There’s much scepticism about Donald Trump’s tax-cutting plans, with many warning stocks are vulnerable to a sell-off if the President is ultimately guilty of over-promising and under-delivering.
Certainly, markets last week gave a muted response to Trump’s ambitious but detail-free tax plans. Where are the spending cuts necessary to finance the tax giveaway? How will deficit hawks be placated? Bipartisan support, anyone?
Markets know tax cuts are likely to involve delay and compromise, and have reined in expectations. Goldman Sachs data shows stocks with the highest tax rates – those most to gain – have lost most of their post-election gains. To quote currency strategist Marc Chandler, markets have "downgraded" the chances Trump will deliver his legislative agenda.
Some analysts see this as a lose-lose situation; even if enacted, substantial tax cuts are reckless and would sow economic uncertainty.
That may be true in the long term, but markets are not going to pooh-pooh free money for major corporations. While the focus on the potential downside is understandable, lowered expectations mean there may be decent upside if Trump somehow surprises the doubters.
French election and steady nerves
Emmanuel Macron’s first-round victory in France’s presidential election was greeted with a mighty sigh of relief last week.
The 4.1 per cent advance in France’s Cac-40 was the biggest since August 2015. Historically, such gains have occurred in less than 1 per cent of all trading days. The VStoxx, Europe’s volatility index, plunged 35 per cent – the largest daily decline in its 12-year history. The US equivalent, the Vix, fell 26 per cent, the fourth-largest decline on record.
The stats are a little misleading, however, in that 2017 is proving notable for the absence rather than the presence of volatility. The VStoxx spiked higher before the election, but has otherwise been an oasis of calm, hitting an all-time low in late March.
As for the S&P 500, its modest 1.1 per cent gain was just the third time this year that it has moved by more than 1 per cent. If this trend continues, 2017 will be the least volatile year since 1965.
No sign of a tech bubble
The five biggest companies in the US are all technology giants, accounting for $2.75 trillion in market capitalisation. The Nasdaq is up almost twice as much as the S&P 500 this year and has decisively moved past dotcom era highs, last week surpassing the 6,000 level. Is another tech bubble brewing?
No – the idea is daft, but excitable commentators are putting two and two together and getting five. They point to high-profile hedge fund manager David Einhorn, in the news after warning "bubble" stocks in tech-land will "pop". Einhorn, whose short bets include Amazon and electric car maker Tesla, says many such stocks are "back in full-blown momentum mode". Bulls protest that "traditional valuation metrics no longer apply to certain stocks", prompting Einhorn to caution that "we have seen this before" – a reference to the dotcom bubble.
However, every market has the odd glamour stock like Tesla sporting stratospheric valuations. Amazon’s valuation is eye-popping, but that’s been true for most of the past decade.
As for the Nasdaq, LPL Research notes it took two months to go from 3,000 to 4,000 back in 2000, an annualised return of 555 per cent. It took 17 years to go from 5,000 to 6,000 – that’s 1 per cent annually.
Even that overstates the gains. Technology now comprises less than half of the Nasdaq’s total value, making the Dow Jones US Technology Index a more appropriate comparison. It remains below its March 2000 highs.
A few bubbly stocks does not equal a bubbly stock market.
Solving the ‘sell in May’ puzzle
Don’t sell in May and go away – a new study indicates investors should sit tight.
The apparent persistence of this seasonal anomaly has long puzzled academics. Since 1950, US stock returns have been confined to the November-April period; stocks actually lost money between May and October. Indeed, it’s seemingly a global phenomenon, one widely-cited study finding it present in 36 out of 37 countries.
The new study (https://goo.gl/dfWT71) confirms that since 1871, winter easily beats summer when it comes to stock returns. The same is true of major international equity markets over recent decades.
However, the researchers found the US effect is concentrated in the third years of presidential terms; then, there was a difference of 11 percentage points between winter and summer returns. If the third years are excluded, the difference between winter and summer largely disappears. The same pattern is found in international markets.
Why? Data indicates uncertainty surrounding economic policy peaks in the third year of presidential cycles, thereby temporarily dampening stock returns.
In other words, the onset of summer is no cause for angst – “sell in May” is just a statistical quirk.