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Via The Daily Bell

Do we owe society taxes?

Tax day is tomorrow. Some people get excited because they will get money back which the government withheld–a clever trick that makes people feel less oppressed and plundered by filing taxes.

Something the regressive left likes to say is that taxes are justified because of the infrastructure of society, provided by the government, makes all earning possible. It is, therefore, only fair to share some of that wealth to continue funding the common property. They say the rich would never have gotten rich without government provided services, and that is why they owe the government.

An up and comer on the left who we will unfortunately not stop hearing from anytime soon has weighed in on why we owe taxes to society. This is an old but relevant quote since progressive champion Elizabeth Warren will probably be a White House contender soon enough. While running for Senate she said:

There is nobody in this country who got rich on his own. Nobody! You built a factory out there, good for you, but I want to be clear, you moved your goods to market on the roads the rest of us paid for. You hired workers the rest of us paid to educate. You were safe in your factory because of police forces and fire forces the rest of us paid for. You didn’t have to worry that mauraduing bands would come and seize everything at your factory, and hire someone to protect against this, because of the work the rest of us did… But part of the underlying social contract is that you take a hunk of that, and pay forward for the next kid that comes along.

I think she slipped up there. Do you see it? Warren says that if the government didn’t provide security for the factory, the business owners would have to “hire someone to protect against” marauding bands. And she is correct in that.

What she leaves out is that their money is already stolen to pay for the police. So why on earth would they say no thanks to a service for which they were forced to pay? (Well, I guess because the police do a terrible job. Most factories do in fact hire their own security in addition to the police that “the rest of us” paid for.)

And this is the whole issue: Which came first, the government or wealth?

Clearly, a business first has to have money in order to be taxed. And it makes sense to think that since the infrastructure already exists, it helps people to earn money. And it does, but it was all paid for first by privately produced wealth.

Think about it, the very first tax payers were farmers that were conquered by herders and forced to pay a share of their yield to the nomadic invaders. The herders realized they could make this a regular thing if they didn’t murder all the farmers, and thus government was born.

Not murdering the people was the first service which government ever provided. Boy, are we lucky to have them!

Ironic that Warren says taxes are paid to basically prevent from happening the very thing which began the existence of government. It was extortion from the very beginning. The farmers paid protection money to their government.

Who was the main threat? The government. The mafia does the same thing.

But looking at the first taxpayers shows that they necessarily had to have earned something and created wealth before they were taxed on it.

And this means we are building on a stolen foundation. It means we didn’t need the government to make wealth creation possible in the very first place. Based on the very function of government, which only came into existence after the first farmers had created wealth, this proves that it is possible to create wealth without that magnificent infrastructure for which “the rest of us” paid.

Warren said it herself when she admitted the factories could simply purchase their own protection. But what they are really paying for, is protection from the people they are paying, the government.

So is taxation the price we pay for the society government has built around us? Without a doubt, certain things taxes pay for are used by everyone living in society and thus contribute to business, like roads for shipping.

And even though the government is used to providing these things, the question remains are taxes what we owe to society for the opportunity to do business? Or did wealth have to be created first before taxes could be paid?

Justifying the Upward Redistribution of Wealth

Everything government does is done with tax dollars, therefore first something of value had to be created before they could tax anything.

So then why do people argue that we owe the government taxes because they have made everything we earn possible?

We wanted to add a Bernie Sanders quote since he was vocally against the wealthy. He is one of the most powerful U.S. Senators at this point, with his unspent war chest of individual campaign donations, and an army of useful idiots.

But it turns out the man said remarkably little for how much he talked. It was all catch phrases and the same repeated lines about how immoral it is to be wealthy. The rich need to pay their “fair share” he says, but that doesn’t actually answer the question of why anybody should have to pay taxes. We all need to be robbed equally?

There are certain ways to become wealthy which are immoral, such as securing government contracts, government bailouts, government grants, government loans, and government subsidies. But Bernie’s support for higher taxes would only exacerbate that upward transfer of wealth.

Sanders actually never tried to justify why the rich owe taxes, his only criticism seemed to be that they were wealthy. He repeated over and over that they basically stole this wealth from the middle class, but offered no real examples other than the Wall Street bailouts (which yes, were theft on their part, but again that was a government transfer of wealth, which giving the government more power would only increase).

Turns out what Bernie was doing has been done since the beginning of government. Jared Diamond explains the origins of Chiefdoms in his book Guns, Germs, and Steel:

These noble and selfish functions are inextricably linked, although some governments emphasize much more of one function than of the other. The difference between a kleptocrat and a wise statesman, between a robber baron and public benefactor, is merely one of degree: a matter of just how large a percentage of the tribute extracted from producers is retained by the elite, and how much the commoners like the public uses to which the redistributed tribute is put…

Make the masses happy by redistributing much of the tribute received, in popular ways. This principle was as valid for Hawaiian chiefs as it is for American politicians today.

Clearly, Bernie is a big fan of the redistribution method; his free college proposals sound pretty good to his young target demographic.

So basically, these “progressive” stars are actually regressing to the oldest forms of government which always looted and tricked the masses into supporting their power grabs and wealth confiscation.

The government didn’t create the wealth in society, and they didn’t even make that wealth creation possible. They simply stole the wealth that others created and redistributed it in obvious and popular ways. They monopolized mechanisms like roads and security in order to make it seem like the government is the only method of laying the infrastructure to create wealth.

But clearly wealth came before taxation, otherwise, there would have been nothing to tax! The premise of their justification for theft is a fallacy.

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Following US Vice President Pence’s earlier remarks that “the era of strategic patience is over.”

.@VP Mike Pence on North Korea: “The era of strategic patience is over.” https://t.co/78WhdfZWfb http://pic.twitter.com/I3JnAal71I

— Fox News (@FoxNews) April 17, 2017

Ambassador Kim, North Korea’s Permanent UN Representative, hosted a news conference in Ryong on “the consideration of non-proliferation in the DPRK to be held in the Security Council on April 28.”

He did not pull any punches…

• *U.S. PUSHED KOREAN PENINSULA TO ‘BRINK OF WAR’: ENVOY KIM
• *ENVOY KIM SAYS U.S. `USURPED’ UN DISCUSSION ON N. KOREA
• *KIM OBJECTS TO SESSION NEXT WEEK LED BY TILLERSON
• *N. KOREA UN ENVOY KIM WARNS OF RISK OF NUCLEAR WAR

“It has been created dangerous situation in which the thermonuclear war may break out at any moment on the peninsula and pose a serious threat to the world’s peace and security, to say nothing of those of northeast Asia.”

And concluded by warning that North Korea will take toughest counter actions; “We will hold the US accountable”

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According to a report by South Korea’s primary news outlet, Yonhap, the Pentagon has directed a total of three US aircraft carriers toward the Korean Peninsula, citing a South Korean government source.

Yonhap reports that in addition to the CVN-70 Carl Vinson, which is expected to arrive off the South Korean coast on April 25, the CVN-76 Ronald Reagan – currently in home port in Yokosuka, Japan – and the CVN-68 Nimitz carrier group – currently undergoing final pre-deployment assessment, Composite Training Unit Exercise off Oregon – will enter the Sea of Japan next week.  According to the senior government official. the US and South Korea are discussing joint drills, which will include the three aircraft carriers and other ships.

CVN-68 Nimitz carrier group

USS Carl Vinson, surrounded by a fleet of US warships, was sent by Washington toward the Korean Peninsula in the beginning of April.

While details are scarce, and we would urge confirmation from US-based sources, Yonhap also reports that according to the government source the operation of three aircraft carriers in the same location is unusual, and demonstrates the US commitment to North Korea.  Other sources said the Trump administration is demonstrating deterrence by acting on its behalf. “We expect it to be completely different from the previous administration.”

On Sunday, Pyongyang launched an unidentified projectile, but the test reportedly failed. South Korea’s Joint Chiefs of Staff (JCS) stated that the attempted launch was conducted from the area near North Korea’s eastern port city of Sinpo, but likely ended in a failure.

The most recent map showing key US naval deployments around the globe is shown below.

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During my testimony of March 28th before the U.S. House of Representatives Committee on Foreign Affairs, I stressed that, to establish stability and turn Venezuela’s economy around, runaway inflation must be stopped in its tracks. After all, stability might not be everything, but everything is nothing without stability.

To grasp the magnitude of Venezuela’s inflation problem, take a look at the chart below. It shows the annual inflation rates (yr/yr) for chicken. Venezuela’s current chicken-price inflation is running at a whopping 700% annual rate.

The New York Times editorial of March 30th, “Crisis Upon Crisis in Venezuela,” picked up on my “stop inflation first” elixir. As the Times put it: “the international community could propose specific macroeconomic reforms that could curb Venezuela’s runaway inflation and stabilize its currency.”

The Times failed to offer a specific inflation-killing strategy, however. There are only two sure-fire ways to kill Venezuela’s inflation and establish the stable conditions which are necessary to carry out much-needed economics reforms. One way would be to dump the bolivar and officially dollarize the economy, an option I covered in my March 30th Forbes piece, “On Venezuela’s Death Spiral.”

A second method would be to adopt a currency board system. In such a system, the bolivar would become a clone of a reliable anchor currency, such as the U.S. dollar.

Just what is a currency board? An orthodox currency board issues notes and coins convertible on demand into a foreign anchor currency at a fixed rate of exchange. As reserves, it holds low-risk, interest-bearing bonds denominated in the anchor currency. The reserve levels (both floors and ceilings) are set by law and are equal to 100%, or slightly more, of its monetary liabilities. A currency board generates profits from the difference between the interest it earns on its reserve assets and the expense of maintaining its liabilities.

A currency board’s operations are passive and automatic. The sole function of a currency board is to exchange the domestic currency it issues for an anchor currency at a fixed rate. In consequence, the quantity of domestic currency in circulation is determined solely by market forces, namely the demand for domestic currency. 

A currency board cannot issue credit. It cannot act as a lender of last resort or extend credit to the banking system. It also cannot make loans to the fiscal authorities and state-owned enterprises. In consequence, a currency board imposes a hard budget constraint and discipline on the economy.

A currency board requires no preconditions for monetary reform and can be installed rapidly. Government finances, state-owned enterprises, and trade need not be already reformed for a currency board to begin to issue currency.

Countries that have employed currency boards have maintained currency convertibility and delivered lower inflation rates, smaller fiscal deficits, lower debt levels relative to GDP, fewer banking crises, and higher real growth rates than comparable countries that have employed central banks.

It is important to mention that the currency board idea became engulfed in controversy – thanks to Argentina. What Argentina termed “Convertibility” was introduced in April 1991 to stop inflation, which it did. The system had certain features of a currency board: a fixed exchange rate, full convertibility, and a minimum reserve cover for the peso of 100% of its anchor currency, the U.S. dollar. However, it had two major features which disqualified it from being an orthodox currency board. It had no ceiling on the amount of foreign assets held at the central bank relative to the central bank’s monetary liabilities. So, the central bank could engage in sterilization and neutralization activities, which it did. In addition, it could hold and alter the level of domestic assets on its balance sheet. So, Argentina’s monetary authority could engage in discretionary monetary policy, and it did so aggressively. 

Because of these flaws, I penned an article which appeared in the October 25, 1991 edition of the Wall Street Journal. I concluded that, unless Argentina embraced orthodoxy and amended the Convertibility Law, the system would eventually collapse, which it did in 2002.

The collapse of Convertibility spawned a cottage industry of currency board critiques. But, since Argentina’s Convertibility System allowed for both monetary and exchange rate policies, it was not a currency board – something most economists failed to recognize. Indeed, a scholarly survey of almost 100 leading economists who commented on the Convertibility System found that almost 97% incorrectly identified it as a currency board system. So, those that used the collapse of Argentina’s Convertibility System to argue against currency boards literally didn’t know what they are talking about.

Just what can the international community do to shine a light on the currency board solution for Venezuela’s runaway inflation? For me, the answer harks back to 1992. That’s when I worked with the then-leader of the U.S. Senate, Bob Dole, and Senators Steve Symms and Phil Gramm, to draft U.S. legislation that would encourage countries with unstable currencies and runaway inflation to install currency boards. This legislation, (HR-5368, Law no. 102-391), was signed into law on October 6, 1992.

This piece was originally published on Forbes.

via http://ift.tt/2nViabc Steve H. Hanke

While trade barriers, immigration control, and exit fees are top-of-mind for many as the Article 50 negotiations begin, it seems British Home Secretary Amber Rudd has other priorities. As The Sun reports, Rudd is looking at introducing new ‘barista visas’ to ensure coffee shops and pubs are still fully staffed after Brexit.

Under the plan, young European citizens will still be able to come to the UK and work in the hospitality industry when we leave the EU. But their time here will be strictly limited to two years and they won’t be able to claim benefits or free housing. The proposal has been suggested by Migration Watch UK chairman Lord Green and was dubbed “a good idea” by a senior Home Office source. It is based on the current Youth Mobility Scheme for travellers from Australia, New Zealand and Canada.

Explaining his plan, Lord Green told The Sun:

“We can kill two birds with one stone here… We can meet the needs of pubs and restaurants and maintain our links with young Europeans by allowing them to come for a strictly limited period of two years to work.”

The crossbench peer and former Foreign Office ambassador added:

“They could work at any level but would not become long term immigrants who would add to the pressure on public services… Nor should they qualify for benefits or housing.”

Raising pay to coax more Brits into the trades or improving production methods should be considered first before exceptions are granted to keep their access to migrants, but Lord Green added: “It is quite possible that an unlimited supply of cheap labour has been a disincentive to investment in machinery”.

So as long as the cheap labor can flow, everything will be fine… where have we seen that before? Or perhaps this is next?

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Authored by Valentin Schmid via The Epoch Times,

Economic theory is like a layer cake: Explanations within one layer make sense, but once you move to another layer, they no longer apply. Economist Steve Keen‘s new book “Can We Avoid Another Financial Crisis?” is an illustrative example. 

The good news is that Keen accurately describes the current economic system; the bad news is that the answer to the question in the title is “no.” (And, despite what I believe is his accurate overall assessment, he misses, or skips over, a few key, hidden elements of economic theory.)

Keen defines his question within the layer of a corrupt banking system, the system we have now. He explains how it is that banks create money in the form of debt, and how this leads to financial instability. In the book he quotes the Bank of England’s own economists:

“In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.”

Keen builds on the work of Hyman Minsky and Joseph Schumpeter to explain why it is that private debt created out of nothing by private banks leads to economic instability.

“Desired investment in excess of retained earnings is financed by debt. This leads to a cyclical process in capitalism which also causes a secular tendency to accumulate too much private debt over a number of cycles,” writes Keen.

The boom-bust cycle is as follows: During the early stages of a debt cycle, debt drives investment, which increases demand. The growing economy can easily service the debt, and most loans are repaid. The longer this benign growth phase lasts, the more banks are incentivized to throw caution to the wind and loan more; asset values backing the loans are also rising in value at this point, which encourages recklessness.

At some point, debt levels become so high that the weaker economic players cannot maintain their interest payments, setting off a wave of defaults which leads the the money supply to contract, and leads to losses at banks. Banks then reduce their lending, further shrinking the money supply (where money is debt) even further, slowing economic activity. At this point, even strong players are in trouble and are forced to liquidate assets. The vicious cycle simply continues.

“The slump turns euphoric expectations into depressed ones and reverses the interest rate, asset price, and income distribution dynamics that the boom set in train. Aggregate demand falls, leading to falling employment and declining wage and materials costs,” writes Keen.

People who have witnessed the subprime boom and bust would mostly agree with this assessment. So why haven’t mainstream economists figured it out?

Mainstream Economics Ignores Debt

In his first major book “Debunking Economics,” Keen promised there was going to be “no more Mr. Nice Guy” toward mainstream economists who completely ignore private debt in their models, forecasts, and policy recommendations.

Keen continues with the same tenor in his current book and dishes out criticism of the profession where it is due, explaining why the mainstream keeps getting it wrong.

“Minsky’s theory is compelling, but it was ignored by the economics mainstream when he first developed it because he refused to make the assumptions that they then insisted were required to develop ‘good’ economic theory,” writes Keen.

Keen, who is extremely well-read in all fields of economics, uses source material from his ideological opponents to debunk their own logic. Here, he quotes former Federal Reserve (Fed) Chairman Benjamin Bernanke:

“Hyman Minsky (1977) and Charles Kindleberger (1978) have in several places argued for the inherent instability of the financial system but in doing so have had to depart from the assumption of rational economic behavior. [A footnote adds] ‘I do not deny the possible importance of irrationality in economic life; however it seems that the best research strategy is to push the rationality postulate as far as it will go.’ (Bernanke, 2000, p. 43)”

Too many illogical and irrational assumptions are the reasons why mainstream economics is suffering from a crisis of confidence.

Technically inclined readers can delve into Keen’s explanation as to why the mainstream extrapolation of macroeconomics from microeconomics is wrong, why the macroeconomy should be modeled after a dynamic system, why a corrupt banking system creates inequality, and why private debt cycles always look best just before the storm hits.

The lay reader can skip all that and go straight to Keen’s explanation of the private debt busts of 1990 Japan and 2008 subprime crisis.

The book is essentially an extended academic monograph, bristling with references to arcane papers, footnotes, and nerdy graphs. It stands as a reliable and fairly straightforward explanation for an educated reader as to what drives economic booms in a corrupt banking system (namely, one based on private debt) and why it is responsible for all manner of pernicious consequences, like busts and income inequality.

Can We Avoid Another Financial Crisis?

Keen answers the $1 trillion dollar question with a resounding “no.” This is because too many countries rode a wave of private debt explosion during the last boom, and are now in the equivalent of economic purgatory. Keen identifies China as the biggest threat.

“They face the junkie’s dilemma, a choice between going ‘Cold Turkey’ now, or continue to shoot up (on credit) and experience a bigger bust later. China is undoubtedly the biggest country facing the debt junkie’s dilemma now. But it doesn’t lack for company,” he writes.

Other countries with a high level of private debt and a reliance on debt to fuel economic demand—Keen calls them “debt zombies”—are Australia, Belgium, Canada, South Korea, Norway, and Sweden.

In total, the influence of China and these smaller economies is simply too great for the world to avoid a financial crisis.

Solutions

According to Keen, the solution within this layer of economic theory is more government regulation of the banking system and government deficits to counter a fall in private demand — which is essentially the policy response to the 2008 financial crisis.

More aggressive options are quantitative easing in the form of “helicopter money,” where the central bank monetizes government debt, and the government then writes a check to households to either pay down debt or spend it in case there isn’t any debt to pay down. There could also be a more official debt jubilee where debt is simply forgiven.

“On its own, a Modern Debt Jubilee would not be enough: all it would do is reset the clock to allow another speculative debt bubble to take off. Currently, private money creation is ‘a by?product of the activities of a casino’ (Keynes, 1936, p. 159), rather than what it primarily should be: the consequence of the funding of corporate investment and entrepreneurial activity,” writes Keen.

The ultimate objective would be for the government to counter excessive private debt bonanzas.

Being an agnostic thinker, Keen also entertains concepts of government issued money and cryptocurrencies, although he doesn’t think they can eventually replace the banking system, partly because of scale, partly because of political resistance.

“As long as that model holds sway over politicians and the general public, sensible reforms will face an uphill battle—even without the resistance of the finance sector to the proposals, which of course will be enormous.”

And within this layer of the economic layer cake, within the constraints of our current political economy, Keen is again absolutely right.

The Hidden Layer

At another layer of economic theory, however, Keen and Minsky are incorrect to argue that capitalism itself causes booms and busts and that more government is the ultimate solution for all economic layers, especially the financial one.  

In a free market for money, banks that give out too much debt with low-quality collateral would have their liabilities devalued in the market, and depositors would take their business elsewhere. This competitive process would drain the offending banks of reserves and eventually lead to bankruptcy—without a bailout—unless they improved their lending processes. 

It is only when governments impose legal tender laws or accept private bank liabilities at face value in the payment of taxes that such over-issued and poorly backed liabilities retain their value, leading to the boom and bust cycle. It is also the government which bails out offending banks time and again to save the corrupt system, leading to the moral hazard Mr. Keen describes.   

Most modern economists, including Keen in this book, ignore this fundamental state interference in the market and then conclude that more government is needed to solve the very problems that government intervention created in the first place.

To Keen’s credit, he has researched historical instances of free market banking and concludes that the history does not confirm the Austrian theory of reflux. Thus, he stands on one side of a hotly contested academic debate, while scholars of the Austrian school of economics stand on the other.

Today, however, we have only this bastardized version of capitalism, where governments and banks collude to create the instability Mr. Keen deals with in this book. It is this layer of the system that Mr. Keen describes for the educated reader: Accurately, convincingly, and with a touch of mordant humor.

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Despite the recent modest profit-taking in the S&P 500, the market – just shy of its all time high 2,400 level – remains in nosebleed valuation territory.

As Bank of America calculates, in March the S&P 500 forward P/E was little-changed amid a flat month for stocks, and at 17.5x continues to trade at its highest levels since 2002 (on a trailing basis P/E is at 19.6 and 29.0 based on the Shiller PE). This is almost one turn higher since we last performed a similar valuation exercise back in December.

Hardly a bargain, stocks remain stretched vs. history on the majority of metrics Bank of America tracks (Table 2) and as Savita Subramanian points out, the only way stocks still look cheap is relative to bonds. While BofA is quick to warn that today’s elevated valuations suggest longer-term caution on stocks, it reminds clients that “valuations typically matter little in the final stage of a bull market during which sentiment and positioning are the key drivers of returns.” This is also known as the so-called “just buy everything” cop out.

Stripping away BofA’s subjective commentary, to allow readers to decide for themselves whether stocks are massively overvalued and overbought, or perhaps cheap, here is a breakdown of the S&P 500 across a wide variety of valuation measures — 20 in total — to gauge whether US stocks look cheap vs. history.  What the analysis shows is that of 20 metrics, the S&P is overvalued based on 18 by as much as 85% (on a historical market cap to GDP basis) and up to 105% if looking at the S&P in WTI terms, and is cheap only according Price to Free Cash Flow (25.1x vs 28.4x) which however is a function of ultra low interest rates, and also based on a ratio of the S&P-to-Russell 2000 fwd PE multiples. A third metric which last December suggested stocks were “cheap“, namely trailing normalized PE (19.6x vs 19.0x average) flipped to “rich” in the past 5 months. 

And while the broader market may be the most overpriced in 15 years, some bargains can still be found. A detailed breakdown shows that multiples were little-changed across most sectors last month, with the biggest relative multiple contraction in Financials (-3%) and the biggest relative multiple expansion in Discretionary (+3%)—but both sectors trade roughly in-line with history on relative P/E. Several sectors do offer sizeable upside or downside opportunities if multiples mean-revert to their long-term  averages. For those seeking potential longs, BofA finds that the biggest mean-reversion opportunities are the defensive and bond-proxy sectors and Tech. Despite seeing its P/E creep up to its highest levels since 2010, Tech still trades at more than a 10% discount to history (even ex. the Tech Bubble). For those seeking to pair a long with a short sector (as nobody apparently trades single-names any more and everything is done by ETF), see Table 1 below.

What is expensive: according to the three chosen valuation metrics, Consumer Discretionary, Energy, Materials and IT are the most overvalued, in some cases by as much as 33%.

So what does this mean for BofA’s market recommendations? For the answer we bring readers back to Savita Subramanian’s March 1 note in which the analyst, already brimming with optimism from her Barron’s round table discussion in December, raised her S&P price target from 2,300 to 2,450, although with many caveats.

Here is what she said 6 weeks ago; she has yet to change her thesis, perhaps because as she admits, “valuations typically matter little in the final stage of a bull market during which sentiment and positioning are the key drivers of returns.”

Raising 2017 S&P 500 year-end target to 2450

 

We are raising our 2017 year-end S&P 500 target to 2450 (from 2300), driven by two changes: (1) we lower our end-of-year equity risk premium (ERP) assumption to 400bp (from 450bp), and (2) within our five-factor framework, we adjust our fair value model weight lower in favor of our sentiment model. These changes reflect an increasing likelihood that we are entering the typical later stages of a bull market, during which fundamentals typically take a back seat to sentiment and technicals. We think the market still has the potential to move higher as investors capitulate into equities; note that the “Great Rotation” out of fixed income into equities has yet to happen. But as we noted in our Year Ahead, we see a wide range for 2017, and investors are likely better served focusing on the internals of the market rather than on a year-end number. And for longer-term investors, elevated valuations and high leverage today shift the risk-reward balance for the market to more risks than were evident a few years ago.

 

 

The stock market has always seen outsized returns leading up to its eventual crash, and we think this time will be no exception. In addition to lowering our end-ofyear equity risk premium (ERP) assumption to 400bp (from 450bp), we are adjusting our fair value model weight lower in favor of our key sentiment model. As a result, we are raising our 2017 year-end S&P 500 target to 2450 (from 2300), which implies a better than 75% probability weighting of our 2700 bull case scenario and less than a 25% probability weighting of our 1600 bear case scenario.

 

We expect the market to overshoot its fair value

 

Typically, in the later stages of a bull market, corporate earnings are cyclically elevated and the multiple that the market assigns to those earnings is often elevated as well. As a result, market prices can become significantly overvalued relative to their intrinsic fair value, and this divergence can last for years. Thus, we would highlight the distinction between our year-end target of 2450 (driven largely by sentiment and technicals) and our estimated intrinsic fair value of 2230. For investors with long time horizons, our long-term (year 2025) target of 3500, which is based solely on valuation, indicates a solid but below-average annual price return of 4-5% (or total return of 6-7%).

But…

Watch out for volatility when the “Trump put” expires

 

We would expect the rally in lower quality stocks to fade as we get more clarity / details of potential stimulus and tax reform, where expectations today are quite optimistic relative to the likelihood of delays, friction and more negative offsets than the market is currently pricing in. Meanwhile, economic surprises are close to a five-year high and we expect S&P 500 earnings growth to decelerate in the second quarter. While we see further room for market sentiment to improve, the market may take some time to digest the recent surge in optimism before heading higher. So while we expect stocks to end the year higher than where they are today, the road could get bumpy as we head into spring and summer months. As such, we see an elevated probability that the market falls below our 2230 fair value estimate before the end of the year.

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