Downgrading Moody's to Junk

Some big political news that affects the bond market (and eventually the stock market) hit on Friday. I was away from my desk on Friday, but was near enough to a TV to notice that CNBC didn’t even talk about it. Yes, I’m talking about the Trump Tax Cuts 2.0 not passing through committee.

As I talked about in my Trump’s second act piece, this tax bill (and the add on spending bill that we don’t have a lot of concrete information on) will define how the US markets (and the dollar so a huge chunk of the international markets) move in the next 18 months. I’ll let you read the whole piece below for some more in depth thoughts, but the market is currently front running this bill. If it continues to struggle to get out of the committee that is near term bearish equities bullish bonds (and likely better for the dollar bulls in the long run).

The other big news was the downgrade of the US debt by Moody’s. This will be a headwind to equities as every down of the US debt has led to a minor pull back of 3 - 6% starting within two trading days and usually lasting about three to four weeks. My working theory is Moody’s was planning on timing this downgrade of the US debt because of this tax bill getting out of committee, likely putting it on the fast track to becoming a law. When it didn’t pass….well they said there’s enough problems anyways, so down it goes.

The important debate to understand with the tax bill is it all about SALT. SALT stands for state and local tax (deduction) and its a tax adjustment that people who itemize get against their property and state income taxes. Before the TCJA it was uncapped, allowing blue states to jack up taxes insanely on their residents but given that they were allowed to claim those taxes as deductions on their federal taxes the residents didn’t feel the full pain of these insane tax policies.

Once the TCJA was passed SALT was capped at $10,000 of deductions. A high number, but not high enough if you lived in NYC, SF, LA or any high cost of living (due to taxes) high income state and area. Suddenly their huge property tax bills were a problem. Their increasing tax burden became more and more painful as these blue state governments continue to pass more and more taxes to pay for their various boondoggles.

While there are a few exceptions the vast majority of people who benefit from an uncapped SALT deduction are the rich and ultra rich. As unless you’re extremely charitable, you likely will not itemize until you both own a house and make well into the six figures, given how high the standard deduction is. SALT is a tax break for the rich.

It has become the battle ground for some republicans, mostly those from NY. They will not pass a tax bill without a much higher limit (they really want 50,000+ but might tolerate 40,000 as their state tax burden is extremely high). Without those votes the GOP cannot get the tax bill out of the both the committee and eventually Congress to push it to the Senate. With increasing the SALT limit to $50,000 the math on the rest of the tax cuts doesn’t work. With increasing the SALT limit there are enough fiscal conservatives who won’t vote for the bill with a higher SALT number.

The truth is the NY GOP members will either lose this battle or the bill won’t get passed. I still think the bill gets passed, maybe with a couple extra weeks of infighting, but it does get passed, but Friday’s issues lower the odds slightly. From 75%+ down to maybe 70%. Not enough to affect the market now, but any more continued delays should send the market lower in the near term. With high beta taking the brunt of the pain.

For any position longer than a day or two this is the subject worth following, as near term growth nor growth trends haven’t been strong enough to justify a full rebound of stocks to their pre-liberation day levels and without the updated tax cuts inertia won’t be strong enough to push the market much higher.

---

The Wall Street Journal has finally started noticing that the bottom is weakening in travel.

Right now airlines are focusing more and more on the higher net worth individuals, but that doesn’t work for the whole travel sector. As Airbnb, Booking, hotel chains in general etc etc, cannot thrive on a significantly cut down travel audience.

I bring this up because this is a trend I’ve been beating on since late last year. It was becoming clear that people are just done with travel and without starting too many fights, its hard to blame them. At some point you need to establish roots where you live and enjoy your local community. That doesn’t mean not traveling at all, but it does mean not jet setting all over the place every few weeks.

Much like the middle class likes to flex with who’s car payment is the larges-- I mean who has the nices Porsche or BMW or even Tesla sitting in their driveway, the rich brag about their travel. Where they went, where they’re going, rarely what they did different there that they couldn’t do within an hour or two drive of their home. The thing is as you travel up the spending ladder there becomes a level of sameness to everything. Every four seasons is similar enough to each other. Otherwise it wouldn’t be a clearly defined brand. Same with other high end hotel chains.

This is the exact same trend that happened before the restaurant bubble popped in the last few years. Everyone started chasing the higher and higher consumer group doing a one two punch to volume growth via pushing price and purposely decreasing availability to make it seem more exclusive. All while spending more and more on each new restaurant and afraid to take risks so everything became inflected with the sameness that eventually restaurant goers got bored with and now the average higher end restaurant goer cares a lot less about Michelin stars and the guidebook.

Travel will not implode the same way due to various factors, but I don’t think continued pushing of only the high end premium fliers will end well for airlines. At least near term. Air France just added a new cabin above first class which costs $11,000 for a flight to NYC from Paris. That’s more than $1,000 an hour for air time.

There’s no world where your time will ever be worth more than $1,000 an hour and also you’re not rich enough to fly private (which is a different subject). Instead this will continue putting pressure on families trying to do a vacation to Europe, and instead they’ll end up elsewhere.

Given now Real ID is a thing the USA and a decent chunk of US travelers still haven’t upgraded their licenses, and cost increases across the board I think shorting Jets here is a solid risk reward. One you can hedge with long booking.com if you you’re worried about it blowing up. The stop would be two closes above the 100dma (blue line) and the press it will be closing below the 200dma.

---

The Trump piece I wrote got a lot of good feedback. And a lot of questions/clarification requests. Before we get into the earnings preview I’m going to cover a few of those questions below, as I thought it would be easier to respond to all of them together instead of individually. Feel free to ask any follow ups in the comments below or in the discord.