Government Policy is Moving Markets

James Juliano Insights

US stock markets have been nervous again as prices recently tested near panic lows seen several weeks ago. Concern over future policy is to blame, and it stems largely from the Democratic side of the aisle.  Policy’s impact on asset prices can clearly be seen in  comments from the Democratic frontrunner for president Hilary Clinton. On September 21, 2015 at 10:56am Clinton tweeted, “Price gouging like this in the specialty drug market is outrageous. Tomorrow I’ll lay out a plan to take it on.” Biotechnology stocks immediately sold off and have continued collapsing. After Clinton’s comments the Biotechnology stock index lost 16.5% in less than a week. Capital was fleeing investment in the biotech sector because investors feared politicians attempting to control the price of certain drugs, effectively picking winners and losers.

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When it comes to election outcomes we much prefer betting market data to polls because they represent real money being wagered instead of just opinion. The Iowa Electronic Markets are small scale, real money futures markets where contract payoffs depend on economic and political events such as elections. The market is operated by the faculty at the University of Iowa, and its current contract for the 2016 US Presidential Election Winner Take All Market has the Democratic Party with a 60% chance of victory. This margin has been widening from 50% since the beginning of 2015. With real money odds increasing for a Democratic president in 2016 and the frontrunner candidate making industry specific price control and tax hike claims, it is no surprise that markets are nervous again. Remember, just last month Clinton proposed doubling the short-term capital gains tax, a move that would have devastating effects on capital formation.

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That’s the bad news. The good news is that Clinton is not guaranteed to win in 2016, and her anti-growth policy proposals may never become reality. Dr. Arthur B. Laffer, Chairman of the Laffer Center at Pacific Research Institute, recently shared his thoughts on the economy and the 2016 presidential race in his address to attendees on PRI’s inaugural Liberty-at-Sea Cruise. We highly recommend you watch the short video below to get his views on how Republicans are actually “winning this battle” over policy. He outlines how the disastrous policy mistakes of Bush2 and Obama have created the worst economic recovery in the history of the United States. He sees the solution coming from political outcomes that will usher in a “two decade period of incredible prosperity” from the next president.

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Three recent positive policy developments have occurred in the Republican Party  that support Laffer’s vision.

First, Republican speaker of the House John Boehner resigned as both speaker and a member of Congress effective at the end of October. This was a huge surprise, especially to his own party. While the move does inject some short term uncertainty into markets, overall we view it as good news and a chance to move Congress even further towards pro-growth solutions. We agree with our friends at Bretton Woods Research who outline Boehner’s positive contributions. They write, “One under appreciated positive that Boehner brought to the table was the fiscal cliff deal of 2013 that brought with it the AMT fix, which no Republican Congress previously was able to achieve. He also successfully fought the Obama Administration’s plan to keep dividends from falling under ordinary income rates (a 39.6% top marginal rate), instead allowing the tax rate to rise to 20% from 15%. He was able to do this without much bargaining clout. Of course, the fiscal cliff deal allowed for a powerful, nearly 30% rally in the S&P 500 in 2013.” Despite those positives, Boehner’s departure opens the door for a more pro-growth leader to emerge. The GOP majority now have a chance to elect a speaker more combative on monetary, tax, regulatory, spending and deficit issues.

Second, Donald Trump released his long awaited tax plan and it is a huge pro-growth improvement over the current tax code. The full version of Trump’s strong, supply side tax plan can be read below. Some of its growth highlights include simplifying the code to four tax brackets, eliminating the marriage penalty, eliminating the AMT, eliminating the death tax and bringing both income and corporate tax rates substantially lower. Below is the rate schedule for personal taxes under Trump’s plan. We are impressed with both the low rates on incomes and cap gains/dividends as well as the decrease in tax progressivity versus the current code. However, the most impressive component of Trump’s plan is the 15% business income tax rate applying to all businesses of any size. While we disagree with Trump’s dangerous ideas to break NAFTA, hike trade tariffs and deport millions on illegal aliens, we applaud his tax ideas and expect his tax proposal to be imitated by other GOP candidates. Such a tax plan is enormously favorable and a real source of economic growth.

Tax Reform that Will Make America Great Again, Donald Trump

Norquist Blesses Trump Tax Plan, Washington Examiner

The third positive policy development is the regulatory proposal issued by GOP presidential contender Jeb Bush. Bush proposes rolling back and appealing onerous regulatory burdens like Dodd Frank and new EPA rules. His ideas represent a huge wedge reduction on US economic growth.

How I’ll Slash the Regulation Tax by Jeb Bush

Overall, Laffer’s high growth optimism seems possible in a week where Boehner’s resignation, Trump’s tax plan and Bush’s regulatory reform proposal are all released. If 2016 ushers in these types of policy agendas instead of the Clinton type regulatory and tax plans that are currently spooking markets, then the US will remain a magnet for global capital.

Just a reminder, we are not yet in a policy “red zone” or US equity bear market despite what the headlines try to tell you. If you want to see what a real capital flight scenario resulting from policy mistakes looks like then look no further than Brazil. We have warned for several years about the strong US dollar’s impact on commodity prices, commodity producers and commodity exporting emerging markets like Brazil. When the US dollar is strong,evidenced by falling gold prices, these commodity linked investments suffer. Brazil is experiencing capital flight not only because it is a commodity linked economy but because it is trying to stop those capital outflows with bad trade, tax and monetary policy reactions. The result of these policy mistakes is a Brazilian stock market that has declined 70% and a Brazilian currency that has lost over 55% of its value in gold terms.


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Other “dead bodies” are appearing in the commodity space as a result of the multi-year strong US dollar (falling gold price.) Brazilian oil giant Petrobras has lost 90% of its value while Swiss commodity firm Glencore faces a complete equity wipeout.

Glencore Shares Plunge as Debt Fears Rattle Investors, Shares are down nearly 90% since their listing in 2011

Strong US dollar equities and the broad US economy are not in a policy “red zone” like commodities, yet. The GOP policy ideas being generated are substantial improvements over present job killing regulations and tax rates. However, what concerns us is that these improved policies are not yet being reflected in footprints of financial markets. There is large uncertainty around who will be the next president, and Democrats over the past week are reminding investors what anti-growth ideas can do. US Equities remain stuck in a “yellow zone” of policy uncertainty.

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