Strategy: Consolidation from stretched levels
Correction should be temporary
This week we have seen some risk-off in equity markets with the S&P 500 now more than 1% lower than a week ago, as markets are correcting from stretched levels (see chart below). Looking at the S&P 500, US stocks still seem overbought and in the short run US stocks may fall further, as investors take profit from the long rally before year-end. In Europe, price momentum is back to neutral. The global surprise index is also high, thus limiting the scope for further increases in the index. In our view, the market correction should still prove temporary, as fundamentals are still strong with a growing economy and low risks. Global GDP growth was strong in Q3 and also looks promising in Q4, as optimism among businesses and consumers remains high across regions, although growth is no longer accelerating but stabilising at strong levels. Profits also seem strong in Q4, and in our view valuation is still decent. Equity volatility (VIX) has increased, but in our view, there are not many risk factors out there, at least not in the short term, which together with central banks only tightening gradually is positive for equity markets.
US tax cuts have become more likely
An important market theme for the rest of the year is whether Republicans are able to pass tax cuts in the US or not. The likelihood has increased significantly, as the Republicans think it is very important for their chances of maintaining control over Congress after the mid-term election in November next year, which also explains why more Republicans have accepted deficit-financed tax cuts (USD1,500bn over ten years). However, there are still many hurdles left (especially as there is opposition to the tax revenue raisers, which are supposed to pay for some of the tax cuts) and although our base case is that Republicans will be able to pass something eventually, there is still some probability that the whole thing explodes, just like with the attempt to repeal Obamacare. By ‘something' we mean that tax cuts will be watered down compared to what is on the table right now in terms of how much they can cut taxes in percent within the USD1,500bn frame. As an example, it costs USD1,500bn to cut corporate tax rate to 20% by itself, meaning there is no room for income tax cuts without finding financing elsewhere.
Author
Danske Research Team
Danske Bank A/S
Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.
