If we assume the recent market run up is due to the presumption of certain things getting done in DC then we could be setting ourselves up for a market decline. Let’s not forget, however, the problem with assumptions regarding markets is they are often proven wrong. Many are assuming the two major political issues driving markets right now are tax cuts and infrastructure spending. I don’t necessarily disagree with this entirely but if this is true then what happens if these don’t come to fruition?
Last month the healthcare reform bill was pulled because a lack of votes. Many assumed the market would have a sharp sell off as it implied gridlock in DC and the potential for other things like infrastructure spending and tax cuts to also fail. The markets again remained resilient. There was a short term sell-off but then it resumed its current course. This left many scratching their heads wondering how the markets could once again brush things off so quickly.
Immediately the attention turned to another area that many call a "make or break" for markets; tax reform. Specifically reform around lowering corporate and personal tax rates. Many analysts and economists are stating that without significant tax reform, global markets could be in for a large correction.
Could this be the case?
If tax reform doesn’t take shape will markets turn?
The market will always have “correction” periods, it is the timing that is difficult to predict and often the consensus is wrong. Global markets have rallied tremendously the last 5 months and many attribute it to potential tax cuts. It leaves me wondering however if one component can make such a difference to market performance for more than a short period of time.
There have been instances where the S&P 500 index rose significantly even as corporate tax rates increased (1949-1952 & 1967-1968). There have also been instances where there the S&P 500 saw minimal gains while corporate taxes decreased (1969-1971). It is difficult however to point to tax changes being the cause of the markets rise or fall during those periods. It goes without saying other components influence markets. Inflation, interest rates, employment, GDP and wage growth also can influence markets. And let’s not forget corporate earnings, growth and profitability.
Bottom line is that it's important to remember the stock market is complex and tax reform is just one of many components that factors into the markets performance. While the talk of tax cuts can move markets on the short term it is hard to point to one thing leading to a sustained rise or fall. Making an allocation decision based on one component of the financial system is not advisable, especially for a long term investor. Let the speculators speculate and move the markets on the short term. That is their game. Yours game is longer term.
Annual Returns on Stock, T.Bonds and T.Bills: 1928 - Current
Corporate Top Tax Rate and Bracket