In light of the persistently low inflation readings that are influenced by the prolonged decline in oil and other commodity prices, there is an uptick in the pace of business for the domestic economy during the latter part of summer. This sets up a strong finish to the third quarter that should see the pace of growth for gross domestic product (GDP) hit its stride going into the fourth quarter, which is typically a seasonally strong time of the year for businesses, especially retail.
This past week, the ISM Manufacturing PMI clocked in at 58.8 for August (Briefing.com consensus 56.8), up from 56.3 in July. The August reading is not only the highest level in 2017, it is also the highest reading since April 2011. More significantly, this increase marks the 12th consecutive month for which the index has been above 50, which is the dividing line between expansion and contraction. The key takeaway from the survey is that it connotes a manufacturing sector running with a full head of steam.
Historically, such a bullish reading from the manufacturing sector normally underpins a strong move up for the dollar in anticipation of further Fed rate hikes. However, there is a counter-intuitive trend in place where the Dollar Index (DXY) is on the verge of breaking down through its long-term uptrend line, which sits at the 93.0 level. Specifically, the dollar weakened as traders moved on the assumption that there won’t be a rate hike at the September meeting. That assumption, in turn, drove some buying interest at the front end of the yield curve.
The buying interest at the back end of the yield curve, however, seemed counter-intuitive, since more supply ostensibly should be seen in longer-term maturities when the Fed scales back its reinvestment. The thinking there, however, could be tied to the expectation that inflation should be tempered by a rise in market rates associated with the balance sheet normalization program. Whatever the case may be, the lower dollar coupled with an extended period of low interest rates is bullish for equities and especially dividend stocks.
What is most impressive in my view is how the market has rallied with literally none of the Trump agenda passed or funded. There is no health care reform, no border wall, no grand infrastructure spending plan, no massive rollback of financial regulations and no major tax overhaul strategy in place… yet. This may all start to change soon. Likely after these several days when President Trump and his team have performed admirably in support of managing the damage and dislocation from Hurricane Harvey.
Natural disasters are non-partisan when they occur and provide a platform for compromise in other areas of contention where politics tend to rule over common sense. It does appear that tax reform is going to be the next priority for Trump and the Republican Congress. If, and that’s a big if, there can be a meeting of the minds on both sides of the isle, then perhaps the overly burdensome tax system can be greatly simplified. It’s thirty years overdue for some sweeping changes and it now looks like there is genuine traction.
Treasury Secretary Steven Mnuchin said last week he hopes to get a plan to the President’s desk by the end of the year. As of yet, Trump’s plan has remained stuck in broad outlines: simplifying the tax code, creating a more competitive tax code, delivering tax relief for the middle class and repatriating offshore profits. Trump also said he would like to bring the business tax rate down to 15%, a figure that has been met with resistance by congressional leaders who see it as too low.
Initially, the timeline for tax reform was August, but as we move into September, the target date has moved to December 31. The fight over health care has taken the oxygen out of the Congressional chambers. Sadly, the White House and Congress have consistently failed to sync up in their ambition for reform amid disagreements over the repeal of Obamacare and other controversies.
Now, the White House faces a jam-packed fall legislative calendar that includes deadlines to avert a government shutdown and raise the debt ceiling and now added pressure to pass a disaster assistance package for recovery efforts in the wake of Hurricane Harvey, as well as the debate over immigration that is weighing on and being highlighted in the midst of the disaster. So, while tax reform looks plausible, the relief effort in Texas and also Louisiana takes priority.
With that said, market participants are bidding up stocks on the back of improving organic economic data and the prospects for rising third-quarter earnings, as evidenced by strong business investment and a weak dollar that serves as a boost to profits from overseas sales. If any semblance of a tax reform bill goes to committee in the House, I suspect the major averages will experience a year-end melt-up that will confound even the most ardent critics of current stock valuations.
I don’t believe this is any time to be buying bonds, but I do strongly agree with the view that buying higher-yielding assets that are sensitive to economic growth, inflation and higher interest rates makes all the sense in the world for income investors. My current model portfolio within the Cash Machine advisory service is positioned for just this scenario. The current set of holdings is widely diversified and boasts a blended yield of 8.5%. I invite all income investors to take a tour of my Cash Machine service here and consider seriously how to maximize income while reducing risk from what could well be a rising rate market in the months ahead.
In case you missed it, I encourage you to read my e-letter from last week about bullish takeaways from the recent Fed meeting.