“If 2003 is any guide, we don’t believe investors should overthink the short-term impact of tax cuts in 2018. The 10-year rose from 3.1% to 4.6% in six weeks after the 2003 tax cut was passed, GDP surged in 2004, and those companies with vast amounts of cash overseas outperformed.” …Strategas Research Partners
Taxes continue to be such a hot topic of conversation that one may begin to think it’s the middle of April instead of early December (here in Florida the weather is pretty much the same either way). Our day yesterday was spent once again fielding questions about what the proposed tax reforms will mean for the market and the economy, though we continue to stress there still exists quite a bit of uncertainty – not only about the long-term impacts of any changes but also how much the stock market has already priced in those changes (Deutsche Bank estimates only about a third is currently priced in). The odds of some form of a tax bill getting signed into law is “extremely high,” according to our Washington Policy analyst, Ed Mills, but its final form and what happens after it’s passed remains largely a mystery to everyone. There just haven’t been many major tax cuts in modern U.S. history to which to draw comparisons, especially not ones taking place after years of monetary stimulus and when many feel stock market valuations are already overly stretched. Yet, if we happen to get a repeat of the reaction after the 2003 Bush tax cuts, higher longer-term interest rates and an uptick in GDP next year would be the expectation, according to Strategas Research Partners, and it appears investors may already be starting to factor something similar into their analysis.
We have largely refrained from trying to pick the ultimate winners and losers of the tax bill, which is a reflection of both the inherent complexity involved and the fact that we think investment decisions should be based on more than just the amount of tax paid; however, when reviewing the S&P 500 companies that have had the highest effective tax rates over the last ten years, energy, retail, health care, and financials are disproportionately represented at the top of the list. The financials, especially, seem to set up quite nicely, with a potential combination of tax relief, higher interest rates, less regulation, and a growing economy contributing to their attractiveness.
It is little wonder, then, that money appears to be rotating into the sector at the expense of areas like technology, which is experiencing a rare period of playing the role of laggard. After such great gains in tech the last two years, it’s not too surprising investors would want to take some profits and look elsewhere. We continue to think tech, as a theme, won’t stay underperforming for too long, but it is definitely under pressure right now and not yet showing signs of hitting a bottom.
Switching back to the market as a whole, it was interesting that one major news source credited the tax bill with helping the S&P 500 (see chart on page 1) break out to another new all-time high early in the session yesterday, but then, after stocks retreated, the same source changed the headline to read that stocks were down as a result of the tax bill. This (perceived) ambivalence exemplifies why trying to trade based on something like tax policy is so difficult, especially when it feels like that is all the market is “talking” about right now. What is not getting talked about, at least not as much as we anticipated, is the potential for pushing out the corporate tax cuts to 2019, which is included in the Senate’s proposal but not the House’s. That is one big decision that will need to be reconciled in committee, but it is difficult to imagine investors completely shrugging off a delay when the expectation seems to have been for tax relief starting next year. Volatility does appear to be picking up, too, and yesterday’s intraday reversal doesn’t exactly look great on the charts, especially in the small cap Russell 2000 and tech-heavy NASDAQ Composite (see chart below). Getting a follow-through day on the downside could set us up for a real chance at some near-term weakness, and this morning the NASDAQ, in particular, still looks to be getting hit hard. Once again, taxes and the government spending deadline are the focus and we expect traders will continue to speculate on every little bit of news.