Tax Reform and the Stock Market’s Relationship to the Media (11-04-2017)

I agree with analysts who say that the recent rally in U.S. stocks has been at least somewhat driven by optimism that tax reform will happen. I find it ironic that the U.S. stock market has performed very well during the Trump administration despite the fact that the mainstream media is portraying his presidency with a decidedly negative slant.

In general, Wall Street-style business conservatives are not thought of as Trump supporters. They are generally thought to be supporters of either Republican or Democratic establishment politicians. Thus, they are not the types of investors who approach the mainstream media with an inherently contrarian attitude.

But at the same time, the stock market is often ahead of the news. Back in 2009, the stock market bottomed out before there was any sign that the recession was shallowing. Furthermore, at that time, the reaction to the Obama administration in financial media had a somewhat negative bias. The actual reporting of financial news was fairly neutral, but doomsayers critical of the administration were getting a disproportional amount of air time. After the market bottom in 2009, there was some sort of drop almost every time Obama announced a new policy proposal, but the trend remained higher.

Sometimes the stock market can cut through the noise of the media to see what is really happening in the economy. In the case of 2009, there obviously was optimism that the end of the recession was on the horizon even though headline numbers didn’t show it early in the year.

At the current time, the stock market’s performance over the past year clearly indicates that long-term investors see signs of an imminent acceleration of economic growth. In October 2015, I wrote that I expected the eventual top of the bull market to occur between 20,000 – 26,000 on the Dow.

If investors did not anticipate an economic acceleration, I would have expected the bull market to top out near 20,000, and it could have happened by the end of 2016, as I described in the post.

However, here we are one year past the more conservative target for a top, and the Dow has gone well above the lower end of my target range (last closing price was 23,539). This, to me, suggests that the market really does anticipate an economic acceleration. And it suggests something bigger than the uptick in GDP over the last couple quarters – similar growth spurts have happened throughout the bull market only to fizzle out within a year, and at market prices as high as what we have now, I don’t think investors would get so excited over it.

If there really is going to be sustained, improved economic growth, tax reform is the only source of it that I can see. That is why I think long-term investors really do expect tax reform to happen amid the current political environment.

But what would that mean for the market over the next few years? Lower corporate and personal income tax rates would be a major boost for the market in the short term. I say short-term for two reasons. The first is that a lot of the economic gains may be priced in already. The second is that stronger economic growth will accelerate the rise in interest rates, which would eventually become bearish for stocks.

As you know I have been calling for a bull market top by the 1st quarter of 2018. Tax reform could extend the bull market further into the year, but I still see the 2019-2020 timeframe as either flat or bearish. It is also probable that there will be a recession of some magnitude by 2020. Since the Great Depression, there has never been a continuous economic expansion lasting longer than 10 years, and the current expansion will be at 9 years in mid-2018.

That said, it is worth noting that the interest rate cycle associated with the current expansion is still in it’s early phases, and if there is a stimulative change in fiscal policy, the next recession could end up simply being a technical contraction that, despite rattling markets for a while, would not have a major impact on society at large.

But in any case, the economic and political events of the next 3-6 months will be critical to forecasts for the next few years.