Investors Shrug off Political Drama to Focus on Policy and Fundamentals
Investors have looked favorably upon the provision to lower corporate tax rates and move to a territorial system of taxation. How to compensate for that lost revenue has proved contentious, however. The Joint Committee on Taxation has estimated that the Senate bill falls short in that regard, creating a $1 trillion budget shortfall over ten years, after adjusting for its positive impact on economic activity. What the specific impact of the tax reform initiative will be depends on the details that emerge from the reconciliation process.
As it became increasingly likely that the Senate would pass its version of tax reform, stocks tracked that progress higher. For the week, the S&P 500 rose 1.5 percent, and was well on its way toward an even stronger close until it was derailed by news that former administration national security advisor Flynn would plead guilty to lying to the FBI. Stocks had started the day on Friday modestly higher, but plunged sharply in late morning when the news broke. In a matter of minutes the S&P was down 43 points, or 1.6 percent. But stocks fought back throughout the rest of the day, before closing with a modest 0.2 percent decline.
Sector Shake up: Financials Take the Lead
Notably in equity trading last week was the sharp rotation in leadership. On Tuesday, as Fed Chair nominee Powell’s confirmation hearing was underway, financial stocks started to rally, banks in particular. Financials were joined in the move higher by industrials, consumer discretionary and materials, albeit to a lesser extent. Energy stocks joined later in the week as OPEC and other oil producing countries announced agreement to extend production cuts through year-end.
The pronounced sector rotation last week initially came at the expense of the high-flying tech sector. The Philadelphia Semiconductor index tumbled 4.4 percent on Wednesday alone. But tech more broadly did stabilize as the week progressed. The question now for investors is whether this rotation represents a new trend in market leadership, at the expense of the old, or rather a broadening out of that leadership. It seems reasonable that there would be some profit taking among tech stocks, whose prices have soared, if suddenly the outlook for other groups has improved. But the environment for tech has not necessary deteriorated, suggesting that market leadership has a good chance of expanding.
Bond yields traced a similar path to equities last week. Bond yields rose sharply beginning on Wednesday, partly in response to an upward revision to third quarter GDP growth. The 3.3 percent estimated pace of growth, combined with the 3.1 percent growth in the second quarter, represents the strongest six-month pace of economic activity in three years. The yield on the ten-year note rose six basis points to 2.39 on Wednesday and edged higher to 2.41 percent on Thursday, its highest in two months. However, on Friday nervous buying following Flynn’s plea pushed the yield back down to 2.36 percent to end the week. And after three weeks of widening, credit spreads narrowed for the second straight week.
Investors Respond to Political Uncertainty
Last week’s singular focus on tax reform will be joined this week by the November job’s report on Friday, in particular, average hourly earnings growth. Overall, the creation of 200 thousand new jobs is anticipated, with the unemployment rate remaining at 4.1 percent. Also, looming on the horizon is Friday’s expiration of the September deal to temporarily fund the government.
Markets made a valiant attempt to put the General Flynn news behind them on Friday, making it almost all the way back. Whether the news has any lingering impact depends, of course, on where the investigation leads. For now, there is nothing that markets are likely to be too concerned about. But that could change. Until it does, markets will respond to the progress of policy and economic fundamentals. But with Flynn’s plea, investors have been reminded that this issue continues to play out in the background. Only now, the spotlight on it is a little brighter.
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Ameriprise Financial, Inc. and its affiliates do not offer tax or legal advice. Consumers should consult with their tax advisor or attorney regarding their specific situation.
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 Philadelphia Semiconductor IndexSM (SOXSM) is a modified market capitalization-weighted index composed of companies primarily involved in the design, distribution, manufacture, and sale of semiconductors.
The Bureau of Economic Analysis released the latest Real gross domestic product (GDP) information November 29, 2017.
Data on the employment situation is released monthly be the Bureau of Labor Statistics.
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