Winter is coming

13 Nov 2017

  • The current environment of depressed volatility is beneficial to investor portfolios
  • The tax legislation published by the House faced intense criticism from a wide range of stakeholders
  • The political situation in the United Kingdom remains chaotic

It was a slow week for economic data, so noise around tax reform, and President Trump’s Asia trip dominated headlines. Large cap stocks fell in the U.S. as investors grappled with reconciling the tax reform plans put forth by the two houses of Congress. Last week marked the one year anniversary of the U.S. presidential elections, and despite the pandemonium on the political front, it has been a steady year in the markets, and investors are certainly not complaining. That said, we remain in a world of depressed volatility and investor portfolios are positioned to benefit from this environment. But what would happen to our portfolios if we were to experience a short term spike in volatility? With or without tax reform, we are certainly near the zenith of this credit cycle, should we reset our expectations for moderate returns going forward? How will our portfolios react to normalization of interest rates? These are questions that are front-and-center in investors’ minds.

US tax reform soldiers on, despite challenges. No sooner was the draft House tax legislation published, than it faced intense criticism from a wide range of stakeholders. This criticism fell along a number of lines: the legislation supposedly punished voters in states with high taxes and property values, as it would reduce popular deductions that had benefited these voters in the past; small businesses felt that they would not receive adequate tax cuts; multinationals balked at taxes on some foreignearned income; and Democrats and others focused on the tax cuts being highly regressive. The Senate tried to address many of these concerns in their own draft legislation released last week, and indeed succeeded on some but not all fronts – their legislation retained the estate tax, lowered tax rates on the smallest of small businesses, increased the child care tax credit and extended it for a full ten years, reduced the level of taxation on foreign-earned income, and maintained the allowable mortgage interest deduction at its current level. Tax cuts are too important an issue for Republicans, philosophically and politically, for them to pass up this opportunity. Still, the challenges ahead are significant, but so is the momentum.

During US President Donald Trump’s state visit, Beijing announced further capital account opening measures on raising and lifting some foreign ownership limits in China’s financial sector. This is good news for foreign investors, but it is still an asymmetric opening of China’s capital account.

The political situation in the United Kingdom remains chaotic. The Prime Minister lost a second member of her Cabinet in a matter of days. Politics dictated a ‘one in, one out’ policy on Cabinet appointments, so Brexiteer Priti Patel was replaced by Brexiteer Penny Mordant. The former British ambassador to the European Union (EU), the man who helped draft Article 50, grabbed the headlines by arguing that Brexit could still be unilaterally aborted by the British Government. However, Mrs. May wishes to remove all doubt by inserting a formal commitment to exit the EU on the evening of Friday 29 March 2019 in the EU Withdrawal Bill that is about to be discussed by Parliament. In the meantime, the UK data on industrial production were surprisingly strong. Activity in the sector as a whole was up 0.7% on the month, with the manufacturing sub-sector up by a similar amount. True, activity in the construction sector fell by 1.6% on the month (the steepest pace of decline in a year and a half) but taken together these data validate the preliminary estimate of Q3 GDP.

Looking ahead, Tuesday brings the all-important October CPI and PPI reports in the US. October retail sales come out the following day. A heavy data week in the United Kingdom this week: we get inflation data on Tuesday, labor market data on Wednesday and retail sales on Thursday. The most informative of the three is likely to be the labor market release, which will provide fresh evidence of the momentum in labor demand and pay. In the Eurozone, we get the second release of GDP, with more color on activity at the national level, the final release of October inflation data, which will clarify the precise source of the weakness in core inflation, and industrial production data for September.

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