, , , ,

US Taxes Returning to Economy-Killing Level

, , , ,

I have written about him many times and posted some of his free work on this blog in the past but this week’s post by Tom McClellan is very enlightening. Tom, one of the fathers of technical analysis, takes on US taxes, US debt, US economy and the US stock market and how they are all interrelated in one fell swoop.  I have copied his insightful look below but I encourage anyone who I wants to stay tuned into the market to check in with him regularly here  

US Taxes Returning to Economy-Killing Level

The April 15 income tax filing deadline came this week, and so taxes are on the minds of a lot of Americans.  As Arthur Laffer noted 3 decades ago, it really is possible to set tax rates too high such that it actually hurts the economy.  We appear to be in such a condition now.

I wrote about this topic back in January, when lawmakers were contemplating raising the tax on gasoline.  But it is worth revisiting as we see total federal receipts creeping up toward 18% of GDP.  Whenever total federal tax receipts have exceeded 18% of GDP, the result has always been a recession for the U.S. economy.  And sometimes we can see that effect from a total federal take at less than 18%. 

The current number is 17.5%, based on total federal receipts for the 12 months from April 2014 through March 2015, and based on projected GDP for Q1 of 2015.  That is very close to the 17.7% reading we saw in 2007, just before the financial market collapse.  It is still some distance away from the all-time high reading of 19.8% seen in early 2001, and because of that some economists argue that we can safely go back to those higher levels and have the same strong economy that we saw in the late 1990s. 

There are two problems with that hypothesis.  The first is that economy of the late 1990s was not as strong as the revisionist historians would like us to believe.  The high taxation then pretty effectively killed the technology boom.  Total stock listings on the Nasdaq actually peaked in late 1996, and were in a genuine free-fall long before the bubble peak of the Nasdaq Composite Index in 2000.  That peak came about because a few large tech stocks were hogging up all of the available liquidity, and crowding out the smaller players, sort of like the biggest hippos taking up the last remaining water hole on the Serengeti during a drought.  Unemployment rates also bottomed out in early 2000 and then started upward.

The second problem with that hypothesis is that we don’t have the same demographic conditions now.  In 1999, the members of the Baby Boom generation (born 1946 to 1964) were between 35 and 53 years old, in the peak of their entrepreneurial years.  They were working hard, building companies, and pushing the economy faster than it would normally go.  Now, they are 51 to 69 years old, and are more interested in playing with their grandchildren than in starting a new company and hiring people.

The children of the Baby Boom generation make up what is known as the “Echo Boom”, which peaked in the birth year of 1990.  Those 1990 babies are now just 24 to 25 years old, and many are just now moving out from their parents’ homes.  So they are not quite at their peak of hard work and entrepreneurialism, and even when they do reach that point, their numbers are just a shadow of their parents’ generation.  So the Echo Boomers cannot absorb the same degree of a repressive tax burden that the Baby Boom generation could. 

This 18% recession phenomenon is not new.  It has worked going all the way back to World War II.  Here is the same comparison for the years 1944 to 1980:

[taxes as percentage of GDP 1944-1980]

[taxes as percentage of GDP 1944-1980]

Federal receipts got all the way up to 19.8% of GDP in late 1945, as Congress was trying to pay for WWII and pay off all of those war bonds.  And in case anyone fondly remembers the strong war-time economy then, we should remember that an economy which requires price-fixing and rationing is not a strong economy.  When people cannot find a place to live because of lumber shortages, and have to grow “Victory Gardens” to have produce, that is not a strong economy.  The effects of that taxation repression finally showed up in stock prices during the late 1940s, and only when taxes dropped back down to a less onerous level did the stock market finally start to rebound again. 

When the federal government takes a smaller portion of GDP as taxes, that leaves more money in the actual economy for real people to spend on what they want, and to spread around employing other people.  Growth is the result.  When the federal government takes too much out, it is like a farmer eating his own seed corn; he does not have as much to plant next year. 

Meanwhile, federal government spending for the latest 12 months equals 20.4% of GDP, almost 3 percentage points higher than receipts.  I keep hoping that someday we will get some leaders who realize that in order to pay off $18 trillion of debt, we have to get the spending number underneath the receipts number, and leave it there for a long time.

And we need to keep the federal receipts number well below 18% if we are to avoid the next recession, and its associated downturn in stock prices.  We may already be too late in that regard. 

Amazon – Set up for a big move higher?

Amazon (AMZN) gave a big, fat buy signal back in late January when it crossed above both the 30 week moving average and the blue downtrend resistance line as noted in my chart below. Since bouncing off the bottom (for the third time just prior to the breakout), it has risen a cool 33% in a month and has since been consolidating sideways creating a high and tight bull flag.  I view these patterns are usually ½ way markers allowing the bulls to catch their breath and unwind overbought conditions.  Which is exactly what is happening now. Also note in the bottom pane of the chart you can see the ratio of Amazon to the SP 500 has turned up from a period of deep under-performance to one of outclassing the index.

Switching to a daily chart and looking at the highlighted consolidation (flag) you can see it is currently on its 3rd touch of the upper and lower boundaries of the box. This is telling me it is not ready to break out quite yet. To be a proper flag I expect to see least 5 or 6 touches (it can be more).  An even number of touches indicates it is a reversal pattern as the flag broke out to the downside and an odd number means it is a continuation pattern breaking higher. Both indicators are set up positively as the upper RSI has unwound its overbought condition and is pointing higher while the MACD in the lower panel is above zero and has just crossed above its signal line.

It seems like AMZN is nicely setup for a move higher.  If the market pushes higher and AMZN follows suit, the target for this pattern is ~470, which is about 90 point (or 25%) higher. AMZN is one of dozens of stocks whose charts are pointing to much higher prices in our future once this consolidation period is behind us.

A Quick Round Trip

Back on 2-18-15 I wrote a post on JC Penny’s stock, JCP, proclaiming the virtues of what the charts were saying.  Here we are 7 weeks later, I am back at you with a recommendation to sell the stock (at least ½ if not the entire position), as I did today.  After a 12% while the SP500 was down fractionally during the same period, locking in some profits seems prudent right here. 

At the time of my initial post here, an inverse head and shoulders pattern had set up and projected an upside target of almost 40%.  That target combined with its risk/reward was so compelling it was one I couldn’t pass up on.  Those that remember this post may be wondering why, if the target was almost 40% higher, would I be selling now only after a 12% gain.   Below is a chart I posted at the time.

Below is the same chart 7 weeks later. Notice how price spike immediately higher after my post and was rejected at the first grey resistance line around $9.25. Once hitting that, It corrected lower, in fact, falling below my entry point and back down almost to the right shoulder.  At the time I really thought I would be eating crow. Thankfully, my stop placement just below the right shoulder worked out perfectly as it was not hit and price immediately pushed higher back up to the grey resistance line today where it was, once again, rejected.  This tells me this price level is hot and must be respected and as such I expect further consolidation and likely more downside from here. It does not mean it cannot eventually reach my projected 11.25 ish target price but, the pattern that made it such an attractive investment has been invalidated. So taking partial, if not all profits, is warranted.

I am circling back around to this post not only because it turned out to be a nice investment gain (an 89% annualized return is nothing to sneeze at), albeit a short holding period, it also turned out to be a great learning tool. Here is what you should take away from this example.

1.       When investing make sure you clear your mind of biases and opinions. They can be very detrimental to making profits.  Before this recommendation who really thought this investment, JC Penny’s, was going to outperform (and in this case massively so) the index?  If you reread my post I had my doubts but what I have learned is to let those thoughts go and follow the charts (price)

2.       Have a plan before you invest.  You aren’t always going to be right so know what price level that is and make sure you incorporate that into an exit strategy that is established BEFORE you invest.  If you are going to take a loss (and losses are a part of investing) keep the size of each loss small.

3.       Taking profits on a portion of your position, once it hits your first level of resistance (these, like your loss exit point should be determined in your investment plan before you invest) and then adjusting your stops accordingly on the remainder will guarantee you can NEVER lose money on that investment. This is good risk management and should be considered on every investment. Sure, it doubles your transaction costs, but the cost of a transaction is so small as compared to most investment losses (even those with a plan), it is a practice all investors should follow.