After the election in November, it seemed that stock and bond markets focused on the potential for a new fiscal policy plan and the economic growth it may bring. While a little of that enthusiasm for the new plan has waned, stocks remain near all-time highs. Bond yields, however, have given up almost .20% of their gains.
We can expect some market volatility as investors evaluate the timing of the new policies. Because the fourth quarter corporate earnings season won’t kick into high gear until January 24, investors will have another couple of weeks to focus on geopolitical events both here at home and overseas.
With Congress back in session, we have some idea of the timing of the proposed fiscal policy changes. These can be lumped into three categories: spending, taxes and health care. Inauguration day is January 20; however, Congress began working on their end as of last Tuesday. It is likely they will pass a budget resolution in the next 45 days that provides some amendment to fiscal 2017 spending and allows the rules to be changed slightly in order to permit changes to the Affordable Care Act (ACA). The idea is that a budget resolution provides the parameters for government spending and permits the Senate to pass tax and spending proposals with a simple majority. At this point, it isn’t clear how this will impact the ACA, but we should begin to see what that impact is as the resolution makes its way through Congress. It is likely they will repeal ACA-related taxes and extend some of the subsidies. Congressional leaders indicate a new bill won’t be passed until 2018.
This could create some difficulty for investments in the health care sector. However, the majority of the uncertainty will affect insurers and providers. Companies that drive revenue growth through product sales (e.g., pharmaceutical and device companies) may cheapen further in the near future, but long-term they should benefit from the wave of retiring boomers whose spending on health care products will increase.
Tax reform will be more complicated. There is almost a $3 trillion difference over ten years between the Trump and House GOP plans. The House plan focuses a little bit more on tax reform than cuts and therefore may be more contentious. The “Freedom Caucus” within the GOP has already made it known that they have concerns regarding the size of the cut and the impact on budget deficits. Last year’s deficit was over $500 billion. With the federal government’s debt to GDP ratio over 100%, there may not be much appetite to extend the deficit further.
In terms of timing, a new tax plan will likely take until the summer to pass. Because of this, the impact on the 2017 fiscal year will be minimal unless some portion of it is retroactive. As GOP members are focused on reform and tax rates, they may be willing to give up on the idea of a retroactive implementation approach to get the rates as low as possible.
That leaves spending. We aren’t likely to see a major infrastructure spending bill included in the 2017 budget resolution. Rather, the near-term focus will be on the ACA and then taxes. However, within the 2018 budget resolution there will be a focus on infrastructure spending and perhaps lifting the cap on defense spending. The impact on company stock prices has already been felt, so the delay in details may provide investors another opportunity to acquire these stocks at cheaper prices.
When the Federal Reserve raised rates last month by .25%, it indicated there was the potential for a further increase in economic growth and inflation in 2017. The consensus among Fed governors was that they would raise rates three times in 2017—up from their last report of two hikes. The bond market sold off and bond yields rose as a result. However, since the announcement, yields have come down off their near-term highs. Until we get more clarity on policies that meaningfully affect the federal deficit, we aren’t likely to see much upward pressure on bond yields. As the spending and tax policies become clearer, the market will reflect the impact on spending in yields.
Remember, at the beginning of 2016, the Federal Reserve estimated four interest rate hikes for the year; it only moved once. We will remain cautiously optimistic that the three hikes planned are one or two too many. Policy clarity will help us determine the outcome.