Stocks are poised to end 2017 much like they ended 2016 — on a high note. The difference is the note will likely be higher this year than last.
The S&P 500 has posted a 17.6% gain through the first 11 months of 2017. The Dow Jones Industrial Average is up one better at 23%. The FANG-fueled NASDAQ Composite Index is up two better at 26.7%.
A major market correction would need to occur in the next few weeks to drop the major stock barometers into the red. History suggests that’s unlikely.
December has historically been an up month for stocks. The S&P 500 rose an average of 1.6% for the month from 1950 on.
If tax reform passes into tax law within the next fortnight, another 1.6% gain would be a smart bet. A couple provisions in the current bills are particularly appealing from an investor’s perspective.
The tax-reform bill that passed the House in November drops the top corporate income tax rate to 20% from 35%. The bill also includes a provision for companies to pay a one-time low rate on existing profits outside U.S. borders — 14% on cash assets and 7% on non-cash assets (e.g., equipment in which foreign profits were invested).
The Senate bill passed last week maintains the 20% top corporate income tax rate. The Senate bill is even more generous on taxing foreign profits. The Senate bill drops the rate to 10% on cash assets and 5% on non-cash assets.
One hardly needs a Mensa IQ to deduce that fewer corporate dollars flowing to Washington means more dollars remaining in cash coffers. More money to invest in the business will generate more dollars to pay shareholders as dividends. The dynamic buoys stock values.
But if tax reform law fails to materialize this year, the bull can still run.
Third-quarter reporting season is complete. FactSet data show that S&P 500 company earnings grew 5.9% year over year.
Strong Fourth Quarter
Projections ramp up for the fourth quarter. Fourth-quarter S&P 500 earnings are projected to grow 10.5% year over year. All eleven sectors that comprise the S&P 500 are expected to report earnings growth for the quarter.
Stocks are expected to maintain their stride into 2018. The preliminary consensus estimate earnings growth is 10.6% for S&P 500 companies in the first quarter.
We have persistent earnings growth. We also have persistent earnings growth most investors view pragmatically. Market sentiment is marked more by malaise than mania.
The American Association of Individual Investors’ (AAII) Sentiment Survey shows investors are well-grounded in their expectations. A reasonable 36.9% are bullish, 34.2% are bearish. Bullish sentiment is below the historical average; bearish sentiment is above the historical average.
Let’s not overlook the economy in aggregate.
Growth in third-quarter gross domestic product (GDP) posted better than expected. Growth was recently revised to 3.3% for the quarter from 3% on an annualized rate. Business investment and consumer spending continue to trend higher.
Stronger economic growth will allow the Federal Reserve to adhere to its interest-rate-rising mission. Fed officials will meet again next week. Most market participants expect that an interest-rate increase is forthcoming.
The Fed raising interest rates would typically be viewed as a brake applied to economic growth. I’m sanguine on the matter.
Despite a series of fed funds rate increases, interest rates remain low from a historical perspective. What’s more, they remain low (at least long-term rates could remain low) despite the Fed’s best efforts to see interest rates rise.
The Fed raised the fed funds rate by five percentage points from 2004 to 2006. The yield on the 10-year U.S. Treasury note — a bellwether security for long-term rates — held mostly between 4.5% and 5% during the time. More important, the S&P 500 rose 25%, while the fed funds rate rose fivefold.
I like stocks. Persistent earnings growth, investor malaise, accelerating GDP growth, and persistently low interest rates point to a market correction that is more far than near.