Last week, the Congressional Budget Office (CBO) released its latest budget deficit and national debt projections for the next 10 years in response to the Trump administration’s December tax revamp. The report warns of a deficit reaching $1 trillion annually starting in 2020, and a national debt reaching $33 trillion in 10 years – a projected 96.2% of GDP for 2028.
To put the reported numbers in perspective, in June of 2017 the CBO reported that the debt held by the public would reach to $25.5 trillion by 2027. According to last week’s revised projections, that number will rise to $27.1 trillion as a result of the new tax legislation.
Similarly, the deficit projections for the next 5 years (2018-2023) have soared from $4.5 trillion to $6.4 trillion – a $1.9 trillion increase from the June 2017 projections.
Despite the headlining debt concerns, a sharp spike in the short term economic growth estimate is the overarching economic takeaway Republicans are pushing from this report.
Economic growth for 2018 is expected to reach 3.3% – compared to the previous 2% projections – and estimates for real GDP have increased from the CBO’s 2017 projections, an outcome the CBO attributes to changing monetary policy as well as tax reform.
This strong short-term growth is expected to decrease in the long term as growth projections have shrunk from 1.9% to 1.7% for the latter half of the next decade. This is due to an expanding deficit crowding out private investment.
Short-term growth will largely benefit taxpayers as it reduces unemployment and the tax cuts causing said growth will increase their disposable income. In the long term, however, decreased growth will have the opposite effect: weakening job markets and hurting millennials seeking employment after college.
The swelling debt and deficit will similarly induce inflation as shown through the projected core price index for personal consumption expenditures (PCE). The Federal Reserve targets a 2% PCE, however the CBO projects that in early 2019 the PCE will exceed 2%, remain at 2.1% throughout the 2019-2023 period, and expand beyond 2.1% for the rest of the decade.
As a result, consumers will see higher prices offset some of the increased income they will gain from the new tax bill.
Inflationary concerns will likely induce an acceleration in the Fed’s interest rate hike timeline as the Fed will try to keep inflation at their 2% target. Rate hikes may very well accomplish the goal of taming inflation; however they will increase the cost of money for consumers seeking loans and corporations seeking to take advantage of the tax bill.
Private investment resulting from the tax bill has yet to be realized as such investments require time to actualize. Concerns are that by the time private entities and corporations have capitalized on the tax cuts, increases in interest rates due to inflation will subdue the impact that the tax cuts will have on investment, all the while increasing deficit and debt anxiety.
Fear surrounding the budget deficit and national debt is focused on the potential for currency devaluation, increased debt costs, and hyperinflation induced market corrections in the long run.
If the national debt is not addressed, the government will find snowballing interest payments and a lowered credit rating increasing the cost of debt, a factor that will exacerbate the deficit if the budget is not balanced.
As a result, major entitlement programs such as Social Security may find themselves on the chopping block in order for the government to finance its operations.
These long run fears are heightened by the Trump administration’s desire to pass a “Phase 2” of the tax bill aimed at solidifying tax cuts for individuals past their expiration date in 2025. Such a bill would potentially result in a spike in economic growth in the short run – similar to Phase 1 – but would accelerate the timeline on long term debt concerns.
The main question in regards to long term debt anxiety is the extent to which they are long term. Analysts have yet to reach any consensus on when the economy will begin to see the major detrimental impacts of sustained ballooning debt and deficits.
In such a market, traders should focus on exploiting the short term benefits the tax bill will have on the economy: strong growth and an accelerated rate hike timeline to combat inflation are the main macroeconomic trends for the next 3-5 years.
Similarly, the full benefit of the tax cut on individuals and corporations has yet to be fully understood as the conservative nature of analyst estimates ought to be taken into account. Nonetheless, recent earnings reports do provide immediate feedback as to the impact of said tax reform.
In examining these factors, JP Morgan shines as a stock primed to take advantage of these macroeconomic trends. An accelerated rate hike timeline benefits financials as a sector as higher interest rates increase revenue from lending. As the largest bank in the US by assets, JP Morgan is set to benefit the most from these increased rates along with other large banks such as Bank of America and Wells Fargo.
JP Morgan is also coming off its Friday earnings beating quarterly expectations by reaching $2.37 in earnings per share (EPS) – Reuters expected a $2.28 EPS – and raking in a company record in return on equity. Wells Fargo and Citigroup reported $1.12 and $1.68 EPS respectively on Friday as well.
The new tax law cut JP Morgan’s first quarter income tax by 4.4% in comparison to last year’s first quarter, a factor in helping JP Morgan achieve a sustainable 13% increase in revenue from last year.
Despite a positive earnings report and buy and overweight ratings from analysts, JP Morgan’s stock fell almost 3% on Friday to $110.30 as investors took their profits.
With a strong earnings report tailwind, an outlook of interest rate hikes increasing revenue, and strong general economic growth, JP Morgan is in an ideal position to capitalize on short-term deficit-related repercussions and economic growth without the baggage its competitors such as Wells Fargo have with potential $1 billion fines.
As other banks such as Bank of America release their earnings this week, questions as to valuation and the extent to which interest rate hikes are already priced into financials will begin to come into focus; however with strong analyst outlook and price to earnings at 15.70, JP Morgan is short term investment traders ought to consider in their portfolio.
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