iftttwall

We noted yesterday that the recent trend of increased volumes into Eurodollar future out-months was 'odd'…

But the sudden surge in interest in Eurodollar calls (vs puts) suggests more than just a few prop bets are being placed on the fact that The Fed does not hike rates in June.

As Bloomberg notes, preliminary futures open interest data for Wednesday shows steep increases in several Jun17 eurodollar call strikes, consistent with view that Fed won't hike in June amid tightening FRA/OIS spread. However, these options bets have largely gone unnoticed as futures-market-implied odds (which the majority of investors are shown) of a June hike have been steady at around 80% for a week.

A second consecutive drop in 3-month dollar Libor setting Wednesday prompted a flurry of dovish Fed bets and waves of buying across Jun17 eurodollar futures.

And furthermore, the Fed Fund Futures curve has flattened dramatically – signalling lost faith in The Fed's hiking trajectory…

And while these bets are being placed – against a June rate hike, the LIBOR-OIS spread – traditionally a signal of bank credit risk, has collapsed back to historic norms.

 

One probable explanation for this is the gusher of bank funding availability that the world's central banks (and even more so China) has unleashed. Nowhere is that more evident than in the total decoupling between "easing" financial conditions, and "tightening" monetary policy…

Despite two rate hikes, Goldman's financial conditions index has improived to its 'easiest' in 8 months – thanks to the world's policy-makers fungible money spigot to keep the dream of reflation alive (as evidenced in the chart above by the S&P 500).

This means, according to Bloomberg's Mark Cudmore, that The Fed’s room to tighten is being underappreciated.

The market adjustment, when it comes, will be felt more in the front end than the long end of the U.S. rates curve.

 

Rates markets are only pricing one-and-a-half more hikes in 2017. That seems reasonable in the blinkered context that inflation shows little sign of accelerating out of control. However, monetary policy analysis needs to be updated.

 

Amid an excess of global liquidity, inflation is being dominated by macro factors. Commodity prices and technological innovations, rather than marginal short-term interest rate adjustments, are top-most in people’s minds.

 

The last two Fed rate hikes had no sustained tightening impact. In fact, financial conditions in the U.S. are the loosest they have been in almost three years, and approaching the extreme of the historical range going back 27 years.

 

 

This suggests that the Fed has plenty of room to tighten policy. Why wouldn’t they take steps to normalize while they can get away with it?

 

Ignoring the fact that this yet again argues for a rethink of inflation targeting and using short-term interest rates as the primary policy tool, it’s important investors don’t misinterpret the rationale and implications of any tightening.

 

The next Fed moves won’t be driven by accelerating growth or runaway inflation, so the yield curve shouldn’t steepen. But a subsequently flatter yield curve shouldn’t be read as signifying a policy misstep.

 

This is just the way of the future. There is extremely abundant liquidity globally due to the expansion of central bank balance sheets. While that’s the case, old economic analysis frameworks are outdated and inadequate.

Which confirms what Morgan Stanley wrote,

Along with record high stocks, credit spreads at the tights since 2014, the broad dollar index continuing to hold little changed about 3% below the high hit in December, and longer-end yields remaining slightly lower year to date, historically low volatility across asset classes adds to a picture of very easy broad financial conditions. So does all the money in the short end helping keep CP yields and LIBOR lower as fed funds rate expectations have been moving up.

 

So the capitulation in pricing of a future reversal in the persistent LIBOR-OIS tightening trend in the past few months accelerated and had a large impact on swap spreads on top of more swapped issuance of corporate bonds by banks. The spot LIBOR-OIS spread fell another 0 7 by to 14 bp, another low since before the first Fed rate hike in 2015 after a 20 by drop in the past two months. That's not far now from the 9bp average from 2004 through the first half of 2007 (before getting as high as 364bp on October 10. 2008. maybe the single most extreme financial market price of the whole crisis). The forward LIBOR-OIS spread to June fell to 14.8bp. down from 15.8bp Tuesday and 19.4bp Friday mostly giving up on any near-term widening. The LIBOR part of that was reflected in the Jun 17 eurodollar futures contract rallying 2bp to 1.265%, down from 1.305% Friday, even as Jul 17 fed funds futures held steady at 1.11%. pricing an 83% chance of a June rate hike, up from 1.095% Friday. Never mind seeing a transmission from the fed funds rate to broad financial conditions in impacts on stocks, long-end yields, the dollar. et al., if higher fed funds rate expectations struggle to even get traction in raising short-term market interest rates.

Which translated into english implies The Fed has lost control of the transmission mechanism of its operations, just as we noted Goldman concerned about, which brings up another question:

If the Fed retains its ability to steer financial conditions, why have financial conditions eased recently despite ongoing hikes? The answer is that Fed policy—especially Fed policy communicated around FOMC meetings—only accounts for a relatively small part of the ups and downs of financial conditions. And other developments such as the sharp pickup in global growth have been helpful for US financial conditions by boosting risk assets while keeping the US dollar from appreciating sharply in response to higher short-term interest rates. While it is difficult to say whether future non-monetary policy shocks will be positive or negative for US financial conditions, our finding that the impact of Fed policy on financial conditions remains (at least) similar to the longer-term average suggests that Fed officials should be able to achieve their goals for financial conditions by moving the funds rate if they try hard enough.

 

Fed Policy Retains Sizable Impact

What Goldman really meant to say is that the Fed's 50 bps in rate hikes since December have been drowned and offset by the trillions in new credit created out of China. That credit expansion is now ending however, and China's credit impulse has tumbled into negative territory (but that's a different topic).

Going back to Goldman, Hatzius adds that "we find that the sensitivity of financial conditions to monetary policy shocks has been quite high recently, at least when we identify these shocks using bond market moves around FOMC meetings. This suggests that the easing of financial conditions is due to other factors, most obviously the improved global environment, not reduced traction of monetary policy."

What form will this monetary tightening "shock" take place? "

Our best (though uncertain) answer is that the committee will need to deliver 50-75bp more hikes per year than priced in the forwards to stabilize the economy at full employment. This is roughly consistent with our current funds rate call that we will see an average of 3-4 hikes per year through the end of 2019, compared with market pricing of just over 1 hike."

Of course, if Goldman is wrong and the Fed has no intention of sending risk assets into a tailspin with a monetary policy "shock", then there is no saying just how much further the combined effort of China's gargantuan, if cooling, credit expansion, coupled with the "dovishly" hiking Fed can take stocks. However, by now it is becoming clear to even the most resentful permabulls – and even Goldman  – that the longer the Fed delays the day of reckoning out of pure fear of the unknown, the greater the chaos and loss in asset values when the Fed no longer has the luxury of picking when to pull the switch.

via http://ift.tt/2pCNIzi Tyler Durden

Background.

The Sun claims that CNN has released new footage of last month’s Syrian chemical incident … and strongly implies that the Syrian government was responsible.

Washington’s Blog asked MIT rocket scientist and chemical weapons expert Theodore Postol^* what he thought of the footage.

Postol replied:

I agree that the footage is harrowing. However none of it is new and none of it proves that the Syrian government was the perpetrator of a nerve agent attack.

 

As such, this article merely falls into the category of propaganda.

 

The kindest alternative description of the article is that it might instead be yet another example of bad reporting that mixes ill-considered assumptions with facts that may or may not be relevant to its conclusions.

 

This kind of reporting could actually be encouraging such attacks.

 

If there was a false flag nerve agent attack, this tells the perpetrators that when they engage in the murder of children they can build a stronger false case against the Syrian government and thereby increase their chances of creating political pressure on the US Government to intervene militarily on their behalf.

 

If people are sickened by the inhumanity of these events, they might want to consider alternative explanations of who might be responsible for the immoralities we are seeing.

* Postol is  professor emeritus of science, technology, and national security policy at MIT.  Postol’s main expertise is in ballistic missiles. He has a substantial background in air dispersal, including how toxic plumes move in the air. Postol has taught courses on weapons of mass destruction – including chemical and biological threats – at MIT.  Before joining MIT, Postol worked as an analyst at the Office of Technology Assessment, as a science and policy adviser to the chief of naval operations, and as a researcher at Argonne National Laboratory.  He also helped build a program at Stanford University to train mid-career scientists to study weapons technology in relation to defense and arms control policy. Postol is a highly-decorated scientist, receiving the Leo Szilard Prize from the American Physical Society, the Hilliard Roderick Prize from the American Association for the Advancement of Science, and the Richard L. Garwin Award from the Federation of American Scientists.

via http://ift.tt/2qXYF2n George Washington

President Trump sat down with The Economist last week to talk trade, immigration, taxes, and health care and the transcript is chock-full of ‘Trumpisms’ that should not go unnoticed.  Here are just a few of our favorite exchanges:

On NAFTA, apparently ‘big’ is not an appropriate adjective to describe the renegotiation that will take place…‘massive’ and/or ‘huge’ are far better descriptors:

It sounds like you’re imagining a pretty big renegotiation of NAFTA. What would a fair NAFTA look like?

Big isn’t a good enough word. Massive.

 

Huge?

It’s got to be. It’s got to be.

 

What would it look like? What would a fair NAFTA look like?

No, it’s gotta be. Otherwise we’re terminating NAFTA.

 

Some people think this is a negotiating tactic—that you say very dramatic things but actually you would settle for some very small changes. Is that right?

 No, it’s not, really not a negotiation. It’s really not. No, will I settle for less than I go in with? Yes, I mean who wouldn’t? Nobody, you know, I always use the word flexibility, I have flexibility. [Goes off the record.] [Our] relationship with China is long. Of course by China standards, it’s very short [laughter], you know when I’m with [Xi Jinping], because he’s great, when I’m with him, he’s a great guy. He was telling me, you know they go back 8,000 years, we have 1776 is like modern history. They consider 1776 like yesterday and they, you know, go back a long time. They talk about the different wars, it was very interesting. We got along great. So I told them, I said, “We have a problem and we’re going to solve that problem.” But he wants to help us solve that problem.

On the discussion of the new tax plan we discover that Trump coined the phrase “priming the pump.”

Another part of your overall plan, the tax reform plan. Is it OK if that tax plan increases the deficit? Ronald Reagan’s tax reform didn’t.

 Well, it actually did. But, but it’s called priming the pump. You know, if you don’t do that, you’re never going to bring your taxes down. Now, if we get the health-care [bill through Congress], this is why, you know a lot of people said, “Why isn’t he going with taxes first, that’s his wheelhouse?” Well, hey look, I convinced many people over the last two weeks, believe me, many Congressmen, to go with it. And they’re great people, but one of the great things about getting health care is that we will be saving, I mean anywhere from $400bn to $900bn.

 

But beyond that it’s OK if the tax plan increases the deficit?

 It is OK, because it won’t increase it for long. You may have two years where you’ll…you understand the expression “prime the pump”?

 

Yes.

 We have to prime the pump.

 

Priming the pump?

 Yeah, have you heard it?

 

Yes.

 Have you heard that expression used before? Because I haven’t heard it. I mean, I just…I came up with it a couple of days ago and I thought it was good. It’s what you have to do.

 

It’s…

Yeah, what you have to do is you have to put something in before you can get something out.

Meanwhile, CNN will be even more eager to track down Trump’s taxes after he seemingly admitted to taking deductions for “birds flying across America.”

But the biggest winners from this tax cut, right now, look as though they will be the very wealthiest Americans.

Well, I don’t believe that. Because they’re losing all of their deductions, I can tell you.

 

But something like eliminating the estate tax.

I get more deductions, I mean I can tell you this, I get more deductions, they have deductions for birds flying across America, they have deductions for everything. There are more deductions…now you’re going to get an interest deduction, and a charitable deduction. But we’re not going to have all this nonsense that they have right now that complicates things and makes it…you know when we put out that one page, I said, we should really put out a, you know, a big thing, and then I looked at the one page, honestly it’s pretty well covered. Hard to believe.

On the merits of a VAT Tax:

Would you consider a VAT for the United States?

Well the concept of VAT I really like. But let me give you the bad news. I don’t think it can be sold in this country because we’re used to an income tax, we’re used to a…people are used to this tax, whether they like it or don’t like, they’re used to this tax. I fully understand because I have a lot of property in the UK. And it’s, sort of, not a bad tax. And every time I pay it, they end up sending it back to me. In fact, my accountant is always saying…

 

That’s a good tax.

 No, it’s really not so bad. Like, I own Turnberry in Scotland. And every time I pay they say, “Yes sir, you pay it now but you get it back next year.” I said, “What kind of tax is this, I like this tax.” But the VAT is…I like it, I like it a lot, in a lot of ways. I don’t mean because of, you know, getting it back, you don’t get all of it back, but you get a lot of it back. But I like a VAT. I don’t think it can be sold in this country, I think it’s too much of a shock to this system. I can tell you if we had a VAT it would make dealing with Mexico very much easier. Because it could neutralise. And I really mean that. Part of the problem with NAFTA, the day they signed it, it was a defective deal. Because Mexico has almost a 17% VAT tax and it’s very much of a hidden tax, people don’t see it. So, but these guys, instead of renegotiating the following week…many years ago, how old is that? 35?

On Healthcare, we’ll never know what brand/model of car was used to describe cheap inurance plans but we did learn that Trump is friends with key executives at the major insurers…“you know, the head people.”

One of the things that was so different about your campaign message compared to other Republicans was, you said things like “I want everyone to be covered”.

We’re not going to let people die on the streets.

 

Look, Obamacare was a disaster. Under Obamacare, you get your doctor; that was a lie. You get your plan; that was a lie. With us, you get your doctor. You get your plan. With us you’ll get hundreds and hundreds of plans. You know, one of the insurance companies, one of the big ones came to see me yesterday. They’re so anxious to start going crazy and you know it’s going to be like life insurance. People that buy life insurance they’re inundated with carriers. All different plans. That’s what this is going to be like. And I said to them, “What do you think the good plans are going to look like?” He said, “Mr President, we’re going to have so many plans. We’re going to have the low version, the high version”, he used the word Cadillac. I won’t tell you what car he used for the low version because I don’t want you to write it because they happen to be friends of mine, you know, the head people. [Goes off the record.]

On Immigration:

Do you want to curb legal immigration?

Oh sure, you know, I want to stop illegal immigration.

 

And what about legal immigration? Do you want to cut the number of immigrants?

Oh legal, no, no, no. I want people to come into the country legally. No, legally? No. I want people to come in legally. But I want people to come in on merit. I want to go to a merit-based system. Actually two countries that have very strong systems are Australia and Canada. And I like those systems very much, they’re very strong, they’re very good, I like them very much. We’re going to a much more merit-based system. But I absolutely want talented people coming in, I want people that are going to love our country coming in, I want people that are going to contribute to our country coming in. We want a provision at the right time, we want people that are coming in and will commit to not getting…not receiving any form of subsidy to live in our country for at least a five-year period.

On releasing his tax returns, Trump says that he may release them after he’s out of office because he’s “very proud of them actually.  I did a good job.”

Mr President, can I just try you on a deal-making question? If you do need Democratic support for your tax plan, your ideal tax plan, and the price of that the Democrats say is for you to release your tax returns, would you do that?

 I don’t know. That’s a very interesting question. I doubt it. I doubt it. Because they’re not going to…nobody cares about my tax return except for the reporters. Oh, at some point I’ll release them. Maybe I’ll release them after I’m finished because I’m very proud of them actually. I did a good job.

via http://ift.tt/2q6WHvq Tyler Durden

One month ago, in his latest letter to clients, Horseman Capital’s Russell Clark revealed a new “investing” strategy using ETF flows as a catalyst for positioning and bets.

Citing the transition from active to passive as a catalyst that makes markets increasingly more inefficient, something One River’s Eric Peters noted in a recent weekly note, Clark repeated a lament made by many short sellers, stating that there “are complaints from some quarters about it being harder to short sell as flows of money push up stocks.”

So what is his new shorting philosophy? This is how he explained it, using his biggest short at the moment, retail REITs:

The biggest short sector in the fund are REITs. In the US, they are mainly retail REITs, and there are two reasons for this. One is that we have guaranteed sellers in the Japanese US Reit fund. The other reason is the appalling performance of the major tenants. However, as an aside, I like them as a short area as they have the highest exposure to ETFs of any sector.

 

Bloomberg allows you to find the biggest ETFs and open ended funds which are invested in US Real Estate Sector. The top 28 funds have total assets of 187bn USD, of which 13.3bn USD invested in Simon Property Group, that is 24% of Simon’s market cap. However, Real Estate passive funds are not the only passive fund invested in Simon. When all passive funds weights are added together I get over 50% of Simon Property Group shareholders are passive. I wonder who will become the buyer if all these funds start to see redemptions if there are some problems in US commercial real estate?

His conclusion:

The long bull market in passive investment has made them wilfully blind to the liquidity risk that they are running. Passive investments are concentrated in the US market…

And, if Eric Peters is right, “when these markets do finally have a correction there will be no bid for many of these stocks”, so all Clark has done is tighten the universe of ETF unwinds from the entire market to a market sector or subset of stocks, in this case the retail REIT space.

What was most interesting about the new Horseman approach, however, was that it combines fundamentals – in this case the declining purchasing power of the US consumer and the secular shift to online buying – with market inefficiency in the form of ETF flows that have pushed stock prices ever higher from their “fair value” in anticipation of an eventual sharp move lower as ETF inflows finally reverse. That said, it was not immediately clear what the catalyst for this reversal in ETF flows would be.

In any case, we said one month ago that one can repeat the exercise for all other sectors, and stocks, that have a substantial exposure to ETFs, and slowly but surely the shorts will start to accumulate, putting further pressure on sectors and stocks that have been abnormally influenced by passive flows, until finally the money flow support breaks, leading to a crack in the current market topology, potentially followed by the next market correction, or worse.

Now, courtesy of Goldman, we have the full breakdown of the most and least concentrated sector ETFs. As the chart below show, the five most concentrated ETFs currently, on both a relative in terms of current weighing of the Top 3 stocks, and absolute (in therms of overall weight of the top 3 names) basis, are the Consumer Discretionary (XLY), Info Tech (XLK), Financials (XLF), Energy (XLE) and Utilities (XLU), all of which have never seen a greater relative weighing of their top 3 companies. On the other end are the Healthcare (XLV) and Industrials (XLI) ETFs.

For those who think the logic behind the Horseman ETF (out)flow-based trading strategy works, the best trade would be to go short all the most heavily weighted ETF constituent stocks, while shorting the least concentrated ones, in creating a relatively low-risk pair-trade ahead of the next “August 2015” ETFlash Crash, which is absolutely assured to take place again, the only question is when, and who to keep the trade on with the lowest possible negative carry.

via http://ift.tt/2qw4MLp Tyler Durden

In the past week, Goldman’s warnings about an imminent market correction have been coming out on almost daily basis. Two days ago, Goldman’s cross-asset strategist Ian Wright warned that “The Last Time Correlations Were This Low Was Just Before The Financial Crisis“, followed overnight by a report by Goldman’s Jan Hatzius, in which the chief economist cautioned that due to the market complacency manifest in the easiest financial conditions in two years despite two rate hikes in recent months, the Fed will likely have to engage in “shock” monetary policy (if only to confirm that Janet Yellen has not lost control of the market).

Now, in yet another note from Goldman, the bank has released its “worst-case survival guide to uncertainty, taxes and trade”, from which we previously showed one chart demonstrating just how concentrated the S&P’s return is in 2017, but which is sufficiently informative to merit a full breakdown.

In the report, the Goldman strategist writes that plunging vol coupled with policy uncertainty are “cause for pause” and adds that “low volatility at this time presumes a pro-cyclical success story in DC”, which however is looking increasingly unlikely and is happening against a lack of clarity on direction of Trump’s future policy, especially after this week’s sacking of Comey which appears to have infuriated Democrats even more.

This, in turn, is creating headwinds for M&A, capex and lending. Furthermore, one of Goldman’s favorite straw man argument, the emergence of “animal spirits” has yet to translate into improved growth at home (witness Q1 GDP) while market breadth narrows, as we showed earlier with the chart demonstrating that only 10 stocks accounts for half of the S&P’s YTD gains.

Some of the material items Goldman is tracking at the moment:

• The clock is ticking on tax reform with the House in session for 39 days before the August recess.
• The 10 states hit hardest by a repeal of the State & Local Tax deduction have 46 Republicans in the House, one more than the GOP’s current majority.
• Corporate spending is showing signs of fatigue with M&A on pace to be down 25% YoY and bank loan growth slowing materially since the Election.
• With improving growth and potential reflationary policy we sit at a crossroads for duration assets, a potential taper tantrum overseas and commodities delinking from commodity equities

Below we lay out key excerpts from the presentation, including the key supporting charts.

2017: Modern Art for the Portfolio Manager

The flat S&P 500 index performance over the last 2+ months belies a large amount of sector rotation under the surface. We note:

1. The Odd Couples: Tech, Consumer Discretionary, Health Care and Utilities are currently leading the market. This is a strange mix as Tech and Consumer Discretionary have historically been negatively correlated with both Health Care and Utilities.
2. Commodity-driven weakness: Energy stands out given how much it has lagged over the last three months and more recently the spill-over into other commodity-driven sectors (Industrials and Materials) has become more evident.
3. The Great Unwind: Financials momentum has faded significantly. We note the sector has given back all its relative outperformance since the day after the US Election (~600 bp since the high-water mark on December 8, 2016).

A Worrisome Disconnect? Uncertainty but no Fear

The juxtaposition of rising policy uncertainty vis a vis declining fear in risk assets raises cause for pause in our view. With investors focused on the ‘Art of the Possible’ as it relates to Trump’s pro-cyclical agenda the market is giving a pass on the negative impact Policy Uncertainty has on corporate spending, M&A and by extension economic activity. Indeed with quarter-over-quarter annualized GDP growth of 0.7%, animal spirits failed to materialize into economic activity in Q1. With much of the optimism priced into the market today hinging on a more complete Washington agenda we note progress may be slow with the House in session for just 39 working days before the August recess.

Further elements of the upcoming tax plan raise questions specifically as it relates to the deduction of State and Local taxes where the top 10 states most impacted yields not a single Republican senator but 46 members of the House. We note that is one more than the GOP’s current majority. Below we frame the history of Policy Uncertainty, its relationship with corporate spending and provide a deep dive on the state of (the lack of) volatility. Lastly we map factor and sector impact in the face of rising fear.

• Policy Uncertainty spiked around the US Election to levels last seen in 2013 and remains above the post-Lehman average. The recent decline in Small Business Future Business Conditions helps illustrate the potential linkage with activity. In its April release, NFIB President and CEO Juanita Duggan noted, “The tax system is a major burden …and an impediment to economic growth… Without clarity on future rules, it is likely difficult for business owners (of any size of company) to make spending decisions.”
• M&A activity, which has historically shown a strong correlation with policy uncertainty, is on pace to be down 25% YoY. In their 1Q17 calls, Lazard CEO Kenneth Jacobs commented, “The M&A market has been uneven this year as corporate decision makers cope with uncertainties regarding U.S. policy under the new administration,” and Evercore Chairman of the Board John S. Weinberg said, “You will see what I would call smaller transactions, there is no hesitation…I think large transactions will be influenced somewhat by tax policy.”
• Bank loan growth has also slowed materially since the Election (down from ~7% YoY to ~3.5%), with business (C&I) and CRE lending showing some of the sharpest declines. This could be indicative of a CapEx slowdown, which has also been correlated with Policy Uncertainty in the past (though with a lag). See Exhibit 13.

Despite elevated levels of Policy Uncertainty, the traditional market proxy of uncertainty – the VIX – is near all time lows. SPX 1M implied volatility hit its lowest level ever this week (note, index options started trading in 1983). This is not just an equity phenomenon as many fear gauges across most asset classes (e.g. US rates, G9 FX, US High Yield) are below average.

Furthermore, positioning suggest investors are positioning for volatility to move lower. AUM of inverse VIX Exchange Traded Products (such as the XIV) has grown ~$600 mn YTD while AUM in long VIX products have declined $460 mn. In addition, short positions on the VXX, the largest ETP product, are currently in the 87th percentile vs. the last year.

 

Tax Reform: Where to from here?

Congress has a number of issues on its plate and is running out of days ahead of the summer recess to address tax reform. It is also unclear how much consensus there is around key issues. Furthermore, both the House and President Trump’s proposals to repeal the State and Local Tax deduction (which costs the government ~$100 bn/yr) look to disproportionately impact Democratic states. An analysis of the top 10 states likely to see their tax bills go up yields not a single Republican Senator, but 46 members of the House of Representatives. That is one more than the Republican’s current House majority.

What’s the timeline? Republican leadership has committed to getting tax reform done in 2017, but may struggle to accomplish this task with the House in session for only 39 days until the five-week August Recess (and 87 days through the end of the year).

Can tax reform get done? It is unclear how much current consensus there is between the House and Senate, and there are also differences compared to President Trump’s proposal. Key differences have emerged in regards to deficit neutrality (and over what time period), Border-Adjustment (BAT), the marginal individual tax rate, corporate tax rate and the State and Local Deduction.

A word on the State and Local Deduction (SALT). The SALT is one of the largest federal tax expenditures with a cost of ~$100 bn in 2017. However, the deduction is used more by higher-income households (about 45% goes to taxpayers with incomes over $200K). It is also concentrated in certain states, with California and New York accounting for one-third of the deduction claimed and about 20% by number of returns. The top 10 states are responsible for almost 2/3 of the deduction and slightly over 50% by number of returns.

If SALT were to be repealed, the average tax increase for someone claiming the deduction is estimated to be $2,348 by the Tax Policy Center, a joint project of the Urban Institute and Brookings Institution. Not surprisingly, those states with a higher tax rate would be impacted more, with the average tax increase in Connecticut, New York, New Jersey, California and Massachusetts projected to be over $3K/person (if the deduction is used).

In Exhibit 20 we leverage our Macro to Micro Compass (introduced in November 2016) to analyze which sectors and factors have historically been most sensitive to shocks in VIX and Policy Uncertainty. As always, past performance isn’t an indication of future results and we note that positioning, momentum and divergent macro trends (among other inputs) may play a role.

The Art of the (Trade) Deal

With support for the Border Adjustment Tax waning in recent months, focus on trade more broadly has for all intents and purposes faded into the background. We remind investors about the potential (and likelihood) for the Administration to flex its Executive Powers. Indeed, trade imbalances were a key focus throughout President Trump’s campaign and the administration has the power to take action without Congress. We note recent commentary from Commerce Secretary Wilbur Ross stating that “[trade rule] enforcement will be one of the major tools for fixing things.” To that end, the need for portfolio managers to understand import/export dynamics is arguably greater than ever. In a bid to help frame the debate we leverage both macroeconomic industry data and our bottom-up analysis to identify the most exposed global sectors and companies.

The liberalization of global trade throughout the post-war era has been a major driver of both US and global economic growth (see page 12 for a brief history of US Trade Policy). As highlighted in Exhibit 21, from 1960 to today total US trade volumes (imports plus exports) increased from less than 10% of GDP to nearly 30% of GDP. We note that during this same time period the United States has gone from a modest trade surplus to a trade deficit surpassing 2.5% of GDP or approximately $500bn per year (see Exhibit 22).

A word on the President’s authority over trade: The US Constitution provides Congress the authority to regulate international trade and to collect taxes, duties and tariffs. Congress has periodically given the president the authority to negotiate tariff reductions (e.g., the Reciprocal Tariff Act of 1934, the Trade Expansion Act of 1962, the Trade Act of 1974), but this delegated authority has always been limited in scope and duration. Thus, any trade-related action by the President must find statutory basis and could potentially be challenged in court.

Free Trade or Fair Trade 101 Revisited

The administration remains focused on the US’s $500bn annual trade deficit. To that end, below we once again identify the net balance of trade in goods via both an industry and a regional lens. We note that while China and Mexico are commonly the focus of political rhetoric, we remind investors that the United States is a net importer of goods from nearly all regions and all sectors.

Further, with investor sentiment towards Eurozone growth clearly improving vis-à-vis the United States, as evidenced by the +10% move in the STOXX 600 year-to-date and the +3% move in EUR vs. the USD over the same time frame, we pause for a minute to highlight that the Eurozone runs an annual trade surplus of more than $100bn (2014 figures) with the United States, driven primarily by Chemicals ($39.5bn), Transports ($30.9bn) and Machinery ($27.0bn).

Global Equity Spotlight: Mapping Cross-Border Sales & US Trade

Considering the administration’s explicit focus on reducing the trade deficit, below we leverage our global coverage footprint to develop a bottom up perspective of US sales exposure and identify which sectors and stocks may have the most at stake. Focusing specifically on non-US domiciled names, Exhibit 26 identifies the 10 sectors that derive the largest percentage of their aggregate sales from the US (ex. Energy & Financials). Further, in Exhibit 27 we highlight the top 25 international companies by total US Sales ($, millions).

We acknowledge that this analysis focuses solely on end-market sales and does not address where the products are produced as there is likely some local manufacturing.

When the P leads the E, Should We Applaud Revisions?

The S&P 500 has staged an impressive 12% rally since the US Presidential election though earnings revisions have not kept pace. The net result? Significant multiple expansion bringing the index P/E to near the highest on record (18.1x). While estimates have started to move higher over the last month we note that in many cases the market has pre-traded this. With multiples elevated across much of the market, we look for companies where estimates have moved higher (though the stocks many not have) and our analysts see further upside vs. consensus including STZ, CMI, BK, MA and LRCX. However, we do see risks out there, particularly as operating margin forecasts look optimistic against a backdrop of higher labor and commodity prices (on a yoy basis). We see downside revision potential for GIS, SEAS, SPR and PCLN.

Putting the S&P 500 multiple expansion in context:

• 2017 earnings estimates are down 1.5% between November and April, while prices are up 11%. The S&P 500 P/E (2017E) is now 18.1x, up from 15.9x pre-Election. On 2018 estimates, the P/E has similarly expanded about 2 points (14.6x to 16.3x).
• Multiple expansion has been evident across the vast majority of sectors, with Energy the lone exception. It has been most pronounced in Materials, Consumer Discretionary and Health Care which have all rallied over 10% at the same time that estimates moved more than 5% lower. The only sectors with positive earnings revisions have been Financials and Industrials.
• Earnings do drive stocks. Indeed, companies with positive estimate revisions have outperformed those with negative by 16% at an index level since the election. This delta is consistent across all sectors and was most significant in Consumer Discretionary (24% delta), Industrials (22%) and Real Estate (21%).

Earnings have started to follow, but will it be the start of a trend?

Consistent negative revisions have become somewhat of a given, with S&P 500 estimates moving lower during nine of the last ten years (2010 was the exception). On a monthly basis, things do not look much better, with estimates moving higher in just six individual months of the last five years. Though estimates are down in aggregate since the election, the latest data point provides a glimmer of hope acknowledging the magnitude was small and one month does not make a trend. In addition, positive revisions outpaced negative revisions by 15%, the highest ratio since 2014. On a sector basis, the balance was skewed positively across most of the market, with Telecom and Energy the outliers on the negative end. See Exhibit 31.

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According to a White House official, Bloomberg is reporting that President Donald Trump is considering Mike Rogers, a former congressman and FBI agent from Michigan, to replace James Comey as FBI director.

Rogers, 53, a former chairman of the House Intelligence Committee, retired from Congress in 2015 after seven terms to pursue a career in talk radio.

He advised the Trump presidential transition team on national security issues but was asked to leave at about the same time New Jersey Governor Chris Christiewas removed as head of the transition.

He was among the seven potential candidates we noted yesterday:

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