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“Yuuuge” Tax Relief on the Way?

| February 13, 2017

Major equity markets advanced further last week, leaving all but the small caps at new highs. To appreciate how “quiet” trading has been recently, consider that, according to the Wall Street Journal, the S&P 500 began the week having gone 34 trading days without a daily swing of over 1%, the longest run of its kind in over two decades. On Wednesday, the index established an all-time record for such a streak, which was extended to 39 days by Friday.

Arriving at midweek where they began on Monday, stocks broke out on Thursday as hopes for higher profits under the Trump administration resurfaced. The financial media credited a meeting between the President and a group of aviation executives, in which Donald Trump alluded to “something phenomenal in terms of tax” in the next few weeks. Other investors took note of signs that Trump would cooperate with Republicans in Congress in pushing for reductions in entitlement spending. Political publication The Hill reported on Thursday that a leader of the House Freedom Caucus was confident from discussions with Trump that the president would back entitlement cuts as long as current beneficiaries were not affected.

Major European stock indexes also enjoyed a bullish week, spurred on by positive earnings reports from key companies. The pan-European Stoxx 600 closed higher in spite of building political uncertainty surrounding the upcoming French presidential election. Government statistics showing retail growth in France and stronger factory orders in Germany also helped to support markets. The basic materials sector led the way for the Eurozone, boosted by strong trade data from China.

The good news stretched to Japanese stock markets, as the Nikkei 225 Stock Average advanced 2.44% (461 points) and closed at 19,378.93. Year-to-date, all of Japan’s major equity market benchmarks are in the black. The media headlines concerned the two-day summit between Prime Minister Shinzo Abe and President Trump at the end of the week. According to sources familiar with the agenda, the leaders were set to talk about Japanese companies investing in U.S. infrastructure projects, Japan’s willingness to increase its U.S. oil and natural gas imports, and solutions to Japan’s $184 billion 2016 U.S. trade surplus. Japan has recently reemerged as the second-largest contributor to the U.S. trade deficit (after China), and it is the largest holder of U.S. Treasury securities.

Finally, China’s foreign currency reserves fell for the seventh straight month in January to less than $3 trillion, an almost six-year low, as the government dipped into its vast reserves to undergird the yuan. The drop was a larger-than-expected $12.3 billion to $2.998 trillion, the People’s Bank of China (PBOC) reported. This is the country’s lowest level of reserves since early 2011. While China still has the world’s largest currency reserves, they have dropped sharply from their mid-2014 peak of nearly $4 trillion

The January decline underscored the persistent pressure among mainland Chinese investors to move money out of the country as the yuan weakened in recent months, as well as the government’s willingness to spend heavily to support the currency. For those wondering why this all matters, China’s management of its capital outflows and currency have major ramifications for investors given that previous efforts to devalue the yuan have occasionally roiled global financial markets since 2015. As such, it will be necessary to continue to monitor the situation in China.