The stock market roared higher on Monday because Macron appears to have locked up the French presidential election. He beats Le Pen in all the polls by at least twenty points. This makes me wonder what it takes for stocks to fall. Stocks rallied after the populist wins which were Brexit and Trump. They then rallied on the establishment victory by Macron. This supports my thesis that stocks would have rallied if Hillary won the U.S. election. Stocks go up on good and bad news. The rally in U.S. equities on Monday makes no sense because the 3% mini correction was not caused by angst over the French election. The stock market fell because of weak macroeconomic data. Now the market is barely down off its all-time high even though the data is lousy. The Nasdaq actually hit a new record high on Monday. I’m not surprised Macron’s win caused a rally because it is what the market wanted. I expected the market to irrationally ignore the disappointing economic data.
The chart below shows the weak data which I mentioned. The Citi U.S. economic surprise index has showed the positive economic trend of surprises has ended quickly. I have showed this chart in a previous article. The new point I’d like to mention is that the index is likely falling because of base effects. As you can see from the chart, the beginning of 2016 had awful economic data. At that point, many, including myself, were expecting the economy to fall into a recession. Coordinated global central bank dovishness prevented a fall. This caused the April 2016 economic data to improve, which is partially why the economic surprises this April are falling. The reason this chart looked so great in Q1 is because of the soft data. The soft data and the hard data have both retreated lately, sending this index down sharply.
Another reason why the market rallied towards the end of the day is because of rumors surrounding Trump’s corporate tax cut plan. It’s being reported that Trump wants the corporate tax rate to be cut to 15% to make it look like he’s delivering a big win to the voters within his first 100 days in office. Stocks shouldn’t be rallying on this report because Trump wanting it doesn’t mean it will happen. An analogous situation would be a poverty-stricken parent telling its child that it will get a Lamborghini for its 16th birthday. The child would be smart enough to know that the family can’t even afford to rent a Lamborghini for the weekend, let alone buy one outright. The stock market is not as rational as the 15-year-old child as it is believing reports which aren’t economically or politically feasible.
President Trump is telling his advisors that he cares more about achieving a big tax cut than paying for it by closing loopholes or adding a boarder adjusted tax. I mentioned that this 15% tax rate would have to be paid for by a boarder adjusted tax because the 15% tax proposal without it will cost the government $2 trillion over the next 10 years. To put the mathematical absurdity of this potential plan in context, the House Republicans want the corporate tax rate to be lowered to 20% along with a border adjusted tax. The House Republicans’ plan is more reasonable as it pays for itself which is important for three reasons. The first is simply because adding $2 trillion to the debt would send the debt to GDP possibly above 100%. The second is because the House Freedom Caucus won’t support increasing the debt. The third is because the plan will need support of 60 senators if it adds to the debt. This means Democrats would have to sign on to a plan which cuts corporate taxes. That would never happen. The best way to sway some Democrats would be an infrastructure spending plan, but there’s no wiggle room to balloon the debt further.
President Trump may be in favor of making the tax cuts only last ten years which would be the way a plan could increase the debt without needing Democratic support. This still seems unlikely to get the House Freedom Caucus’ support which has already stopped the establishment from passing the American Healthcare Act. As I mentioned in a previous article, Wednesday is the day Trump will lay out the plan he is supporting.
Ordinarily I would say it would be bullish if he gave specific details because Wall Street likes clarity. However, in this case, it is bullish if he doesn’t give specifics because the specifics of a 15% tax rate and no border adjusted tax cannot pass Congress. With the healthcare plan, President Trump let the House Ways and Means committee draft the bill. He then supported the plan they came up with. It would be the best-case scenario if Trump let’s the House come up with a plan because it wouldn’t decide to balloon the debt by $2 trillion. There is more consensus among Republicans on tax cuts than healthcare reform. The key holdup will be the border adjusted tax. This issue will come down to either cutting taxes to 20% and including the border tax or cutting the rate to 25% and not including the border tax. Either plan will be fine for stocks because they will be affected the most by the repatriation tax holiday. All the potential plans will likely include a repatriation tax holiday which is why stocks will be happy with whatever plan is passed.
Conclusion
Stocks rallied even though it is being reported by the Wall Street Journal that Trump is pushing for a tax cut which isn’t possible. The best-case scenario for Trump’s Wednesday announcement would be him putting his weight behind the House Republicans’ plan. The base case would be if he is vague on the details of the plan. The worst case would be if he is wedded to cutting taxes to 15% without a border tax. Stocks will likely rally no matter what happens, but they will eventually sell off after the worst-case because that plan won’t pass Congress.