Alberto G. Rossi
What should be the administration’s priorities for tax reform? How might tax reform, specifically corporate tax reform, impact stock prices in the short and long run?
In principle, a lowering of the corporate tax rate from 35 percent to 20 percent would improve corporate earnings. An increase in corporate earnings should increase corporate stock prices. This view, however, does not consider that a lowering of the corporate tax rate is also inducing a large increase in the deficit. If investors correctly incorporate the adverse effects of an increase in deficit into the future prospects of U.S. corporations, stock prices may not move a lot. Also, one of the reasons why the stock market has been appreciating so much since the election of Trump could be attributed to the expectation of this tax reform. It is not clear how much these expectations may be incorporated into prices already, because there has always been considerable uncertainty regarding the probability of the proposed tax overhaul to be passed in congress. This makes me believe we are not going to see a significant positive price change in stock prices going forward. If anything, I expect to see a correction.
Rather than focusing on the tax rates, tax reforms should mainly focus on reducing the economic distortions associated with the tax system. Right now, the system has a high statutory tax rate, but a lot of opportunities for tax avoidance. Reducing loopholes across the board should be the priority for the administration.
To what extent does President Trump’s administration deserve credit for recent stock market performance?
The answer is probably “not much.” The market has been performing extremely well since 2011. Research has shown (see Santa-Clara and Valkanov, 2003, and Pastor and Veronesi, 2017) that the stock market has performed better under democratic presidents, rather than republican presidents. This is not necessarily due to their policies, but rather to the economic environment under which these presidents are elected. Democratic presidents are usually elected in periods of crisis, when the majority of the population wants a higher welfare state and investors’ risk aversion tend to be high. The result of the high-risk aversion is higher subsequent return on the stock market.
Republican presidents are more likely to be elected when the economy is doing well, individuals are not particularly concerned with social protection, and risk-aversion is low. The result is low subsequent stock market returns. Trump won by a narrow margin in 2016, meaning that the risk-aversion of investors was neither high or low, so we should not expect spectacular results going forward. In fact, the returns on the stock market have not been that spectacular under the Trump administration so far.
Is the current stock market prone for a correction or is there still room for growth?
Going forward, I don’t expect the stock market to perform as well as it has done over the past couple of years. The stock market has realized very high returns since 2011. I don’t expect these high returns to persist in the next year or two.
What tips do you have for an individual investor? What sectors are expected to grow the most in the coming years?
It is hard to say what specific sectors will grow in the future. If a specific sector is expected to grow in the future, this information is likely to be already incorporated into stock prices.
My tip for individual investors is to expose themselves to factors that have been shown to outperform the market. For example, it has been shown that value stocks outperform growth stocks, that small companies outperform large companies, and that high momentum stocks have outperformed low momentum stocks. Academic and industry research has shown that other factors are likely to exist. Gaining exposure to these factors is relatively easy using ETFs.
Having exposures to these factors will give higher returns to investors on average, but lower portfolio performance during economic recessions. If an investor is able to weather economic recessions, exposing himself/herself to the Value, Small Cap and Momentum factors will result in superior returns, on average.
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Guan Jun Wang
Associate Professor of Finance in the College of Business Administration at Savannah State University
Guan Jun Wang
What should be the administration’s priorities for tax reform? How might tax reform, specifically corporate tax reform, impact stock prices in the short and long run?
I agree that the current tax code is outdated, complex and extremely burdensome. I think the priorities for tax reform should be: make the tax code simple, fair, easy to understand, and more supportive of American families, especially the middle class, both in the short and long run.
A drop in corporate tax rate should provide a boost to corporate earnings and private investments; a drop in individual tax rate should provide a boost to spending, at least in the short term, thus further boost corporate earnings. Since stock prices reflect expected future cash flows, which are positively correlated with future expected corporate earnings, tax reform, specifically corporate tax reform should impact stock prices in a positive way.
Market expectations for tax reform actually have already picked up. These expectations in part have helped stocks reach new all-time highs. Stock markets will continue to react to expectations and adjust to the new reality. If the current version tax reform bill can’t be signed into law, the market will have to correct its expectations for the effect that lower taxes will have on corporate earnings.
On the other hand, cutting taxes reduces government revenues, at least in the short term, and creates budget deficit unless there is spending cuts. If the tax cuts are not financed by immediate spending cuts, they will likely also result in an increase in interest rates, which would crowd out private investors and offset some of the earlier direct effects brought by tax cut. So, in the long run, the impact of tax reform on stock prices is not clear.
To what extent does President Trump’s administration deserve credit for recent stock market performance?
The last 10-year daily index charts show stock markets have been on the rise for the past nine years, which indicate that the rally started without the Trump administration and it could continue without him. A look back at history shows that presidential election cycles indeed correlate with stock market returns, and twice in the past 30 years, the markets did better post-election than after November 2016, which could indicate the recent rally is merely post-election effect.
I believe the recent superior stock market performance is in part due to strong corporate earnings growth, solid economic fundamentals and hopes for tax reform and Trump’s other campaign promises. That’s because the stock markets tend to react to expectations and adjust to the reality, so it’s reasonable to assume that investors responded to some of Trump’s campaign promises, such as tax cuts and job acts. Though promises to cut taxes and fight terrorists are the type of promises any presidential candidates might make, this has been overshadowed by Trump’s unusual profile and approach as a businessman. I would say President Trump’s administration deserves some credit for recent stock market performance.
Is the current stock market prone for a correction or is there still room for growth?
Whether stock markets still have room for growth or not in the long run depends on economic growth fundamentals, though in the short run, market sentiment can affect the performance. Though nine years into a bull market for the Nasdaq and S&P 500, I still feel the positive market sentiment and economic growth opportunity in many sectors, such as health care, technology, construction, etc. Economy has just reached full employment, the interest rates are still low and there is no inflation, so I believe growth will keep going for a while, but correction will eventually come.
What tips do you have for an individual investor? What sectors are expected to grow the most in the coming years?
Before an individual investor dives into stock markets, he or she first needs to meet investment prerequisites among which are sufficient emergency funds kept in liquid or low-risk assets, adequate insurance coverage and paying off high interest debt. Regarding investment tips, as always, knowledge is power in investing. One common mistake individuals make is following the crowd instead of research. Information is power, and knowing important news before most other investors and acting sooner is the key to successful investing.
The ongoing tech boom and population aging mean a growing demand for computer professionals and home health care. Health care and technology, though already giants today, are expected to keep growing along with other sectors over the next decade.
Methodology
This report is based on information from the latest public disclosures (Form 13F-HR for Q3 2017 and SC amendments from Oct. 1 to Nov. 14) for over 400 of the largest U.S. hedge funds. Data refer only to equities (i.e. not American Depository Receipts, Global Depository Receipts, Notes, Bonds or any other type of tradable securities).
To construct the “Most Popular Stocks” list, we looked at each of the over 400 funds’ positions, added up the positions for the same stock and rank-ordered the stocks by their total holdings value.
To calculate the “Sector Breakdown” of the positions held by the tracked hedge funds, we added up all the positions of the hedge funds from the same sector and then divided by the total amount of the hedge funds’ positions.
For the “Most bought/sold stocks”, we added up all the sold transactions and all the buy transactions for a given stock in the last quarter and rank-ordered based on total activity.
