Political Calculations
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January 22, 2018

Wall Street certainly didn't have much in the way of negative thoughts with respect to the prospects for a federal government shut down last week. Even though White House Office of Management and Budget and interim Consumer Finance Protection Bureau director Mick Mulvaney gave a "between 50 and 60 percent" chance that the U.S. Congress would fail to reach an agreement to keep the entire government open as a legislative deadline neared, which was widely known well before the market closed, U.S. stock prices went on to close on Friday, 19 January 2018 at their highest level ever.

Alternative Futures - S&P 500 - 2018Q1 - Standard Model - Snapshot on 19 January 2018

That's largely because where investors are concerned, politicians do little more than offer noisy distraction. Except for those very rare times where they might do something that actually affects the interests of investors, such as changing tax laws, it just isn't worth taking the time and energy to pay much attention to the things that grandstanding politicians say. Particularly where federal government shutdowns are concerned, seeing as there have now been no fewer than 19 since the passage of the 1974 Congressional Budget and Impoundment Control Act, which has made shutdowns like this latest one a recurring feature of how elected politicians choose to manage the U.S. government.

As for what things do attract the attention of investors, the trajectory of stock prices during Week 3 of January 2018 suggests that they are presently focusing much of their attention on 2018-Q4 and the expectations associated with that distant future quarter. Previously, we had thought investors might be splitting their focus between 2018-Q1 and 2018-Q3, but with the probability of a Fed rate hike occurring in 2018-Q3 now seemingly a low probability event, a shift in investor focus to 2018-Q4 appears to be a better explanation for what we're observing.

We should also note that the accuracy of our dividend futures-based model's projections are currently being affected by the echo effect from the past volatility of stock prices, which arises as a result of our model's use of historic stock prices as the base reference points for making its projections of the future. Here, since the magnitude of the current echo is relatively low, our model's projections for all alternative futures for the period from 11 January through 24 January 2018 are slightly understated from what they would be if no echo effect were present in the projections.

Taking that small understatement into account along with what we know about how far forward in time investors are looking, we find that the S&P 500 is tracking along the lower end of the range that we would expect they would if investors were closely focused on 2018-Q4 in setting today's stock prices, which frankly is not much different from what the unadjusted chart above indicates. To the extent that investors solidify their attention on 2018-Q4, we may have come to the end of the Lévy flight event that characterized the movement of U.S. stock prices during the first two weeks of 2018.

Regardless, outside of the better-than-even odds that the U.S. government would need to shut down a portion of its operations after Friday, 19 January 2018, there wasn't much notable in the news headlines of the third week of January 2018.

Tuesday, 16 January 2018
Wednesday, 17 January 2018
Thursday, 18 January 2018
Friday, 19 January 2018

The Big Picture's weekly listing of all the positives and negatives that Barry Ritholtz saw for the U.S. economy and markets in the holiday-shortened third week of January 2018 is up!

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January 19, 2018

One week ago, the Wall Street Journal broke the news that the World Bank had a serious problem with one of its most popular and useful products, its annual Doing Business index.

The World Bank repeatedly changed the methodology of one of its flagship economic reports over several years in ways it now says were unfair and misleading.

The World Bank’s chief economist, Paul Romer, told The Wall Street Journal on Friday he would correct and recalculate national rankings of business competitiveness in the report called “Doing Business” going back at least four years.

The revisions could be particularly relevant to Chile, whose standings have been volatile in recent years—and potentially tainted by political motivations of World Bank staff, Mr. Romer said.

The report is one of the most visible World Bank initiatives, ranking countries around the world by the competitiveness of their business environment. Countries compete against each other to improve their standings, and the report draws extensive international media coverage.

In the days since, Romer has clarified that he doesn't believe that the World Bank staff engaged in a politically-motivated strategy aimed at disadvantaging Chile's position within its annual rankings, but instead failed to adequately explain how changes that the World Bank's staff made in updating their methodology of its Doing Business index affected Chile's position within the rankings from year to year.

Looking at the controversy from the outside, we can see why a political bias on the part of the World Bank's staff might be suspected, where positive and negative changes in Chile's position within the annual rankings coincided with changes in the occupancy of Chile's presidential palace.

That's why we appreciate Romer's willingness to openly discuss the methods and issues with communication, including his own, that have contributed to the situation. In time, thanks to the demonstrations of integrity and transparency that Romer is providing today as the staff of the World Bank works to resolve the issues that have been raised, the people who look to the Doing Business product will be able to have confidence in its quality. That will be the reward of demonstrating integrity and providing full transparency during a pretty mild version of an international public relations crisis.

Not every matter involving correcting the record has the worldwide visibility of what is happening at the World Bank. We can find similar demonstrations of the benefits of integrity and transparency at a much smaller scale, where we only have to go back a couple of weeks to find an example. Economist John Cochrane made a logical mistake in arguing that property taxes are progressive, which is to say that people who earn higher annual incomes pay higher property taxes than people who earn lower annual incomes.

In search of support for his argument, he requested pointers to data indicating property taxes paid by income level from his readers, who responded with results that directly contradicted his argument. How he handled the contradiction demonstrates considerable integrity.

Every now again in writing a blog one puts down an idea that is not only wrong, but pretty obviously wrong if one had stopped to think about 10 minutes about it. So it is with the idea I floated on my last post that property taxes are progressive.

Morris Davis sends along the following data from the current population survey.

No, Martha (John) property taxes are not progressive, and they're not even flat, and not even in California where there is such a thing as a $10 million dollar house. (In other states you might be pressed to spend that much money even if you could.) People with lower incomes spend a larger fraction of income on housing, and so pay more property taxes as a function of income. Mo says this fact is not commonly recognized when assessing the progressivity of taxes.

Not only is Cochrane providing insight into the error in his thinking, his transparency in addressing why it was incorrect is helping to advance the general knowledge of his readers.

In both these cases, we have examples of problems that could have been simply swept under a rug and virtually ignored with nobody being the wiser, but where the ethical standards of the people involved wouldn't let them do that. Even in making mistakes while addressing the mistakes they made or discovered, they made the problems known as they worked to resolve them, and because they did so, we can have greater confidence in trusting the overall quality of their work.

In the real world where people value honesty, admitting or acknowledging errors is no penalty. In fact, there are solid examples where scientists have retracted papers because of errors they made that, ultimately, had zero impact on their careers. Which in some cases, involved going on to be awarded Nobel prizes in their fields.

Retracting a paper is supposed to be a kiss of death to a career in science, right? Not if you think that winning a Nobel Prize is a mark of achievement, which pretty much everyone does.

Just ask Michael Rosbash, who shared the 2017 Nobel Prize in physiology or medicine for his work on circadian rhythms, aka the body's internal clock. Rosbash, of Brandeis University and the Howard Hughes Medical Institute, retracted a paper in 2016 because the results couldn't be replicated. The researcher who couldn't replicate them? Michael Young, who shared the 2017 Nobel with Rosbash.

This wasn't a first. Harvard's Jack Szostak retracted a paper in 2009. Months later, he got that early morning call from the Nobel committee for his work. And he hasn't been afraid to correct the record since, either. In 2016, Szostak and his colleagues published a paper in Nature Chemistry that offered potentially breakthrough clues for how RNA might have preceded DNA as the key chemical of life on Earth - a possibility that has captivated and frustrated biologists for half a century. But when Tivoli Olsen, a researcher in Szostak's lab, repeated the experiments last year, she couldn't get the same results. The scientists had made a mistake interpreting their initial data. Once that realization settled in, they retracted the paper - a turn of events Szostak described as "definitely embarrassing."

What isn’t absurd is the idea that admitting mistakes shouldn’t be an indelible mark of Cain that kills your career.

Indeed it shouldn't. And for honest people with high standards of ethical integrity and a willingness to be transparent about the mistakes that they have made or that have occurred on their watch, it isn't.

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January 18, 2018

The relative period of order for the S&P 500 that began back on 31 March 2016 has come to an end.

The breakdown of order in the S&P 500 became clearly evident on 11 January 2018, when the level of the S&P 500 surged to be more than three standard deviations above the mean trend curve that has described the relationship between stock prices and their trailing year dividends per share since the end of the first quarter of 2016. Tracing this break in trend backwards to when it first took hold, we find that the last day that the previous period of relative order could be reasonably be said to have held is 29 December 2017, the last day of trading at the end of the fourth quarter of 2017, which is when stock prices were last within one standard deviation of the established mean trend curve.

S&P 500 Index Value vs Trailing Year Dividends per Share, 30 September 2015 Through 17 January 2018, with Period of Order Between 31 March 2016 and 29 December 2017

That makes the explanation for what caused the break in order relatively easy to determine. We believe that it may be fully attributed to the passage of the Tax Cuts and Jobs Act of 2017 on 22 December 2017, the provisions of which would take effect in 1 January 2018, to which investors would respond vigorously to their new incentives from the law beginning with the first day of trading in 2018 on 2 January 2018. It then took just eight trading days for the break in the previous period of relative order in the U.S. stock market to become definitive.

The new incentives for investors arise from the large and permanent reduction in corporate income tax rates, where investors may benefit by realizing larger dividend payments, by companies using their newly-freed funds to increase their productive investments, to lower their prices to consumers to gain market share, to better insulate themselves against having arbitrarily higher costs from government-mandated expenses imposed upon them (firms boosting the wages of their lowest paid employees can be said to be taking this action), or to simply use the opportunity of the newly-freed funds to improve their balance sheets. Or some combination of any or all of the above.

In a number of ways, the initial response of the stock market to the passage of the Tax Cuts and Jobs Act of 2017 is similar to what happened to stock prices following the passage of the Tax Relief Act of 1997, which caused the Dot Com stock market bubble to inflate. Unlike that event, where the differences in tax rates between dividends and capital gains changed the rate of return math for investors with dramatic and unstable effects upon stock prices, the changes that U.S. firms make in response to the Tax Cuts and Jobs Act of 2017 are much more likely to affect the fundamental expectations that investors have for their future business prospects, making a similar bubble unlikely.

No matter what, the U.S. stock market has entered into a very different period than it was before. How will that affect your investment decisions?

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January 17, 2018
Pay Advice Example - Source: U.S. Department of Labor - https://blog.dol.gov/sites/blog.dol.gov/files/images/2015/01/johnsmith.jpeg

How much will your net take home pay change because of the Tax Cuts and Jobs Act of 2017 becoming law?

This is the third of three tools that we've built to do paycheck-related math in 2018, and is the only one that goes straight to the bottom line in showing how different your take home pay may be because of the new tax law. If you want greater detail into all the major parts of where your money goes in your paycheck, be sure to check out the previous two tools that we've developed:

In this version, we've stripped down the inputs and outputs to just the bare essentials, just to get at the bottom line answer that many Americans are seeking. Please enter the indicated information into the table below, click "Calculate" to get your results, and hopefully, you'll be pleased by the results. [If you're reading this article on a site that republishes our RSS news feed, please click through to our site to access a working version.]

Your Paycheck and Tax Withholding Data
Category Input Data Values
Basic Pay Data Current Annual Pay
Pay Period
Federal Withholding Data Filing Status
Number of Withholding Allowances
401(k) or 403(b) Contributions Pre-Tax Contributions (%)
After Tax Contributions (%)
Flexible Spending Account Annual Contribution Data Health Care Spending Account
Dependent Care Spending Account

Federal Income Tax Withholding Estimates
Calculated Results Values
Before 2018's Tax Cuts Take Effect
After 2018's Tax Cuts Take Effect
How Each of Your Paychecks Will Change (Positive if increase, Negative if decrease)
Change Multiplied Over All Paychecks for an Entire Year
Equivalent Tax-Free "Raise" With Respect to Annual Income

Previously on Political Calculations

We've been in the business of calculating people's paychecks (not including state income tax withholding) since 2005!

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January 16, 2018

The S&P 500 continued its rapid rise in the second week of January 2018, having now risen some 112.63 points, or 4.2%, since the last day of trading in 2017, to close at a new record high value of 2,786.24 on Friday, 12 January 2018.

Alternative Futures - S&P 500 - 2018Q1 - Standard Model - Snapshot on 12 January 2018

Although slower than in Week 1, the actual trajectory of the S&P 500 in Week 2 of January 2018 continues to be consistent with a Lévy flight, where investors are shifting their forward looking focus from one point of time in the future to another.

We are observing an interesting development in that process. More often than not, when we see shifts in how far investors are looking into the future, we can typically tie the shifts to changing expectations for things like how and when the Fed will change its interest rate policies, which is why we pay close attention to the CME Group's Fedwatch tool, which provides an indication of the kind of odds that investors are giving for various changes in the Federal Funds Rate that investors are expecting at different points of time in the future. The following table summarizes those probabilities at several key future dates.

Probabilities for Target Federal Funds Rate at Selected Upcoming Fed Meeting Dates (CME FedWatch on 12 January 2018)
FOMC Meeting Date Current
125-150 bps 150-175 bps 175-200 bps 200-225 bps 225-250 bps 250-275 bps
12-Mar-2018 (2018-Q1) 26.3% 72.6% 1.1% 0.0% 0.0% 0.0%
13-Jun-2018 (2018-Q2) 8.4% 40.7% 49.2% 1.8% 0.0% 0.0%
26-Sep-2018 (2018-Q3) 3.6% 22.0% 43.0% 28.2% 3.0% 0.1%
19-Dec-2018 (2018-Q4) 2.3% 15.3% 35.1% 33.2% 12.4% 1.6%

What this table shows is that investors are expecting two rate hikes in 2018. The first would be a quarter point increase that they expect would be announced at the FOMC meeting scheduled for 21 March 2018, which has been expected for some time. The second would be another quarter point increase that would take place at the FOMC meeting scheduled for 13 June 2018, which is a new development - prior to the second week of January 2018, investors had been anticipating that action would not take place until sometime during the third quarter of 2018.

So there would appear to be a disconnect between where our dividend futures-based model is indicating that investors are focusing their future-oriented attention and what the current expectations are for the future of the Fed's monetary policies. The current trajectory of the S&P 500 with respect to our model's projections suggests that investors are focusing more of their attention on the more distant future of either 2018-Q3 or 2018-Q4, which coincides with where stock prices are today, than they are on the nearer term future of either 2018-Q1 or 2018-Q2, where stock prices would be considerably lower if that were the case.

The question is why, and we suspect the answer may be the recently passed permanent reduction in the U.S. corporate income tax rates, which would primarily impact investor expectations for their investments in one of three ways:

  • The corporate tax cuts make more money available to pay increased dividends to shareholders.
  • The corporate tax cuts make more money available for U.S. firms to pursue new growth opportunities that can lead to faster than previously expected growth.
  • The corporate tax cuts make more money available for share buybacks for U.S. firms without strong growth prospects, allowing them to artificially boost their dividends per share.

Many of these share price-boosting actions at different companies may be in addition to other changes, where the corporate tax cuts have also made more money available to pay higher wages and/or bonuses to their employees or to lower their prices to their consumers, which we've seen in the case of public utilties, but would also apply in the case of companies seeking greater market share.

As of 12 January 2018, we haven't seen any significant change in the expected levels of future dividends, but that may be about to change as we get into the earnings reporting season for 2018-Q1, where we've mainly been waiting for corporate boards to meet and set their new policies following the passage of the Tax Cuts and Jobs Act of 2017 back on 23 December 2017. The next six weeks have the potential to be a lot of fun!

As for the second week of 2018, here are the headlines that stood out.

Monday, 8 January 2018
Tuesday, 9 January 2018
Wednesday, 10 January 2018
Thursday, 11 January 2018
Friday, 12 January 2018

Barry Ritholtz lists the positives and negatives for the U.S. economy and markets in Week 2 of January 2018, and if that weren't enough, also discovers a new investment strategy based on betting on companies slammed by President Trump that has been delivering outsized returns.

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Welcome to the blogosphere's toolchest! Here, unlike other blogs dedicated to analyzing current events, we create easy-to-use, simple tools to do the math related to them so you can get in on the action too! If you would like to learn more about these tools, or if you would like to contribute ideas to develop for this blog, please e-mail us at:

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