rumor regarding tax cuts and sell once the news of a tax reform is announced

Nevertheless, the hopes of a tax reform have kept the markets buoyed. How much can these tax cuts add to the markets and what is the risk if the reforms are watered down or just don’t see the light of the day?

Analysts expectations for the S&P 500

The S&P 500 is expected to end 2017 with earnings of $131 per share, increasing about 10% over 2016. For 2018, analysts expect the S&P 500 companies to collectively earn $145.2 per share.

However, there are differing views on whether these figures include the benefits accrued from the tax cuts or not. If the tax benefits are incorporated, then to what extent.

The most bullish analyst on the street, Morgan Stanley’s chief U.S. equity strategist, Mike Wilson, believes that about $9 of $145.2 in the earnings projection is based on the benefits arising out of a tax cut. On the other hand, the most bearish analyst, Weeden & Co.’s Mike Purves, believes that $14 per share is from the tax cuts.

Let’s take a bullish scenario.

Analysts expect the annual per-share earnings to increase by $15 if the corporate taxes are cut from 35% to 20%.

However, Wilson has only accounted for $9 in benefits from the tax cuts. Therefore, we will have to add another $6, which gives us a figure of $151.2.

So, in the most bullish scenario, at 2580, the S&P 500 is trading at a forward p/e of 17 times.

Factset data shows that the 5-year average and 10-year average forward earnings P/E ratio of the S&P 500 is 15.6 and 14.1 respectively. Therefore, even with the most optimistic scenario of earnings built in, the S&P 500 is currently trading above its past averages.

However, just because its current valuations are above the historical averages will not cause a correction in the markets. But, can a failure to pass the tax cuts start a fall?

What if the tax cuts don’t see the light of the day or are diluted in their effect

Again, we shall consider the most bullish scenario. If the Republicans fail to pass the tax reforms, then the earnings projection for next year will fall by $9, to $136.2. At that level of earnings, the S&P 500 is currently trading at a P/E of $18.9, which starts to look pricey.

What level was the S&P 500 trading prior to the two previous crashes of 2000 and 2007?

As seen in the chart sourced from yardeni.com, the S&P 500 is already trading at a higher forward P/E than 2007. This confirms that we don’t have the comfort of valuations behind us. However, we are still a distance away from entering into a bubble territory when compared with the forward P/E of 24, recorded during the heights of the dotcom bubble. Therefore, a crash might not be in the offing.

How much will the S&P fall if the tax reforms don’t go through

Here again, there are two schools of thoughts. While one says that a failure to ring in the tax reforms can easily plunge the S&P 500, others believe that the stock market is unlikely to fall more than 5%.

Treasury Secretary Steven Mnuchin believes that a lot is riding on the tax reforms. In a podcast with Politico he said: “To the extent we get the tax deal done, the stock market will go up higher. But there’s no question in my mind that if we don’t get it done, you’re going to see a reversal of a significant amount of these gains.”

However, Credit Suisse and Morgan Stanley differ, as they don’t see a market crash even if the tax reforms fail.

“The market rewarded firms with high effective tax rates for only three weeks post-election, but not since,” wrote Jonathan Golub, Credit Suisse’s chief U.S. equity strategist. “For that reason, we do not believe that stocks would be at risk if a deal isn’t struck,” reports CNBC.

In a note to its clients, Morgan Stanley has painted three different scenarios with no tax cuts, modest cuts, and substantial cuts.

Morgan Stanley believes that the markets will only fall by 1% if the tax cuts don’t happen.

What do we believe?

We believe that the US market rally in the past year has been driven by hopes of a fiscal boost and tax reforms. These have kept the sentiment positive. As a result, the markets have risen on favorable economic data in the US and around the world and has not given up ground even when the news was unfavorable.

However, after failing to repeal Obamacare, if the Republicans fail to push through a meaningful tax stimulus, the sentiment will be dented.

That will leave the markets vulnerable to sharp drops on any adverse news because the floor of the reforms and an earnings increase will be lost.

On the other hand, if the tax reforms are announced, the markets are certainly likely to surge in the short-term, however, the bump up is unlikely to last for more than a few weeks. Usually, experienced traders buy the rumor and sell the news. We expect the same to repeat once the reforms are announced.

The markets will correct and the focus will shift to the effects of the stimulus at this stage of the recovery, which has been questioned by many economists. The Federal Reserve may also have to tighten at a faster pace than expected, which may neutralize some of the effects of the rate cuts.

Bottom line – To buy or to sell?

Buy the rumor of a substantial tax cut. However, once the cuts are announced, please book profits in the ensuing buying stampede.

On the other hand, if the tax cuts fail to materialize, keep the buy list ready to enter on any fall, which is closer to 8% to 10%.

Featured image courtesy of Shutterstock. 

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.7 stars on average, based on 9 rated postsRakesh Upadhyay is a Technical Analyst and Portfolio Consultant for The Summit Group. He has more than a decade of experience as a private trader. His philosophy is to use technical analysis for momentum trading and fundamental analysis for long-term positions. Rakesh likes to keep himself fit by lifting weights and considers himself to be a spiritual person.




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Analysis

GBP/USD Price Prediction: Cable Could be Hit Harder This Week

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  • Big fundamental data points will play a massive role in the direction of GBP this week.
  • GBP/USD downside targets are eyed at 1.2800 and then the range of 1.2750-1.2650.

It is another week where GBP takes the spotlight with a raft of key economic data points being released from the UK. This comes after an extremely volatile week where GBP/USD finished another close in the red. In an already delicate time for the UK and its domestic currency, given the Brexit palaver, this slew of key fundamental data is only going to see volatility rising.

Recap Last Week

Cable last week came under quite a large amount of selling pressure, which was initially kicked off due to weaker PMI data. Britain had produced soft construction and services PMI data, which triggered the bears to get into action. Furthermore, the Bank of England released their monetary policy decision, where they left rates unchanged; however, officials were very much dovish. They slashed their growth forecasts, citing Brexit damages. GBP managed to reverse this initial spike to the downside, after Carney essentially hinted rate rises could still come. The market read between the lines following his comment: “There is upside for UK economy if there is clarity on Brexit deal sooner”.

Critical Data Points This Week

On Monday, UK will release its GDP figures, which are expected to cool across the board. This is not too much of a surprise, given lacklustre economic data points that have been released already this year, including falling retail sales and a drop-in consumer confidence to around weakest levels in more than fives years. PMI sectors are close to recession and most recently the BOE downgraded its growth forecasts. Elsewhere, later in the week, eyes will also be on the retail sales and CPI numbers, both of which are expected to cool. Should all above-detailed data come in soft, then expect further selling pressure to continue for GBP this week.

Technical Review – GBP/USD

GBP/USD weekly chart.

The weekly chart view remains firmly bearish, following on from the last two consecutive weeks of losses. In terms of the daily, price action is currently trying to break down near-term demand. This can be observed between 1.3000 down to around 1.2915. Should the bears manage to convincingly break and close below, then eyes will be on a retest of 1.2800 to the downside. GBP/USD last traded down there on 17th January. Further downside targets would be the 1.2750-1.2650 range, where the next major area of demand can be seen. Shorts would likely be off the cards near-term if the price manages to break and close back above the psychological 1.3000 mark.

GBP/USD daily chart.

In terms of direction this week, it is very much going to be dictated by the above-listed key economic data points. The bears will likely capitalize on the described downside targets, only if the numbers disappoint market participants.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.6 stars on average, based on 123 rated postsKen has over 8 years exposure to the financial markets. During a large part of his career, he worked as an analyst, covering a variety of asset classes; forex, fixed income, commodities, equities and cryptocurrencies. Ken has gone on to become a regular contributor across several large news and analysis outlets.




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Bitcoin

Davos: What’s Bitcoin’s Role in Trump and China’s ‘New World Order’?

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According to Investec CEO Hendrik du Toit, despite U.S, President Donald Trump and China’s President Xi Jinping not coming face to face at Davos this week, the event is still encapsulated by their simmering economic battle.

The chief of the global investment firm suggested that Davos represents a thrashing out of the coming ‘new world order’ – with the U.S. and China fighting for a seat at the head of the table.

Amid these talks some still found time to throw FUD on Bitcoin and cryptocurrency in general. But putting aside price predictions for the moment, just what is crypto’s role in this new world order? The answer probably has nothing to do with its role as a digital currency.

New World Order at Davos

Du Toit told was quoted as telling CNBC reporters on Thursday morning that:

“The big uncertainty is the U.S.-China trade negotiation which is not really about trade, it’s about a new world order.”

Henrik also made allusions to China’s recent slump in GDP growth, which just hit the thirty year low of 6.6%. As many former communist nations have discovered in the past thirty years, it’s easier to record growth when you don’t have much to begin with. Now China is up in the big leagues, and it’s not entirely clear how the country will adapt to its new surroundings. Du Toit continued:

“And if we get a dysfunctional world order having come from a space which was very, very good business over the last 20, 30 years since communism fell, then there may be some big hits along the way and there may be some big challenges.”

Keeping Score

China’s GDP growth rate is still almost three times that of the U.S, and the trade deficit between the two nations saw China record a $350 billion surplus at the end of the year in 2018. Exports to the U.S. rose 11.3% last year, compared to the measly 0.7% increase in U.S. goods shipped to China.

However, few statistics tell the whole story, and according to financial analyst Gary Shilling, the trade deficit is a clear sign of American dominance, as he recently posited:

“The thing is…we (the U.S) are the buyer, and they’re the seller – and when you’ve got plenty of goods and services, it’s the buyer who has the upper hand. And besides, where would China sell all this stuff if it wasn’t to American consumers?”

Shilling went so far as to say that Donald Trump currently has the upper hand in the trade war, and that U.S. economic dominance would continue to eclipse China – specifically due to Trump’s ‘America first’ policies.

“I think ultimately we’re going to see more imports of American goods into China; they are going to be less aggressive on exports; they’re going to steal less technology, they’re going to demand less technology for the cost of doing business in China. I think it’s going to shift in America’s favour, but the transition is rough.”

Weaponizing Bitcoin

Shilling’s take encapsulates a best-case scenario – one where the growing number of Chinese troops terraforming the South China sea, and the constant theft of U.S-patented technologies don’t cause global tensions to boil over.

But if they did boil over there’s every reason to assume that cryptocurrency, and Bitcoin in particular, would have a major role to play. However, that role may be its last on the world stage.

Estimates towards the end of 2018 placed over 80% of Bitcoin’s mining power in China. Given the Chinese government’s tendency to simply take things they like, any conflict between them and the U.S. would likely see Bitcoin weaponized, and its ‘distributed’ ledger commandeered.

A recent Forbes article suggested as much, and claimed that China’s Bitcoin’s dominance posed a real threat to American tech, finance and economy. Furthermore, many nations have already taken steps to curb that dominance:

“While U.S. regulators are wrapped up in their own turf wars, other nations are moving fast to create a welcoming regulatory environment for cryptocurrency.”

That includes the U.K and the European Union, both of which have taken steps to increase the popularity of cryptocurrency and blockchain within their respective regions. It might terrify the banksters to see blockchain spread around the Western world, however, the shadowy figures at the levers of governmental control are already attempting to leverage blockchain technology in their favour.

Hash Wars

How much would it be worth to China and the U.S. to gain control over Bitcoin’s ledger? In the previous century we saw the world’s nations sacrifice not only money and resources, but also a majority of their male adult populations for a slice of whichever pie was being baked at the time.

While many major cryptocurrencies can be commandeered for just a few thousand dollars per hour, Bitcoin would cost $261,379 per hour to control according to independent data. The Ethereum Classic blockchain can currently be bought for $4,275 per hour via cloud-mining marketplaces like Nicehash, but control of BTC wouldn’t be sought in that way.

More likely both nations would get to work on building the largest mining farms they could, made up of as yet unseen super-computers from various R&D labs hidden around the country. A digital battle for control of Bitcoin would ultimately be decided by which nation could develop their computational tech the quickest.

America needs YOUR Bitcoin!

Such a scenario would see the sharpest minds in silicon valley employed as government agents in much the same scenario as mathematicians and codebreakers during the second world war. By the end, the Bitcoin blockchain would be illegitimate and abandoned; and the lasting legacy of BTC would be as a bit-part player in the much larger engagement that was World War 3.

Looking Ahead

Not all the noises coming out of Davos this week were so ominous. The CEO of Nasdaq, Adena Friedman, recently offered the possibility that cryptocurrency could still be the global currency of the future.

Meanwhile, Circle CEO, Jeremy Allaire, suggested that if humanity is to survive the digital age, it will require the resilient and decentralized tools which crypto and blockchain provide.

Disclaimer: The author owns bitcoin, Ethereum and other cryptocurrencies. He holds investment positions in the coins, but does not engage in short-term or day-trading.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.5 stars on average, based on 145 rated postsGreg Thomson is a full-time crypto writer and digital nomad. He eats ICOs for breakfast and bleeds altcoins. Wherever he lays his public key is his home.




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Analysis

GBP/JPY Price Prediction: Cable Jumps Over 150 Pips With Room for Another Squeeze Higher

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  • GBP/JPY saw decent gains on Wednesday, receiving a helping hand from Brexit and BOJ fundamentals.
  • Brexit optimism helps GBP higher, while BOJ remain dovish, adding pressure to JPY.

GBP/JPY jumped to its highest levels seen since 14th December 2018. The session high print was observed at 143.56, with the pair having gained over 150 pips. In terms of the reasoning, it was heavily attributed to fundamental factors, both for Britain and Japan.

Bank of Japan Dovish Tone

In the very early hours of European trading, the Bank of Japan (BOJ) released its monetary policy decision. As anticipated, the central bank maintained much of a dovish tone to its rhetoric. Policymakers slashed their inflation forecasts, while maintaining their huge stimulus programme. Governor Haruhiko Kuroda noted strong and growing risks to the economy, including trade protectionism and faltering global demand.

The BOJ added that, “Such downside risks concerning overseas economies are likely to be heightening recently, and it also is necessary to pay close attention to their impact on firms’ and households’ sentiment in Japan,”

As such, there were no changes made to monetary policy this time round. It is likely going to be a challenge for the Bank of Japan to discuss policy normalization or even an exit strategy for the moment, given as they themselves highlight that global economic risks are rising. This tone added to the broad JPY weakness observed across the board.

Renewed Brexit Optimism

The rally seen for GBP today was sparked following the Labour Party publicly saying they will back a postponement proposal. This essentially could hold off any decision on Brexit until the end of the year, extending Article 50. Elsewhere, the European Commission commented on the news wires, noting they will do their best to avoid a hard border in Ireland.

These fundamental developments were huge drivers in the aggressive move north for GBP/JPY. The Brexit news as detailed was supportive for the pound, whereas the BOJ commentary was largely digested as a JPY negative.

Technical Review – GBPJPY

GBP/JPY 1-hour chart.

Upside momentum looks set to maintain it course. With that in mind, it is worth knowing the next major barriers for the bulls. Looking via the daily chart view, the next area of resistance is not seen until 143.95. This was the 13th December high, which would be closely watched, as it could produce a double top formation. If the bulls have enough steam behind their run higher to breakthrough, then eyes will be on 145.50.

GBP/JPY daily chart.

In terms of the 60-minute chart view, price action is supported by an ascending hourly trend line. This has been running since the early hours of trading on 22nd January. A failure of this holding could see a drop back down to 142.20, hourly support. Further south, if selling pressure picks up pace, then a demand zone can be seen down at 140.80-50 range.

To conclude, the bias remains bullish near-term for a decent run up a the 13th December high area, 143.95. Longs may be off the cards if the hourly ascending trend line is breached, but this remains intact at the time of writing.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.6 stars on average, based on 123 rated postsKen has over 8 years exposure to the financial markets. During a large part of his career, he worked as an analyst, covering a variety of asset classes; forex, fixed income, commodities, equities and cryptocurrencies. Ken has gone on to become a regular contributor across several large news and analysis outlets.




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