Beyond Healthcare…Tax Reform is Top of Mind for Investors
While the delivery of healthcare is of vital social importance, for investors the more important legislative initiative remains tax reform. But to get there, the administration must work through healthcare first so that its impact on the budget can be determined. From there, the baseline for tax reform can be identified and its potential nature and scope estimated. The Congressional Budget Office is expected to score the bill’s budgetary impact as early as Monday to give members of Congress a basis for making a judgement. The eventual transition to working on tax reform will not necessarily be derailed should healthcare reform fail. But clearly, legislative momentum would be lost, and room in the budget for tax reform would be diminished.
For the past several months, investors have put aside expectations for meaningful changes in fiscal policy. The initial optimism for reflationary legislation following the election has been supplanted by a focus on the pace of both economic growth and monetary policy. A potential boost to the economy from tax reform became a nice to have element in most forecasts for growth, but certainly not a variable being counted upon. And certainly, not in terms of any impact this year. But success in healthcare reform could reenergize enthusiasm for tax reform, and provide the boost to stocks that has been set aside since March.
Q2 Ends This Week – What can we Expect?
The second quarter ends this week. So far, the S&P 500 is up 3.2 percent, led precisely by healthcare, which is higher by 8.2 percent. Other sectors outperforming the broader market in the quarter include technology, industrials and utilities. Bringing up the rear is energy, which is down 7.9 percent. Since the start of the quarter, the price of domestic crude oil has fallen 16 percent to $43.14 a barrel. The average price for the quarter-to-date is $48.94. That is down from an average of $53.76 in the first quarter, and below the $49.26 average price in the second quarter of last year.
According to Factset, aggregate earnings growth for the second quarter is now expected to total 6.6 percent, down from 8.7 percent when the quarter began. The lowered estimate is attributable primarily to reduced expectations for energy, which is nevertheless still expected to post a year-over-year earnings gain of almost 400 percent. Excluding energy, aggregate earnings growth in the quarter is estimated to be just 3.7 percent.
Energy Weighs on Fixed Income too
The stress in energy is not confined to equities. The high yield energy bond sector has been under pressure for most of June. The Bank of America Merrill Lynch High Yield Energy Index has seen its spread over government bonds widen to 546 basis points from 457 at the start of the month. In contrast, the overall high yield market spread to governments has climbed just 13 basis points to 386.
As for the overall economy in the quarter, the Atlanta Fed GDP Now forecast calls for 2.9 percent growth. In contrast, the New York Fed estimates just 1.9 percent growth, and just 1.5 percent for the third quarter. We must wait until July 28 to learn of the first estimate from the Bureau of Economic Analysis. If the result is closer to the New York Fed’s estimate than to the Atlanta Fed’s, full year earnings estimates (beyond the energy patch) may need to be reduced. In which case, a boost from fiscal stimulus, including tax reform, will become even more important to investors.
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Indexes are unmanaged and are not available for direct investment.
The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.
The Bank of America Merrill Lynch High-Yield Bond Master II Index is an unmanaged index that tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.
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