The Dow Jones has soared to an intraday record high following the US Senate’s vote for tax reform.
In early trading the blue-chip index – which passed 24,000 for the first time on Thursday – was up 1.2 per cent to 24,524.74 as the Senate passed a bill that should see corporation tax cut from 35 per cent to 20 per cent.
US equities have been on an upward trajectory this year, rising to record levels in anticipation of corporate tax cuts, boosts from President Trump’s other policies and positive macro data.
WisdomTree says the proposed tax changes should reduce the S&P 500’s tax rate of just under 28 per cent to 19.7 per cent, due to the 69 per cent of the index that generates profits domestically.
“Earnings would increase for many S&P 500 constituents, and consequently, the P/E ratio of the index would fall below 20x,” WisdomTree’s Nizam Hamid says.
“Given the nature of the tax proposals, companies with a bias towards domestic earnings, such as small and mid-cap companies, will benefit more from a shift to a 20 per cent marginal tax rate. It is estimated that the effective tax rate for companies of this size will decrease significantly, from close to 31 per cent to just over 20 per cent,” Hamid adds.
Accendo Markets analyst Henry Croft says: “While the Senate bill will have to be aligned with the lower house’s equivalent bill, this marks a key legislative victory for President Trump who has seen his efforts to repeal and replace Obamacare fail while struggling to maintain a ban on the entry of some foreign nationals.”
Russ Mould, investment director at AJ Bell, warns that when the US market has reached similar levels historically, it has come crashing down.
“America’s financial markets continue to write nearly as many headlines as its President. However, market cap-to-GDP and Professor Robert Shiller’s cyclically adjusted price/earnings (CAPE) ratios both suggest the US stock market has only ever been similarly or more expensive two or three times in its history, in 1929,1999 and 2007,” Mould says. “All of those episodes ended with a bang rather than a whimper so investors need to be on their guard, despite or indeed maybe because of the prevailing optimism.”
Mould adds that based on the past 20 years performance data, when the Russell 2000, the Dow Jones Transportation index and the SOX index are doing well, the Dow Jones Industrials will do well and when the former three indices are doing badly the broader US stock market will do badly.
Although the Russell 2000 is forging new all-time highs, the Transportation index has been lagging lately and the SOX has had its first wobble since May when it fell 4.4 per cent last week.
“While none of these indicators are yet a screaming sell signal there is enough uncertainty here to suggest investors in the US market should be watching their portfolios carefully and considering when might be the right time to bank some of the handsome profit they could have made over recent months.”