Major stock averages close at record highs on tax reform news
- 2017-12-18
- By William Lynch
- Posted in Corporate Earnings, Dow Jones Industrial Average, Economy, Federal Reserve, Fixed Income, Interest Rates
The only time to buy that which you don’t understand is on the day with no Y in it. – Warren Buffett
All three of the major stock averages closed at record highs last week as the odds that the Republicans would pass a tax reform package increased substantially. While there was some doubt as to whether or not the Republicans had enough votes after Senator Marco Rubio argued that the child tax credit should be larger, his wish was granted by Friday and stocks rallied on the news. With a cut in the corporate tax rate to 21% and reductions in individual tax rates as well, investors became convinced that this legislation will boost earnings growth in 2018. Continued efforts by the Trump administration to eliminate burdensome and unnecessary government regulations should also help increase corporate profitability. Confident now that they have enough votes to pass tax reform, Republican leaders hope to vote on the bill this week and have it on President Trump’s desk for his signature by Christmas. Stocks have risen on the hope for tax reform and could fall when it actually becomes a reality as investors sell on the news, but most investment strategists believe that the tax plan will lead to more upside in the stock market. Almost forgotten last week with the focus on tax reform was the Federal Open Market Committee (FOMC) meeting. As expected, the Fed raised its benchmark interest rate a quarter point to a target range of 1.25% to 1.50%. This was the third quarter point increase this year and three more similar hikes are planned for 2018. Fed members also raised their estimate slightly for GDP growth and inflation next year and expect that the unemployment rate will dip below 4% in 2018. Overall, the Fed remained optimistic about the economy and forecast that the labor market will remain strong. Even outgoing Fed Chair Janet Yellen conceded that the possibility of tax cuts and tax reform was helping to boost the economic growth outlook. The announcement last week that Walt Disney agreed to buy 21st Century Fox’s movie studios and other assets for $52.4 billion also helped give the stock market a lift as investors believed more deals could be on the way.
Last Week
Inflation data released last week was generally higher than expected due to the increased price of gasoline. The producer price index (PPI) for November posted the biggest monthly gain in 6 years while the consumer price index (CPI) and U.S. import prices were also higher than in October as gas prices surged. However, core CPI, which excludes food and energy, rose only 1.7% for the year ending in November and the personal consumption expenditures (PCE) index, the Fed’s preferred measure of inflation, has also been running below 2%, the Fed’s targeted rate for inflation. Retail sales in November were much higher than expected, and as a result, it appears that the economy is poised to gain strength. Weekly jobless claims fell 11,000 to 225,000, less than the 239,000 that were expected, as the labor market remains strong and November industrial production rose modestly as expected.
For the week, the Dow Jones Industrial Average rose 1.3% to close at 24,651 while the S&P 500 Index added 0.9% to close at 2,675. The Nasdaq Composite Index jumped 1.4% to close at 6,936.
This Week
November housing starts, existing home sales and new home sales should all show numbers that are consistent with a healthy housing market. The final reading of third quarter GDP is expected to remain unchanged at 3.3%. Durable goods orders for November are forecast to show a big increase due to a rebound in civilian aircraft orders but leading economic indicators are expected to show only a modest increase after a strong October.
The U.S. government could face a partial shutdown if Congress does not pass a funding bill on Friday.
The most notable companies that are scheduled to report earnings this week include Carnival, Darden Restaurants, Micron Technology, FedEx, General Mills, Nike, Accenture and Con Agra Brands.
Portfolio Strategy
The late legendary investor, Sir John Templeton, once said that “bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria”. Right now the stock market is in a stage of optimism as investors are confident about the economy and future earnings growth, believe inflation is under control, are sanguine about the jobs market and hopeful that tax reform will solidify economic growth. Since it bottomed back in March 2009, the stock market has had a remarkable run with the S&P 500 posting a total return of nearly 400%. However, valuations are now stretched as this benchmark currently trades at about 22 times trailing earnings, compared to the historical average of about 15 or 16. Based on earnings estimates for 2018, the stock market trades at about 18 times expected profits, still not cheap. On an absolute basis, the stock market is very expensive. But relative to current bond yields, stocks are not nearly as overvalued as they may appear. The earnings yield of the S&P 500 Index, which is the inverse of the price earnings ratio, is about 4.5%, which is almost double the current yield of 2.35% on the 10-year Treasury. Not only are earnings expected to grow by about 10% next year, but the effects of tax cuts have not been figured in and should mean even higher profit growth. While stocks may not be cheap, they are not in bubble territory, either, as many pundits have been quick to point out. There are no visible signs of euphoria, at least not yet, and until there are, this bull market could continue to move higher.
Recent Posts
Archives
- October 2024
- September 2024
- August 2024
- July 2024
- June 2024
- May 2024
- April 2024
- March 2024
- February 2024
- January 2024
- December 2023
- November 2023
- October 2023
- September 2023
- August 2023
- July 2023
- June 2023
- May 2023
- April 2023
- March 2023
- February 2023
- January 2023
- December 2022
- November 2022
- October 2022
- September 2022
- August 2022
- July 2022
- June 2022
- May 2022
- April 2022
- March 2022
- February 2022
- January 2022
- December 2021
- November 2021
- October 2021
- September 2021
- August 2021
- July 2021
- June 2021
- May 2021
- April 2021
- March 2021
- February 2021
- January 2021
- December 2020
- November 2020
- October 2020
- September 2020
- August 2020
- July 2020
- June 2020
- May 2020
- April 2020
- March 2020
- February 2020
- January 2020
- December 2019
- November 2019
- October 2019
- September 2019
- August 2019
- July 2019
- June 2019
- May 2019
- April 2019
- March 2019
- February 2019
- January 2019
- December 2018
- November 2018
- October 2018
- September 2018
- August 2018
- July 2018
- June 2018
- May 2018
- April 2018
- March 2018
- February 2018
- January 2018
- December 2017
- November 2017
- October 2017
- September 2017
- August 2017
- July 2017
- June 2017
- May 2017
- April 2017
- March 2017
- February 2017
- January 2017
- December 2016
- November 2016
- October 2016
- September 2016
- August 2016
- July 2016
- June 2016
- May 2016
- April 2016
- March 2016
- February 2016
- January 2016
- December 2015
- November 2015
- October 2015
- September 2015
- August 2015
- July 2015
- June 2015
- May 2015
- April 2015
- March 2015
- February 2015
- January 2015
- December 2014
- November 2014
- October 2014
- September 2014
- August 2014
- July 2014
- June 2014
- May 2014
- April 2014
- March 2014
- February 2014
- January 2014
- December 2013
- November 2013
- October 2013
- September 2013
- August 2013
- July 2013
- June 2013
Categories
- Commodities
- Corporate Earnings
- Covid-19
- Dow Jones Industrial Average
- Economy
- Elections
- Emerging Markets
- European Central Bank
- Federal Reserve
- Fixed Income
- Geopolitical Risks
- Global Central Banks
- Interest Rates
- Municipal Bonds
- Oil Prices
- REITs
- The Fed
- The Market
- Trade War
- Uncategorized