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Market Recap Friday, September 29, 2017

In Brief

  • U.S.: Trump gives a new “red line” for his 20% corporate tax rate; tax reform framework; consumer confidence index fell to 119.8 while data skewed by hurricanes
  • Europe: France consumer confidence fell; both German and French business optimism was also appearing toppy; German election update
  • Asia: S&P warns of correction as Asia bond spreads hit decade low; recovery durable through politics and now stimulus in Japan; polls show Abe in the lead for snap election; sales tax to be hiked in 2019 unless disaster strikes
  • Thought: Implications of the Leadership from the Party Congress in October

On the U.S.

President Donald Trump said September 27 that the 20% corporate tax rate proposed in the newly released Republican tax reform plan is a “red line” and he will not go higher. Trump long ago promised to decrease the rate to 15% for corporations, but a nine-page outline released by the “Big Six” tax negotiators in the White House and Congress called for a rate of 20%. By making it slightly above the president’s originally desired level, it will make the budgetary math easier. Most analysts believe that the corporate tax rate will eventually have to be increased to the mid- to high- 20s for the tax reform plan to qualify under Senate rules.

According to the September 27 Tax Reform Overview, President Trump has laid out four principles for tax reform: (a) make the tax code simple, fair and easy to understand; (b) give American workers a pay raise by allowing them to keep more of their hard-earned paychecks; (c) make America the jobs magnet of the world by leveling the playing field for American businesses and workers; and (d) bring back trillions of dollars that are currently kept offshore to reinvest in the American economy.

A Conference Board report showed the September U.S. consumer confidence index faded to 119.8 from a revised 120.4 in August but within expectations; consensus expectations from most news organizations called for a headline index reading of around 119.5 to 120.2. Optimism has been unwavering, but the latest wave of events, including healthcare bill, hurricanes, North Korea threats, and budget uncertainty, could have been too much. Confidence in Texas and Florida decreased considerably, as these two states were the most severely impacted by hurricanes Harvey and Irma.

On Europe

French household confidence fell for a third successive month in September, wiping out most of its post-election spike as new president Emmanuel Macron pushed through contentious labor market reforms. The official measure of household confidence fell from 103 to 101, compared to expectations that it would stay steady. Household assessments of their past and future financial situation, saving capacity, standard of living and unemployment fears all deteriorated, but the main index is still well above the depths it plumbed over the last few years. Both German and French business optimism is also appearing toppy.

On German Election, the Chancellor Merkel’s CSU/CDU party maintained its majority in the Bundestag, but did worse than anticipated; it was its worst performance since 1949: (a) the AfD party, the right-wing populist party, obtained more votes than expected; (b) SPD raked in less votes than expected, resulting in its worst performance in the post-WWII era. SPD leader, Martin Schulz, announced he will make the party the opposition, ending its grand coalition with the CSU/CDU. That would make SPD the largest opposition party in parliament; (c) the composition of the Bundestag moved from center to the left and right extremes; (d) the election results present an alternative coalition called the Jamaica coalition among the CSU/CDU, FDP, and the Greens. Nothing was resolved at the so-called “Elephant round” where the party leaders met and stated their coalition intentions; (e) party leaders are waiting to see how the Lower Saxony regional election goes; and (f) the final coalition outcome will likely be the Jamaica coalition, which has mixed implications.

On Asia

According to S&P Global Ratings, the trend of falling premiums on Asian bonds amid abundant liquidity may not last for long, as global monetary stimulus will inevitably fade, and a significant correction in process of assets, such as bonds, equity, and real property, is likely. Rising threats include market overreaction to geographic conflicts, such as North Korea’s missile testing, the rise of populist or extremist trends, and tax or trade wars.   

In Japan, the Mfg PMI moved up broad base to 52.6, finishing the third quarter on a strong note. Sentiment remains upbeat through escalating North Korea threats and ahead of the general elections. Japanese Prime Minister Shinzo Abe announced snap elections for October 22, and an economic stimulus package of two trillion yen or $17.8 billion for subsidizing education and child-care costs and boosting corporate investment to, in turn, improve productivity. Additionally, Abe has reiterated his government’s plan to hike the consumption tax to 10% from the current 8% in October 2019 unless a setback such as a major financial crisis or massive earthquake occurs.

Thought: Implications of the Leadership from the Party Congress in October

The new or old leadership will focus on further suppressing economic and financial volatility through a combination of continued leverage expansion, financial repression including tight capital controls and an imposition of supply discipline in commodities industries. If so, unlike in 2015–2016, China would not be an exporter of volatility to global financial markets. While this is a possible outcome, another distinct possibility is that the likely consolidation and concentration of power opens the door for significant and surprising policy changes, including major reforms affecting state-owned enterprises and forced deleveraging, which would weigh heavily on growth and could lead to more tolerance for currency depreciation. This could potentially be signaled by a highly symbolic shift, such as the leadership dropping the growth target. Such changes, or the fear thereof, have potential to disrupt global markets. In addition, a more assertive China in foreign affairs under President Xi Jinping raises the risk of an escalating trade conflict in case the U.S. administration decides to get tough on trade policy.


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