Tags: trump | tax | cuts | stocks

Trump Tax Cuts Give US Stocks Edge Over Global Rivals

Trump Tax Cuts Give US Stocks Edge Over Global Rivals
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Monday, 20 August 2018 09:22 AM Current | Bio | Archive

Stocks I: America First.

US stocks have been outperforming other major overseas stock price indexes since early February. That’s when President Donald Trump started his “America First” protectionist campaign aimed at making free trade fairer trade with America’s major trading partners. During the current bull market, Joe and I had been recommending a Stay Home investment strategy until the fall of 2016. On November 8, 2016, we switched to a Go Global strategy on mounting evidence that the global economy was rebounding from the worldwide energy-led mini-recession of 2015. We switched back to Stay Home in early June of this year in response to the escalating trade war.

US stocks have outperformed the major overseas stock indexes priced in local currencies so far this year. They’ve done even better when foreign indexes are priced in local currencies because the dollar has soared in response to Trump’s escalating trade war. Meanwhile, the 10-year US Treasury bond yield has remained below 3.00% since May 24. All this suggests that the greenback and US financial assets are viewed as the winners in a trade war.

However, Stay Home isn’t all about a risk-off approach to overseas economies. In fact, Joe and I believe that the outperformance of Stay Home so far this year also owes a lot to Trump’s stimulative tax cuts at the end of last year. Consider the following:

(1) The dollar. The preceding statement doesn’t seem to apply to the trade-weighted dollar, which jumped 7.4% since the year’s low on February 1 (Fig. 1). That coincides with the implementation of Trump’s America First trade campaign.

Debbie and I have often observed that the dollar tends to be strong (or weak) when the rest of the world is looking relatively weak (strong). That explains why the dollar tends to be inversely correlated with commodity prices, as measured by the Goldman Sachs Commodity Index (GSCI) (Fig. 2). So far this year, the GSCI is holding up reasonably well. However, it is heavily weighted with the prices of petroleum products, which have been propped up by looming US sanctions on Iranian crude oil.

Looking somewhat weaker is the CRB raw industrials spot price index, which has been weighed down by a significant drop in the price of copper in recent weeks (Fig. 3). The price of copper remains highly and inversely correlated with the value of the dollar (Fig. 4).

Of course, some of the relative weakness in the rest of the world reflects the relative strength provided the US economy by Trump’s tax cuts. In other words, the dollar’s strength isn’t all about the trade war. Fed officials continue to say that while the trade war may be a threat to US economic growth, they believe the economy will remain strong enough to justify further hikes in the federal funds rate from 1.75%-2.00% currently to possibly 2.75%-3.00% next year. Meanwhile, both the ECB and BOJ show no signs of normalizing their official interest rates, which remain abnormally low just below zero (Fig. 5).

(2) Relative forward earnings. The main reason why Stay Home has been outperforming Go Global since the start of the bull market is that the forward earnings of the US MSCI has outpaced the forward earnings of the All Country World ex-US MSCI (in local currencies) (Fig. 6). The former is up 172.4% since it bottomed during the 4/30 week of 2009 through the 8/2 week this year, while the latter is up 78.2% over the same period (Fig. 7).

(3) S&P 500 sectors. As Joe and I have previously observed, the ytd relative performance of the S&P 500 sectors’ stock indexes suggests that concerns about ongoing Fed rate hikes are having a more pronounced impact on stock prices than worries about the trade war. Here is the ytd derby for the 11 sectors: Information Technology (15.8%), Consumer Discretionary (14.2), Health Care (8.4), S&P 500 (6.0), Energy (3.9), Utilities (0.4), Financials (0.0), Real Estate (-0.4), Industrials (-1.1), Materials (-2.9), Consumer Staples (-7.0), and Telecommunication Services (-8.3) (Fig. 8). The leaders are mostly cyclicals, while the laggards are mostly interest-rate-sensitive sectors.

Drilling down some more, we can see that the ytd relative performance of the S&P 500 sectors’ forward earnings can explain some of the price action: Energy (56.3%), Telecommunication Services (20.9), Industrials (20.2), Financials (18.2), Materials (17.8), S&P 500 (17.4), Consumer Discretionary (16.3), Information Technology (15.8), Health Care (14.0), Utilities (5.6), Consumer Staples (5.1), and Real Estate (3.1). (See Table 2E in Performance Derby: S&P 500 Sectors & Industries Forward Earnings & Revenues.)

Stocks II: SmallCaps First. The widely held view is that SmallCaps have outperformed in the US because they are less exposed to the escalating trade and currency wars. That does make sense. However, their underlying fundamentals are improving faster on a relative basis as well. Consider the following:

(1) Forward revenues. Here are the ytd performances of forward revenues for the S&P 500/400/600: 6.2%, 6.0%, and 14.4% (Fig. 9).

(2) Forward earnings. Here are the ytd performances of the forward earnings of the three: 16.7%, 16.1%, and 27.9% (Fig. 10).

(3) Stock price indexes. Here are the ytd performances of the S&P 500/400/600 stock price indexes: 6.0%, 5.0%, and 13.4% (Fig. 11).

SmallCaps may be getting a bigger after-tax earnings boost from Trump’s tax cuts than larger corporations that have had the means to dodge taxes better than smaller ones.

That still begs the question of why small companies’ revenues are so strong on a relative basis. Perhaps Trump’s deregulation policies benefit smaller companies more than larger ones. After all, regulations are often promoted by large companies to keep small competitors at bay. The monthly survey conducted by the National Federation of Independent Business shows that significantly fewer small business owners have been reporting concern about government regulation and taxes since Trump was elected (Fig. 12).

Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.

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EdwardYardeni
U.S. stocks have outperformed the major overseas stock indexes priced in local currencies so far this year. They’ve done even better when foreign indexes are priced in local currencies because the dollar has soared in response to Trump’s escalating trade war.
trump, tax, cuts, stocks
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2018-22-20
Monday, 20 August 2018 09:22 AM
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