Economic Update 22 December 2017
Please note this blog post was published over 12 months ago and so may not include the most up-to-date information, for example where regulation around investing has changed.
The Investment Management team round-up some of this week’s news.
In addition to the long lunches, drinks receptions and Christmas parties being held across the country at this time of year another seasonal tradition appears to be underway – the Santa Rally.
Like the man whose name it bears, the phenomenon is something of a mystery but for true believers it offers investors the prospect of additional cheer at the year end. Financial egg nog if you like.
The Santa Rally is of course not the only stock market soar routinely trotted out. However, unlike “Sell in May and go away” there is evidence that a festive pick up does exist.
An examination of returns on the FTSE 100 index during the month of December over the last three decades reveals that the market has enjoyed a yuletide rally for 27 out of the last 32 years – an 84% success rate.
FSTE 100 One Month Returns (30th Nov to 31st Dec)
Source: Bloomberg, 20 December 2017. Note: Data for 2017 is 30th Nov to 21st Dec
Opinions differ on why it happens. Some point to a general feeling of happiness and goodwill around the holiday season while others more cynically put it down to thin markets when trading volumes are seasonally low. It could be fund managers rebalancing portfolios at the year end or hedge funds closing down short positions and returning borrowed stock to the institutions who lent it to them.
Or more simply a self-fulfilling prophesy – it happens most years so investors buy in expectation of it happening again.
Whatever the reason, investors seem to be trying to re run this particular sleigh ride as the FTSE 100 has increased 2.81% so far in December (not included in our historic numbers) and will be hoping to extend the run into 2018.
However, whether investors turn out to have been naughty or nice this year it’s worth remembering that sustainable returns come from soundly-based investment decisions rather than trying to time the market over the last 31 days of the year.
An investment portfolio is not just for Christmas.
TAX CUTS GET THE GREEN LIGHT
Nearly a year after Donald Trump took office, one of his key initiatives – tax reforms – which helped lead him to victory has finally been approved.
Early on Wednesday the US Senate, passed a landmark plan for the most significant tax overhaul in a generation. Hours earlier, the House of Representatives (the other chamber), also rubber stamped the tax reform bill after overcoming an obscure rule in the US Senate called the Byrd Rule.
The Byrd rule which is in place to stop the Senate from considering “extraneous” additions to bills caused the last-minute stumble. This involves three small provisions:
- The bill’s title: “The Tax Cuts and Jobs Act”. This is said to violate a rule that has no impact on the budget.
- The use of language that would let families use tax-advantaged 529 college savings accounts for the costs of home-schooling children.
- Conditions the bill uses to decide whether private universities will have to pay a new excise tax on their endowments.
Mr Trump marked the completion by declaring “I promised the American people a big, beautiful tax cut for Christmas”, “With final passage legislation, that is exactly what they are getting”.
The tax reform package involves an estimated $1.5 trillion increase in the budget deficit with the corporate tax rate falling to 21%, from the current 35%. Republicans are betting this will increase economic growth, create jobs and raise wages and they expect faster economic growth to drive up the tax take. Individuals at all income levels will also see tax cuts, including a top rate of 37%, down from 39.6%.
Republicans believe their package will energise the economy but not everyone agrees. Polls have shown that the reform is unpopular with the public and Democrats will hope to take advantage of this at next year’s mid-term elections. However, sceptics may turn out to have been wrong especially if the growth rate accelerates, unemployment falls further and wage growth picks up.
The new tax bill is expected to create winners and losers determined largely by industry or geography. However, an analysis by the Tax Policy Centre found that the bill would reduce taxes, on average, by about $1,600 in 2018, increasing after-tax incomes 2.2%. Controversially, the analysis also shows that the largest benefit will fall to the wealthiest households.
Shortly after the announcement of US tax cuts, US government bond (10-Year) yields climbed to their highest in nine months reaching 2.5% as investors interpreted the plans as a boost to economic growth which will put added pressure on the need for interest rates to rise.
US 10-Year Treasury Yield
Source: Bloomberg, 20 December 2017