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Tax Cuts Are the Dream Pushing a Market That Won't Stop Climbing

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Tuesday, 03 October 2017 03:31 PM

Market pessimists are warning investors to temper their exuberance over President Donald Trump’s proposed tax cuts.

Stocks raced to records last week, the dollar hit a two-month high and 10-year Treasury yields rose to a three-month peak after the administration and congressional leaders announced a framework that would lower the corporate tax rate. Now, a growing chorus of analysts sees a tax trade that’s gotten ahead of itself. And they’re voicing skepticism on whether the plan will become law anytime soon

“We struggle to understand the positive market reception to the unveiling of the detailed tax reform proposal last week,” David Woo, Bank of America Merrill Lynch’s head of global rates and currencies research, wrote in a note. He added that the plan “has little chance of becoming a reality in its current form,” in part because it will fail the so-called Byrd test, a senate rule designed to limit legislation that significantly increases the federal deficit.

The excitement surrounding tax cuts echoes the contours of a post-election rally that had since fizzled out. Small cap stocks, which typically stand to gain more from lower rates, closed at seven consecutive records through Monday. Meanwhile, a Goldman Sachs Group Inc. basket of the 50 stocks in the S&P 500 Index with the highest 10-year median effective tax rate gained 1.1 percent, compared to 0.6 percent for the lowest tax rate stocks.

Though economic data has improved, expectations of a tax bill passing by early 2018 fueled the move, according to Matt Maley, an equity strategist at Miller Tabak & Co. However, the odds of that occurring are low for a plan that’s unpaid for and will increase the deficit, he said.

“It’s great that Speaker Ryan is ‘confident’ he can get passage by year-end, but more realistic experts say we’ll be lucky to get it by the end of 2018,” Maley wrote in a note. “This doesn’t mean interest rates cannot go higher for some other reasons, but we doubt it will be due to the passage of a tax bill in the near future.”

Untested Environment

To be sure, signs of doubt have already begun to surface in U.S. as Republican leaders question the White House proposal. While the S&P 500 held near its record Tuesday, small caps pulled back from their peak, the dollar slumped and Treasuries rose.

Even so, tax cuts are responsible for the small cap Russell being the most overbought it’s been been since 1997 judging by its seven- and 14-day relative strength index, according to Peter Boockvar, chief market analyst at Lindsey Group.

Politics aside, there’s still reason to doubt the sustainability of recent stock market gains. In particular, how much impact tax cuts will have is unclear considering they’d increase the deficit with an already low unemployment rate -- an untested economic environment, according to Jim Paulsen, chief investment strategist at Leuthold Group LLC.

“The U.S. has never cut taxes in the ninth year of a recovery, with the unemployment rate nearing 4 percent and while the Federal Reserve was already tightening monetary conditions,” Paulsen wrote in a note to clients Monday. “It is an odd time for a tax cut.”

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Market pessimists are warning investors to temper their exuberance over President Donald Trump's proposed tax cuts.
tax, cuts, market, dream, trump, stock
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2017-31-03
Tuesday, 03 October 2017 03:31 PM
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