Excellent, But Vulnerable Markets With all the risks today, are investors complacent?

Q3 Market Commentary:

By Paul Hoffmeister, Chief Economist

It is our belief that 2017 has been a rewarding year for most investors. Through the third quarter, the S&P 500 is up nearly 13% and the Nasdaq 23%, while the Barclays Aggregate U.S. Bond Index has returned almost 3%. Even more, in July, stock market volatility was the lowest in the last 10 years. Investment returns appear to have been strong, and markets are calm. We believe the primary factors behind this sanguine environment are the prospects of tax reform and a Fed policy approach that, at least for this year, has been looking to “do no harm”.

By all appearances, the Federal Reserve seems to be implementing policy more reactively than proactively. In other words, the FOMC has been only raising interest rates to a degree that we believe won’t agitate financial markets. And in Congress, the House has passed a tax reform bill whose primary aim is to reduce the corporate tax rate from 35% to 20%, in addition to providing some individual tax relief. Holding all other variables constant, the 15 percentage point reduction in the statutory corporate tax rate should increase corporate earnings up to 23.1%. If market multiples hold, this tax reduction should theoretically correlate with an equivalent increase in stock prices. Perhaps not coincidentally, the S&P 500 has rallied nearly 20% since Election Day.