The post-election rally continued in February due to a variety of factors. Some will point to the change in political leadership in Washington as the primary driver of the market rally. There is likely some truth to this as investors anticipate both personal and corporate tax reform as well as the rollback of some regulations that are viewed as costly and inefficient. However, it is important to note that they may also be responding to stronger economic data, which is a trend that began before the change in political leadership in the US.
More recently, the stock market rally has faded in March as the “Trump Rally” threatens to turn into a “Trump Slump.”
Source: Yahoo! Finance
The decline in March may simply be a response to the large gains in February as some investors take profits. On the other hand, the bulk of the pullback occurred during the negotiation around repealing and replacing the Affordable Care Act. One could argue that investors are now questioning the likelihood that the new administration and leadership in Congress will be able to implement the portions of their platform that investors favor.
Arguably, progress toward corporate tax reform should be the biggest concern. The US currently has one of the highest corporate tax rates in the world, making the country less competitive in a global economy. In addition, the tax rules contain some antiquated provisions which have resulted in many companies holding billions in cash outside the US to save tax rather than deploying that money where it would be most needed. A redesign of the corporate income tax to reflect today’s global economy could give a boost to economic growth in the US. In addition, such a plan would likely be applauded by investors as income taxes represent one of the largest expenses for US corporations. Therefore, a reduction in corporate taxes would likely increase reported profits. However, the past has shown that corporate tax reform can be politically risky. Corporations do not vote, people do. Voters may look unfavorably on tax breaks for corporations, making it politically challenging to get a consensus. With the Republican Party already fractured between business interests and the more libertarian-minded Freedom Caucus, budget hawks (who want to reduce the federal deficit) and supply siders (who want to cut taxes), and isolationists and free-traders, it may be difficult to deliver on Wall Street’s hopes of a more competitive and efficient tax system.
Assuming that the political dysfunction in Washington continues, further market gains may be dependent on an improvement in fundamentals. For example, first quarter earnings season is around the corner. Given the sharp increase in stock prices since November, investors will likely be looking for the recent strong economic data to translate into strong earnings reports. On the other hand, should the recent market rally prove to be built on investor optimism with little fundamental support, many investors may begin to rethink their outlook for stock prices in 2017.