The Year of Living Dangerously

Jim Woods

It was one year ago today when America elected Donald J. Trump to be its 45th president. The incredibly unlikely ascent of the billionaire businessman to the highest office in the land defied the odds, stunned the world and rewrote the book on political propriety.

The Trump victory also has brought about something that few pundits (although there were some) failed to predict. That something was the rise of hope.

This is a hope laced with optimism, and a renewed sense that the economy finally had a chance to extricate itself from the shackles of onerous big-government regulations, mandates and high taxation.

Indeed, it’s that hope that’s driven financial markets to one of their best years in a very long time. The chart below of the S&P 500 Index over the past 52 weeks clearly shows the dramatic 21.2% ascent in markets since Election Day last year.

As you can see, markets have barely tested the 50-day moving average (blue line) let alone tested the long-term, 200-day moving average over the past year. That move is a testament to the Trump pro-growth hope trade that remains intact… yet that’s clinging precariously.

In fact, one could describe this market in literary terms as, “The Year of Living Dangerously.” That’s a reference to the 1978 C.J. Koch novel of the same name, which also was made into an outstanding, and highly recommended, 1982 film of the same name.

I say that because we are dangerously close to failing on all three fronts that ignited the Trump hope trade.

Those three fronts are: Increased infrastructure spending, deregulation (the main component here was the repeal/replace of Obamacare) and, most importantly, tax reform.

Well, Washington is currently 0-3 so far, but there’s still a chance to get that most-important big win, and that’s tax reform. Unfortunately, tax reform is no guarantee.

Moreover, the proposed tax reform I’ve seen so far doesn’t represent the kind of big economic stimulus I was hoping for. Now, to be fair, I am a purist on taxation, so zero income tax is my idea of proper (and moral) taxation.

That said, what’s come from the House so far is, I fear, a lukewarm proposition that cuts some taxes, but that does not go far enough in terms of an overseas profit repatriation plan, or in terms of individual tax rates. Those individual rates also include the controversial high-profile reductions in state and local taxes, and restrictions and caps to mortgage interest deductions.

If this market is to continue the Trump hope trade, we need to see improvement on the tax front in the Senate, and then again in the House where the tax bill will go into reconciliation for its final adjustments.

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If we fail to get something substantive out of Washington, this year of living dangerously for the bulls could turn into a hostile takeover for the bears.

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ETF Talk: Explore Low-Cost Fund Options with Vanguard

The Vanguard Total Stock Market ETF (VTI) represents the biggest Vanguard exchange-traded fund (ETF) in terms of total assets, which are valued at nearly $87 billion.

As one of the most well-known ETF managers, Vanguard has revolutionized the ETF space by offering some of cheapest-to-own index funds in the business to make Vanguard attractive to investors who want to allocate their money and then forget about it for years. For example, an Investopedia article published in early 2016 found that if two of the largest and best total stock market funds, VTI and IWV (the iShares Russell 3000 ETF), were given a head-to head-comparison, IWV’s expense ratio of 0.20% was 4 times that of VTI’s current 0.05% ratio.

While inexpensive Vanguard funds are great for long-term investing, they are also an interesting option for more active traders. Investors who are interested in the approach of owning a basket of companies via an ETF, but who are put off by high expenses, can find a wide variety of options to suit their needs through Vanguard.

Specifically, VTI is a broad-based fund designed to emulate the performance of the entire U.S. stock market. For this reason, it can be used as a good benchmark. The fund includes large-, small- and mid-cap stocks, as well as a nice blend of value and growth plays.

There are other funds out there that are useful as general market investments, but few have the low expense ratio boasted by this fund. In fact, currently at 0.04%, there are few funds on the market that are cheaper, period.

Over the last 12 months, VTI has returned 21.57%. This is just a little more than the S&P 500 returned in the same period, which makes sense as the two measures are similar. VTI pays a dividend of slightly less than 2%.

Top holdings for this fund include Apple Inc. (AAPL), 2.7%; Microsoft Corp. (MSFT), 2.2%; Alphabet Inc. (GOOGL), 2.2%; Facebook Inc. (FB), 1.5%; and Amazon.com Inc. (AMZN), 1.5%. The top 10 holdings represent 17.4% of the fund’s assets.

For investors looking for ways to invest in a large basket of companies across the expanse of the stock market, and at a low price, the Vanguard Total Stock Market ETF (VTI) could be a leading contender.

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3 ETFs to Play the ‘Reflation Trade’

For much of the past two months, the equity market has been engaged in a bout of flirtation with what I’ve called the “reflation trade.”

During reflationary periods, bond yields rise as they reflect investor expectations for future economic growth and inflation.

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Also during reflation, we tend to see market sectors linked to economic growth, i.e. banks and financials, industrials, consumer discretionary and small-caps, make a concerted move to the upside.

We saw the beginnings of the reflation trade in September, as we saw a surge in 10-year bond yields, a rise in the U.S. dollar vs. rival foreign currencies and the move higher in banks, financials and small caps.

We know that by looking at two key charts — the CBOE 10-Year U.S. Treasury Yield ($TNX) and the KBW Bank Index ($BKX).

We see both 10-year yields and bank stocks surged in September, with both breaking above their respective 50-day and 200-day moving averages that month.

In mid-October, the reflation trade wobbled a bit, as we saw bond yields fall and bank stocks slide from their recent highs. Yet the recent trend of rising bond yields, and rising bank stock prices, tells us that the reflation trade is still largely in place.

For that trade to continue, I think we will need to see a couple things happen.

First, we need to see more inflation. Indeed, the lack of significant inflation metrics is quite a surprise in 2017. According to Federal Reserve Chair Janet Yellen, “The biggest surprise in the U.S. economy this year has been inflation.”

Yellen made those comments recently at the Group of Thirty’s Annual International Banking Seminar in Washington, D.C., where she expressed a sense of puzzlement as to why the inflation rate has remained below the Fed’s 2% goal, even at a time when the unemployment rate has fallen to 4.2%, its lowest level since 2001.

Second, we need to see material progress on tax reform. If Congress can manage to hammer out a tax-reform plan that contains a substantive corporate tax cut (to 20-25% from 35%), the reflation trade will get a big boost.

The question then for investors becomes: What’s the best way to position your money to take advantage of a continued reflation trade?

Here I think we can look to three exchange-traded funds (ETFs) that will position your capital to take advantage of the reflation trade.

Reflation Trade ETF #1 — SPDR S&P Bank ETF (KBE)

Bank stocks likely will be the biggest beneficiaries of the reflation trade, and that means having exposure to the segment via an ETF pegged to bank stocks will make sense.

The SPDR S&P Bank ETF (KBE) seeks to provide investment results, before fees and expenses, that correspond generally to the total return performance of the S&P Banks Select Industry Index.

Top holdings in KBE include Comerica Incorporated (CMA), Bank of the Ozarks Inc. (OZRK) and First Horizon National Corp. (FHN).

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KBE shares have spiked nearly 12% since the September lows in a move that supports the reflation-trade thesis, and that augurs well for a continued move higher in the segment.

Reflation Trade ETF #2 — iShares Russell 2000 ETF (IWM)

The return of the reflation trade will be good for small-cap stocks, as these are the stocks most affected by a rising economic tide. Fortunately, gaining exposure to small caps is easy via the iShares Russell 2000 ETF (IWM).

This ETF is pegged to the fate of the Russell 2000 Index, and its top holdings include Kite Pharma, Inc (KITE), bluebird bio, Inc. (BLUE) and Exact Sciences Corporation (EXAS).

Since falling to its recent low in late August, IWM is up nearly 10%. Once again, it shows another confirmation sign of the reflation trade in action.

Reflation Trade ETF #3 — Industrial Select Sector SPDR Fund (XLI)

Industrial stocks will also be big beneficiaries of the reflation trade, and that means you’ll want to consider exposure to the Industrial Select Sector SPDR Fund (XLI). This fund seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of publicly traded equity securities of companies in the Industrial Select Sector Index.

Top holdings in XLI include industrial stalwarts such as General Electric (GE), Boeing (BA) and 3M Co. (MMM).

Since the September emergence of the reflation trade, XLI is up about 4.5% (from its Sept. 5 low). And while the gains have come off their October highs, a continued reflation trade likely will lift this high-flying sector back to new highs.

We just recently added one of these ETFs to our growth-oriented portfolio in my Successful Investing advisory service. If you’d like to find out which one, I invite you to check out Successful Investing today.

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Orwellian Political Truth

“In our age there is no such thing as ‘keeping out of politics.’ All issues are political issues, and politics itself is a mass of lies, evasions, folly, hatred and schizophrenia.”

— George Orwell

Perhaps the greatest political novelist ever, George Orwell seldom failed to illuminate the true nature of government, politics and its corresponding repugnant human deeds. Remember this quote as you view the political landscape, and always be suspicious of the motivations of those in power.

Wisdom about money, investing and life can be found anywhere. If you have a good quote you’d like me to share with your fellow readers, send it to me, along with any comments, questions and suggestions you have about my audio podcast, newsletters, seminars or anything else. Click here to ask Jim.

In the name of the best within us,

Jim Woods

Editor, Successful Investing & Intelligence Report

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