Stocks have rallied to record highs since Republican Donald Trump won the presidency with promises to cut taxes, promote job growth and spend $1 trillion on roads, bridges and airports. As investor euphoria fades, the market faces the possibility of a steep decline in the range of 20 percent, according to a blogger on Seeking Alpha.
“Despite Trump's commentary this last week that ‘big league’ tax cuts would be coming soon, when they do we don't think there is going to be that much more room for the market to move up,” Orange Peel Investments, whose comments appear under pen names, said on the website. “These cuts could wind up being a ‘sell the news’ event.”
“Buy the rumor, sell the news” is a Wall Street adage to explain how forecasts change with new information. The saying may have special resonance as investors realize that corporate tax cuts won’t necessarily translate into a huge windfall.
“Most corporations don't pay tax rates over 30 percent to begin with. So, these tax cuts may not even affect as many companies as people think,” Orange Peel says.
Higher interest rates also could pressure borrowers who have depended on cheap money for the past eight years since the financial crisis, as the Federal Reserve cut its target rate to record lows. The central bank sought to revive the economy with a debt-fueled expansion.
“Rising rates are going to start to tighten the noose on corporations, individuals and businesses that have to service the debt that they have taken over the last seven or eight years,” according to Orange Peel. “As this cost of capital becomes more and more, we are prone to see more delinquencies and defaults as well as less capital drop to the bottom line of corporations.”
With stocks getting more expensive compared with company earnings, the market may fall as much 20 percent to get in line with historical valuations.
“Wall Street strategists trying to tempt investors into buying more stocks at these levels are playing with fire,” Michael Lewitt, a hedge fund manager, said in the Feb. 1 edition of The Credit Strategist newsletter.
He pointed to valuation metrics such as the Shiller cyclically adjusted price-to-earnings, which is closing in on a ratio of 30 times for the S&P 500, almost twice the historical mean of 16.7 times, as a sign that stocks are in bubble territory.
“At this point in the bull market, we have reached a period of what really feels like ‘tremendous’ euphoria,” according to Orange Peel. “People are buying stocks and they don't even know why. All people know is that the market simply will not go lower.”
The Dow Jones Industrial Average has risen 4 percent, the S&P 500 is up 4.6 percent and the Nasdaq Composite index has gained 8 percent this year.
Trump on Thursday sent a message by Twitter saying stocks will keep rising from this week's record levels.
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