Pixabay
           

What’s a word worth? If the word is “phenomenal” and it’s uttered by Donald Trump, apparently $175 billion.

That’s how much the value of U.S. stocks increased on Thursday, according to Wilshire Associates’ calculations, after the president used that word to describe the tax plan that, he said, his administration would bring forth “ahead of schedule.” The ascent continued on Friday, adding another $100 billion to shareholders’ paper wealth and a total of $225 billion for the week, as the Standard & Poor’s 500 index, the Dow Jones Industrial Average, and the Nasdaq Composite all ended at records.

For the financial markets, the week’s swirl of bad news for the Trump administration, from the rejection of the reinstatement of its travel ban from seven mainly Muslim nations to Kellyanne Conway’s ethics gaffe in touting Ivanka Trump’s “stuff” after Nordstrom  (ticker: JWN) decided to discontinue carrying the latter’s fashion items, hardly mattered.

The devil is, of course, in the details, and they involve some hellish trade-offs. “Will [the tax proposal] be the Ryan plan that includes a border adjustment tax, or will that be left out and we’ll get clean tax cuts at the expense of a much higher deficit?” wonders Peter Boockvar, chief market analyst at the Lindsey Group.

“That distinction is very important because if it’s the former, it won’t be so ‘phenomenal’ for those companies that import a large portion of the cost of goods sold if the dollar doesn’t rally by the same extent as the tax,” he continues. That would hit retailers especially hard, but the strength of those stocks suggest there won’t be a border adjustment tax, or BAT. However, Boockvar believes that Trump backs the plan from House Speaker Paul Ryan, with some tweaks.

Whatever the details, the president’s tax proposals face “a very long slog” on Capitol Hill, observes Greg Valliere, chief strategist at Horizon Investments. The House may move quickly, despite possible quibbles over the price tag, but “the problem, as usual, will be in the glacial Senate.”

Orrin Hatch, the octogenarian Finance Committee chairman, “has made it clear that there are huge unresolved issues,” says Valliere, including the BAT, debt deductibility, caps on individual exemptions, and abolishing the estate tax. While tax reform is definitely coming, a final bill is still a long way off, and a 2017 effective date is looking less likely, he concludes.

Yet, as the action late last week suggests, the equity markets are more than willing to give the new administration the benefit of the doubt. Something’s coming, even if we don’t know what or when. And that seems good enough to bid stocks higher, especially compared with the competition.

Particularly when part of that competition is what is called in polite company high-yield bonds—or junk bonds by anybody else. Last week, the iShares iBoxx $ High Yield Corporate  exchange-traded fund (HYG) hovered near its 52-week high. At that price, the popular junk ETF yielded a hair under 5.25%, which, as I recall, is what my grandmother’s passbook savings account paid way back when (though without a free toaster).

While the markets mull the matter of future fiscal policy this week, they will ponder the course of monetary policy. Federal Reserve Chair Janet Yellen makes her semiannual trek to Capitol Hill to testify on the state of the economy, starting with the Senate on Tuesday, Valentine’s Day.

There is little love lost between the Republican-led Congress and Yellen, whom Trump has said he’d like to replace when her term expires early next year. There already are two vacancies on the Fed’s Board of Governors, with a third opening looming, after Gov. Dan Tarullo on Friday announced plans to step down in April.

At the last “live” Federal Open Market Committee meeting in December, the Fed indicated that it expected three increases—each of one-quarter point—in its federal-funds target rate over the course of 2017.

Assuming that the panel stands pat at the March 14-15 meeting, as the fed-funds futures market expects, that points to hikes at the June, September, and December confabs. But the futures market has priced in only two moves, the first in June and the second in December (unless the FOMC breaks precedent and imposes an increase at the November meeting, which isn’t supposed to be a “live” one with a scheduled press conference).

The Trump fiscal package surely will be a subject of the Capitol Hill inquisition this week, even though neither Yellen nor her questioners will know what’s in it or when it’s coming. The possible impact of the president’s proposals also enters into the formulation of monetary policy, even though it remains imponderable at this point.

A more esoteric matter for Fed watchers will be the central bank’s balance sheet, which has become the subject of increased discussion of late. The Fed’s assets ballooned to $4 trillion in the wake of the financial crisis, nearly five times its pre-crisis size. Critics had contended that this expansion would result in hyperinflation. Instead, it has mainly pumped up asset prices.

The Fed had planned to normalize its balance sheet whenever the crisis had passed, which it surely has, with the stock market setting records. And then the plan was to let maturing securities run off, rather than selling them outright.

“We believe that there is a sense of apprehension within the Fed with regard to moving too quickly to start reducing the size of the balance sheet, given that markets have shown much greater sensitivity to that process—judging by the infamous taper tantrum in the summer of 2013—than for the more orderly and tightly scripted process of gradual rate increases so far,” says Anthony Karydakis, chief economic strategist at Miller Tabak.

Markets are supposed to climb a wall of worry. Now, however, they continue to levitate on expectations of positive, pro-growth fiscal policies and continued accommodative monetary policies. As for the Fed, the uncertainties are relatively slight. But as “phenomenal” as the Trump tax plan may turn out to be, it’s a long way off at best.

Stop me if you’ve heard this one before. After a long spate of easy money, seemingly high-returning investments burgeon in popularity. Even if they’re rather opaque, their credulous but happy investors don’t mind, as long as the returns keep coming. Then, as the tide of easy money recedes, it’s apparent who has been swimming naked, to use Warren Buffett’s famous metaphor, and—to cite George Costanza’s equally famous observation—who has been subject to shrinkage.

It was after the financial crisis burst open that Bernie Madoff’s Ponzi scheme fell apart. Prior to that, many eminent financial institutions eagerly fed clients’ cash into Madoff’s funds without asking too many questions, as long as the returns came like clockwork. And those returns were just too regular to be true, coming without fail as the Fed steadily tightened policy from 2004 to 2007 and even after the mortgage bubble went bust afterward.

A similar scenario appears to be building again in China, according to J Capital Research’s Anne Stevenson-Yang. While there have been defaults of peer-to-peer lending and so-called wealth management products, the underpinning of these schemes—the property market—looks increasingly vulnerable, she writes in a report titled “Before the Deluge.”
 
The investments involve perhaps thousands of boiler-room companies, bombarding anybody with a Chinese mobile phone with cold calls, as well as pitching on online platforms. “Both high levels of liquidity and the credibility of these investments—up until now—are keys to their success,” she writes. But this is a “greater-fool business in which new money raised covers returns to earlier investors or simply losses from previous fund investments.”

In one case she cites, rising defaults are obscured by increasing loan volumes, in a manner reminiscent of LendingClub (LC), whose plunge followed presciently negative stories in Barron’s in 2015. Stevenson-Yang calls another a “straight-up loan-sharking company.”

Meanwhile, the biggest and best-run of the lot features all kinds of curious accounting, including earnings up just 2.9% in the third quarter while assets soared 49% from a year earlier. Its business includes sales of bundles of real estate loans, with 40% to 50% going to related entities, which typically raises red flags.

Disclosure is vague and shifting, and the luxury property ventures aren’t selling, but relationships matter more—as was the case with many of Madoff’s investors.

The Wild West atmosphere of Chinese investing is nothing new, of course. What’s different now is that the People’s Bank of China has been tightening its monetary policy, including engineering an uptick in its key money-market rate.

Research firm BCA notes that repurchase-agreement transaction volumes in the interbank market also have dropped since late last year. Along with regulators’ curbing of banks’ wealth management products and off-balance-sheet items, these actions “underscore the determination to rein in excesses in the banking sector,” BCA adds.

That could be viewed as the domestic counterpart to the PBOC’s actions to prop up the yuan in the face of capital flight. As Kopin Tan writes in the Streetwise column, that has drained China’s foreign-exchange reserves to below the $3 trillion mark. The capital outflow has slowed as Chinese authorities have stiffened restrictions on taking money out of the country. But it seems that rich Chinese want to move their funds before the deluge, as the title of Stevenson-Yang’s report suggests.