Dear Valued Clients and Friends,
It has been a week, to say the least. In my world, I started off in New York City with a very full Monday, coming off a weekend of being severely under the weather, and then flying to California in the middle of the night and having a very full day and a half in the Newport office before heading to Arizona with a cabal of team members late Wednesday, speaking twice in Phoenix Thursday, and enjoying a handful of wonderful meetings with our Phoenix team and various clients there. I have another speaking engagement on Friday night in Phoenix (such as a romantic Valentine’s Day) and then fly back to NYC at 6 am Saturday morning.
But that all pales in comparison to what feels like is playing out in the news cycle, and much of it warrants some coverage today in the Dividend Cafe. There is a bit of continuation of last week’s discussion on tariffs as well as a bounce around other topics that deserve commentary. It is not easy to separate signals from noise these days, but if there is one place I am determined to always have that distinction in effect, it is the Dividend Cafe.
So brace for signal, tune out noise, and let’s jump into the Dividend Cafe!
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[non] Tariff Thursday
Thursday was heralded by the press (and many in the administration) as “Tariff Thursday” – the day when Trump 2.0 was going to announce the much broader, wider, more unilateral, more universal tariffs he had talked a lot about in the campaign. Beyond the sector-targeted tariffs of steel and aluminum, beyond country-specific negotiation moves with Canada or Mexico, the next iteration was going to be “finding reciprocity” with countries who had tariffs imposed on us. Markets were “braced for impact.”
The Dow was up +350 points on Thursday, and the S&P 500/Nasdaq were up over +1% each on the day.
How could such sweeping tariffs create such a market rally? Well, the “tariff Thursday” announcement ended up being this: A memo asking federal agencies to study reciprocal tariffs and to provide more details later on how to think about some of the options here. When I read the memo, it sounded like a Presbyterian committee assignment (okay, most of you don’t know what I am talking about, but some do). Essentially, markets made the decision that there was not something negative to respond to in “an order to study something about which questions to ask about what might be done around something that might be happening.”
Now, do I say this to be critical? Not at all. I will point out that markets were up +166 points on Monday this week in the aftermath of steel and aluminum tariff announcements. Why the benign response? Again, if you are detecting a theme, it is that markets have priced in the sub-text to all of this well … that across the broad ecosystem of “tariff talk” is a lot of bark, a broader strategy and set of objectives, and very little intent to impose real cost to the economic order. Any number of things could change this, and there exist several potential catalysts for escalation, but regardless of how trading partners respond to the threats, conversations, and negotiations, markets are continuing to hum along without a strong concern for the potency of these possibilities. Mankind learns by example and little else. The same is true for markets.
You Asked
In the aftermath of last week’s comprehensive discussion of the current tariff tango, one reader asked if “fair trade was possible when two countries have different standards of living.” It is a great question, most importantly because there has been a school of thought that has used the mere sound of the thought to give the impression that there is something to this. There is not.
First of all, let’s understand that no two parties in a transaction ever have “the same standard of living.” When you buy something on Craig’s List or ETSY or EBAY, your counterparty may have a substantially higher standard of living than you or, very possibly, a lower standard. In the pursuit of their best interests, they set a price and terms that meet their needs and wants, and you do the same in the pursuit of your best interests. When the two things meet, a trade happens. And, it should be pointed out, two parties come out of it with a higher standard of living (albeit very marginally so) – or the deal would not have happened. Two people gave up something they were willing to give up to get something they wanted more. The net result is two parties who are better off.
With mass amounts of trading across two borders, the same principles are at play, albeit now likely at scale. Very poor countries get richer by selling things in which they have a comparative advantage to richer countries that benefit. Very rich countries get richer still when they can benefit from the free exchange of other countries’ exports. There is one thing, and one thing only, that makes the trade “fair” – and is not the standard of living of either party before or after the trade – it is agreement with the terms of the transaction. If the exchange is voluntary and it is agreeable, it is fair – because otherwise, it would not happen. A country with a low standard of living exporting to another country with a higher standard of living is going to experience a higher standard of living after enough of such trade because that is what free exchange does – make two parties better off. The relative station in which both parties function is immaterial to the fairness of that specific trade. When you go to get a haircut, it should not be on your mind whether or not the person providing that service to you for the price he or she deems in their best interests has the same standard of living as you. Each party acts in the moment, and each party benefits themselves and most certainly benefits the other party.
That people believe these principles change when we go from you and your barber to two large companies trading across a border is the source of all sorts of economic fallacy.
The Tax Stage is Set
The main reason I had to wait this week to write Dividend Cafe until Friday morning was not the suspense around “Tariff Thursday,” but rather some degree of finality as to where House action on the budget would end up. And indeed, late Thursday night, the House Budget Committee did vote to send a massive budget blueprint to the full House, where a razor-thin majority now needs to pass it. If that happens, which is not a slam dunk, the Senate needs to pass its own version. And if there are differences between the House and Senate versions, those two have to be reconciled in conference. And if that conference resolution is passed (by a simple majority in both chambers), then, and only then, can tax legislation be introduced that is reconciled to that passed budget (again, with only a simple majority requirement).
The budget passed Thursday night (by the Budget Committee, not yet by the whole House) calls for $4.5 trillion in tax cuts. It calls for $1.5 trillion in discretionary spending cuts (over ten years), with $2 trillion of cuts in mandatory spending where a dollar of tax cuts goes away for each dollar of this $2 trillion of cuts to mandatory spending that doesn’t happen.
In the meantime, the Senate does appear to be going forward with a “two-bill” approach, which runs in conflict with the House’s plan for one bill that marries tax cuts and budget concerns to other immigration, border, and energy priorities.
So, politically, what does this all mean? Well, the fact that it got out of committee does not mean it is going to get through the House, but obviously, if it had not gotten out of committee, it was not going to even get to the House at all. But the bottom line here is this: The stage is set for $4.5 trillion in tax cuts, but that includes the extension of the current 2017 Trump tax cuts. The administration’s priorities need more than $4.5 trillion of room to get done. Even $2 trillion of that $4.5 trillion is not assured if they cannot find agreement on spending cuts, so to get above $4.5 trillion in tax cuts they need over $2 trillion in spending cuts. It is not going to be easy.
Of course, what they do with the tax cuts, assuming they get this framework past the full House and assuming they find the spending cuts to move it forward, remains to be seen. The only thing we know is that the first step is an extension of the 2017 tax cuts. Let’s assume that is table stakes and gets done … beyond that, some House Republicans in California and New York have said they will not vote for anything that does not include a lift on the $10,000 state and local tax (SALT) cap. Finding room above that for “no tax on tips” is going to be hard, and finding room above that for “no tax on overtime” will be impossible. Finding room above all of that for “no tax on social security” would require a different stratosphere.
I think the basic framework is set, and they more or less have to roll perfect dice to even get this done from here, but it is doable. However, what is doable within this not-at-all-assured framework includes a Trump tax cut extension and a couple of new tax cuts, but a much more modest version of what had been initially envisioned.
Chart of the Week
Don’t look now, but for all the concerns that significant pain and uncertainty are coming in the U.S.-China negotiation process, the Chinese stock market has taken off.
Quote of the Week
“Those who do not learn from history are doomed to repeat its mistakes.”
~George Santayana
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There will be no Dividend Cafe on Monday as markets and banks are closed in honor of President’s Day. Other than that, it will be a full and busy week next week, and I am looking forward to whatever next week may bring in the Dividend Cafe. As always, enjoy your weekends and reach out with any questions, any time.
With regards,
David L. Bahnsen
Chief Investment Officer, Managing Partner
The Bahnsen Group
thebahnsengroup.com
This week’s Dividend Cafe features research from S&P, Baird, Barclays, Goldman Sachs, and the IRN research platform of FactSet
