With little in the way of economic data last week amid the continued earnings announcements maelstrom, the driver of the market’s climb was more political than fundamental. On Thursday, President Donald Trump said that in the coming weeks he would announce something “phenomenal” in terms of tax, although he offered no further details.
We are all for tax reform here at Tematica and the freeing up of capital that would get businesses to invest and help put more disposable income dollars into consumer pockets. With the consumer accounting for a purported two-thirds of the country’s economic engine, such actions could go a long way to helping the economy break out to the 2 to 2.5 percent GDP doldrums it’s been trapped in over the last several years.
In many ways, Trump’s tax comments were the second or third wave of the Trump Bump. This latest wave not only pushed all the major stock market indices higher last week, it also put them back in record territory. As investors, we’ve seen a number of times when the market gets ahead of itself, which often tends to be in lockstep with one of Wall Street’s favored sayings — “buy the rumor, sell the news.”
Getting back to Trump’s tax overhaul strategy, it appears the current administration is looking to decouple the tax reform issues into two buckets — corporate and individual — which we think is a smart move.
In our view, there is a better chance of passing corporate tax reform on a standalone basis than if it were tied to overhauling the individual tax code. As you know we largely stay out of the political fray here at Tematica, but even we can hear the faint chant of “fat cat” as Washington looks to overhaul the individual tax code, which means it is bound to be a larger fight. Color us pessimistic, but we’d be remiss if we didn’t consider any potential risks. When we do, the two we see are timing and magnitude — the timing of business-friendly tax cuts and the degree of the cuts vs. existing corporate tax rates.
Building on those two concerns, as much as we like to see the stock market moving higher, it appears the overall breadth of the market move has been rather narrow.
At the same time, given the move back into record territory valuations are once again stretched with the S&P 500 exiting the week at forward P/E ratio of 17.3, which is well above the 5-year average of 15.2 and the 10-year average of 14.4. It’s worth noting that, at least from a historical perspective, when valuations are stretched, breadth is narrow and complacency high, the stage tends to be set for pullbacks. And with that said, the Volatility Index (VIX) is near 10-year lows.
We suspect that combination is not only raising some hairs on the back of our collected necks but likely also on the necks of Wall Street traders.
Christopher (Chris) Versace is the Chief Investment Officer at Tematica Research, editor of the newsletter Tematica Investing, co-host of the Cocktail Investing Podcast and is a featured columnist to The Street.com as well as a contributor to Business Insider andForbes.com
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