Even as stocks bounced around and volatility spiked on news that a former member of President Donald Trump’s inner circle pleaded guilty to lying to the FBI, analysts were betting that optimism over tax cuts on top of a Santa rally will carry the market higher.
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Any selloff “is a short-term knee-jerk reaction. At the end of the day, the drama in Washington is unlikely to derail the robust economy and corporate earnings growth,” said Karyn Cavanaugh, senior market strategist at Voya Investment Management.
Former National Security Adviser Michael Flynn reached a plea deal with Special Counsel Robert Mueller who is investigating Russia’s alleged interference in the U.S. election. Flynn played a prominent role in Trump’s campaign and the activities that Flynn lied about were during the postelection transition period.
Richard Hastings, macro strategist at Seaport Global Securities LLC, expects the latest political development may act as a brief speed bump for the market.
“We’ve seen some dips on Trump legal risks before,” said Hastings, “and the Flynn situation could trigger a new outbreak of Trump allegations. But going from minor stuff to bigger steps seems like a big chasm, and we doubt Trump is doing things that totally goes into the disaster bucket.”
But with tax cuts looming on the horizon, investors are expected to experience a short-term memory loss when it comes to Flynn.
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Once the tax bill passes, “then another 5% to 7.5% upside could erupt on sheer momentum trading,” turning what until now has been an A market into an A+ market, said Hastings.
With double digit gains so far, the S&P 500 is poised for one of its best years since 2013.
S&P 500 Historical Annual Returns
The Senate early Saturday passed the Republican-sponsored tax reform proposal along the party lines, paving the way for lower corporate taxes and the repeal of Obamacare’s individual-insurance mandate among other changes.
The vote will be viewed as a crucial victory for Trump who had promised sweeping tax reforms as part of his pro-business agenda. Anticipation over tax cuts was widely credited with fueling the stock market’s record-setting streak since Trump’s election.
The Senate’s bill must now be reconciled with the version passed by the House of Representatives last month before sending it to Trump for his signature.
“Tax cuts will likely get done and that will strengthen corporate earnings further. So the bias is still to the upside,” said Cavanaugh. “Investors are unlikely to stray too far from the dinner table before the main course is served.”
Seasonality is also likely to play a part as investors gear up for the end-of-year surge commonly referred to as the Santa rally.
December has always been a strong month for equities. The Dow Jones Industrial Average has gained 74% of the time over the past 100 years in December for an average return of 1.6%, according to Bespoke Investment Group.
In fact, given the market’s strength throughout the year, stocks may see outsized gains this month compared with previous Decembers.
Since 1990, the S&P 500 has climbed 82% of the time in December with an average gain of 2.5% when the index has risen at least 10% by the end of November, according to Frank Cappelleri, a technical strategist at Instinet LLC.
As of Friday, the S&P 500 is up 18% for the year even though it fell 0.2% to close at 2,642.22. The Dow shed 0.2% to 24,231.59, snapping a five-day winning streak and the Nasdaq Composite Index declined 0.4% to 6,847.59.
The CBOE Volatility index spiked above 14 during the day but eased back as initial Flynn jitters wore off.
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