Markets

As D.C. Tests New Lows, Markets Keep Soaring

July 29, 2017 1:11 a.m. ET

This is truly a tale of two cities: Washington and New York. One is setting highs, the other is reaching previously unimaginable lows. And it’s not the National League East standings we’re talking about.

Stocks traded on the New York Stock Exchange, downtown at Wall and Broad, and those on the


Nasdaq,



NDAQ 0.05381407237992735%



Nasdaq Inc.


U.S.: Nasdaq


USD74.37


0.04
0.05381407237992735%



/Date(1501275600226-0500)/


Volume (Delayed 15m)
:
501884



AFTER HOURS



USD74.37



%


Volume (Delayed 15m)
:
16459




P/E Ratio
58.1015625

Market Cap
12277680579.7021


Dividend Yield
2.0438348796557753%

Rev. per Employee
895491









More quote details and news »


headquartered in Times Square, set record highs last week, at least in terms of the major market averages. That contrasted with the lows being plumbed in the nation’s capital, both in the quality of discourse and the ability to advance policies.

Not that any of what happens within the Beltway seems to matter much in economic and financial terms. The U.S. economy continues to chug along, steadily if unimpressively, and prices of stocks and other so-called risk assets, such as speculative-grade bonds, continue their ascent. They seem undeterred by the disarray in D.C., which requires no further elaboration here (especially since an adequate description is not fit to print in Barron’s), or by the ongoing threats around the globe.

On the latter score, news on Friday of North Korea’s latest missile test scarcely caused a ripple in the markets, despite estimates that this ICBM had a significantly longer range than the one fired on July 4 as a taunt to America, and was easily capable of reaching the continental U.S.

The Dow Jones Industrial Average ended on Friday at yet another record, up 1.2% for the week, while the Standard & Poor’s 500 and the Nasdaq Composite set marks on Wednesday, but trimmed their gains over the next two sessions, ending the week lower by 0.02% and 0.2%, respectively.

Exuberance, rational, or not, returned to the market for initial public offerings with the debut of


Redfin



RDFN 44.666666666666664%



Redfin Corp.


U.S.: Nasdaq


21.7


6.7
44.666666666666664%



/Date(1501297200273-0500)/


Volume (Delayed 15m)
:
9445001




P/E Ratio
N/A

Market Cap
N/A


Dividend Yield
N/A

Rev. per Employee
131429









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(ticker: RDFN), which describes itself as a “technology-powered residential real estate brokerage.” The stock was priced at $15 a share, above the expected $12 to $14 range, and popped more than 40% in its initial trading session on Friday, with bulls evidently focusing on a rapidly growing top line, rather than losses on the bottom line. Redfin’s opening-day pop also contrasts with the post-IPO plops of


Snap



SNAP -1.3571428571428572%



Snap Inc.


U.S.: NYSE


USD13.81


-0.19
-1.3571428571428572%



/Date(1501275755982-0500)/


Volume (Delayed 15m)
:
16695804



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USD13.83


0.02
0.14482259232440262%


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:





P/E Ratio
N/A

Market Cap
16505885680.5938


Dividend Yield
N/A

Rev. per Employee
277209









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(SNAP) and


Blue Apron Holdings



APRN 0.2976190476190476%



Blue Apron Holdings Inc. Cl A


U.S.: NYSE


USD6.74


0.02
0.2976190476190476%



/Date(1501272067672-0500)/


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:
1938158



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USD6.8


0.06
0.8902077151335311%


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:





P/E Ratio
N/A

Market Cap
1274005819.62178


Dividend Yield
N/A

Rev. per Employee
164052









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(APRN).

A key underpinning of the equities continues to be the credit market, which is readily funding all manner of corporate transactions. The latest example:


AT&T



T -1.0403450900786602%



AT&T Inc.


U.S.: NYSE


USD39


-0.41
-1.0403450900786602%



/Date(1501275610485-0500)/


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34423948



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USD39.08


0.08
0.20512820512820512%


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:





P/E Ratio
18.39622641509434

Market Cap
241977399063.11


Dividend Yield
5.0256410256410255%

Rev. per Employee
604228









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(T) last week sold the third-biggest corporate bond offering ever, some $22.5 billion, which was upsized from the originally planned $15 billion and was still nearly three times oversubscribed, Barrons.com’s Income Investing blog reported.

The AT&T deal was to fund part of the planned $85 billion acquisition of


Time Warner



TWX -0.45542635658914726%



Time Warner Inc.


U.S.: NYSE


USD102.73


-0.47
-0.45542635658914726%



/Date(1501275840643-0500)/


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USD104


1.27
1.2362503650345567%


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P/E Ratio
19.66350202894112

Market Cap
80035521803.1677


Dividend Yield
1.5672150296894773%

Rev. per Employee
1189800









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(TWX). It trails the record


Verizon Communications



VZ 0.2719096423342397%



Verizon Communications Inc.


U.S.: NYSE


USD47.94


0.13
0.2719096423342397%



/Date(1501275811023-0500)/


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:
24654259



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USD47.94



%


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:





P/E Ratio
12.292307692307693

Market Cap
195034632543.079


Dividend Yield
4.8185231539424285%

Rev. per Employee
768421









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(VZ) $49 billion bond sale in 2013 to fund its acquisition of the portion of Verizon Wireless it didn’t already own, and


Anheuser-Busch InBev’s

(BUD) $46 billion bond sale in 2016 for its merger with SABMiller. The corporate bond market has been the enabler for these megadeals.

The ability to do bond deals the size of a small country’s gross domestic product reflects “the unparalleled global demand for U.S. dollar-denominated corporate debt,” says Cliff Noreen, deputy chief investment officer of MassMutual, the big insurer. Institutional buyers still need fixed-income assets, which, even at historically low yields, offer income, plus the assured return of capital not available from stocks.

As a result, he continues, “there are no cheap assets anywhere.” That emphatically extends to the high-yield market, which has become a misnomer. The popular


iShares iBoxx $ High Yield Corporate Bond



HYG 0.01124859392575928%



iShares iBoxx $ High Yield Corporate Bond ETF


U.S.: NYSE Arca


88.91


0.01
0.01124859392575928%



/Date(1501290000000-0500)/


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:
4847802



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89.1


0.19
0.21369924642897312%


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:





P/E Ratio
N/A

Market Cap
N/A


Dividend Yield
5.094216623551906%

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N/A









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(HYG) and


SPDR Bloomberg Barclays High Yield Bond

(JNK) exchange-traded funds






HYG 0.01124859392575928%



iShares iBoxx $ High Yield Corporate Bond ETF


U.S.: NYSE Arca


88.91


0.01
0.01124859392575928%



/Date(1501290000000-0500)/


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:
4847802



AFTER HOURS



89.1


0.19
0.21369924642897312%


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:





P/E Ratio
N/A

Market Cap
N/A


Dividend Yield
5.094216623551906%

Rev. per Employee
N/A









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hit or hovered near 52-week–high prices, which translate to record-low yields. The former yields a hair above 5%, about what Treasury bills paid before the financial crisis started a decade ago.

Nor have the junk-bond ETFs been tested in market downdrafts, especially in terms of the uncertain liquidity of their underlying speculative-grade securities in times of crisis. Noreen says he views the high-yield ETFs as trading vehicles, as opposed to long-term investments, unlike equity ETFs, which he calls suitable for that aim.

As an institutional investor, MassMutual goes off the beaten track for assets not available to individuals and not readily tradeable. “We’re investing for decades, not the next quarter,” he explains, so daily liquidity is less important. One example he cites is middle-market loans, with yields of 300 to 500 basis points over the London interbank offered rate, the money-market benchmark (at least until it’s phased out in 2021) for first-lien loans and 600 to 900 bps for second liens. (A basis point is one-hundredth of a percentage point.)

That’s not readily replicable by most readers, but demonstrates the lengths needed to obtain income in a low-yield world. The beneficiaries, Noreen notes, are MassMutual policyholders’ dividends. Closed-end funds, which by their nature don’t have to meet redemptions, also benefit, he adds.

WITH THE FAILURE TO REPEAL or replace Obamacare, Republicans in Congress are expected to turn their attention to the legislative goal nearest and dearest to the stock market: tax reform.

But leaving aside all the stuff that makes material for cable-TV commentary and late-night comedians, there are a couple of items on the congressional agenda that must be addressed before taxes.

First is the federal debt ceiling, which has to be raised to prevent a U.S. default when Uncle Sam runs out of tricks for juggling his accounts, probably in October.

The specter of such an ignominy appeared to recede last week, as indicated by a return to normalcy in the Treasury bill market. The higher yield that had been demanded on three-month bills due in October, compared with six-month bills, disappeared last week, and the yields reverted to their usual relationship. That may well change as the deadline gets closer and the specter of default appears again.

As for taxes, the “Big Six”—House Speaker Paul Ryan, Senate Majority Leader Mitch McConnell, Treasury Secretary Steven Mnuchin, National Economic Council Director Gary Cohn, Senate Finance Committee Chairman Orrin Hatch, and House Ways and Means Committee Chairman Kevin Brady—released a new statement on tax reform last week. The big change was to scuttle the unpopular border-adjustment-tax proposal, as Barron’s Economics Editor Gene Epstein had urged months ago (“Why the Border Adjustment Tax Should Be Killed,” March 18).

Few other details were included, but elimination of a BAT leaves less money to pay for other cuts. Chief among those would be a reduction in the corporate income tax, which currently has a statutory rate of 35%, one of the highest in the world. President Donald Trump had wanted to slash that to just 15%.


Morgan Stanley



MS -0.9131450414100658%



Morgan Stanley


U.S.: NYSE


USD46.66


-0.43
-0.9131450414100658%



/Date(1501275783363-0500)/


Volume (Delayed 15m)
:
7653596



AFTER HOURS



USD46.66



%


Volume (Delayed 15m)
:





P/E Ratio
13.369627507163324

Market Cap
87106233834.5004


Dividend Yield
2.1431633090441493%

Rev. per Employee
744771









More quote details and news »


strategists Michael D. Zezas, Todd Castagno, and Mark T. Schmidt write that a reduction to the 25% to 28% range had always been more likely. The removal of the BAT, which they always thought was a long shot, underscores their view that a more modest cut was probable.

From a stock market standpoint, many of the big-capitalization companies that make up major indexes, such as the S&P 500, already pay well under 35%—an average of 25%, by some estimates. Lowering the rate to the mid-20s may not help these giants as much.

Another key tax-reform aspect could be what the Big Six dub “unprecedented” capital expensing, which the Morgan Stanley analysts infer to mean something less than full and immediate expensing of capex.

But the prospects of any of the tax changes going through depends on an arcane procedural change, notes Cowen Washington watcher Chris Krueger, to use “regular order” instead of the reconciliation process. He explains: “The advantage of not going through the reconciliation process is that you do not have to pass [a fiscal-year 2018] budget.” But, he adds, that also means the Senate GOP would need the Democrats’ help from to get a bill passed, something that he calls a “pipe dream.”

DEPENDING ON HOW YOU LOOK AT IT, the U.S. economy rebounded in the second quarter. Or slowed down. Or remained the same.

Real GDP grew at an annualized rate of 2.6% in the period, up from 1.2% in the first quarter, the Commerce Department reported on Friday. After taking out the effect of inventory swings, real final sales decelerated slightly, to 2.6% from 2.7% in the prior period. But when trade flows are removed, real domestic final sales continued at a 2.4% pace, unchanged from the initial quarter. All of which shows that the economy continues to plod along at about a 2% annual clip.

That’s apparently good enough for the Federal Reserve to press ahead and normalize monetary policy. At last week’s policy meeting, it indicated that it could begin paring its $4.4 trillion balance sheet “relatively soon,” presumably starting after its Sept. 19-20 meeting. Another quarter-point interest-rate hike is expected in December, although the federal-funds futures market pegs the probability of that at just 38.7%, Bloomberg reports.

Those odds may be low because inflation remains well under the Fed’s 2% target. The central bank’s favored measure, the “core” personal consumption deflator, which excludes food and energy prices, was up only 1.5% in the second quarter from its level a year earlier, compared with 1.8% in the previous quarter, according to the GDP report.

Financial conditions overall—including high stock prices and low bond prices—actually are easier now than in December 2015, when the Fed announced its first of four quarter-point short-term rate hikes in this cycle, according to John Ryding and Conrad DeQuadros of RDQ Economics. That makes policy tightening via balance-sheet reduction likely in September, they conclude. 

Email: randall.forsyth@barrons.com

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