What matters above all else to traders and investors alike this week is that they remain focused on the two subjects that have real, long-term significance, and don’t get distracted by stories that seem more interesting, but have limited impact. By the end of the week we will know more about two of the most important drivers of this rally: taxes and Fed policy, and that is what we should be watching.
Negotiations and deliberations regarding the tax proposals from the House and Senate will continue, and the Consumer Price Index (CPI) release on Wednesday will give us a big clue as to where the Fed is headed next year. Those two things will in many ways set the tone for months to come, but there are a host of corporate stories that could distract attention.
This morning, for example, the General Electric (GE) saga continues. It is a fascinating corporate story with plot twists worthy of a soap opera and does have some general implications. GE became, in many ways, the ultimate conglomerate from the second half of the last century, expanding into multiple, diverse industries and using its sheer size to gain market share. There was, it seemed, no such thing as too big for GE, but that has changed rapidly. Now, the diversification that was perceived as a strength is seen as a major weakness, and words like "sprawling" have become part of the conversation.
After pressure from activist investors, GE has vowed to make some changes, and today is when plans were expected to be unveiled. It has started with a bang: the announcement that the dividend is being halved has been quickly followed by a broad plan of rationalization.
The market reaction to that news illustrates how twisted this story has become. A company that, in the past, was applauded for takeovers and expansion and much of whose value was supposedly derived from its dividend saw its stock jump on the news that it was breaking apart and that said dividend had been slashed. It is a compelling story that may have long-term implications for other conglomerates, but even so, it has limited broader impact.
Another story that will attract a lot of attention this week is even more limited. Tesla (TSLA)’s promised unveiling of their semi on Thursday could be significant for that particular stock. Elon Musk has even promised that it will “blow your mind,” but it obviously means little beyond TSLA.
There is an argument that this announcement, unlike others in the past, will not even prove that significant for TSLA, let alone the broader market. Radical, stunning concepts, that argument goes, are plentiful at Tesla, and another will not really move the needle, especially without a believable timetable for production.
In the long term, autonomous electric trucks probably represent the future of freight haulage, however, so some attention is warranted.
A case can therefore be made for following both of those stories as they break, but the most relevant news for investors will come from two much more mundane sources, politics and data.
Most observers believe that a tax bill of some kind will be agreed on soon. The President has asked that it be done before Christmas, and last week’s elections and the admittedly remote possibility of losing a Senate seat in Alabama will have done wonders for Republicans’ focus. Tax cuts were already a unifying policy for the party, but add in those other factors and an out and out rebellion this week seems unlikely. That will be supportive of stocks, but any wobble along the way will result in volatility.
The other news of significance is harder to read.
The CPI data due to be released on Wednesday is now, it seems, the key to Fed policy. After years of saying that monetary policy would be tightened when the labor market suggested the time is right, we have now moved to looking at inflation, as measured by CPI. We are at, or very near, what is to all intents and purposes full employment, but there is no sign of inflation to this point.
That has led the Fed’s board to conclude that there is no harm in continuing with ultra-low interest rates and allowing QE to reverse only passively by not replacing maturing bonds rather than actively selling holdings.
CPI is expected to come in at a slightly reduced annual increase of 2%, which you would think would mean more of the same from the Fed. There are, however, a couple of problems with that. The new Fed Chair, Jerome Powell, has been more hawkish than Janet Yellen in the past, and the Fed will be aware of the potentially stimulative effects of tax cut. That may make them see even an “as expected” number for CPI as reason to move a little more aggressively, and a higher than expected print would definitely have traders worried about that.
As with taxes, though the reality may not be as bad as the fear. Powell is a businessman and a political animal, not an economist, so risking a little inflation to encourage growth, especially when his party is in control, may not seem as big a deal to him as it would have been to Yellen, or for that matter, Bernanke, Greenspan, or Volcker.
There are then reasons to believe that neither taxes not CPI will upset the apple cart as their stories unfold this week, but both have the potential to do so. That makes them far worthier of your attention than the situation at GE or the latest announcement from Tesla, even if those will receive more coverage from financial media. Stay focused!