Tax Cuts Will Be Proposed By The House Next Week

In 2016, we were used to having high political uncertainty. The Brexit and U.S. presidential elections were cause for concern as populism ruled the day. 2017 was nothing like that as France and Germany had elections where the establishment won (Macron and Merkel respectively). The change has led to the policy uncertainty declining as seen below. In America, there’s uncertainty about the tax code, but the uncertainty is between getting a tax cut done with some reforms or getting nothing done. While no one knows what will happen, the variety of outcomes is fairly narrow.

The latest news out of Washington is that the Senate has set a November 13th deadline to draft a bill that cuts taxes. The current chance for a corporate tax cut by the end of the year is 38% and the current chance for an individual cut is 30%. The plan needs to be drafted. Then we’ll review which Senators will be the deciding factors on whether the plan passes. This time it won’t just be healthcare stocks that will show volatility when the headlines break since every company will be effected by this. As expected, the Senate will pass it under a budget resolution which needs only a majority to pass. The House wants to pass a budget by next week. After both chambers pass a plan, they will meet to hash out the differences. The rule is the plan can’t cost more than $1.5 trillion over 10 years without accounting for the economic growth that the tax cuts will bring which will increase revenues. The problem is the tax cuts cost $5 trillion. This is just like the healthcare plan where the Republicans want to cut spending without throwing millions off their health insurance. At least with healthcare, free market reforms can lower costs. With the budget, either large spending cuts are made or the tax cuts can’t be as large as initially proposed.

The chart below shows the percentage of tax deductions according to income. The goal with tax reform is to eliminate deductions and lower the rate to make filing easier The chart indicates that the only way to do this would be to eliminate the state and local tax deduction. There’s been talk about eliminating the real estate tax deduction, but that’s small potatoes compared to the state and local tax deduction. As you can see, the state and local tax deduction being eliminated would hurt the rich more. That might be a benefit because the GOP will catch flack for the fact that the tax cut will benefit the rich the most. Whenever taxes are cut it always helps the rich the most because they pay the most taxes.

Moderate Trade Weakness

The chart below shows the global trade indicators. The Baltic Dry index is spiking while the China Commercialized Freight index is falling. The overall result is seen in the grey line. It supports my thesis that we will see moderate economic weakness in the first half of 2018. There might be a boost to all these indicators if a big tax cut is announced which is why we discuss it so often.


The scenario in stocks is that there is a Goldilocks scenario supporting high valuations which aren’t near the 2000 high, but are much more expensive than average. The chart below is a unique depiction of valuations and expected returns. The grey line is the retained earnings yield which aims to forecast future returns. The 10 year forward price only compound annual growth rate is the green line. It would be clearer if there were two scales because the grey line has a lower amplitude. Either way, the lower the earnings yield, the lower the future returns. You would expect this relationship to be consistent, but it isn’t. In the 1940s, the earnings yield was low and the appreciation was high. There was also a gap in the 1980s where the yield was low and appreciation was high. If the basic trend in the stock market and yields continues, there will be another one of those periods starting in 2019 because the bull market started in 2009. That would be a strong sell signal. The green line is about to drop in the next 12-24 months as it starts to include the financial crisis.

It’s A Party And All The Indexes Are Invited

This market has been relentlessly powering higher which is why I’m expecting a correction next week, especially in the small cap stocks. The Russell 2000 (RUT) has been up 6 straight days as the increase from August 21st has reached 9.87%. The Dow is up for 8 straight quarters which is the longest streak in 20 years. The S&P 500 is up 11 straight months which is the second longest streak ever. The VIX closed the month at 9.51 which is the lowest monthly close ever. The 12-month rolling volatility is 5.4% which is near the lowest ever. The average VIX in September was 10.44 which was the lowest VIX for a September and the second lowest monthly average (the lowest was July 2017). The biggest decline this year in the S&P 500 was 2.8% which is the second smallest decline ever (smallest was 2.5% in 1995). The streak without a 3% correction has lasted 226 days and has seen a 20.8% increase. That’s the second longest streak (longest 241 days) and the third biggest increase (biggest 30.4%). The micro-cap IWC has been up every day for the past 3 weeks which is the longest streak ever.


The stock market has been in one of its best streak ever all year. The latest ramp has been catalyzed by the potential for a $5 trillion tax cut. The only problem is how the $3.5 trillion gap is filled. This rally has caused the market to have above average valuations which likely imply stocks won’t repeat the past 8 years of performance in the next 8 years.



Don Kaufman: Trade small and Live to trade another day at Theotrade.

Neither TheoTrade or any of its officers, directors, employees, other personnel, representatives, agents or independent contractors is, in such capacities, a licensed financial adviser, registered investment adviser, registered broker-dealer or FINRA|SIPC|NFA-member firm. TheoTrade does not provide investment or financial advice or make investment recommendations. TheoTrade is not in the business of transacting trades, nor does TheoTrade agree to direct your brokerage accounts or give trading advice tailored to your particular situation. Nothing contained in our content constitutes a solicitation, recommendation, promotion, or endorsement of any particular security, other investment product, transaction or investment.

Trading Futures, Options on Futures, and retail off-exchange foreign currency transactions involves substantial risk of loss and is not suitable for all investors. You should carefully consider whether trading is suitable for you in light of your circumstances, knowledge, and financial resources. You may lose all or more of your initial investment. Opinions, market data, and recommendations are subject to change at any time. Past Performance is not necessarily indicative of future results

Analysis feed

Latest Forex Analysis

Editors’ Picks

EUR/USD turns below 1.10 as market mood eases

EUR/USD has dropped below 1.10 as the market mood improves. Earlier, it hit three-week highs as the stock market crash and rush into bonds is raising the chances of the US Fed cutting rates. Further coronavirus headlines are awaited.


GBP/USD hits new 2020 low amid Brexit rhetoric, coronavirus headlines

GBP/USD has dipped below 1.2850, hitting a new 2020 low as concerns about a no-trade-deal Brexit are weighing on the pound. Coronavirus-linked USD weakness is minimal in this pair.


XAU/USD tumbles near two-week’s lows, sub-$1600/oz

Gold has been dropping sharply this Friday while reaching the 200 SMA on the four-hour chart. XAU/USD bulls gave up as sellers took the market down sharply. The bears seem to be in charge and more down could potentially be expected. 

Gold News

WTI remains under pressure around $45.00

Nothing new around crude oil prices, with rising concerns on the Chinese COVID-19 and its potential impact on the economy and the demand for the commodity keeping traders’ sentiment well depressed.

Oil News

FXStreet launches Real-Time Trading Signals

FXStreet Signals offers access to explanatory live webinars, real-time notifications when signals are triggered and exclusive membership to the company’s Telegram group, where users get direct guidance by our analysts and get room to discuss and interact.

More info

Forex Majors