Covenant Weekly Market Synopsis for December 1, 2017

December 4, 2017

13 is not an unlucky number for this bull market as November marked the thirteenth consecutive month of gains for the S&P 500 (inclusive of dividends). This streak is not unprecedented (since 1871 there have been six occasions where total returns were positive in 12 or more months according to Bloomberg), it’s just unusual. In case you were wondering, the longest streak was 15 positive months from March 1958 until May 1959. Time will tell if this bull market has the stamina to challenge the record and reach 16 months (mark your calendar to check back at the end of February 2018). Momentum is certainly on the bull’s side at this point.

Below is a quick summary of monthly and year-to-date performance for a handful of key indices, while more detail on weekly, month-to-date and year-to-date asset class performance can be found if you click here.



Emerging Markets



EAFE (Europe, Australasia, Far East)



MSCI All Country World Index



S&P 500



Barclays Aggregate Bond Index



Source: Bloomberg and Covenant Investment Research


Tax Cuts? – As the Senate and House Republicans push closer to passing tax reform policy, most sell-side analysts expect the plan’s reduction in the corporate tax rate to 20% will provide a boost to corporate earnings. It seems logical that if corporations are currently paying out 35% of pre-tax profits, that a reduction in the rate to 20% would yield higher earnings. It’s just math. But what if corporations aren’t paying taxes at a level anywhere close to 35%? Well, then the “math” gets a little squirrely. The GDP data released last week showed that corporations paid $472.9 billion in taxes over the most recent four quarters through Q3 2017. Dividing this value by the pretax profits over this period of $2,281.4 billion, implies an effective tax rate of 20.7%. Don’t trust the GDP Data (provided by the Bureau of Economic Analysis)? Let’s look at the amount of corporate tax revenue actually collected by our good friends at the IRS over this same timeframe. According to their data, the IRS collected $297.0 billion in corporate taxes, equating to an effective tax rate of 13.0%. As the chart below highlights, the effective tax rate on corporations (the blue line showing taxes paid to the IRS) has been continuously below 20% since the Financial Crisis (source: Yardeni Research).




So… while the common narrative is that a lower corporate tax rate will dramatically increase profits, the reality may be different. At a minimum, there will not be a 1:1 ratio in which each % decline in the corporate tax rate translates into a % increase in profitability, at least not for those companies already experiencing a tax rate significantly lower than 35%. This inconvenient nuance likely won’t prevent stocks from rallying if the tax bill passes, but expectations of materially improved corporate profits in the future based solely on tax reform may be misguided. Having said that, even if expectations of improved corporate profits from tax reform are overdone, one positive effect of lowering the domestic corporate tax rate is that U.S. corporations will have less incentive to expand overseas. This, in turn, will increase job creation (and tax revenue for the government) at home. And that’s not a bad outcome at all.


Millennials’ White Picket Fences – Millennials are the first generation raised in an entirely digital world, which has shaped their identities as well as their political, social and cultural attitudes. With a population of 88 million, Millennials have surpassed Baby Boomers as the nation’s largest living generation and their spending habits will have a dramatic impact on the economy. One aspect of Millennials that has been noted is their apparent indifference to purchasing a home (aka living the “American Dream”) as evidenced by the relatively low cumulative homeownership level of 20-34 year olds compared to prior generations. Yet, research published last week which offers a more granular analysis of the data, including the rate of change in homeownership (as opposed to cumulative home ownership) flies in the face of conventional wisdom about Millennials. This research, which tracked the buying patterns of discrete groups of Millennials grouped by age as they got older, reveals that Millennial homeownership is accelerating. For example, in the chart below the green oval highlights homeownership growth for the two year period in which those 28-29 years old aged to 30-31 in 2012-2014 and 2014-2016. The red oval shows the same age cohorts, but for the time periods of 2008-2010 and 2010-2012.



If you consider, based on their respective ages, that 28-29 and 30-31 year-olds were experiencing the worst of the Financial Crisis in 2008 – 2012, it should not be surprising they purchased fewer homes. The bottom line is that it does not appear that Millennials are so different than previous generations when it comes to their desire for homeownership. Rather, it seems that the the Financial Crisis prevented the Millennials from being able to purchase homes, whether it was fear of the real estate market or being able to get a loan. If that is indeed the case, increased home purchases by the massive Millennial generation will bolster the housing industry, an important linchpin of the domestic economy.


Trader Humor – Low volatility has become a hallmark of financial markets over the last two years and something lamented by Wall Street traders (for whom volatility equates to opportunity). Hence, the sudden, but short-lived, 1.6% decline in the S&P that began just after 11am on Friday morning generated some “gallows humor” that was making the rounds on Wall Street that afternoon.



Be well,