Profit-taking is a natural and expected part of the stock market. That's why no one should be surprised that this week we are witnessing a period of consolidation. It is actually a good thing.

 

Given that most investors need a reason to explain any market declines, this week's announcement that President Trump is postponing his meeting with Xi, his Chinese counterpart, was both a surprise and a disappointment. It shouldn't be.

 

Over the last few months, I have tried to reduce investors' expectations of an easy, one-shot, Chinese break-through on the trade front. The postponement is actually a positive, in the sense that both sides are taking the negotiations seriously. There is just too much to negotiate, which is why I expect that the March 1 deadline to institute additional tariffs will again be postponed.

 

Part of the problem is the president's insistence that he be the one to make most, if not all, of the decisions on the China front. That is difficult to do when his attention has been focused on getting his Wall money, fending off investigation after investigation, shutting down the government (or not), and feuding with Nancy Pelosi and Chuck Schumer.

 

There just isn't enough time in the day. To accomplish all of the above and move forward to solve an array of issues that have evolved over decades of trade with the world's second-largest economy is asking the impossible. I have to hand it to Trump for even attempting to renegotiate our long-standing China trade issues. No other president before him has tried.

 

As such, investors should take a more realistic view of what can and cannot be done between now and March. But try telling that to the machines that drive most of the daily trading. All they need is the word "postponement" and the selling begins. 

 

Last week readers might recall that I expected this pullback.

 

"We have seen some good gains, however. So, I would expect to see a period of consolidation in the weeks ahead. Any dips in the market would be an opportunity to buy, not sell."

 

My target was 2,715 on the S&P 500 Index. We hit that level and a bit beyond before profit-taking began on Wednesday. Regardless of the reason, stocks were over-bought, in need of consolidation, and the China news provided the excuse. 

 

I said last week that if you had sold out of the markets during the downdraft we experienced in the last quarter of 2018, you now have an opportunity to get back in the market. I am sure you will be wondering at what level. Short-term timing advice is purely a guesstimate. From a technical point of view, the S&P 500 Index could drop another 50 points easily from here to 2,646.

 

It could go lower, but I wouldn't worry about it. You see, all it would take is an encouraging tweet by the president to trigger a buying frenzy among the machines. Investors, please ignore the day-to-day noise. The economy, earnings and employment are still growing. The Fed is no longer tightening and that's all you need to know.

 

After two years of tightening monetary policy, the U.S. Federal Reserve Bank signaled this week that it was time to put their monetary tightening program on hold. The stock market soared in celebration.

 

As we closed out the month of January, stocks are gaining. The October-December declines that culminating in the "Christmas Eve Massacre," which were the worst in 80 years, are rapidly disappearing. Investors who were smart enough to hold fast should be made whole again by the end of this quarter, if not before.

 

That does not mean that the volatility that has beset the markets of late will fade away. Quite the contrary, I expect the wild swings in the stock market to continue. But for now, the Fed has once again provided a floor of support for equities. The question to ask is:

 

"Was the Fed's move justified, or did the markets (and Donald Trump) scare Chairman Jerome Powell and his committee into backing off?"

 

I would say there is a little of both in the Fed's actions. While the economy is still growing, "the case for raising rates has weakened somewhat," according to Powell, who spoke after the FOMC meeting on Wednesday. Of course, he reminded his audience that the Fed would still be "data dependent" in deciding when the next interest rate hike might occur.

 

That was a sea change in rhetoric from last quarter when the Fed chief said rate increases and sales of $50 billion a month U.S. Treasury bonds were largely on autopilot. President Trump threw a fit, making his own dissent from that policy quite clear. He believed that the Fed's actions were causing the economy to slow. He lashed out at the man he hired last year to lead the Fed and threatened to have him fired.   

Whether it was his words or the fact that the markets threw a hissy fit, plummeting almost 20 percent in a matter of weeks, is debatable. Whatever the reason, the Fed did a 180 and has returned to the easy money religion that has galvanized the stock market since the financial crisis of over a decade ago.

 

Some of the key variables that the Fed studies in order determine monetary policy are wage growth, inflation, GDP, and unemployment (among others). None of them are flashing warning signs yet. Yes, economic growth is moderating but is still growing. Yes, we are seeing some wage growth, but it is not out of hand by any means.

 

Friday's employment report indicated wage growth is moderating, although jobs are still gaining. Nonfarm payrolls surged to 304,000 jobs versus estimates of 170,000. Evidently, the government shutdown didn't have that much impact on the data, although the official unemployment rate did tick up to 4 percent, which is where it was back in June of last year.

 

Granted, corporate earnings are slowing, but if this quarter's earnings season is any indication, many companies are still seeing good gains from the economy.  So maybe, just maybe, all those Doom Sayers predicting an imminent recession are wrong. It seems to me that we are in an economic sweet spot that will support stock prices through the remainder of the winter.

 

Last week, I predicted the S&P 500 Index would touch 2,715. We hit 2,716 on Friday. That brought the gains for the three averages for the month of January to 8 percent for the Dow, 9.5 percent for the S&P 500 Index, and 12 percent for the NASDAQ. That was the best stock market performance in thirty years.  For those of you who followed my advice and held on to your positions through the last quarter of 2018, you have now recovered the lion's share of your losses.

 

We have seen some good gains, however. So, I would expect to see a period of consolidation in the weeks ahead. Any dips in the market would be an opportunity to buy not sell. For those of you who sold last quarter, I am sorry, but you will probably get a chance to buy back in the months ahead.

 

 

The European Community is beset by worries. Brexit, trade threats, a slowing Chinese economy, and internal politics at home have all conspired to slow growth, employment, and positive sentiment.

 

This year, the EU will be lucky to see 1.5 percent GDP growth. In fact, the International Monetary Fund reduced their overall forecast this week for global growth largely as a result of poor performance out of Europe. Europe's powerhouse, Germany, saw its growth for 2019 cut by 0.6 percent because of anemic consumption and weak industrial production data. 

 

Italy, one of the problem children of the EU, saw its growth forecasts cut by 0.4 percentage points as a result of weak domestic demand and out-of-control government borrowing. France did not escape the knife either. Its GDP was reduced by 0.1 percent, largely because of the continuous, production-stopping street protests.

 

Trade tensions top the list of obstacles afflicting Europe. While most of the news coverage tends to dwell on the slowing economy of China (because of the ongoing trade war), this issue is impacting businesses throughout the world. Automobile tariffs on EU exports, for example, have impacted growth, especially within Germany.

 

Brexit has also cast a dark shadow over Europe. Uncertainty has infected every corner of the 18-nation union ever since the UK referendum to leave the EU back in June 2016. The unsuccessful exit negotiations, which recently culminated in the British Parliament's rejection of the terms, brought to naught years of talks between Prime Minister Teresa May and her cabinet and EU negotiators.

 

Since then, both sides are grappling with the next step forward. Some believe another referendum will need to be called. Others hope new (and better) terms for the UK exit will be required, although the chances of the EU offering better terms is hard to believe. This issue will continue to weigh on investment and growth on both sides of the Channel until it is resolved.

 

No discussion of Europe would be complete without mention of Italy.  This southern nation is already flirting with recession. Fourth quarter growth was already the weakest it has been in four years.  Unwilling to adhere to the strict guidelines of EU lenders, the nation's voters insist on upping spending year after year, borrowing more and more, while digging itself deeper and deeper into a financial hole.

 

The nation has replaced Greece as the "Bad Boy of Europe" with a real risk of witnessing a collapse of their financial sector. The Italians, of course, are watching the exit negotiations of the United Kingdom. There is an implied threat if EU authorities lean on Italy too hard that what the UK can do, so can Italy.

 

Amid this unsettling backdrop, Mario Draghi and the monetary authorities of the EU's Central Bank (ECB) are walking a tightrope of maintaining some stimulus, while taking some away. Like our own Federal Reserve Bank, the EU has been slowing their purchases of government bonds, which should wind down to zero this year. This may or may not be followed by the ECB's first interest rate hike late in the year — if the data warrant it.

 

My own bet is that while the ECB is talking a good show, the economic worsening of conditions in Europe will postpone any rate hikes. If, on the other hand, a Brexit agreement can be reached, if a trade agreement with the U.S. can be resolved, and if Italy were to ‘find religion,' conditions may improve. But don't hold your breath.

 

The government's partial shutdown has everyone on edge this year. Despite assurances from the powers that be, many taxpayers are concerned that their tax returns won't be processed on time. Should you be worried?

 

One misconception many have is that the Internal Revenue Service is closed. Not true, the IRS remains open, despite having no budget since Dec. 21, 2018. The agency is running under a contingency plan, which includes operating with only 12 percent of its staff.

 

Usually, you can e-file your returns in late January, and that remains doable. The IRS announced it will be accepting 2018 tax returns starting January. 28, 2019. They also said they would be issuing refunds. To do so, they will be bringing back a large portion of their laid-off workers. Those workers, like the other 800,000 furloughed federal workers, won't be getting a pay check until the shutdown is over.

 

The question remains: how many of those workers are willing to return to their jobs without a paycheck? We are already seeing some departments (such as Homeland's TSA workers) balk at working for free any longer. But the government shutdown is not all the IRS needs to worry about.

 

Thanks to the Tax Cuts and Jobs Act passed in a hurry by Congress last year, the IRS has been working overtime to deal with the mountain of new changes and adaptions necessary to reflect the new tax laws.  To add insult to injury, it took months before the new rules were actually delivered to the IRS from the legislative branch. At the time, the Inspector General said that it would take "massive resources" to do what was necessary to fulfill taxpayer expectations, while making sure the IRS is compliant with the new laws.

 

The new tax reform legislation contained nearly 120 provisions, affecting both domestic and international taxation of American individuals and corporations. As a result, nearly 450 new forms, sets of instructions, and publications would need to be published and disseminated. On the IT side, another 140 information technology systems would need to be modified so that tax returns could be processed, and compliance monitored.

 

Conservatively, the IRS estimated that 4 million additional phone calls and other contacts would be required to deal with questions taxpayers and their accountants were going to have about how to file individual returns. And here we are beginning tax season and those calls have just begun! Remember, the IRS warned months ago that there might be delays due to the enormity of changes required of them.

 

"The tax reform is certainly making life difficult for us," says Barry Clairmont, a partner in Lombardi, Clairmont & Keegan, one of the leading accounting firms in the Berkshires. "Tax preparation is taking longer, and, on the corporate side, there is more reporting required due to what we call 'QIB' or qualified business income." 

 

Clairmont's advice is that corporations should begin the filing process now and not wait until the last minute.

 

On the other side of the country, Terry Milrany, one of the most respected accountants in Fort Worth, Texas, echoes much of what Clairmont says. He, too, sees the general business deductions of the 20 percent "pass-through" change in the tax law as something that is "still evolving" from within the IRS.

 

"Just in the last two days," he said, "I received another (and hopefully final) update from the IRS on this rule." As for the shut down's impact on tax returns, Milrany, who has been doing tax returns for 50 years, says, "We just don't know how the shutdown or the tax changes are going to impact returns. We are not deep enough into the filing season yet."

 

It was a week where lackluster earnings battled with the Fed's willingness to hold off on rate hikes for investors' attention. The Fed won. Investors bought on the dips and helped to push the markets out of correction territory.

 

From a technical point of view, however, all the U.S. indexes are overbought, extended, and in need of some kind of pullback. Traders know this and have been shorting the market as it climbs, betting that we will see at least a 100-point decline in the S&P 500 Index. It hasn't happened — yet.

 

Normally, markets will do what is most inconvenient for the greatest number of traders.

 

In this case, the indexes simply keep going up. But before you exhale in relief, be advised that when the last bear throws in the towel, that's when the markets will blind-side you.

 

For those who followed my advice last quarter and have remained invested, your paper losses are rapidly disappearing. I expect that, despite continued volatility through March, the second half of the year should see all your losses recouped and I expect further gains after that.

 

Earnings, which were not forecasted to match the gains of the last few quarters, have come roughly in-line with investor's lower expectations. So far, the average results indicate about a 7 percent gain for the quarter. In cases where a company announced less than that, traders were quick to punish their share price.

 

In some cases, for example, banking stocks, where trading profits were down last quarter as a result of the steep drop in equities, the Algos were whipping prices around on almost an hourly basis. Clearly, this is a market where the only smart thing to do is buy and hold for the longer term.

 

One positive (but suspicious) development occurred on Thursday afternoon. Someone (I'll call him the Trade Whisperer), let it be known through a Wall Street Journal report that the Trump House was considering pulling the Chinese tariffs in a bid to trigger a breakthrough in the U.S./Sino trade negotiations. It took all of 10 minutes for stocks to spike much higher.

 

Despite the outpouring of denials from all of Trump's men, U.S. markets still closed higher and continued the move into Friday. I found it interesting that, despite the denials, Asian markets, especially China, gained over one percent Thursday night. Where there's smoke, there may be some fire down the road.

 

I mention this because, in my opinion, events like this illustrates the extreme fragility of global markets. Anything (real or imagined) can spark a violent move in financial markets. A case in point is the troubling (and expanding) revelations that seem to be surrounding Donald Trump.

 

At last count, 16 of his closet aides and/or campaign staff have been linked to Russian nationals in an effort to tilt the presidential election in Trump's favor. His former closest confidant, Michael Cohen, is now admitting that his ex-boss actually conspired to obstruct justice (committed a crime) and that the Mueller investigation can prove it.

 

These are developments that every investor should take on board and treat seriously, regardless of political affiliation. There is potentially a risk that, despite Trump's repeated denials, Mueller does have the goods on the president. If so, look out below.

 

The bottom line: There is simply too much lurking out there to make an informed investment decision. As such, the best option is to stay invested, but keep looking over your shoulder.