Investment Insights: Keeping a close eye

Wade Balliet
Posted by Wade Balliet
Investment Strategy

This weekly report presents insights from our Global Investment Management team.

close up on business section of a tax formThe S&P 500 Index has gained just over 2% since mid-last week on further investor optimism from earnings data and amid dwindling geopolitical tension, despite increased military exercises near the Korean peninsula. The U.S. corporate earnings spigot has been released, and reports are flowing in with nearly 40% of large domestic companies posting numbers this week.

So far, sales for S&P 500 companies have grown 4.45% since last quarter and earnings are up a whopping 13.04%, according to Bloomberg data. While earnings data is showing strong support for stock prices, valuations remain elevated and earnings may have to continue to show promising results in order to keep prices aloft. Amid a backdrop of rising rates, companies could decrease borrowing for dividends and share buybacks. According to data compiled by Bloomberg Intelligence, around 30% of the substantial bull-run in the S&P 500 from late-2009 to the end of 2016 was due to buybacks.

Increases in lending rates may cause some downside pressure, but corporations could soon benefit from new laws. Republicans have drafted plans to replace Dodd-Frank, while President Trump signed executive orders that would review regulations within banking and taxes. Trump seems to be prioritizing making good on his 15% corporate tax promise despite growing deficit concerns. Treasury Secretary Steve Mnuchin confirmed that this reform would be the “biggest tax cut” in American history. However, members of Congress are voicing concern for the cut as legislators search for a “revenue-neutral” bill in an effort to offset associated revenue loss and pass something more permanent. The balance sheet remains a contentious subject as the U.S. government works to avoid a potential shutdown this weekend. The administration may be willing to wait until later this year to secure funding for a border wall that could cost upwards of $20 billion, based on a report from the Department of Homeland Security seen by Reuters. A tax plan announcement from the Trump administration was released earlier today calling for a federal income-tax rate of 15% for corporations and a one-time tax on offshore earnings, while consolidating tax rates for individuals including lowering the highest rate to 35% from 39.6%.

European equities started the week higher as political risk eased slightly. Macron and Le Pen emerged as the leaders from Sunday’s polls and both candidates advanced to the second round of the French presidential election that will occur on May 7th. The CAC 40 Index, a gauge of the largest 40 stocks listed in France, opened Monday over 4% higher on the news. Based on polling results, the market’s reaction may be pricing in a win for Emmanuel Macron, the independent centrist candidate. Conversely, Chinese stocks tumbled 5.43% in the past two days as a slew of new regulatory initiatives were put in place for the banking sector. A recent Moody’s Investors Service report warned Chinese banks are facing increased risks due to rising corporate leverage, rapid housing appreciation, and the possibility of China’s slowing economic growth.

We eagerly await the Congressional review of the President’s tax proposal, but the final plan will likely end up being meaningfully different based on the dissatisfied reaction from legislators. The markets may be beginning to recognize the struggles faced by the Trump administration to pass their pro-growth policies as is. Our team believes this remains a downside risk for the markets until the plans are passed into law. A surprise in the French election, a severe slowdown in China, or an unexpected rise in inflation are our key risks to look out for over the near term.

Chart showing various market returns as of 4/25/17

Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.

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