Equity Investors Focused on Tax Reform Possibility

Market Updates

Equity Investors Focused on Tax Reform Possibility

Mike Gibbs, Managing Director of Equity Portfolio & Technical Strategy, discusses the recent influence of politics on investor sentiment.

March 30, 2017

The failure to pass healthcare reform is a chink in the armor of the reflation trade. With tax reform and infrastructure spending yet to be addressed, it may be a precursor of additional challenges to the Trump administration’s agenda. For now, the bullish undertones in the market remain, as equities managed to shake off the healthcare setback as investors quickly shifted their attention to the more important (to the market) attempt to reform taxes. If all goes well, equities are likely to remain undeterred. Yet, with the Republicans far apart regarding the border adjustment tax and reduction of current deductions, another battle could be brewing. A reach across the aisle may be needed to move the legislation through, but at this point it is uncertain if the Democrats are willing to work with the President on anything. We feel something will eventually be done that the markets will deem beneficial, but as the back and forth process plays out, we also feel investor emotions will be tested numerous times.

For the near term, a government shutdown in late April is a possibility if the Freedom Caucus digs in on certain issues such as Planned Parenthood. The shutdown would only be a short‐term minor hit to GDP growth and should not derail the positive market tone. More importantly, such action by this faction of the Republican Party will refocus investor attention to the challenges tax reform may face. Volatility is likely to increase in the months ahead as the process plays out.

In the next few weeks as Q1 earnings are reported, fundamentals will join politics as key market influences. An exceptional quarter of 9.1% growth is expected, according to FactSet. While this is down from the 12% expected on 12/31/16, the revisions are less pronounced than in recent years (FactSet). Nevertheless, the lower revisions are an issue if they continue with equities reaching ~20x trailing earnings recently. Forward guidance offered by companies during earnings season will be a key to help determine if the revisions will lessen in the coming periods.

For the intermediate term, this technical backdrop rates as healthy. In this context, pullbacks, such as the 3.2% retreat from 2400 on March 1 to an intraday low on March 27 should be purchased. The market seems to be following the script as it found support near the 50 day moving average. The next phase will help determine if the index can resume the upward slope or if a consolidation or deeper pullback period is in the offing. A failure to take out overhead resistance (2390‐2400) along with a move to a new reaction low (below 2322) will raise the odds a consolidation period has set in. Given our view that the political process will remain a challenge, we think a consolidation period is likely just ahead.

Opinions expressed are those of the author and are subject to change. Past performance may not be indicative of future results. There is no assurance any of the trends mentioned will continue or any forecasts will occur. Investing involves risks including the possible loss of capital. Information provided is general in nature, and is not a complete statement of all information necessary for making an investment decision. The S&P 500 is an unmanaged index of 500 widely held stocks. Investors cannot invest directly in this index.

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