Tax Legislation Pushes Stocks Higher
Domestic stocks were mostly higher last week, although the dispersion of returns among the major indexes was noteworthy. The narrowly focused Dow notched its best weekly gain for the year while the tech-heavy Nasdaq recorded a loss (although it joined the other indexes in reaching an intraday record high on Tuesday before falling back later in the week). We have also seen a record 13 months in a row of gains for the S&P 500 (when including dividends) and the longest streak ever without a 3 percent correction. Financials outperformed as an increase in longer-term U.S. Treasury yields boosted the outlook for bank lending margins. The rising yields hurt real estate stocks, however, by making their relatively high dividend payments less attractive in comparison. Energy stocks were stronger after crude prices rallied following an agreement between OPEC, Russia, and other major oil exporters to keep current production limits in place through 2018.
A number of factors were seen as boosting sentiment during the week, but chief among them was progress on Senate Republicans’ efforts to reduce corporate tax rates as part of their broader tax reform package. As things stood at the end of week (the Senate passed its bill in the few hours of Saturday morning), however, the Senate’s tax plan differed considerably from the House version, meaning that Republican leaders will still have to work out compromises in a conference committee.
While generally supportive, the political environment also sparked some volatility in the markets. Stocks dropped sharply midday Friday after reports surfaced that former National Security Advisor Michael Flynn had pleaded guilty to misleading the FBI and was cooperating in the Mueller investigation. Earlier in the week, the latest launch of a North Korean ballistic missile also weighed on sentiment and appeared to spark another midday sell-off.
The Senate’s tax bill may have also contributed to sharp declines in tech and internet-related stocks on Wednesday. Netflix fell nearly 6 percent, and semiconductor maker Nvidia dropped over 7 percent. These multinational businesses currently pay relatively low effective tax rates (due to various deductions and credits), making lower rates with fewer exceptions less beneficial to their earnings. A simple desire to lock in substantial recent gains may also have been at work, however. Before the declines, for example, Nvidia stock had more than doubled since the start of the year.
The week’s economic data was also generally constructive. Pending home sales rose at the fastest pace in eight months in October, and the Conference Board’s gauge of consumer confidence surprised on the upside. The Commerce Department also slightly raised its estimate of third-quarter gross domestic product growth, which showed the economy expanding at an annualized pace of 3.3 percent, its best showing in three years. Corporate profits rose to an annualized rate of $1.86 trillion, a new record.
The strong economic signals and the improved prospects for tax cuts pushed U.S. Treasury yields higher last week. Positive comments about the economy from Federal Reserve Chair Janet Yellen provided further upward pressures on yields.
Most major European stock markets closed lower last week, weighed down in part by uncertainty surrounding the passage of tax reform in the U.S., weaker-than-expected inflation in the eurozone, and not much apparent investor enthusiasm following a report of robust manufacturing data in the region. The STOXX Europe 600 Index ended the week lower, as did Germany’s blue chip DAX 30. The UK’s FTSE 100 was hurt by the strength of the pound, which can impede the profits of multinational companies that earn revenue in foreign currencies. In Asia, performance was mixed. Japanese stocks advanced for the week, powered by gains in financial stocks.