What’s the Risk of a ‘Sell the Tax Reform’ News Reaction?

After just about twelve months of pricing in the Trump administration’s tax reform package, this week could be the week when it all gets signed into law. US stocks if measured by the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) are close to 20% higher for the year to date with nine trading sessions left in 2017. The question I have been pondering along with my network of hedge funds and other institutional investors is whether we could indeed see some “sell the news” reaction in stocks if and when the tax deal gets signed, sealed and delivered.

What's the Risk of a 'Sell the Tax Reform' News Reaction?

As I have been telling my subscription members and advisory clients for the past few months, historically speaking, stocks tend to hold up into year-end (Santa Claus rally) and while that is once again my base case this year, some immediate-term gyrations in stocks following a tax deal cannot be ruled out.

What from this angle looks to be somewhat more likely, however, is an early 2018 sell-off (floored at 5% to 10%) for stocks as the question rises from a catalyst perspective; once taxes are out of the way, what else is there to be looking forward to?

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Moving averages legend: blue – 8 day, yellow – 21 day

If we look at the year-to-date move in the SPY ETF, the persistent steepening of the slope is apparent along with notable overbought readings from the MACD oscillator. Another momentum oscillator called the relative strength index or rsi has actually recently made a marginally lower high versus the October highs. None of this should be a catalyst however to go out and short stocks or sell everything and hide under a rock.

Price action as always is the ultimate arbiter and prices for now continue to make higher highs and higher lows.

What’s the line in the sand I am watching in the SPY ETF for a more serious risk off environment you ask? The yellow 21-day simple moving average has served me well as a risk on/risk off environment gauge. Should the SPY etf be able to hold below this moving average on a daily closing basis we could be in for a bumpier ride and a better mean-reversion lower in the range of the aforementioned 5% – 10%, possibly even a little more.

Tech Stocks Still Strong

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Moving averages legend: red – 200 day, blue – 100 day, yellow – 50 day

One part of the U.S. equity market that has ramped all year long and continues to act well is large cap technology as represented by the PowerShares QQQ Trust, Series 1 (ETF) (NASDAQ:QQQ). Just last Friday, the QQQ ETF and along side it some of the highly correlated constituents like Microsoft Corporation (NASDAQ:MSFT) scored fresh breakouts of multiweek consolidation phases.

Taking into consideration the widespread fund manager performance anxiety, it looks likely that these names could see a further lift into year-end and MSFT stock toward the $90 area. Any sharp reversal in these names alongside a broad market reversal would be a stop loss signal.

Check out Serge Berger’s Trade of the Day for Dec. 18.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here.

For a list of this week’s economic reports due out, click here.

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