“It’s the economy, stupid” – James Carville
As the Republicans make their final push to get a tax reform package completed before year end, it is natural to think what the odds of a deal getting done are. In some senses, tax and health care reform have taken on a zombielike characteristic, getting shot down only to be revived again a month later. Given how narrow the Republican’s Congressional majority is, combined with the presence of fiscal conservatives in the GOP and near zero support from Democrats (not to mention all the distractions stemming from the special investigation of President Trump’s campaign), it is our view that the likelihood of a tax package getting passed in 2017 is slim. We would be happy to be proven wrong, as it is hard to argue with paying lower taxes, but the question then turns to the stock market reaction if tax reform falls through.
From our perspective, there could be increased volatility if a tax package does not materialize, but in the long run, to cop the refrain that James Carville so eloquently spoke to in the early 90’s, it’s the economy which matters most for stock market returns. To be sure, absolute tax levels can help or hinder economic growth, but taxes will always be around. Consumers and corporations adjust to this reality when thinking about their budget and spending. Far more important is where we stand in the stage of the economic cycle and whether or not companies and consumers are feeling confident about the outlook before them.
Since the end of September, a significant number of companies have reported quarterly earnings, giving an executive level view of corporate sentiment on the economy. The verdict looks to be positive. Caterpillar noted that they are seeing “broad-based sales increases across a number of industries in all regions.” Texas Instruments highlighted that “industrial demand remains strong…revenue [was] up in three of four regions year on year in Europe, Asia, and the U.S. and it was about even in Japan.”
The chart above shows durable goods orders accelerating from their trough in 2015. On the job market, Robert Half is seeing clients starting more new projects and spending greater amounts of money on staffing. In short, the corporate outlook seems positive and the underlying trend in growth remains favorable for U.S. equity earnings.
To close, we are cognizant of the potential for stock market disappointment if a tax reform deal does not get passed, but believe that the current positive momentum in the economy will be a better long-term driver than any short-term disappointment from legislative shortfall. On the economy, house prices have been appreciating, the job market is performing well, and corporate guidance is upbeat. These elements should help underpin broad economic growth in the near term and provide support for corporate earnings and stock prices.