Bears Return to Hibernation on Bullish Economic Data

Optimism over the economy trumped (pun intended) political risk today. The three main stock indices closed higher Friday. The bears have mauled investors this week, but today ended on a bullish note.

The Federal Reserve reported Friday that industrial production surged 1.1% in February, the strongest gain since last October. The gain in output was well above consensus expectations of a 0.5% increase. Manufacturing output in February jumped 1.2%.

The main indices nonetheless posted losses for the week, amid rising political turmoil and trade war fears. High personnel turnover and myriad scandals continue to engulf the Trump White House. At the same time, America’s trading partners are threatening retaliatory action against the president’s recently implemented tariffs. But for today at least, the bears were dormant.

Among the biggest gainers today were financial services stocks. Banks have been in the media spotlight all week, as conditions for their out-performance fall into place.

On Wednesday, the Senate passed a major loosening of Dodd-Frank financial regulations. These rules were enacted in 2010 to prevent the abuses that helped cause the 2008-2009 financial crisis. Bankers viewed them as onerous and wanted them gone.

Banking stocks got clobbered during the last recession. The 2008 meltdown sparked a reconstruction of the entire sector; long-time stalwarts went belly up. Management teams were sacked; stringent federal regulations were imposed. Massive government bailouts were handed out that needed to get repaid. Investor faith in the sector was shattered.

That was then; this is now. Financial stocks bounced back in 2017 after a challenging decade. The catalyst for the resurgence was the unexpected election of Donald Trump in 2016. Although he decried “globalist bankers” during the presidential campaign, Trump stocked his administration with veterans of the big banks.

During the 2016 campaign, Trump and the GOP vowed to roll back Democratic-inspired regulations such as Dodd-Frank. Now that they’re in power, Republicans are making good on their promise.

Among other provisions, the Senate bill passed Wednesday raises the asset threshold for being designated systemically important financial institutions. The House has taken up the legislation. On Thursday and Friday, key members of the House said they wanted to loosen regulations even further. Some form of deregulation is expected to eventually pass both chambers, with Democratic support.

It’s not just deregulation that favors banks. The fundamentals are in place for the sector to rack up market-beating growth this year.

The steady rise of interest rates makes it easier for banks to reap profits. Then there’s the $1.5 trillion tax overhaul bill signed in December by President Trump. Banks tend to take fewer deductions than other corporations; the slashing of the top corporate tax rate will prove a bonanza for banks.

This past summer was the first time since the financial crisis that all examined banks passed the Federal Reserve’s tough stress tests. Armed with solid balance sheets, financial firms have been able to increase dividend payouts and buyback plans.

Financial stocks also enjoy the highest correlation with Treasury yields, a tailwind for the sector as yields continue to rise. The 10-year Treasury yield on Friday topped 2.84%. The following data is from the Federal Reserve, as of market close today:

10-Year Treasury Yield (percent)

What’s more, increasingly confident consumers are extending their debt levels. Default rates remain low. Non-performing loans are on the wane.

But even though Congress can repeal Dodd-Frank, it can’t repeal the boom-bust cycle.

We’re now nine years from the last recession; we’re overdue. Since World War II, the time between the end of one recession and the start of another is about eight years on average. As Congress dismantles the rules that prevented the last crisis, it could be sowing the seeds of a new one.

The major indices posted losses for the week amid rising investor anxiety over tariffs and the Trump-Russia investigation. But on Friday, Wall Street decided to ignore the bad news bears.

Friday Market Wrap

  • DJIA: +0.29% or +72.85 points to close at 24,946.51
  • S&P 500: +0.17% or +4.68 points to close at 2,752.01
  • Nasdaq: +0.00% or +0.25 points to close at 7,481.99

Friday’s Big Gainers

  • Eastman Kodak (NYSE: KODK) +12.12%

Imaging company issues robust full-year guidance.

  • Jabil (NYSE: JBL) +10.07%

Electronics provider beats on earnings.

  • Quorum Health (NYSE: QHC) +4.55%

Hospital operator posts strong earnings.

Friday’s Big Decliners

  • TC PipeLines (NYSE: TCP) -10.93%

Tax ruling triggers sell-off in MLP sector.

  • Wayfair (NYSE: W) -5.99%

Demand slumps for home furnishings firm.

  • Broadcom (NSDQ: AVGO) -4.81%

Scuttled merger weighs on chip maker.

Letters to the Editor

“In your view, what are the major provisions of the new tax bill?” — Alan D.

The new tax law reduces the corporate tax rate to a flat 21% from the highest 35% rate. Lowering the corporate tax rate will boost the bottom lines of many companies, especially banks. This in turn benefits shareholders.

The new law keeps seven tax brackets but changes the tax rates, which shifts income into lower tax brackets. The long-term capital gains tax rates remain unchanged. Short-term capital gains will be taxed at the new ordinary income tax rates.

The new law nearly doubles the standard deduction, to $12,000 from $6,350 for single filers, and to $24,000 from $12,700 for married filers. About 70% of taxpayers claim the standard deduction. Most taxpayers claiming this deduction will benefit from this change.

Tax season is upon us! The filing deadline for 2017 returns is April 17. Worried about the long arm of the IRS? Send me your tax question:

John Persinos is managing editor of Personal Finance and chief investment strategist of Breakthrough Tech Profits.



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