Hot Dog! Why Stocks Are Where They Are

David B. Armstrong, CFA Weekly Market Commentary, Weekly Market Commentary Page 18

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The Hot Dog and the Bun – gotta love it.  They go together like the Dow and the S&P 500…the Dow has pushed past 21,000 and the S&P 500 Index is near a record high, too.

Some people are citing that valuations seem rich with the 1-year forward price-earnings (P/E) ratio for the S&P 500 at 17.5x. The average over the last 10 years has been 14.4x and 20 years has been 17.2x, according to the trusty FactSet terminal.

So where is the support for stocks?

  • First quarter (Q1) earnings season has been strong, with S&P 500 profits up nearly 15%, according to Thomson Reuters, with 87% of firms having reported. Forecasts have generally been upbeat (Bespoke).
  • The U.S. economy is moving forward…oh, and we’re seeing an acceleration in global growth.
  • Geopolitical tensions have subsided…for now.
  • France’s election is over…can you remember the last time you ever followed the French election? Sans vouloir vous offenser…
  • The Fed remains on a gradual upward trajectory for interest rates. Sounds bad, but it’s not completely bad.
  • Low interest rates and low inflation lend support to higher P/E ratios, like above.

So where are the risks?

  • Recent softness in commodity prices. This is primarily attributable to China worries.  Yeah, the same China that everyone has been talking about for what seems like forever.
  • Geopolitical tensions could resurface, injecting short-term volatility into the market. If North Korea starts to feel their oats again and we take counter action, there will be some short-term fall out.

So What?

For now, investors are brushing aside potential distractions and focusing on the fundamentals.  Personally, seeing one of the best earnings seasons in a long, long time is what I think is worth focusing on.

Finally – Thoughts on the Trump Tax Plan

In fairness, it’s a one pager…but I find one component interesting and it’s the deductibility of state and local taxes.  This is a big deal in the states that have really high state and local taxes because if residents in those states can’t deduct them anymore, that’s bad for them.

States impacted?  Well, according to TrendMacro, 50.5% of the aggregate tax deduction amount is shared by 6 states…California, New York, New Jersey, Illinois, Maryland and Massachusetts.

All blue states.

Since the Republicans in the Senate can pass tax changes for 10 years without a single Democrat vote, it’s possible that this becomes a huge negotiating point.  The Republicans COULD offer to strip removal of state and local tax deductions out of the plan in exchange for some Dems to vote for the final package.  With 60 votes, the tax reform could be permanent and not just 10 years.

The 10 Dems fighting for 2018 reelection in states that Trump carried in the election could be interested in this – especially if the other option is losing the state and local deductions for 10 years in 6 big blue states that make up 50.5% of the aggregate amount.  In that case, big blue states lose at the expense of red states.

That’s a tough pig to put lipstick on.

I think there could be a good chance we see permanent tax reform with 60 votes on a package that DOES NOT include the state and local tax deduction.

That could be a catalyst for a continuation of the current rally.

Please call with questions.

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About the Author
David B. Armstrong, CFA

David B. Armstrong, CFA

David B. Armstrong, CFA, is a President and Co-Founder of Monument Wealth Management. Viewed as an industry leader in digital marketing and social media, Dave is the writer of Monument Wealth Management's weekly "Off the Wall" Financial Blog and Market Commentary. His expertise is frequently sought after by journalists and event coordinators. Visit his full biography here.

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