Tax Party: Weekend Senate Vote Paves Way For Optimism About Possible Cuts

Stocks looked poised to leap out of the starting gate Monday as enthusiasm built about possible tax cuts after the Senate’s weekend vote. There’s a lot of hope that if corporate taxes go down, earnings could improve next year and give stocks an additional tailwind.

Dow Jones Industrial Average ($DJI) futures charged up more than 200 points before Monday’s opening bell following an amazing comeback stock indices had Friday. There’s a definite positive response to the Senate’s passage of tax legislation early Saturday, though the two houses of Congress still have to find a way to work through differences between the House and Senate versions. Republicans say they want to get this all finished before Christmas.

Tax reform is just one component of the Washington watch in coming days. Congress also has to find a way to keep the government running, a debate that could pick up steam as the week advances. At this point, the government is funded through Friday, but Congress has to take action to keep agencies going after that. Failure to do that would likely mean what we’ve seen in past government shutdowns, including national parks closing and many federal employees not coming to work. Also, it might mean delays in economic data for Wall Street.

However, all that remains a worst-case scenario, and Republican congressional leaders said over the weekend that a shutdown isn’t happening. The hope is that the Senate getting taxes done could help with momentum in avoiding a government shutdown. However, keep an eye on volatility this week if there’s any sign of problems on this issue.

Volatility spiked Friday after what turned out to be an erroneous news report about the Russian investigation, but quickly settled down. VIX remains above 11, which is on the high side for this year but low historically.

Believe it or not, there are things besides Washington to think about as well. Investors face a full slate of economic data — including payrolls — this week as they get ready for the Fed meeting later this month.

While Friday’s November payrolls report arguably stands head and shoulders above all the other economic reports, the new week also brings factory orders, a look at the U.S. trade balance, and ISM services data. This all comes after the final week of November yielded a full basket of robust numbers, including Chicago PMI, new home sales, construction spending, and the ISM manufacturing index. All of these came in above Wall Street analysts’ expectations, helping solidify anticipation of another possible Fed rate hike later this month.

Payrolls come out just a few days before the Fed meeting. If you think back to early November (seems like a long time ago), you might remember that October job creation totaled 261,000 after a weak September report that was dogged by hurricanes. In the past, job creation has sputtered immediately after a major storm and then made steady gains the following months. We’ll see if that’s the case again this time, though past performance can’t predict the future.

The oil market might also draw some eyeballs in the days ahead to see if there’s any more reaction to OPEC’s decision to extend its production cuts through all of 2018. Front-month U.S. futures pushed through resistance at $58 a barrel on Friday, but the real mark to watch might be $60, a level that U.S. futures haven’t reached since mid-2015. Oil lost a little ground early Monday amid talk that U.S. producers might keep ramping up output now that OPEC has acted.

As market volatility increased Friday, it looked like some investors began gravitating toward the more “defensive” parts of the market. Both gold and U.S. Treasury bonds found buyers, though neither really took off in a major way. Gold prices remain in the same $1,200 to $1,300 an ounce range they’ve been in most of the year, though at the upper end.

Merger and acquisition news didn’t take the weekend off, as Sunday brought word of CVS Health Corp CVS agreeing to buy Aetna Inc AET in a $69 billion deal. This potentially combines one of the biggest drug store companies with one of the biggest health insurers. There hasn’t been a huge amount of M&A this year, but Investor’s Business Daily recently pointed out that companies — especially those in the industrial sector — are sitting on an immense hoard of cash, so it’s not out of the question that we might see more M&A in the weeks and months to come. Before the AET/CVS deal announcement, $1.2 trillion in M&A had been announced so far this year, down from $1.65 trillion last year and nearly $2 trillion the year before.

Another thing that’s getting a lot of attention lately is bitcoin, and we haven’t spent any time discussing it in this column. Here’s something to keep in mind: What happens when a product like bitcoin goes to these high levels is that you get people trading who probably shouldn’t be, and who might not understand it. If you can’t define what the product is, you might want to be extra careful.

FIGURE 1: ROLLER COASTER FRIDAY. The S&P 500 Index (SPX) had quite a wild ride Friday, as a mid-morning news report about former national security adviser Michael Flynn was followed a few hours later by a report the U.S. Senate had secured enough votes to pass its version of the tax bill. Data source: CME Group. Chart source: The thinkorswim^® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Where’s the Competition?

Though market volatility spiked last week as political battles raged in Washington, one thing that might have been revealed — and something we touched on recently — is that there still appears to be money on the sidelines that can get injected into stocks when there’s good news. That looked to be the case Thursday when markets quickly rose 1% on hopes of a Senate vote on tax reform. With bond yields still low, there’s not a lot of competition from other markets for investors’ rain day funds. That said, stocks have come a long way this year, so investors should consider checking allocations and making sure they’re comfortable with their percentages of equities vs. fixed income. 

How Many Rate Hikes in 2018? Jury is Out

One question heading into the new week is whether investors have fully baked in the possibility of several more rate increases next year. At this point, that’s debatable. The futures market predicts 90% odds of a Fed rate hike before year-end, and just about a 50% chance of another hike in March. Odds of an additional hike don’t rise above 50% until September, futures prices indicate. Much of Wall Street is pricing in just three rate hikes next year, which would mean rates of between 1.75% and 2% by the end of 2018. However, some analysts are starting to pencil in a possible fourth hike. That’s more in line with what the Fed itself has projected, according to its “dot plot” from September, and might be a reason bonds saw some selling pressure late last week. The Fed meeting next week could provide further insight.

One Possible Rally Explanation

You hear a lot of explanations for the recent stock market rally, including strong economic data, hopes for tax cuts, signs of a positive start to holiday shopping season, and high bond prices. Another thought is that some of the strength could be seasonal, and, if that’s the case, it might point toward further gains in the coming weeks, though nothing is guaranteed. Here’s how the seasonal factor might be playing out: Portfolio managers often want to show they were holding stocks that worked at the end of the year. That can sometimes lead to the “winners” being pushed higher in the year’s closing weeks. With this in mind, keep tabs on which sectors have been “winners” so far this year to see if some of the end-of-the-year positioning gives them further support. Info tech is the leading sector with year-to-date gains of nearly 37%, followed by health care (21%), materials (19%) and consumer discretionary (18.5%).

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