Political Calculations
Unexpectedly Intriguing!
29 March 2018

The FANG stocks have been taking quite a beating in recent weeks. So much so that just a handful of stocks are responsible for causing significant drops in major market indices.

What are the FANG stocks? That's an acronym that traders uses as shorthand to specifically describe the following firms that, until 2018, had handsomely rewarded investors in recent years.

  • Facebook (NASDAQ: FB)
  • Amazon (NASDAQ: AMZN)
  • Netflix (NASDAQ: NFLX)
  • Google [Alphabet-C NASDAQ: GOOG) and Alphabet-A (NASDAQ: GOOGL)]

But a looser version of that acronym also ropes in some other big tech firms, including Apple (NASDAQ: AAPL), Microsoft (NASDAQ: MSFT), and NVIDIA (NASDAQ: NVDA), which have also been sucked into the "Tech Wreck" of 2018.

So why is such a small group of stocks having such a large effect on the world's stock markets?

In a nutshell, the rapid growth of these firms in recent years has swelled their market capitalizations, where investors have bid up their stock prices as they've bought millions of their shares.

Meanwhile, the major stock market indices, like the S&P 500 and the Nasdaq 100, are made up of individual component stocks whose weighting within the indices are set according to their market capitalization.

Consequently, as the market capitalizations of Big Tech stocks have grown, they have also grown to account for a much larger share of the value of these stock market indices. The following chart shows what that means for the S&P 500 (Index: INX):

Big Tech in the S&P 500, 28 March 2018

Together, the eight stocks that we've listed above account for over 15% of the entire value of the S&P 500 stock market index as of 28 March 2018. They hold a much larger share however of the Nasdaq 100 (Index: IXIC), which unlike the more diversified S&P 500, is predominantly composed of firms in the technology sector:

Top Firms in the Nasdaq 100, 28 March 2018

At nearly 48% of the Nasdaq 100's value, even small changes in the share prices of these eight stocks can have a large impact on the value of the index. And that, for investors, is why bad news for Big Tech is bad for stocks, and why investors need to consider alternatives to holding large quantities of these companies' stocks in their investment portfolios.

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28 March 2018

In January 2017, Philadelphia imposed a 1.5-cent-per-ounce tax upon all naturally and artificially sweetened regular and diet beverages distributed for retail sale within the city. Philadelphia's civic leaders promised that the new tax would raise $92.4 million in revenue, which they promised to use to fund pre-Kindergarten schooling for 6,500 children, 25 community schools and the city's "Rebuild" community initiative, which would pay for improvements to public parks, libraries, recreation centers and other city-owned infrastructure.

The tax failed to live up to the promises of Philadelphia's politicians, who have since scaled back their promises when tax collections fell nearly 15% short of their target, where now, they are only promising to provide "free" pre-K schooling for 5,500 students, 20 community schools and also the funding for the city's "Rebuild" program, where they haven't yet specified how large the spending cuts to that initiative will be.

At the same time, the city has redirected at least $62 million of the $78.8 million in revenue that they did collect from the controversial tax to the city's general fund, where it sits unspent today.

But one aspect of the implementation of the Philadelphia beverage tax has proven to be unexpectedly successful. Because the tax raised the price of soft drinks to be similar to that of many alcoholic beverages sold in the city, a large number of consumers in Philadelphia appear to have responded by consuming alcohol instead, which has significantly increased the amount of revenue that Philadelphia collects through its liquor tax.

Trailing 12 Month Philadelphia Liquor Tax Collections, July 2014 to January 2018

Prior to the implementation of Philadelphia's soda tax in January 2017, the city's liquor tax collections were rising at an average rate of $4.4 million per year, where in the calendar year ending December 2016, the city collected $67.8 million.

But since December 2016, as the city's soda tax went into effect, Philadelphians appear to have sharply increased their consumption of alcohol, where the city's liquor tax collections have risen at an average rate of $9.7 million per year, more than double what was seen in the period prior to the implementation of the city's soda tax. For the twelve months ending in December 2017, Philadelphia collected nearly $76.3 million. [Note: Philadelphia's liquor tax collections in December 2017 were low, which the city appears to have caught up in January 2018.]

Since Philadelphia assesses a 10% tax on the sale of alcoholic beverages, that $8.5 million per year increase in liquor tax collections means that Philadelphians consumed an additional $85 million worth of alcohol in 2017 as compared to the amount they drank in 2016 (and about $53 million more than they were otherwise on track to consume without the tax). And that was before the Philadelphia Eagles even made it into the NFL postseason! In fact, the increase in the rate at which Philadelphians were consuming alcohol began to increase sharply above its previous trend in January 2018, long before football season started, coinciding with the implementation of the tax.

Meanwhile, on the opposite end of Pennsylvania, Allegheny County (Pittsburgh), which has an alcohol tax like Philadelphia, but which does not have a soda tax (making it an almost ideal control sample in a natural experiment for assessing the impact of Philadelphia's soda tax), did not see a similar boost to its liquor tax collections. Here, prior to August 2016, when Pennsylvania revised the state's liquor laws to allow wine sales at grocery stores, the county's liquor tax collections were growing at an average pace of $2.0 million per year.

Trailing 12 Month Allegheny County Liquor Tax Collections, 
July 2014 to January 2018

Although liquor tax collections moderately picked up after the new state law went into effect, it proved to short lived as the region experienced a significant number of layoffs and the closure of multiple businesses and state-run institutions, which prompted a short term downward shift in alcohol sales and tax collections from November 2016 to February 2016. Since February 2016 however, Allegheny County's alcohol tax collections have largely resumed the same $2.0 million per year rate of growth that existed prior to the new statewide liquor law going into effect and the short term disruption to the area's employment situation.

Which is to say that Pittsburgh, with no soda tax, saw no boost to its alcohol sales the way that Philadelphia did after it imposed its tax on sweetened beverages within the city and made soft drinks cost nearly as much as drinks containing alcohol, where the reduced difference in cost is less of a deterrence for additional alcohol consumption in Philadelphia.

Sadly, the extra millions being collected through Philadelphia's liquor taxes aren't enough to make up the shortfall of revenue from Philadelphia's soda tax. The cuts to promised funding for pre-K schooling, community schools and public infrastructure improvements would still have to happen, because the city doesn't have the money to pay for all its politicians' promises.

And then there's the problem for Philadelphia's Department of Public Health, which has argued that increases in alcohol sales will fuel increases in "violence, alcohol-related traffic crashes, and other public health and social problems", especially for residents of low-income neighborhoods.

That's quite the negative externality, isn't it? Especially on top of the role of the soda tax has had in shrinking the city's economy below what it might otherwise have been without its controversial soda tax.

Previously on Political Calculations

We've been covering the story of Philadelphia's flawed soda tax on roughly a monthly basis from almost the very beginning, where our coverage began as something of a natural extension from one of the stories we featured as part of our Examples of Junk Science Series. The linked list below will take you through all our in-near-real-time analysis of the impact of the tax, which at this writing, has still to reach its end.

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27 March 2018

Roughly every three months, we check in on the overall state of the new home market in the U.S. by estimating its market capitalization, where we take the average prices of new homes sold in the U.S. and multiply it by the number of new homes sold each month, then calculating its twelve month average to minimize the effects of seasonal variation in the monthly data. The following animated chart shows the results of that math, both in nominal terms and adjusted for inflation, for the period from December 1975 through the preliminary data just reported for February 2018. [If you're accessing this article on a site that republishes our RSS news feed, please click through to our site to see the animation.]

Animation: Trailing Twelve Month Average New Home Sales Market Capitalization, Not Adjusted for Inflation [Current U.S. Dollars] and Adjusted for Inflation [Constant February 2018 U.S. Dollars], December 1975 - February 2018

In nominal terms, after stalling in October 2017, the effective market cap of the U.S. new home sales market has resumed increasing, where its trailing twelve month average has reached $19.5 billion in February 2018. Adjusting the data for inflation to be in terms of constant February 2018 U.S. dollars indicates that the growth of the U.S. new home sales market has picked up after recently hitting a trough in November 2017.

Our next animated chart shows the nominal and inflation-adjusted year over year growth rates for the trailing twelve month average of the market capitalization of new home sales from January 2000 through February 2018, where we can confirm that the market for new homes in the U.S. is decelerating.

Animation: Year Over Year Growth Rate of Nominal and Inflation-Adjusted Trailing Twelve Month Average of New Homes Market Capitalization, January 2000 - February 2018

The nominal year over year growth rate for U.S. new home sales last peaked at 21.4% in March 2017, which has since dropped to 10.6% in February 2018. Meanwhile, the inflation-adjusted growth rate has likewise declined over this period of time from 22.3% in March 2017 to 5.8% in February 2018.

This deceleration in part reflects a somewhat delayed reaction to the Federal Reserve's series of interest rate hikes, which have increased steadily since December 2016, and have risen by a full percentage point through February 2018. The Fed announced that it will increase its Federal Funds Rate by another quarter percentage point at its March 2018 meeting. The Fed actually began raising short term interest rates from a near-zero level back in December 2015, but did so at a slower and more irregular pace until December 2016. Meanwhile, the apparently greater deceleration in the real growth rate also reflects the effects of rising oil and commodity prices, as inflation has increased in the U.S., particularly in the latter part of 2017 through the present.

Will that decelerating trend continue? We'll check back to find out in another three months!


U.S. Census Bureau. New Residential Sales Historical Data. Houses Sold. [Excel Spreadsheet]. Accessed 26 March 2018.

U.S. Census Bureau. New Residential Sales Historical Data. Median and Average Sale Price of Houses Sold. [Excel Spreadsheet]. Accessed 26 March 2018.

U.S. Department of Labor Bureau of Labor Statistics. Consumer Price Index, All Urban Consumers - (CPI-U), U.S. City Average, All Items, 1982-84=100 [Online Application]. Accessed 26 March 2018.


26 March 2018

What a difference a week makes!

Last week, we were on very firm ground in noting that President Trump's proposed tariffs were having very little impact on stock prices, where we closed our weekly observations with the following comment:

We're making a point of noting the major international trade-related headlines, where U.S. President Trump's planned tariffs are certainly getting lots of attention, but through the first half of March 2018, we'll agree with Goldman Sachs' assessment that stock prices really aren't reflecting much of a concern over the probability of a broad trade war. Despite what the headlines are indicating, what we are seeing so far is mostly consistent with the typical levels of noise that have historically characterized the day-to-day volatility of stock prices. We'll continue paying attention to both trade headlines and stock prices to see if that apparent investor response continues.

That remained through through Thursday, 22 March 2018, where we observed the investors complete their transition in shifting their forward-looking attention from 2018-Q2 just over a week ago to the much more distant future quarter of 2019-Q1.

Alternative Futures - S&P 500 - 2018Q1 - Standard Model - Snapshot on 23 March 2018

That transition marked, by our count, the fourth complete Lévy flight event for the U.S. stock market in 2018, which occur whenever investors shift their forward-looking focus from one distinct point of time in the future toward another, where differences in the change of the rate of growth of dividends per share expected at the different points of time are large enough to drive larger changes in stock prices than would be expected if they genuinely followed a "normal" random walk (they don't!) Here's our tally of the Lévy flight events that we've observed since 2018 began:

  1. Shift from 2018-Q2 to 2018-Q4: 3 January 2018 to 12 January 2018
  2. Shift from 2018-Q4 to 2018-Q1: 30 January 2018 to 5 February 2018
  3. Shift from 2018-Q1 to 2018-Q2: 7 March 2018 to 9 March 2018
  4. Shift from 2018-Q2 to 2019-Q1: 12 March 2018 to 19 March 2018

After 19 March 2018, we find that the trajectory of the S&P 500 has largely remained consistent with our dividend futures-based model's projection for stock prices that assumes that investors are predominantly focused on 2019-Q1 and the expectations associated with that point of time in the distant future as they make their current day investment decisions.

At least, through Thursday, 22 March 2018. On Friday, 23 March 2018, something remarkable happened to the S&P 500, where we can directly trace the impact of new information related to a trade war-related headline in prompting outsized noise event for the U.S. stock market. The following chart shows the trajectory of the S&P 500 on that day:

Google Finance: S&P 500 on 23 March 2018

Here, we see that the S&P 500 showed typical levels of volatility, with stock prices hovering within about a half of a percent of its previous day's closing value of $2,643.60.

That state of affairs lasted all the way up until 2:42 PM Eastern Daylight Time when they hit 2,632.17, after which, stock prices began trending strongly downward, dropping by over one and a half percent by the time the market closed at 4:00 PM, where the S&P 500 recorded its closing value of 2,588.26, a loss of 43.91 points, or 1.6% of the S&P 500's value, occurring in just 78 minutes.

We've repeatedly observed that it takes investors approximately two to four minutes after unexpected news breaks for their response to that news to begin affecting stock prices. Since the S&P 500 began to break sharply downward after 2:42 PM Eastern time, that would put the beginning of the specific news event to which investors responded somewhere between 2:38 PM and 2:40 PM.

That event appears to be the wide publication of an Associated Press article that hit the nation's news wires within that very narrow window of time:

Associated Press (via U.S. News and World Report): China Targets $3 Billion of US Goods in Tariff Spat, 23 March 2018, 2:40 PM Eastern Time

Doing some quick math, China's threatened tariffs on $3 billion worth of selected U.S. goods were sufficient to reduce the S&P 500's estimated market capitalization by more than $393 billion.

That's quite the scare multiple! At the very least, investors have sent a very loud and expensive message to both Washington D.C. and Beijing that a trade war is a lose-lose proposition.

And though the rest of the week's news headlines didn't have that kind of market-moving power, here they are, as we noted them.

Yoda: Begun the Trade Wars have
Monday, 19 March 2018
Tuesday, 20 March 2018
Wednesday, 21 March 2018
Thursday, 22 March 2018
Friday, 23 March 2018

Elsewhere, Barry Ritholtz found that the week's positives outweighed the negatives for the U.S. economy and markets during the third full week of March 2018.

As we wrap up our summary of what happened for the S&P 500 in Week 3 of March 2018, we may very well have a new, negative noise event for investors to factor into their geopolitical calculations. Oil prices may be something very worthwhile to pay close attention to in this fourth and final week of March 2018.

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23 March 2018
How Did They Ferment Beer - Add Yeast to Wort + Time = Carbon Dioxide + Alcohol Source: NIH - https://www.nlm.nih.gov/exhibition/fromdnatobeer/exhibition-interactive/fermentation/fermentation-alternative.html

The basic process of making beer goes back hundreds, if not thousands, of years. It starts when brewers add yeast to wort, which is a mixture of grain, flavoring agents and water that have been prepared to maximize their sugar content. The mixture is then stored away in a closed container, where the yeast goes to work to convert, or to ferment, the sugar into alcohol, carbon dioxide and other products, which become what we know as beer.

In recent centuries, brewers have taken to adding the flowers of the hop plant to their beers during the brewing process to add additional flavor, which often gives them a citrusy, floral, or bitter character that many beer drinkers crave.

Alas, for craft brewers, obtaining high quality hops can be a problem, where the water-hungry plant has been in short supply in recent years.

That's where today's invention comes into play, because a team of biologists led by Charles Denby at the University of California-Berkeley have developed a method to give a beer all the flavor of hops, without using any. Their secret? Use CRISPR technology to modify genes in yeast so that it can provide the flavor profile that is traditionally obtained by hopping the beer as it is brewed:

To achieve this, the researchers inserted four new genes, as well as the promoters that regulate the genes, into industrial brewer’s yeast using the gene editing tools. Linalool synthase and geraniol synthase—two of the genes used that came from mint and basil—code for enzymes that produce flavor components common to several plants....

Two other genes from yeast boosted the production of precursor molecules required to make linalool and geraniol—the hoppy flavor components.

All the genetic components—the Cas9 gene, four yeast, mint and basil genes and promoters—were inserted into yeast on a tiny circular DNA plasmid. The researchers used the yeast cells to transplant the Cas9 gene into the Cas9 proteins, which cut the yeast DNA at specific points. Yeast repair enzymes were then spliced in the four genes and promoters.

Brewers need at least 50 pints of water to grow the hops needed for each pint of beer. They also need fertilizer and energy to transport the crop, making cultivating hops for beer an expensive process.

But by engineering yeast to do the job of hops in flavoring beer, they can reduce the demand for water that now goes to growing hops to support beer production while still delivering the kind of final product that consumers enjoy.

We know that, because they put it to a taste test after getting clearance from an Institutional Review Board (IRB):

After IRB approval (you have to love science), 40 dedicated employees of the Lagunitas Brewing Company (28 males and 12 females), ages 20 to 50 with 2 to 154 tasting episodes annually participated in the evaluation. They were provided 5 2-ounce pours consisting of 1 control, three various genetically modified yeast beers and one blind control and asked to rank the tastings on a 9 point scale. They determined “that the finished beers exhibited a range of hop flavor/aroma intensity” or as Bryan Donaldson, Lagunitas’s innovations manager found “notes of ‘Fruit Loops’ and ‘orange blossom’ with no off flavors.”

It's a brave new world. As for what CRISPR is and how else that technology might affect the future for beer, be sure to watch the following video from Engadget:

Other Fun Food-Related Innovations

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22 March 2018

In California, the rising number of homeless people are not who you may think they are. The Los Angeles Times editorial board recently drove home that point by personalizing what it means to be homeless in the United States' second-most populous city in 2018.

Many people think of homelessness as a problem of substance abusers and mentally ill people, of chronic skid row street-dwellers pushing shopping carts. But increasingly, the crisis in Los Angeles today is about a less visible (but more numerous) group of “economically homeless” people. These are people who have been driven onto the streets or into shelters by hard times, bad luck and California’s irresponsible failure to address its own housing needs.

Consider Nadia, whose story has become typical. When she decided she had to end her abusive marriage, she knew it would be hard to find an affordable place to live with her three young children. With her husband, she had paid $2,000 a month for a three-bedroom condo in the San Fernando Valley, but prices were rising rapidly, and now two-bedroom apartments in the area were going for $2,400 — an impossible rent for a single parent who worked part time at Magic Mountain.

Nadia and her children are among the economically homeless — men, women and, often enough, families, who find themselves without a place to live because of some kind of setback or immediate crisis: a divorce, a short-term illness, a loss of a job, an eviction. In many cities across the nation, these are not necessarily problems that would plunge a person into homelessness. But here they can. Why? Because of the shockingly high cost of housing in Los Angeles.

Perhaps the most important thing that anyone should take away from Times' editors' take on Nadia's situation is that she is functional adult who is more than capable of improving her lot. Later in the editorial, the LA Times' editors disclose that she was able to get her family into a homeless shelter and that she has been able to secure a full time job doing data entry at an insurance company, where only a few of her co-workers know of her homeless status.

Nadia is far from alone in Los Angeles.

Estimates of People Experiencing Homelessness in Los Angeles City and County, 2012-2017

Meanwhile, north of Los Angeles, Santa Barbara is one of the wealthiest cities in California. There, the New Beginnings counseling center has made arrangements to allow up to 150 Californians who are either living in their cars or in recreational vehicles to be able to park them overnight in the otherwise empty parking lots of local churches and government offices.

The clients can park after 7 p.m., but have to clear out as early as 6 a.m. The benefit is that the vehicles are no longer parked on city streets, which riles some residents and merchants. And because the lots are monitored by New Beginnings, the clients, who all go through a screening process, can at least feel safe while they sleep.

Santiago Geronimo works in the kitchen of a high-end Santa Barbara restaurant and until recently, he, his girlfriend and her son Luis lived in a two-bedroom apartment shared by four adults and three kids. But the girlfriend, Luisa Ramirez, lost her retail clerk job because of a back injury, and they've lived in a Ford Explorer since September. Their new home is a church parking lot on the Goleta border.

There is a common element among many of California's employed homeless, in that many were living in apartments or houses until one of their household's members experienced a job loss. Beyond that, many were employed with relatively good incomes until they lost their jobs, where they soon found that their available employment options were limited to low-paying jobs that weren't enough to pay their rents or mortgages.

Then the evictions came, and they became homeless. All across the state.

Estimates of People Experiencing Homelessness in California, 2012-2017

Steve Lopez, a LA Times columnist, asked a good question about why California's working population doesn't move to where housing is cheaper:

You might ask why people of lesser means don't head to less expensive areas than Santa Barbara — it's a fair question, and I've written about people who eventually did make such a move. In Santa Barbara, the answers I got were the same ones I've heard elsewhere in coastal California. People hold open the option of leaving, but many are connected to specific places by history, family and employment connections, and they're not quite ready to give up on a turnaround, move to a place they don't know, and start over from scratch.

Besides that, local economies rely on those of lesser means, so where are they supposed to live?

"You know," said Phil, "there's a huge Hispanic population that does all the damn work around here. Every restaurant you go into, you can watch them slaving away. And they're taking care of people's gardens and everything else, and they wind up with eight or 10 people living in a one-bedroom place."

Until that doesn't work, as Santiago Geronimo found out.

The truth is that many Californians have tried to move to greener pastures, as many have from California's economically-distressed Central Valley, where that region's oil industry has yet to recover from the decline of oil prices from July 2014 through February 2016. According to Moody's, for every job lost in the oil and gas industry, an additional 3.43 jobs may be lost in other sectors, creating a negative deficit that other, more strongly growing sectors of the economy must be in overdrive to overcome, just to get to the point where any positive economic growth may be recorded. California's Central Valley lost thousands of oil and gas industry jobs during the downturn, where some of the impact of those losses are also being felt in other communities throughout the state's interior.

In Bakersfield, in Kern County, where many of the state's oil and gas industry jobs are centered, the city's homeless shelters were forced to turn away Californians seeking shelter earlier this year because they ran out of space to accommodate them during a short cold snap, when having to sleep outdoors became too intolerable.

Some of the economically displaced from California's Central Valley have migrated to where jobs are available in the state's thriving metropolises, such as San Francisco and Los Angeles, where they've run into the same situation of excessively high rents. Consequently, they've joined the ranks of the employed homeless.

Others are fleeing the state altogether, paradoxically seeking to escape the "prosperity" of the state's coastal cities, with the housing shortage-driven soaring rents and declining quality of life in those cities becoming a primary motivation for their flight.

All these things together would appear to have set California on a very different course than the rest of the United States. At the very least, where the trends for homelessness are concerned.

Estimates of People Experiencing Homelessness in the United States, 2012-2017

For his part, the state's governor, Jerry Brown, refused to declare the state's homelessness crisis to be an emergency in 2016, which denied the state's counties and cities any additional resources to combat homelessness. The state's data for homeless in 2017 shows the results of that decision, where at the national level, if not for California, the trend for homelessness in the U.S. would have improved.


U.S. Department of Housing and Urban Development. Annual Homeless Assessment Report (AHAR) to Congress. [PDF Documents: November 2012, November 2013, October 2014, November 2015, November 2016, and December 2017].


In 2014, the Point-In-Time (PIT) estimates from 2007–2013 were revised to be lower than the figures originally reported in previous AHARs, where the reduction reflects an adjustment to the estimates of unsheltered homeless people submitted by the Los Angeles City and County Continuum of Care during these years. The adjustment removed: 20,746 people from 2007 and 2008, 9,451 people in 2009 and 2010; 10,800 people in 2011 and 2012; and 18,274 people from 2013. A similar, but smaller downward adjustment was made to the estimates from 2007-2014 in 2015, reflecting an adjustment to previous estimates of unsheltered homeless people submitted by the Los Angeles City and County Continuum of Care and Las Vegas Continuum of Care. The figures we've presented incorporate these adjustments.

Meanwhile, in Modesto, the city's police took action to ensure that city's homeless population count for 2018 would come in lower than it did in 2017....


21 March 2018

Last week, the stock prices of one particular class of companies crashed after regulators at the U.S. Federal Energy Regulatory Commission acted to terminate a tax benefit that it had previously allowed.

Here's an excerpt from the FERC's official 15 March 2018 press release:

FERC Revises Polices, Will Disallow Income Tax Allowance Cost Recovery in MLP Pipeline Rates

The Federal Energy Regulatory Commission (FERC) today responded to a federal court remand by stating it no longer will allow master limited partnership (MLP) interstate natural gas and oil pipelines to recover an income tax allowance in cost of service rates.

The U.S. Court of Appeals for the District of Columbia Circuit in United Airlines, Inc. v. FERC, (827 F.3d 122 (D.C. Cir. 2016) held that FERC failed to demonstrate there was no double recovery of income tax costs when permitting SFPP, L.P., an MLP, to recover both an income tax allowance and a return on equity determined by the discounted cash flow methodology.

The Commission today acted in response both to the court remand and comments filed in response to an inquiry issued after the court ruling. FERC will now revise its 2005 Policy Statement for Recovery of Income Tax Costs so that it no longer will allow MLPs to recover an income tax allowance in the cost of service.

Normally, the intersection of federal tax laws, regulations and accounting procedures would make most investors' eyes glaze over with extreme boredom, but the market's response to the FERC's announced change was both swift and dramatic.

Shares of U.S. energy master limited partnerships (MLPs) plunged on Thursday, after regulators said they will no longer allow certain tax benefits for interstate oil and gas pipeline operators structured as MLPs.

MLPs are tax-exempt corporate structures that pay out profit to investors in dividend-style distributions. In 2016, a U.S. Appeals Court ruled that energy regulators were allowing these companies to benefit from a “double recovery” of taxes.

On Thursday, the U.S. Federal Energy Regulatory Commission (FERC) said the companies, largely oil and natural gas pipeline firms, will no longer be allowed to recover an income tax allowance as part of the fees they charge to shippers under a “cost of service” rate structure.

This could affect MLP earnings, and as a result shares stumbled. The Alerian MLP index, which tracks a number of pipeline firms, fell as much as 9.4 percent on Thursday to its lowest since February 2016.

The stock market tape for the Alerian MLP index (NYSE: AMLP) reveals the carnage for the nation's Master Limited Partnerships (MLP), many of which were specifically set up under that legal structure to support the distribution of natural gas and oil within the U.S.:

Google Finance: AMLP, 14 March 2018 through 20 March 2018

You can see almost the exact moment in time when the FERC made its announcement of its new policy on 15 March 2018, which looks like came out somewhere between 11:06 AM and 11:10 AM Eastern time.

For investors, the change in tax allowances means that companies structured as MLPs will have reduced revenues, which in turn, will reduce the amount of money available to pay what had been high-yielding dividends to their shareholders.

And though these companies have yet to announce changes in their dividend policies, their stock prices swiftly declined in anticipation of that outcome. One MLP, Williams Companies (NYSE: WMB) saw its share price drop by nearly 11% on 15 March 2018, which proved to be the biggest loss of any component company of the S&P 500 that day.

One question going forward is how many of these firms will seek to restructure themselves or that might seek to consolidate in light of the FERC's new tax allowance policy. What might at first seem like an arcane tax regulation change will likely have a significant impact on what the future will look like for the U.S. natural gas and oil pipeline industries.

And if changes in a corporate income tax allowance that affects a small number of companies can do that to their stock prices, imagine what new tax on total revenue like the EU's proposed 3% tax on the gross digital revenues of tech companies in the European Union like Amazon (NASDAQ: AMZN), Apple (NASDAQ: AAPL), Alphabet (NYSE: GOOGL), and Facebook (NYSE: FB) might do to their stock prices. And to the S&P 500, since these firms account for nearly 10% of the entire market cap of the stock market index.

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20 March 2018

The risk of a national recession beginning in the United States anytime in the next year, or specifically between 16 March 2018 and 16 March 2019, is slightly over 0.5%. If that sounds very familiar, that is because we wrote an almost identical lead sentence nearly six weeks ago!

Then, as now, the occasion for our using that introductory sentence once again is the eve of a two-day meeting for the Federal Reserve's Open Market Committee (FOMC), which is expected to announce that it will boost its target range for short term interest rates in the U.S. by a quarter percent, increasing to be between 1.50% and 1.75%.

But it hasn't yet, so the probability of a national recession starting sometime in the next 12 months has remained about the same, as confirmed by the latest update to our recession probability track.

U.S. Recession Probability Track Starting 2 January 2014, Ending 16 March 2018

This update confirms a prediction that we made six weeks ago, where we made the following observation after finding something worth noting about the direction of U.S. Treasury yields:

The interesting thing about what's happening in the bond market is that long-term yields are increasing faster than short term yields, where the spread between the 10-Year and 3-Month constant maturity Treasury yields bottomed at 0.98% on 27 December 2017. Since then, the spread between the two Treasuries has opened up to 1.29%.

For our recession probability track, that means momentum has been building for a potential reversal in the downward component of its trajectory toward increased odds of recession.

Sure enough, that's exactly what happened over the last six weeks! Unfortunately, we do not expect that positive trend to continue.

Going into the FOMC's March 2018 meeting, we find that the trend for the 3-Month Constant Maturity U.S. Treasury since January 2018 is slowly rising yields. Meanwhile, the trend in the yield for the 10-Month Constant Maturity U.S. Treasury has reversed from growing to falling in recent weeks. The two trends together mean that the spread in the U.S. Treasury yield curve, the difference between the 10-Year and 3-Month Treasuries, has begun to shrink once more.

Since that is happening at the same time that the Fed is set to hike its Federal Funds Rate, the combination of all these things means that the risk of future recession starting in the U.S. economy will rise, primarily as a consequence of the Fed's action.

Our analysis above is based on Jonathan Wright's 2006 paper describing a recession forecasting method using the level of the effective Federal Funds Rate and the spread between the yields of the 10-Year and 3-Month Constant Maturity U.S. Treasuries. If you would like to play the recession forecasting game at home, or just want to run the latest numbers yourself without having to wait another six weeks for us to get around to it when the Fed is getting set to meet again, our tool for Reckoning the Odds of Recession is available to satisfy your recession forecasting needs.

If you use the latest data for the treasury yields and the Federal Funds Rate in our tool, you'll find that your results will differ from the data we've presented in the chart above. That is because the chart follows Wright's methodology in using the one-quarter average for the yields and rates data used in its calculations, where the tool's results based on the most recently available data can be taken as an indication of the direction that the recession probability track is heading when compared with the information provided by our recession probability track chart.

Give it a shot - there's no legitimate reason why economists should have all the recession forecasting fun!

Update: Lance Roberts offers some valuable insights into the difficulties of recession forecasting and considers a variety of other indicators.

Previously on Political Calculations


19 March 2018

It has been a long week and a half since we closed out our month-long red zone forecast for the S&P 500. Since then, investors appear to have briefly flirted with focusing their forward-looking attention on 2018-Q2 in setting stock prices, but that didn't last very long, where in the second full week of March 2018, they would appear to be splitting their attention between 2018-Q2 and the much more distant future quarter of 2019-Q1.

Alternative Futures - S&P 500 - 2018Q1 - Standard Model - Snapshot on 16 March 2018

It has been pretty quiet week on the FedWatch front during all that time, which is attributable to Federal Reserve officials going into a news blackout period ahead of the Federal Open Market Committee's two-day meeting in this upcoming week, which will conclude on Wednesday, 21 March 2018. At this point, investor expectations of a quarter point rate hike being announced this week are all but locked in, where investors are anticipating at least two more quarter point rate hikes to be announced in the next six months, before the end of each of the next two quarters.

Probabilities for Target Federal Funds Rate at Selected Upcoming Fed Meeting Dates (CME FedWatch on 16 March 2018)
FOMC Meeting Date Current
125-150 bps 150-175 bps 175-200 bps 200-225 bps 225-250 bps 250-275 bps 275-300 bps
12-Mar-2018 (2018-Q1) 5.6% 94.4% 0.0% 0.0% 0.0% 0.0% 0.0%
13-Jun-2018 (2018-Q2) 1.0% 22.0% 72.3% 4.7% 0.0% 0.0% 0.0%
26-Sep-2018 (2018-Q3) 0.3% 7.9% 37.1% 46.2% 8.2% 0.4% 0.0%
19-Dec-2018 (2018-Q4) 0.2% 4.1% 21.8% 39.7% 26.8% 6.8% 0.7%

That marks a change in expectations, where previously, investors had expected three rate hikes in 2018, but in the first, second and fourth quarters, as opposed to occurring in the first, second and third quarters as they are now anticipating. At the same time, expectations of an additional quarter point hike in the fourth quarter are building, but as yet, have not reached the level where investors are giving at least a 50% chance of that happening.

With Fed officials clammed up during the past 10 days, investors had little more than news headlines to catch their attention. Here are the potentially market-moving news items that caught ours....

Wednesday, 7 March 2018
Thursday, 8 March 2018
Friday, 9 March 2018
Monday, 12 March 2018
Tuesday, 13 March 2018
Wednesday, 14 March 2018
Thursday, 15 March 2018
Friday, 16 March 2018

For those keeping track, Barry Ritholtz found that the positives outweighed the negatives for the U.S. economy and markets in the first full week of March 2018, and that the they balanced each other during Week 2 of March 2018.

We're making a point of noting the major international trade-related headlines, where U.S. President Trump's planned tariffs are certainly getting lots of attention, but through the first half of March 2018, we'll agree with Goldman Sachs' assessment that stock prices really aren't reflecting much of a concern over the probability of a broad trade war. Despite what the headlines are indicating, what we are seeing so far is mostly consistent with the typical levels of noise that have historically characterized the day-to-day volatility of stock prices. We'll continue paying attention to both trade headlines and stock prices to see if that apparent investor response continues.

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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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