After surging to peak levels, the Dow and the S&P 500 snapped an eight-week winning streak — the longest since 2013 — while Nasdaq ended a six-week winning streak. Meanwhile, the Russell 2000 logged its biggest weekly decline since August. The sell-off stemmed from concerns over the delay in the implementation of corporate tax cuts, which happened be the major driver of the recent stock market rally.
The tax plan unveiled by the Senate Finance Committee differs from that of House Republicans on various fronts. The Senate proposal defers the corporate tax rate cut of 20% until 2019, does not repeal the estate tax, and leaves the mortgage interest deduction unchanged. Additionally, the proposal maintains the current number of individual income tax brackets of seven but slashes the top bracket by a percentage point to 38.5%. It also provides small-business owners with a deduction rather than a special business rate.
Given this, Trump’s proposal will face several roadblocks for approval by this year-end. Investors should note that tax reform is a key catalyst to keep the bull market alive. As such, delay or no progress in tax overhaul could lead to huge sell-off in the stock market. Further, if the Senate proposal is passed, then the battle for tax reforms will intensify giving a way for the major correction in the stock market. According to Arrow Funds Director of Research John Serrapere, the failure of corporate tax cuts could trigger a correction of as much as 15% in stocks.
Moreover, one of the leading indicators, high-yield market, has started to flash warning signs for the broader equity market. The last week sell-off in these bonds could be a precursor of a larger pullback in the stock market.
However, the Arms Index, also known as the short-term trading index and used to measure buying or selling intensity, suggesting investors are in a buying mood. It is calculated by dividing the Advance-Decline Ratio by the Advance-Decline Volume Ratio. An Arms index value above 1.00 is a bearish signal while value below 1.00 is a bullish sign. A value of 1.00 indicates a balanced market. As of the close on Nov 11, the NYSE Arms rose to 0.77 and the Nasdaq Arms slipped to 0.80.
Further, solid corporate earnings and pickup in global economic activity have been the key drivers of the stock market rally throughout this year despite the political turmoil in Washington. The combination of these two factors will continue to keep the positive momentum alive in the stock market albeit at a slower pace.
How to Play?
Given this, value investing seems appealing at present. Here, one can bet on stocks with strong fundamentals – earnings, dividends, book value and cash flow – that trade below their intrinsic value and are undervalued by the market. Value stocks have the potential to deliver higher returns and exhibit lower volatility compared with growth and blend counterparts. In fact, these stocks outperform the growth ones across all asset classes when considered on a long-term investment horizon and are less susceptible to trending markets.
As a result, investors may want to consider a nice value play in the current volatile market environment. For them, we have presented five ETFs and stocks that will likely outperform in the coming weeks if volatility persists.