Now that 2017 is in the books with its record-setting market highs, I’ve been asked to share my thoughts on both tax reform and 2018.
At the top of most minds in December was whether, and how quickly, the Tax Reform Bill would pass. With Congress eager to get home for the holidays, the bill passed quickly. However, many are still wondering how tax reform will impact the markets.
I believe tax reform will be good for the equity and corporate credit markets. Corporate income tax cuts will be very positive for earnings estimate changes over the next quarter. Cash is returning to the U.S. and will be spent on wages, capex and stock repos. Domestic-oriented industries should see the largest pop to their tax rates. Small caps should benefit more from tax reform than large cap companies.
As of late December, the Citigroup U.S. Economic Surprise Index hit six-year highs—before any further stimulating effects. Wages will go up this year and unemployment is low (so low, the state of Maine cannot find people to snow plow the roads). But will the inflation make it through to the consumer or is all the buying on Amazon and price comparing on Google snuffing out higher prices? Seems like interest rates should move higher than they are but other forces are in play. I am as torn on this as the Fed is.
While some industries will get the pop from tax reform, I still want to own those industries winning from growing global GDP, as well as secular growth plays. I continue to prefer to own international stocks over U.S. stocks for their significant valuation discount, as well as the U.S. Dollar—which gets hurt when interest rates rise due to the accelerating U.S. debt levels. After 8-10 years of underperformance, it is time for U.S. investors to outperform in developed and emerging international equities. For targeted U.S. equity sectors, I believe the focus should be on areas of solid international sales growth, such as materials and commodity companies, semis and technology industries and any industrial that has leading market share and margins (e.g., Caterpillar).
As for 2018, within the U.S., the themes will be:
- 1) ongoing automation (to help Maine plow their roads without drivers and factories to work with fewer employees)
- 2) continued housing shortage, so U.S. homebuilding stocks and derivatives industries will win, as long as the President doesn’t close the borders and end the work visa program
- 3) cloud-based storage and apps for everything.
Energy remains a wildcard. Oil services may be a good contrarian bet given the lack of major capex over the past three years. However, the light at the end of the tunnel is always a Tesla Powerwall connected to a solar panel.
Bank stocks are a most favored group right now for the higher interest rate play, but as a former bank analyst, if there is the potential for a recession in the next two to three years, I would be scared to death to have financials as my largest weighting.
With this bull market entering its tenth year, there are a couple of leading indicators for the U.S. equity markets that I will be watching: credit quality and market breadth. While both remain stellar right now, if they deteriorate, I will be grabbing my hardhat, depleting my stack of SELL trade tickets and raising cash.
In the meantime, it is a good time to hold the umbrella upside down so you can catch every bit of free money falling from the sky. When the times are really, really good you need to capture the returns while you can.
Read more from Blaine Rollins in the latest Weekly Research Briefing >