Stocks and Taxes

Leave it to Tom McClellan to look at how stocks react to the tax rate (as a percentage of GDP). I find this data absolutely fascinating. The good news is, at least as of right now, if stocks are to fall, it won’t be because tax rates are too high. Take a look at Tom’s most recent study below. For those interested all his studies can be found (free) at www.msoscillator.com.

Treasury Department Is Not Biting Too Hard

 The good news for the stock market bulls is that the federal government is not taking too big of a bite out of Americans’ incomes.  The latest data from the Treasury Department show that total federal receipts from all sources for the 12 months ending September 2019 amounted to 16% of GDP.  That still seems like a pretty high percentage empirically, but it is below the average of the past 4 decades.

This week’s chart compares that measure of the tax bite to the movements of the SP500.  The important lesson is that pushing taxes up too high tends to cause recessions and bear markets, eventually leading to a falloff in total tax receipts.  Generally speaking, 18% qualifies as “too high” because we have seen a recession every time it has gone up there.  Even getting close to 18%, as we saw in 2007 and 2016, can lead to economic distress.

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But lower readings like we see now tend to be followed by months or years of uptrend for stock prices.  More money gets left in the hands of taxpayers, and so they can do things like bid up stock prices with it. 

The problem is that taking in 16% of GDP in taxes does not pay the bills.  The last 12 months’ expenditures by the federal government amounted to 20.6% of GDP.

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For FY2019, which ended in September, total raw dollar receipts were up 4.0%, which is pretty good.  But total raw dollar expenditures were up 8.2%, because our elected leaders in Washington, D.C. cannot get control of their spending impulses.  It is a spending problem, not a taxing problem.  And it does not help that Baby Boomers are entering retirement and starting to draw Social Security and Medicare in larger numbers than the older generations are dying off.  So we have a spending problem, and an actuarial problem, but not a taxing problem.

And those problems are really only a concern to those of us who don’t want to leave a mountain of debt to our grandchildren.  For investors, a deficit like that is an enormously stimulative force for the stock market.  Here is that comparison:

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The higher the deficit now, the more bullish it is for the months that follow.  Deficits only become a problem for the stock market at the point when somebody tries to do something about it.  But while they are at a high level and climbing, it is reminiscent of the old saying, “A fool and his money… are some party!!

Avoiding Land Mines

With one of the downsides of owning individual stocks having been recently eliminated (trading costs), the biggest one (earnings surprises) becomes a bigger concern. In the early stages of bull market (think 2009), news and earnings tend to have positive impact on stock prices. Regardless what is reported. Why? Because investors have very low expectations and, as such, even bad news turns out to be good since it is not a surprise. As you would expect, the opposite is true too. As an aging bull lingers, expectations become increasingly higher (priced to perfection) and even good news often turns out to a land mines for stock prices. For this reason, as this bull market has persisted, my default action is to not hold individual stock positions through earnings announcement.

Yesterday we reluctantly sold MTCH position in client portfolios as it has been a nice winner, up >20%, because they were announcing their earnings results after hours. They were down as much as 20% immediately following their announcement but have tempered the losses somewhat this morning. Here is today’s chart, reflecting the markets opinion on their announcement.

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Tempered reaction aside, this chart now looks very ugly and one that is screaming to avoid and potentially setting up to eventually be a decent short setup. Not the predominance of selling that has occurred since price topped out in August. For those watching, this is a huge sign the institutions have shifted their opinion on MTCH from buy to sell.

Risk Back On

It’s really an interesting time to be an investor right now. With global risk, uncertainty and emotional warning signs around every corner, the world’s stock markets are thumbing their collective noses at it all. The US SP500 index has broken out to new highs and its price is above a rising 50 and 200-day moving averages, the sign of a healthy and strong uptrend. RSI momentum as also broken above its downtrend.  Using on-balanced-volume (OBV) as a secondary confirmation indicator (bottom pane), it hasn’t batted an eyelash as it too, has broken out to new, all-time highs.

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If you look across the globe, while few countries stock markets are at all-time highs, most have broken their downtrends and are positioning for a run higher. Whether this is anything more than just a reflexive, counter-trend bounce won’t be known until later but the message it is telling is very powerful to those who are listening, the risk trade is back on for global investors.

Stocks or Gold as the Better Investment?

Even going back millennia, it has been shown trends persist when it comes to investing. The reason why is because there is one thing that has been constant throughout, humans and human behavior. While the vehicles in which to invest changed as have the markets themselves, human behavior perseveres. One of the most recent examples has been investors 8-year preference of investing in US stocks over gold. During that period, US stocks (using the Dow Jones Industrial index as a proxy) have outperformed gold by > 275%. In hindsight, it made no sense to be “diversified” in gold as it was nothing more than an anchor to your portfolio. Stick with those that are in an uptrend and outperforming. The DJI/gold ratio chart below provides additional data that things just may be a changin’ with respect to under-performance of the shiny metal.

Ratio charts are a useful tool to help identify potential changes in longer term trends in addition to finding relative strength.. The sooner you can identify and confirm a change in direction, the sooner you are on board a rising, profitable trend and why every investor should have this arrow in their quiver.

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What makes the DJI/gold chart so interesting right now is that it peaked late last year and has since 1) broken its uptrend line and 2) formed 1-lower high and 2- lower lows. Both of these are required, at a minimum to confirm a trend change. If true (I would like to see the ratio create one more lower high before jumping on board), this is critically important as it potentially marks a huge change in where investors should commit their investment capital. Nothing moves in a straight line in either direction, but if true, be prepared for some gut checks along the way as the precious metals area are highly impacted by the FED’s decisions.

Supply and Demand

If there is any wonder why pot stocks dropped like a rock over the past year, the chart below helps to clear it up. The data contained within is really an amazing tell. As it turns out supply grew 100x and demand grew 2x. In case it’s not clear or a surprise, warehouses full of unsellable anything, including pot, leads to not only lower prices but stock prices too.

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