Congress is inching ever closer to passing sweeping changes to the tax code, and many traders are starting to wonder what these changes, if passed, are going to do for their portfolios.
Could stock prices continue to rise, or is tax reform already priced in? Is this one of those classic “buy the rumor, sell the news” moments we hear so much about on Wall Street?
Sell the News?
With the S&P 500 near its all-time high after having risen more than 8% since Labor Day, it’s hard to make the argument that some of the anticipated impacts of tax reform aren’t already priced into the market.
The question now is, have all of the anticipated impacts been priced in and are traders who are buying now just setting themselves up for losses if the market starts to sell the news as soon as President Trump pulls out his pen to sign the new legislation?
Looking at the bearish volatility the market has been experiencing during the past few trading periods, it would be easy to conclude that traders on Wall Street are already starting to sell the news on tax reform, but we think that’s a misreading of the market.
Yes, traders are causing a bit of volatility by taking some profits off of the table — especially in the momentum-driven technology sector — but they’re not taking profits because they believe all of the positive impacts of tax reform have been priced in and that companies are not going to continue to benefit from the tax changes well into 2018.
Instead, they are taking profits for two reasons: First, some of those profits have reached long-term capital gains status and, second, they’re worried about the volatility that the failure to fund the federal government and raise the debt ceiling could cause.
Long-Term Capital Gains
The presidential election in November of 2016 triggered a wave of buying on Wall Street. Stocks surged higher for a full three weeks before pausing briefly as traders caught their breath and decided this was a bullish uptrend that had some legs.
As you can see in the daily chart of the S&P 500 in Fig. 1, it has been 12 months since the post-election surge, which means that those traders who were feverishly adding bullish positions to their portfolios in the immediate aftermath of the election are now only subject to long-term capital gains, not short-term capital gains.
In other words, if they take profits now, they get to keep more of those profits because they won’t have to pay as much in taxes.
Fig. 1 — The S&P 500 12 Months After the Post-Election Surge
Not everybody got into new positions right after the election, which is evidenced by the continued strength of the bullish uptrend we have seen this year, but there is bound to be some end-of-year selling by those who did. This could exacerbate the volatility in December, but it doesn’t doom the bullish uptrend.
Funding the Government and Raising the Debt Ceiling
The primary concern — other than missile tests in North Korea — that has proven it has the capacity to slow down the tax-reform bullishness on Wall Street is whether Congress is going to be able to work together to fund the federal government and raise the debt ceiling.
As you can see in the daily chart of the S&P 500 in Fig. 2, the market started pulling back in the run up to Labor Day knowing that Congress was going to have to tackle funding the government and the debt ceiling when it returned from its holiday.
However, as soon as both the Senate and the House cleared the road to work on tax reform by passing a short-term extension — kicking the can down the road to this Friday, Dec. 8 — the market rallied.
Fig. 2 — Daily Chart of the S&P 500
Now that we are once again approaching the Dec. 8 deadline that could potentially shut the government down, traders are becoming a little antsy.
Most expect Congress to kick the can down the road again by passing another short-term extension, but the uncertainty isn’t good for business on Wall Street.
The Bottom Line for Next Week
Traders aren’t selling this week because they don’t think the final passage of a tax-reform bill won’t lead to further gains in corporate profits, which will likely lead to higher stock prices. Instead, they are concerned that other fundamental factors could slow growth in the short term.
Watch for some long-term capital gains profit-taking, and keep an eye on Congress and its “can-kicking” abilities, but so long as the government remains open and tax reform ultimately passes, the S&P 500 is likely to continue rising into 2018.
You can learn more about identifying price patterns and using them to project how far you think a stock is going to move in our Advanced Technical Analysis Program.
InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next SlingShot Trader trade and get 1 free month today by clicking here.
