Reaching the Heights
The 40,000 level for the Dow has been a long time coming. I recall having serious discussions about whether the Dow would cross the 1,000 level after being in the doldrums for many years. How wonderful an investing world it has become.
Some are calling for the S&P 500 to attain the 5600 level. The 5,300 level arrived much faster than any of the pundits had forecasted. Nasdaq is also at the high.
The real question is whether there is room for improvement in the equity markets from here. As long as the earnings materialize and the economy does not have a greater slowing in growth, there is room for further advances.
What does all this mean for fixed income? At the same time as equities have been cresting, rates have been moderating with some fluctuations. The ten-year Treasury at 4.379% is well off the 52-week high of 5%. Municipal rates have also rallied with some inversion still present at the shortest end of the curve.
We are now past the tax paying season and flows to the municipal mutual funds have turned positive once again. We are approaching the heavier roll over the months of June and July. With the uptick in issuance of late the negative net supply problem should be diminished.
California has released its May Revision to include recommendations for the final shape of the $288 billion all funds budget. Tax increases have been ruled out. Some tactics include delaying, deferring, and shifting certain expenditures. The plan has been changed to have a lighter drawdown from reserves in FY25 and to have a greater drawdown in FY26. The Budget Stabilization Account/Rainy Day Fund is targeted to decrease from $22.555 billion to $19.429 billion in FY25. Some $8.9 billion is proposed to be withdrawn from the BSA/RDF in FY26. This approach should serve to keep rating agencies at bay in the near term.
The real ponderable in the May Revision is whether the state will be able to cut $24.9 billion y.o.y. or (11%) from the General Fund to $200 billion in FY25. Every agency will experience cuts except for K-12 Education that will increase by 3.5% and Higher Education that will increase by 0.9%.
Some expenditures for capital outlay that would have been made from the operating budget will instead be shifted to being financed from bond issues.
On the revenue side, Personal Income Tax and Sales and Use Tax are estimated to increase by 4.6% and 2.2%, respectively. Since the equity markets are attaining new highs, the PIT estimate may be driven higher by the all-important consideration of capital gains. At the slightest indication of any turn in the markets, investors will be expected to exercise some of their gains.
We still must be mindful that this is an election year. Negative jabs by both candidates appear to be the order of the day. Among the major topics that need some airing is what approach both candidates will take regarding the expiration of the tax cuts at the end of next year. We have some parameters from the Democrats and await further details from the Republican side. How you cut taxes and reduce the increasing deficit would require much more growth than we have at present. The all-important details are to follow.
Treasury issuance has continued to ramp up with some record auctions occurring recently. Treasury has maintained a good approach that has not unsettled the markets so far. In addition, the Fed has eased up on its asset sales.
The Fed has remained on message about forcing inflation down to its 2% target. There have been some moderate improvements on the inflation front of late but we are still far from the target.
Rate cuts may be on the table still but the urgency to go ahead and to put them into effect is not. Some think September would be an appropriate time but it is far from a lock. Cuts next year are looking ever more plausible.
In the meantime, mega deals are getting done in Muni land with no adverse consequences. There remains an appetite for yield and high yield is commanding more attention than ever. As long as the economy continues to perform, we do not anticipate any hiccups that are prolonged.
I always break out into a smile when I hear that nuclear power is clean. I agree that the process itself is better than the alternatives. But what about all the spent fuel sitting in pools at plants around the country?
I first encountered the concept of a nuclear repository when I started in the business in 1978. Nevada was selected as the site due to its geology and the fact that in certain locations water intrusion would not be as much of an issue.
The spent fuel was to be encased in glass canisters and was intended to be buried far below ground. Senator Harry Reid effectively blocked the creation of the repository. I am not certain if there are any other sites that offer the same superior characteristics. I do know that spent fuel has an exceptionally long half-life so a site with excellent properties is required.
There was also a great debate about how the spent fuel would be trucked or sent by rail to the site with a fair degree of controversy.
Perhaps, the most important consideration is that large scale nuclear plants take ten years or so to construct. There is a movement to construct smaller plants that may be delivered more efficiently. Restarting existing plants that have been shuttered also has its own set of special factors to consider.
Turning to the development of nuclear power is not as simple as some would like us to think. Perhaps, it would be an effective approach to building more “clean” generation. But the topic of spent fuel needs to be addressed. Reprocessing has been done successfully in other countries. We have always been wary of whether reprocessed fuel could be made into weapons grade material.
I hope you are having a good and productive infrastructure week. Thanks to the Infrastructure Law and the Inflation Reduction Act many projects are being accomplished around the nation that otherwise may have gone unfunded or may have languished. Federal funding is key to many projects. Yet, the most cost-effective financing in existence remains the tax-exempt format. Other alternatives have been applied to several projects but the costs and the effective control of the project should always be carefully considered. Some projects that have been financed by P3s have been “bought” back by their host communities. However, other projects have been successfully delivered that may not have been accomplished any other way. Cost considerations to the end users remains the key. If the tolls or other charges are too high, the project may be at risk.
The tax-exempt format is here to stay unless Congress sees the need to tinker with the tax exemption to assist in our growing federal deficit and debt.
John Hallacy
John Hallacy Consulting LLC
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