Whilst the US stock markets looked a little shaky at the start of 2017, the year ended up being quite phenomenal for the US equity indices. Strong earnings and optimism over President Trumps tax reform bill pushed the Dow to trade over 24% higher and hit 70 new all-time highs. Meanwhile, the S&P 500 jumped over 18% during the course of the year. But after such a strong performance in 2017, can we expect it to continue in 2018?
Just over a year after his election, President Trump won his first legislative victory and signed the sweeping $1.5 trillion tax cut bill into law before leaving for his Christmas break. Stocks have already rallied hard in the lead up to the bill being passed, however there could be more to come. Whilst stock markets are driven by many factors, in the long run they follow earnings and a 21% tax cut will mean that corporate earnings growth is certainly doable.
The two key sectors will continue to be the tech sector and the financials. The tech sector had a wobble in the final month of the year. After a super strong 2017, which saw the sector rally 37%, December saw the sector gain an anaemic 1%. This sector could potentially be an initial loser of the tax bill, given the amount of money that tech companies hold overseas and the global nature of their business. However, we could expect to see a repatriation of a significant amount of these funds held overseas in order to reduce a new levy payable, which could then see these stocks prepare to take another step higher.
Financials have already benefited from the optimism of the tax bill and we could expect to see that continue as the bill is implemented. The tax bill could enhance inflation and enhance borrowing, both of which are supportive to financials, not to mention the lower tax bill. Furthermore, financials tend to benefit in higher interest rate environments and given the Fed’s desire to continue hiking, potentially three times, the future still looks rosy for this sector. We expect financials to outperform the broader market and deregulation of the sector could also provide a tailwind for financial companies.
The interesting thing about 2018, is the high levels of optimism on which we are entering the year. Almost no one is bearish. Ultimately, markets correlate to the direction of earnings, this direction is driven by economic activity, which certainly looks positive and will be supported by the tax cuts. We could expect to see the S&P earnings growth hit double digits next year and the S&P index itself possibly jump over 10% and close in on 2850 by then end of 2018.
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