Sevens Report: September 2017

Friday 29 September 2017

Virtuous vs. Non-Virtuous Reflation Trades

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Can the economic data support a continued bullish “reflation” trade in the markets? So far, the events of this week (strong Durable Goods, “progress” on pro-growth tax reform) have supported that idea, and that’s why the S&P 500 is sitting at fresh all-time highs.

But, the next seven days will present both risks and opportunities for the reflation trade to accelerate, or falter.

In yesterday’s issue, I referenced a “virtuous” reflation trade—one that is positive for the broad stock market and especially positive for our reflation basket.

In this scenario, 1) Inflation firms and gradually accelerates, 2) Growth accelerates modestly, 3) Central banks gradually raise rates but not at a pace that unnerves the stock market or sends yields too high, to quickly.

That’s what we’ve seen from the data starting almost three weeks ago with the Chinese inflation numbers
(followed by firm British CPI and US CPI). That’s why stocks have rallied, and it’s why our reflation basket has outperformed.

Conversely, there is a “non-virtuous” reflation we need to be aware of. In this scenario, growth and inflation accelerate too quickly, and markets begin to price in a more hawkish Fed, ECB and BOE.

In this scenario, while banks and other ETFs listed in our reflation basket would either outperform on an
absolute basis and/or on a relative basis, the rest of the market might not fare as well (particularly tech).

This is what we saw in June, where the declines in tech weighed so much on the market that it began to “suck in” other, more cyclical sectors. This is the negative side of reflation we need to watch for in the weeks ahead.

Bottom line, the market now again nearing a tipping point, and the data today and next week will go a long way to telling us 1) Whether we’re seeing a legitimate reflation, and 2) Whether it’s virtuous (bullish).

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Thursday 28 September 2017

Reflation On? Why the Durable Goods Number Was Important, September 28, 2017

Durable Goods
• August Durable Goods rose 1.7% vs. (E) 1.5%.

Takeaway
Wednesday’s Durable Goods report was a surprisingly strong number, and if it’s the start of a trend in the data, then we could finally be seeing an economic reflation.

The reason the Durable Goods number was so strong wasn’t because of the headline (it was a mild beat, but revisions largely offset it), but instead because of the key New Orders for Non-Defense Capital Goods ex-Aircraft (NDCGXA). NDCGXA surged 0.9% vs. (E) 0.3%, and the July number was revised sharply higher to 1.1% from 0.4%, signaling that business spending and investment accelerated during the summer.

That’s a legitimately positive surprise, as business spending and investment have been lackluster so far in 2017.

But if we see that activity pick up (and importantly close the gap between actual data and survey data), then that will help push broad economic growth higher. And if inflation keeps accelerating, then we’ve got a legitimate reflation.

Stocks reacted accordingly to this surprisingly good data, as the market rallied (growth is good) and was led higher by our “reflation basket” of banks (KRE), industrials, smalls caps, and inverse bond ETFs. That carried through to other assets, as bond yields surged on the news to new multi-week highs while the dollar also broke above 93.00.

Bottom line, this was a legitimately positive surprise for markets, and stocks and the dollar/bonds reacted accordingly. However, one number does not make a trend, so we’ll need to see continued acceleration in other data (industrial production) before we can confidently say the gap between very strong, “soft” survey data and actual, hard economic numbers is closing in a bullish way. Still, yesterday’s number was definitely a good start.

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Wednesday 27 September 2017

Tax Cut Preview, September 27, 2017

Today we should see the next step in the tax cut drama, as Republicans unveil a more detailed tax cut plan. But while some of the headlines around this are sure to seem “pro-growth” and positive, it’s important to realize that almost nothing announced today will actually make it into any legislation (and it doesn’t remove the chances nothing gets done at all).

Still, tax cuts are the most credible and legitimate “bullish” or “bearish” wildcard remaining for the markers in 2017.

From a bullish standpoint, real tax cuts could easily push the S&P 500 up another 4% (to 2610) because that will increase expected 2018 EPS to (conservatively) $145/share.

From a bearish standpoint, while tax cuts aren’t fully priced into stocks, there is the expectation something does get done, especially regarding foreign profit repatriation. If tax cuts, like healthcare, fail, then we’re now sitting with a market at 18X next year’s earnings—and no identifiable future growth catalyst (and a Fed raising rates). That will cause investors to reduce exposure.

Regarding today’s announcement, here’s what’s (generally) expected:
1. Corporate rate cut to 20% from the current 35%.
2. 10% tax on foreign profits (this is the foreign profit repatriation piece).
3. Individual top rates cut to 35% from 39.5%.
4. “Pass through” rate cut to 25% from 39.5%.

Again, little (if any) of this will make into final legislation.

But, it’s the starting point for negotiations to a potential deal.

Bigger picture, the expectations for tax cuts (what makes them bullish of bearish) won’t change regardless of today’s details.

To review, from a corporate rate standpoint…

What’s Expected: Corporate rate cut to around 28%.

Likely market reaction: Mildly positive.

Bullish If: Corporate rate cut below 25%. Likely market reaction: Reflation basket outperforms.

Bearish If: Corporate rate doesn’t change. Likely market reaction: Modest Decline, but not a bearish game changer.

Foreign Profit Repatriation Holiday: Expected to pass.

Likely market reaction: (Withheld for subscribers only—unlock specifics and ETFs by signing up for a free two-week trial).

Wildcard to Watch: I was actually surprised and encouraged to see that a “pass through” rate cut is in this proposal. This is very important to small businesses (like mine). Approximately 95% of American businesses are “pass through” (LLCs, S Corps, etc.) where the business owner is taxed at the individual rate. So, in many ways that makes corporate tax cuts just important for large corporations and shareholders.

A cut to the pass through rate lowers taxes for small business, and that could be a potentially significant (and unexpected) positive for the economy, if any of this actually gets passed into law (and that remains very much in doubt).

Bottom line, don’t let positive (or negative) headlines fool you today. The tax cut fight has only just begun, but how it works out will have potentially significant consequences for the economy. We will remain on top of it for you throughout the process.

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Tuesday 26 September 2017

North Korea Update, September 26, 2017

Starting at last week’s UN General Assembly, the war of words between US and North Korean leaders has been steadily escalating, but things got even more serious yesterday for two reasons.

First, the North Korean foreign minister said Trump had “declared war” on North Korea with his tweets.

Second, the same foreign minister said North Korea reserves the right to shoot down US bombers, even if they are not in North Korean airspace.

This is no doubt in retaliation to the US flying bombers very close to North Korea in a recent show of
force.

Of the two statements, the later is much more important than the former for this simple reason: The
war of words can escalate, but the event that makes North Korea a bearish game changer for stocks would be the firing (but not necessarily striking) of a missile or rocket at anything US, including planes or Guam.

The North Korean threat to fire a missile at US war planes operating outside of North Korean airspace ups
the ante and creates another opportunity for a potential incident.

From a market standpoint, despite the uptick in tension, and despite yesterday’s mid-day dip, I don’t think the North Korean threat is going to cause a pullback, at least not in its current situation. Taxes (will we get cuts?), rates (will they rise?), inflation (will it gain momentum?), the dollar (will it appreciate?) all are much more important in the near term for stocks than North Korea.

But, that said, clearly this is something that can still move markets and dominate the headlines, so we’ll continue to watch it for you and look for signs of it legitimately becoming a bearish game changer for stocks.

For now, and until North Korea shoots at something US, the situation remains more bluster than bearish (although it still makes me uncomfortable).

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Monday 25 September 2017

Weekly Market Preview, September 25, 2017

Friday 22 September 2017

When Will Rate Hikes Kill The Rally?

Thursday 21 September 2017

Is It Time to Buy Our Reflation Basket, September 21, 2017

Trading Color and Bottom Line: Is It Time To Allocate to Our “Reflation Basket”?

There’s a simple question that we need to address following the Fed’s hawkishly interpreted announcement: “Is it now time to rotate out of defensives (super-cap internet, healthcare, utilities, staples) and into cyclicals/reflationary sectors?”

I bring this up for two reasons.

First, getting this rotation right was the key to outperforming in 2016, and I don’t think it will be different this year. Second, there are growing signs that it may be time to make this tactical rotation.

Looking at the sector trading yesterday, it was a classic “reflation rotation.” Tech, utilities and consumer staples (sectors that have outperformed YTD) all lagged the market while cyclical sectors (which have badly underperformed) rose. Meanwhile, banks surged 1.1%, energy rose 0.35% and industrials gained 0.73%, while consumer discretionary rallied 0.34%. Additionally, small caps (which have been laggards YTD but are playing catch up in a hurry), rose 0.35% and the Russell 2000 was again the best-performing major index.

So, to answer the question of whether we need to begin to rotate into these cyclical sectors, I believe the answer depends on your time frame.

For medium- and longer-term investors, I continue to believe the answer is “no,” or at least “not yet.”
However, for short term oriented, tactical traders/investors, legging into some reflation/cyclical sectors at
these levels could make sense.

For medium and longer term investors/advisors, I’m looking for two key indicators to tell me when to rotate
into cyclicals.

First, I want to see the bank index ($BKX) hit a new high for the year. That means trading above $99.77, and closing above $99.33 (so call it 100 to make it easy).

Second, I want to see 10-year yields close above 2.40% (currently 2.28%).

If those two signals are elected, then for medium- and longer-term advisors/investors, I would advocate booking (large) profits in healthcare (XLV/IHF/IBB), super-cap internet (FDN), consumer staples (XLP) and utilities (XLU).

And, I would advocate allocating those dollars to our “Reflation Basket” we introduced earlier this summer: KRE/KBE (bank exposure), XLI (global industrials), IWM (small caps), TBT/TBF (short bonds). Additionally, I view yesterday’s price action as position for European financials and EUFN specifically.

Again, for those investors who are nimble and can stand some pain, establishing positions now does make some sense. But, for the remainder (again medium– and longer-term investors) I’d wait until those two indicators (BKX and 10-year yield) have been elected.

Regardless, we are witnessing a potential sea change in the outlook for central bank policy, and that’s going to require more vigilance on the part of advisors and investors.

If the global rate-hike cycle is now underway, then the proverbial hour glass just got flipped and the sand is now running out on the eight-year bull market (more on that in tomorrow’s issue).

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Wednesday 20 September 2017

Import and Export Price Analysis, September 20, 2017

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Import and Export Prices
• Import Prices rose 0.6% vs. (E) 0.4% in August
• Export Prices rose 0.6% vs. (E) 0.2% in August

Takeaway
A normally overlooked price report, Import and Export Prices came out yesterday and the release is worth mentioning. The headlines showed a decent upside beat in both import and export prices, which underscored the uptick in inflation we saw last week in several overseas CPI reports including China, Britain and India.

The reason this is worth pointing out is the bond market. Over the last several weeks, firming inflation overseas has become a recurring theme that has started to influence global fixed income markets, including Treasuries, pushing yields higher despite the fact that US inflation still remains very low.

Bottom line, yesterday’s Import and Export Prices report is showing the effects of both a weaker dollar, but also the fact that global inflation is beginning to edge higher.

From a macroeconomic standpoint that is encouraging for the reflation trade argument.

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Tuesday 19 September 2017

FOMC Preview, September 19, 2017

On the surface, tomorrow’s FOMC meeting is expected to be relatively anti-climactic. The Fed is expected to go forward with balance sheet reduction while keeping interest rates unchanged. But, this is a meeting where the Fed will produce updated “dots,” and combined with the fact that the market is very complacent with regards to a December rate hike (i.e. the market doesn’t expect it) there is the chance for a hawkish surprise.

From a practical standpoint, the key here is how the 10- year yield reacts. If the Fed is marginally (or outright) hawkish and the 10-year yield pushes through short-term resistance at 2.27% and longer-term resistance at 2.40%, that could be a tactical game changer and warrant profit taking in defensive sectors, and rotation to more cyclical sectors.

Hawkish If: The Fed provides a (very) mildly hawkish surprise if the “dots” show one more rate hike in 2017 (so unchanged from June). Specifically, in June four Fed votes expected just two rate hikes in 2017. If that number decreases to three or two, it will be a mild hawkish surprise. The Fed will provide a more serious hawkish surprise if the dots show another rate hike in ’17 and an additional rate hike in 2018 (so the median dots staying at 1.375% for ’17 and rising to 2.375% from the current 2.125% in ’18).

Likely Market Reaction. Stocks: If it’s a mildly hawkish surprise, then it should…(withheld for subscribers only—unlock specifics and ETFs by signing up for a free two-week trial).

Meets Expectations If: There are no changes. The median dots still signal a December rate hike is expected, but one or two Fed officials change their dot to reflect just two rate hikes in 2017. That would imply a December rate hike is far from certain (matching the market’s current expectation) and it would be taken as mildly dovish.

Likely Market Reaction. Stocks: Cyclicals and bank stocks would likely see some…(withheld for subscribers only—unlock specifics and ETFs by signing up for a free two-week trial).

Dovish If: The dots show that more than four Fed voters switch their dot to reflect no rate hike in December. That would effectively put a December rate hike off the table.

Likely Market Reaction. Stocks: A decidedly week (on a sector level). Stocks would likely rally in an
algo-driven…(withheld for subscribers only—unlock specifics and ETFs by signing up for a free two-week trial).

Wildcard to Watch: Balance sheet reduction. Everyone expects the Fed to commence balance sheet reduction tomorrow, but they haven’t ever explicitly said they will reduce the balance sheet in September. So, there is a slim chance they might not, and that they might opt to wait for the next meeting (in November). This is a remote chance, as the Fed has clearly telegraphed the balance sheet will be reduced in September, but it’s possible for a last-minute change.

Likely Market Reaction: Very dovish…(withheld for subscribers only—unlock specifics and ETFs by signing up for a free two-week trial).

In all likelihood, this Fed meeting should meet expectations, but that will leave the market at risk to a potential hawkish surprise later as investors are not pricing in a December rate hike despite the Fed signaling it all year.

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Monday 18 September 2017

Weekly Market Preview, September 18, 2017

Friday 15 September 2017

Is an Economic Reflation Finally Starting, September 15, 2017

Assuming that North Korea is another temporary headwind on stocks (and again it will be temporary as long as they don’t shoot a missile at Guam), then the bigger story of the week is the outperformance of the cyclical sectors and the underperformance of YTD sector outperformers (super-cap internet, utilities, etc.).

I continue to believe that if we are going to see the stock market extend this 2017 rally, it will have to be driven by the expectation of an economic reflation. And, after months of lack luster inflation data, this week provided some hope for that cause. Now, today’s growth data needs to be better than expected to complete the week.

But, even then, one month does not make a trend—so I’m not saying abandon utilities, healthcare and super cap internet for banks and small caps. All I’m saying is that we need to be prepared to make a switch, if we get the compelling signals in the near future.

Regardless, the upcoming economic data (especially the Core PCE Price Index at the end of the month) just got a lot more important.

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Thursday 14 September 2017

CPI Preview, September 14, 2017

I normally don’t do CPI previews (sometimes if it’s a non-event number, I won’t even bother you with a CPI review), but this number is different for two reasons.

First, the fledgling hopes of an economic reflation have pushed stocks to new highs. Second, if this CPI report does meet or beat estimates, then it might continue the sector rotation that has seen cyclical sectors (banks in particular) outperform this week at the expense of YTD outperformers such as utilities, healthcare and super-cap internet. So, it will raise the question of whether a tactical rotation is necessary.

Hawkish If: Core CPI beats the 0.2% m/m expectation.
Likely Market Reaction (assuming it’s a small beat): Stocks should continue to rally. Look for Treasury yields and the dollar to continue to rally, and for..(withheld for subscribers only—unlock specifics and ETFs by signing up for a free two-week trial).

Neutral If: Headline CPI meets the 0.3% m/m expectation while core CPI meets the 0.2% m/m expectation. Likely Market Reaction: A mild continuance of the…(withheld for subscribers only—unlock specifics and ETFs by signing up for a free two-week trial).

Dovish If: CPI misses the headline or core expectations of 0.3% m/m or 0.2% m/m. Likely Market Reaction: An unwind of the…(withheld for subscribers only—unlock specifics and ETFs by signing up for a free two-week trial).

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Wednesday 13 September 2017

Green Shoots of A Global Reflation, September 13, 2017

Are We Seeing “Green Shoots” of A Global Reflation?
• Chinese August CPI rose 1.8% yoy vs. (E) 1.7% yoy.
• British Core CPI rose 2.7% vs. (E) 2.5% yoy.

Takeaway

Are there “green shoots” of inflation? I reference the Bernanke comments regarding economic growth here, because very quietly we’ve seen two better-than-expected inflation numbers in two big economies (technically three if you count the uptick in Indian CPI,although that’s not widely followed).

August Chinese CPI beat (it came out Friday but couldn’t be priced in until markets opened on Monday) but it was the big uptick in core British CPI that saw the market extend the rally on Tuesday.

So, the logical question, given these two surprise beats is, “Will US CPI also surprise markets?”

The inclination is to believe in the trend, but to be clear, higher Chinese and British CPIs have no real bearing on US CPI—so strong numbers in those two reports don’t increase the likelihood of a strong CPI number.

But, if it comes, expect some potentially big market moves across Treasury yields, the dollar, and in stock
sector trading (banks and cyclicals will scream higher while defensives, including parts of tech, will likely badly lag). But again, that will depend on tomorrow’s number.

From a market standpoint, looking at the effects of the strong Chinese and British CPI, the clear ETF winner is…(withheld for subscribers only—unlock specifics and ETFs by signing up for a free two-week trial).

I continue to believe that an economic reflation (better growth, higher inflation) remains the key to a sustained US and global stock rally. And while two numbers don’t make a trend, they were the first positive surprises we’ve had on inflation in months, and we think that’s potentially very important (if it continues).

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Tuesday 12 September 2017

New Stock Highs, September 12, 2017

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Stocks surged to a new record high on Monday after the damage from Hurricane Irma wasn’t as bad as feared, and in the absence of North Korea performing an ICBM test over the weekend. The S&P 500 rose 1.08%.

Stocks were higher from the start on Monday thanks to the two aforementioned positive catalysts: Hurricane Irma and North Korea. Both events turned out to be not as bad as feared, and that caused a classic “buyers chasing” rally.

Reflecting the fact that it was those two “not negative” macro catalysts that sent stocks higher on Monday was the fact that the S&P 500 gapped higher at the open and rallied throughout the morning on that buyers chase. Then, stocks spent the afternoon grinding sideways near the day’s highs.

Outside of Irma/North Korea, there weren’t any notable catalysts in the markets Monday. Economic data was non-existent, as was any notable political or geopolitical news (outside of North Korea). Also helping stocks rally was the fact that the week’s important events (CPI, Retail Sales, Industrial Production) are on Thursday and Friday, and there aren’t many looming catalysts on the calendar between now and then.

Stocks maintained their gains into the close to finish the day at a new all-time high.

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Monday 11 September 2017

Weekly Market Cheat Sheet, September 11, 2017

Friday 8 September 2017

EIA Report Analysis and Oil Update, September 8, 2017

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Yesterday’s EIA report was taken with a grain of salt, as the effects of Hurricane Harvey badly skewed the data resulting in a print that was basically worthless from a fundamental analysis standpoint. As would be expected with a large number of refinery outages, crude stocks rose +4.6M bbls, but that was slightly less than estimates calling for a +5.0M build.

EIA Report Analysis and Oil Update

Meanwhile, both gasoline and heating oil inventories declined (as refineries runs were way down) by -3.2M bbls and -1.4M bbls, respectively (but both declines were smaller than expected). On balance, the headline prints were largely dismissed. WTI finished the day down 0.22% while RBOB gasoline futures fell 0.98%.

The production portion of the report was a little shocking at first glance, but at the same time, the data made sense when you consider the impact Harvey had on the Gulf Coast oil industry. Lower 48 production declined -783K b/d last week, or 94% of the 2017 output gains.

For perspective, the average weekly change coming into this week was +24K b/d. Like the headlines, the production data was largely overlooked by traders because the data was so badly skewed by Hurricane Harvey.

Looking ahead, it will be very important to watch the production data. If output does not recover in a swift manner that will be a bullish supply side development, as the relentless grind higher in US oil output has been the single-largest headwind for oil prices this year. For now, the outlook for oil is neutral with a bias to the downside, as nothing has changed materially enough to push futures through resistance between $50 and $54/barrel in WTI.

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Thursday 7 September 2017

Why the Debt Ceiling Deal Isn’t a Positive for Markets, September 7, 2017

Bottom Line: Fischer & Debt Ceiling Not Market Positives

The two big news items Wednesday were the resignation of Fed Vice Chair Fischer, and the agreement on a three-month debt ceiling extension/government funding deal.

Starting with the former, Fischer’s resignation makes the Fed very slightly more dovish (Fischer was a modest hawk) but really the future path of Fed interest rates depends a lot more on inflation data than it does Fed personnel.

From a market standpoint, the odds of a December rate hike appropriately declined slightly Tuesday. But again, Fischer’s departure isn’t a dovish gamechanger, and if inflation metrics move higher between now and December we’ll still get a rate hike. From a stock standpoint, other than the temporary pop yesterday, I don’t see this news as an influence.

Turning to Washington, as usual, politicians have kicked the can down the road. On a positive note, we won’t see a debt ceiling drama or shutdown drama in late-September.

On a negative note, we likely will see an even more intense budget battle into the year-end. This will be all the more contentious because now tax cuts will be thrown into the mix, assuming Republicans have a concrete plan by then.

From a market standpoint, this is a very short-term positive in so much as it removes the possibility of a crisis over the next few weeks.

However, it sets up an even bigger potential negative into the end of the year. Bottom line, the debt ceiling/government funding agreement is not an incremental positive for markets, and we don’t expect it to push stocks higher from here.

In sum, both of Wednesday’s headlines had no real impact on our overarching macro view. We remain cautiously positive on stocks, but continue to believe that tax cuts and earnings hold the key to performance for the remainder of 2017.

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Wednesday 6 September 2017

European Central Bank (ECB) Interest Rate Preview, September 6, 2017

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The ECB is expected to signal it will begin to taper its QE program sometime in 2018 at tomorrow’s meeting; however, the details regarding that tapering announcement remain unclear.

Why It Matters: The dollar. The falling dollar, which is down more than 10% year to date, has been an under-appreciated tailwind on the stock market (a weaker dollar boosts exports and corporate profits). If the ECB is more hawkish than expected tomorrow, that will cause a potentially big reversal in the dollar. I say that, because “long euro/short dollar” is a very crowded trade at the moment, and if it reverses, it could be violent.

The reason this meeting will punch above its weight from a market standpoint is because the ECB commentary on tapering will be (correctly) taken as implicit commentary on the strength of the euro.

The market assumes that the ECB is not concerned about current euro strength. If the ECB fails to announce tapering intentions tomorrow, or is very vague about those intentions, the market will infer that the ECB thinks the euro is too high. If that happens, the euro will drop, hard, and the dollar will soar—and that will likely be a headwind on US stocks, and a (big) tailwind on European stocks (so HEDJ will begin to rally again).

Meeting Expectations If: ECB President Draghi confirms, at the press conference, that the ECB Governing Council intends to taper QE in 2018, and that it will reveal details of that plan at a future ECB meeting. So, Draghi announces tapering is coming, but doesn’t give any details.

Dovish If: Draghi does not announce the intention to being tapering QE sometime in 2018. This is a remote possibility, but given the strength in the euro I don’t want to completely rule it out.

Mildly Dovish If: Draghi announces that the ECB intends to taper QE, and that it will announce the details at the December meeting, at earliest. Draghi likely won’t single out December, but he won’t say details will be revealed at the “next” meeting, which would be October.

Hawkish If: Draghi announces that the ECB intends to taper QE, and says the details of the taper will be revealed at the “next” meeting. That’s the key phrase to watch for. If that’s the case, look for the euro to modestly rally as there is not clear consensus on an October reveal, and that would be taken to interpret urgency on the part of the ECB, and a disregard for the strength in the euro. It’s the latter point that would cause the euro to rally.

Finally, I don’t want to say that something is impossible, but it’s incredibly unlikely that Draghi and the ECB will reveal detailed plans regarding the tapering of QE tomorrow. The wide consensus will only be to announce they want to start tapering QE.

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Tuesday 5 September 2017

3 Catalysts for the Market, Plus a Wildcard to Watch, September 5, 2017

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Ever since I started my career I’ve viewed the post Labor Day time in the market as the “make or break” period of the year—because I’ve found the September-December months provide an inordinate share of both risks and opportunities for portfolios… and I believe this year will be no different.

So, as we start this “stretch run” into the end of the year, the current market set up remains as follows: Stocks have had a great year from a return standpoint, and momentum and the benefit of the doubt remain with the bulls. Yet at the same time, cracks are appearing in this Teflon market, and as such I view the market as being at much more of a tipping point than most analysts.

I believe we will either get the positive catalysts that will send stocks higher between now and year end, or the forces that have powered stocks higher throughout 2017 (earnings growth, momentum) will begin to recede, potentially opening an “air pocket” like we saw in August 2015 and early 2016.

I want to spend time today focusing on the key catalysts that I believe will decide whether the market extends the 2017 gains between now and year end, or whether we see a pullback.

But before I go into these catalysts, with regards to the weekend’s news, it goes without saying that a military conflict with North Korea is a near-term bearish gamechanger.

To be clear, I do not think that it will happen, but at the same time the level of tension here is rising considerably. If there is a military strike against North Korea, reducing tactical positions will be prudent, and it’s one reason why I continue to advocate buying puts on the Nasdaq or Russell with September or October expirations.

Away from North Korea, the catalysts that, in our opinion, will make or break 2017 are: Tax cuts, earnings, and the ECB/Fed decisions.

3 market catalysts to watch

Catalyst 1: Tax Cuts. Why This Matters—It Could Spark Another 5% Rally (Easily). Tax cut disappointment is a risk to the markets, but in reality, the likely market implications for the tax cut issue are either 1) Nothing, or 2) Positive.

I say that for a simple reason… the market is expecting very little in the way of tax cuts (28% corporate rate, foreign profit repatriation). So, it’ll take literally no change to the tax code to really disappoint markets and cause a tax cut related pullback. Conversely, the market has not priced in 25% (or lower) corporate tax rates and aggressive foreign profit repatriation. If that happens, expected 2018 S&P 500 EPS will rise immediately to $145/share (conservatively), which should allow the S&P 500 to rally close to 5% and still not breach 18X 2018 earnings.

Key Dates: There needs to be a formal bill introduced into one of the chambers of Congress by mid-October if we’re going to get something done by early 2018. If there’s no bill by then, look for stocks to be mildly disappointed. If there’s nothing by year end, look for it to be a headwind.

Catalyst 2: Earnings. Why This Matters—It Could Make the Market Too Expensive on a Valuation Basis. The 2017 earnings estimate for the S&P 500 is about $131/share. The 2018 S&P 500 earnings estimate is $140/ share. That’s about 7% yoy earnings growth—so that’s accounted for the vast majority of the S&P 500’s 10% YTD return.

But, there are some early signs that the growth rate of earnings is starting to peak. More specifically, a good Q2 earnings season failed to spark much of a rally in the market, so if Q3 earnings disappoint (even a little bit) that could cause some concern about that $140 2018 S&P 500 EPS, and investors might begin to book profits, which could easily snowball given extended valuations.

Key Dates: Oct. 9. That’s the unofficial start of Q3 earnings season (the big banks report that week).

Catalysts 3: Fed/ECB. Why This Matters—The Dollar. The ECB decision on the announcement of tapering (which will come this Thursday), and the Fed’s commentary at the meeting on Sept. 20, will be important for the markets for one main reason—currencies.

The Dollar Index is near multi-year lows on the expectation of ECB tapering, and that’s been an unsung tailwind on the markets so far in 2017. But, if the ECB surprises this Thursday and doesn’t announce its intention to taper QE starting in 2018, the dollar will surge and the euro will drop, and that could be a surprise headwind on U.S. stocks.

Additionally, since July the market has largely convinced itself that the Fed won’t hike rates in December, but it’s important to realize that Fed leadership (Yellen, Dudley, Fisher) haven’t really confirmed that expectation. If economic data gets better between now and then, even with low inflation, the market could have to price in another rate hike, which could also be a near-term head-wind.

Key Dates: Sept. 7 (ECB Meeting), Sept. 20 (FOMC meeting).

Wildcard to Watch: Withheld for subscribers. Unlock with a free two-week trial subscription to the Sevens Report.

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