A string of new records has fallen this week on Wall Street as investors bet on President Trump’s tax reforms keeping the equity bull market running into a tenth year.
The Dow Jones Industrials Index closed on Monday at 24,792.2. That was the 70th record closing high of 2017, the first time that landmark has been reached in a calendar year. It is also the first time that the index has risen by more than 5,000 points in a single year.
Other records to fall this week include Nasdaq rising above 7,000 for the first time ever. It looks like 2017 will also be the first year in which the US stock market has risen in all 12 months.
Some caution is required with at least one of these records. A list of the biggest annual rises for the Dow is heavily skewed to recent years for the obvious reason that it is easier to rise by 5,000 points when your starting point is nearly 20,000 than when, a few years ago, it was just 10,000.
But this is quibbling. The truth is that the US stock market is on a roll. And you don’t have to look far to see the main driver.
Donald Trump’s first year in the White House has been notable more for what he has failed to deliver from a long list of campaign promises. But that is about to change if, as expected, a significant set of tax reforms gets the nod from Congress this week and is signed into law by the end of the year.
The proposals would see the headline tax rate for companies fall from 35% (one of the highest in the world) to a much more competitive 21%.
There are cuts aimed at individual tax-payers too.
While there remains some controversy over the President’s tax-reforms - they seem to favour the rich and big business more than the dispossessed and angry who voted Mr Trump into power a year ago - there’s no mistaking the benefit they offer to stock market investors.
As well as boosting profits, the reforms offer the prospect of billions of dollars currently stashed overseas returning to the US to be handed to shareholders in the form of dividends and share buybacks.
Lower individual taxes would feed through to higher spending too. That matters in an economy so heavily weighted to consumption.
Should we be worried?
The recent surge in the US stock market caps a strong year. The main S&P 500 index has risen by 20% this year, the Dow by 25% and the tech-heavy Nasdaq index by an even more impressive 29%.
Those performances are doubly impressive given that they come at the end of a near-nine-year bull market that rose from the ashes of the financial crisis in early 2009.
This has been one of the longest, and biggest, bull markets in history.
So where does it leave investors today? Will the tax reforms see the bull market roll over into a tenth year or should the current euphoria ring alarm bells?
The outlook for Wall Street looks balanced. On the positive side of the ledger, in addition to the tax reforms, stands America’s dominance in the sector that is driving the market higher - technology. The high margins of US companies, and their ability to defend them via a flexible hire-and-fire job market, suggest profits can continue to rise.
It’s also worth pointing out that investor sentiment is not as blindly optimistic as it usually becomes at the top of the cycle. Even popular technology stocks like Apple trade on quite reasonable multiples of earnings because, while their share prices have soared, so too have their profits.
And the benefits have been shared broadly across both the old economy and the new. Berkshire Hathaway, Warren Buffett’s famously defensive investment vehicle, recently saw its share price rise above $300,000 (yes, really) as it is seen as a major beneficiary of lower taxes at its mainly domestic businesses. A big exposure to financials, which benefit from rising interest rates, has also helped.
But there is also a long list of reasons to worry about the US stock market at today’s elevated levels. The first is valuation. The US is the world’s most expensive major market. Compared to earnings, share prices stand at high levels by historic comparisons. The dividend yield offered by the average US company is barely half that available in the UK.
Secondly, there is growing evidence that the US economy is in the later, riskier phase of the cycle. Companies are accumulating record amounts of debt (because it is cheap) and starting to use it to make deals - a classic sign of a market top approaching.
The third reason to be nervous about the US market is the Federal Reserve. Bull markets tend not die of old age but to be ‘murdered’ by monetary tightening by central banks. The Fed is clearly the most advanced of all the world’s rate-setters in the return to monetary normalisation. Rates rose three times in 2017 and will probably do the same next year.
So investors should enjoy the surge in the US market while it lasts. But they should also prepare for more volatility and perhaps a correction in 2018. A well-diversified portfolio across different assets and geographies looks sensible at this late stage in the party.
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