Stock Indices Reach New Highs – Domestic Equity Overview

Many analysts believe that the stock market rally following Trump’s election reflects the expectations of a new era of fiscal stimulus. Both economists and analysts agree that the Fed has basically exhausted all of its stimulus efforts by means of using traditional and newly devised monetary policy tools that are now considered ineffective.

Small caps outperformed large caps following the election, primarily driven by the growth factors expected to benefit small cap stocks. Proposed corporate tax rate cuts also favor small caps, which benefit more than large caps from tax rate reductions. Proposed deregulation is good for small caps as large caps can handle higher costs of regulation easier than small caps, leaving small caps to benefit the most under deregulation.

Protectionism is expected to benefit small company stocks which typically generate less than 20% of their sales overseas while larger company stocks generate well over 30% from overseas sales. A reduction in the corporate tax rate to 15% would be much more beneficial for small company stocks, which generally don’t have the resources to bring tax rates below 35%.

The Dow Jones Industrial Average reached 19,000 in November, a milestone level for the index, which was at 1000 in November 1972. The Dow Jones Industrial Average rose 5.4% in November, while the S&P 500 Index increased by 3.4% and the Nasdaq Composite added 2.6% for the month. The Dow Jones Transportation Average climbed 11% in November, it’s single largest monthly gain since October 2011. As a leading indicator of economic growth, strong gains in the index are often a good sign for the U.S. economy. (Sources: S&P, Dow Jones, Bloomberg)

U.S. Has Among Highest Corporate Tax Rates – Fiscal Policy Review

One of Trump’s fiscal proposals is to reduce the inherently high U.S. corporate tax rate from 35% to 15%. The United States currently has one of the highest corporate tax rates of any country worldwide at 35%. The average corporate rate globally is just over 23%.

Some countries maintain low tax rates or no corporate tax at all, such as Cayman Islands and Bermuda, in order to encourage companies to invest and hire within their countries. If U.S. corporate tax rates drop, it might discourage U.S. companies from seeking tax havens overseas, such as tax inversions. Inversions occur when a U.S. company buys or merges with a foreign domiciled company in order to adopt a lower tax rate. A report released by the OECD is concerned that some European countries are being used as tax havens, but with little or no benefits achieved by the underlying workforce or economy. (Source: OECD)

Rates Heading Higher – Fixed Income Update

Bond markets reversed their long-term trend of descending yields as economic growth expectations and inflationary pressures mounted. The anticipation of lower taxes sent demand for municipal bonds down. A primary reason for buying munis is the tax benefit of municipal interest, thus resulting in a drop in muni prices in November. High-yield corporate bonds enjoyed a generous run up in November as optimism regarding economic growth and jobs tend to benefit high-yield bonds. High-yield bonds are issued by companies that are considered less credit worthy and more at risk for default. The same companies who issue these bonds tend to prosper in a growth environment, thus generating greater profitability and increasing the likelihood of paying their bond obligations.

The 10-year U.S. Treasury yield ended November at 2.37%, up from 1.87% before the election and 1.37% in July after Britain’s vote to exit the EU. Even as U.S. Treasuries have fallen in price during this yield increase, they are notably the highest yielding government bonds among developed countries. Such a disparity may attract new buyers in search of yield resulting in higher prices and yield constraint. The forces affecting the U.S. bond markets are global, as U.S. debt from various sectors look attractive yield wise as well as conservative relative to higher yielding emerging market debt. (Sources: Bloomberg, U.S. Treasury Dept.)

OPEC Caves In & Cuts Oil Production – Oil Industry Update

OPEC agreed to cut production among its 13 members by 1.2 million barrels a day from the current 33.6 million barrels. The agreed upon reduction would reduce global output by about 1%, easing high levels of supplies. Domestically, the U.S. Energy Administration reported that U.S. stockpiles of oil shrank by 884,000 barrels in the final week of November. The price of WTI, the benchmark for domestic crude oil, ended November at $49.17 per barrel.

Since supply and demand are the primary determinants in setting oil prices, OPEC’s production cuts along with less supply in the U.S. are expected to shore up the price of oil. In addition, the anticipated growth generated from any economic expansion in the U.S. and abroad may increase demand for the commodity, adding pricing pressure as well. The crude oil benchmark WTI was up over 50% at the end of November from January 2016.

Saudi Arabia, OPEC’s largest oil producer, launched an aggressive campaign against U.S. oil drillers two years ago by continuing to produce oil at record levels in order to maintain and build upon its market share. Saudi Arabia’s relentless approach to put U.S. shale drillers out of business is an indication of how serious a threat U.S. oil production has become to OPEC and its members. The U.S. shale industry, known for its fracking technology to extract oil from shale rock formations, has continued to surprise the world oil markets with its resistance to low prices. U.S. drillers have thus far been able to beat Saudi Arabia’s “pump and dump” strategy of lower oil prices in order to maintain market share. (Sources: EIA, OPEC)