Q4 2017 Market Commentary:
By Paul Hoffmeister, Chief Economist
On January 16, the Dow broke through another record. The headline at CNN read, “Dow 26,000: The Stock Market Is a Runaway Freight Train”.1
Journalists and market pundits seem to be stepping over each other to herald the nearly 40% rally in the Dow since late 2016, as well as the speed of its ascent. As CNN reported, it took 14 years for the Dow to climb from 10,000 to 15,000; three and a half years to reach 20,000; and less than 12 months to rally from 20,000 to 25,000.2 Given these statistics, “melt-up” and “euphoria” are some popular terms being used today to describe the market.
In our Q3 market commentary in November, we highlighted the strong equity market performance and narrow credit spreads at the time, and suggested that the primary factors behind the sanguine environment were the prospects of tax reform and a Fed policy approach that had been looking to “do no harm”.
Considering whether the environment (or “enthusiasm”) was sustainable, our conclusion was: …[d]uring the near-term, the passage of tax reform and the continuation of moderate Fed policy could easily extend the strong market trend of the last year. If fiscal and monetary policy (the “twin pillars of productivity”) remain supportive, then the future remains bright.
We believe this has been the case, as we look back at the last two months. The major macroeconomic variables are evolving positively, and igniting investors’ animal spirits.
Of course, on December 22nd, President Trump signed the largest tax cuts in American history, including a reduction in the statutory corporate tax rate from 35% to 21%. For companies previously paying a 35% tax rate, the new 21% rate will enable them to increase corporate earnings by 21.5%, thanks simply to this change in the tax rules. For example, a company that previously paid $35 in taxes on $100 in earnings can now keep $79, a 21.5% earnings increase.