The big question hanging over the stock market right now
Is it time to sell the news?
There’s an old saying in the stock market: Buy the rumor, sell the news. Basically, if there’s an expectation for something to happen, trade on that expectation right away. And once that thing is confirmed, sell.
Ever since Donald Trump was elected president in November 2016, investment pros have been buzzing about the prospects of bullish corporate tax cuts. Yahoo Finance’s Myles Udland predicted (correctly) it would be the one narrative that would define the stock market in 2017. And it’s a rumor that investors have been buying.
On Saturday, the U.S. Senate approved its version of the legislation, bringing tax reform that much closer to becoming reality. Stock markets surged on Monday in the wake of the news.
‘Tax reform is priced in’
“Since it is clear the market is pricing in at least some of the benefits of tax reform, we must ask the question of whether this will be a classic ‘sell the news’ event,” Academy Securities’ Peter Tchir wrote on Sunday.
Tchir noted that the “market has reacted positively to each step forward,” suggesting a lot is priced in. Indeed, with stock market valuations elevated and prices at record highs, it’s not crazy to think that this weekend’s news isn’t really news at all.
“On the one hand, the average earnings of companies should increase,” he said. “That should drive prices higher, but P/E ratios are already high, so it would not be surprising to see earnings estimates rise on the back of proposals becoming law, but to also see multiples decline.”
According to data from FactSet, the forward P/E ratio on the S&P 500 stands at about 22.5, which is well above its five-year and 10-year averages.
“Tax reform is priced in and, assuming we get the rally overnight and Monday morning, that should follow Saturday morning’s vote, [and] the risk/reward in the market will likely be skewed to the downside,” Tchir said.
‘Expect further upside’
Despite tax reform being one of the most telegraphed market stories this year, many Wall Street strategists disagree with Tchir.
“We expect further upside for equities with the leadership rotation to continue, despite some pundits calling for ‘sell on the news,’ ” JPMorgan’s Dubravko Lakos-Bujas said on Monday. His predictions: “S&P 500 to reach 2,800 by early next year on this catalyst (we estimate tax reform currently ~50% priced-in), continued synchronized global economic growth and potential flows from developed market bonds and equities.”
Currently, most Wall Street strategists expect the stock market to go up over the next 12 months. But in their forecasts, few incorporated corporate tax cuts into their expectations for earnings.
“While the current statutory rate is 35%, companies are paying only 27% on average,” Credit Suisse’s Jonathan Golub wrote on Monday. “While specifics are unclear, investors are presuming the new effective rate will move toward 20%. If the change goes into effect in 2018, consensus EPS would jump from $146 to $160.”
UBS’s Keith Parker, whose baseline scenario target for the S&P 500 is 2,900 by the end of 2018, told clients on Thursday that the S&P could boom to 3,300 should the GOP’s tax plan pass. Parker said he expects progress on tax cuts to provide “fuel” for the ongoing rotation out of stocks of low-tax companies like big techs and into stocks of high-tax companies like retail, telecom and banks.
Early trading on Monday reflected as much, with tech stocks dragging the tech-heavy Nasdaq (^IXIC) into the red while the Dow (^DJI) and S&P (^GSPC) traded higher.
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Sam Ro is managing editor at Yahoo Finance.
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