reaction-stocks-dropping

President Trump’s tax overhaul sent the S&P 500 up 0.7% last week to a record high. The increase was “led by by banks and energy, while healthcare and utilities lagged,” says BMO senior economist Robert Kavcic in a weekly equity report.

“Exchange and fixed income markets were also impacted, with the greenback appreciating, and the 10-year yield rising to its highest level in two months,” says TD economic analyst Katherine Judge in a weekly economics report.

The tax proposal contains a sharp reduction in the corporate tax rate to 20% from the current 35%.

Read: U.S. to roll out tax cuts that help wealthy

“If delays or opposition to the proposal prevail, equities could pare their gains on diminished expectations for future earnings,” warns Judge.

Many are urging markets to curb their enthusiasm on the proposed tax cuts, says BMO chief economist Douglas Porter in a weekly economics report.

“Legislative hurdles facing the tax package are legion,” he says. “There are rumblings in the rank and file, and it won’t take much opposition to thwart the plan.”

For example, Republicans differ on whether tax reform should eliminate the federal reduction on state and local taxes.

Further, the proposal’s benefit to the U.S. corporate sector could be overstated, “since figures from the U.S. Treasury suggest that the effective corporate rate is closer to 22%,” says Nick Exarhos, director at CIBC World Markets, in a weekly economics report.

Taking that into consideration, there’s a wide distribution between U.S. sectors for that metric, he says.

“Service industries, wholesale/retail trade and construction appear set to benefit the most, with their current effective rates almost 10% points higher than Trump’s proposed statutory mark,” says Exarhos. “Utilities stand at the opposite end of the spectrum.”

Read: Follow the money to find best industrials, tech picks

Another part of the tax plan allows immediate expensing of new capital investment.

“That’s another positive for what is already a healthier backdrop for business capital spending,” says Exarhos.

Porter calls the S&P rally this week “muted” and also a “testament to the lessons learned from the rush-to-judge late last year,” referring to market response after the U.S. election.

“We continue to build in only a tiny dose of net fiscal stimulus into our U.S. growth forecasts over the next two years,” says Porter, who adds that fiscal policy makes no sense at this point in the economic cycle, what with the Fed tightening, low unemployment and “near-frothy” financial markets.

Market performance last week

As U.S. stocks push record levels, valuations are relatively stable.

“The S&P 500 forward P/E ratio is currently pegged at 17.7x based on Bloomberg’s earnings estimates, little changed from where it sat at the start of the year,” says Kavcic. “Unlike the three prior years, when valuation expansion was doing most of the lifting, better earnings momentum has been supporting U.S. equities this year.”

The TSX rose 1.2% last week, “on the back of technology, energy and banks, with WTI oil prices holding above $50,” says Kavcic. (The WTI benchmark hit US$52 per barrel last Wednesday.) The Canadian market is up 3.7% in the past month, outpacing the S&P.

Canadian valuations have improved “slightly,” says Kavcic, “as earnings expectations are still climbing out of the oil-shock pit.”

He says the TSX forward earnings multiple has shrunk about a point since early 2016, while that of the S&P is up a point since then.

That means, on a relative basis, that the TSX is at the widest discount to the S&P 500 since the financial crisis, notes Kavcic.

Read the full reports from Kavcic, TDBMO and CIBC.

Also read:

Canada should lower corporate taxes to stay competitive with U.S.: MEI

Originally published on Advisor.ca
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