The stock markets are doing just fine without a tax cut, thank you

I have been wondering recently whether the current strength of the stock markets is attributable to expectations of tax cuts. I decided this week to check in with local financial market experts and find out.  

They uniformly told me that the biggest reason for the rise in the equity markets is economic fundamentals. For example, Anne McCabe Triana, president and CEO of the Reston wealth management firm Curo Private Wealth, told me “stock prices are definitely elevated,” but there were objective facts supporting valuations. The equity market was not a bubble, and reflected instead “low interest rates and an increasingly positive business environment.” Brad Smith, chief investment officer at MTX Wealth Management in Reston, pointed to continued corporate earnings growth and low unemployment as additional contributing factors. 

I did hear from these experts that the possibility of federal tax cuts was contributing to some recent acceleration in stock market gains. John Devine, partner and strategic advisor at Brown Advisory, thought that “optimism about tax cuts” was reflected in the market, but that “it is always hard to pinpoint what drives the market in the short term.” Triana echoed this point and also highlighted that companies likely to benefit from tax cuts were getting a recent valuation boost in the market. 

In fact, the biggest effect of the tax cut anticipation may be in the valuation of smaller public companies. Barry Glassman, president of Glassman Wealth Services, said the possibility of tax cuts was having a disproportionately positive effect on these businesses, with their valuation as a group increasing 11 percent in the last month alone, a valuation change significantly higher than that of larger companies.

Since the expectation of tax cuts is providing a boost to some companies’ market value, this raises the question of what happens if tax cuts don’t happen.  Not surprisingly, these financial experts who see the underlying economic factors as the primary driver of the market don’t see the failure of tax cuts to materialize as likely to cause a lasting downtown in valuations. The absence of tax cuts would be the sort of unexpected news that can cause markets to dip in the short term, but the underlying economy is what drives the long-term trend. And, those objective facts support ongoing growth in the value of equities.  

But, what happens if the proposed tax cuts occur?  There was agreement among those that I spoke with that the stock markets would get an upward valuation boost. How much was difficult to predict, since the current valuations have already built in the expectation of tax cuts. For them the biggest determinant for future growth would be the objective facts of the underlying economy.  

This is where many of these experts expressed concern. Tax cuts and their accompanying changes in the federal debt raised significant risk of higher inflation and higher interest rates. For example, Glassman pointed out that inflation could occur either because the tax cuts accelerate wage growth through new hiring, or through a rapid increase of federal deficits.

Inflation causes higher interest rates, which adversely affect private borrowers and federal expenditures on debt service. Inflation will also erode the value of the U.S. dollar, which will make imports and oil more expensive. Hard to imagine that this is a policy choice to make if you are a President trying to promote manufacturing jobs, exports and traditional energy industries. 

This is where many of these experts expressed concern. Tax cuts and their accompanying changes in the federal debt raised significant risk of higher inflation and higher interest rates. For example, Glassman pointed out that inflation could occur either because the tax cuts accelerate wage growth through new hiring, or through a rapid increase of federal deficits.

Inflation causes higher interest rates, which adversely affect private borrowers and federal expenditures on debt service. Inflation will also erode the value of the U.S. dollar, which will make imports and oil more expensive. Hard to imagine that this is a policy choice to make if you are a President trying to promote manufacturing jobs, exports and traditional energy industries. 

For years Republicans have been saying they believe in free markets. The financial markets are clearly saying that tax cuts are not necessary. Who is telling them that they are?  

 

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