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A little stumble

Peter Warnes  |  31 Mar 2017Text size  Decrease  Increase  |  

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Market expectations of a fast track to pro-growth taxation reform and fiscal stimulus in the US have been derailed in the short term, Morningstar's Peter Warnes says.


US equities markets have ignored the failure of President Trump to convince his own party to introduce the American Health Care Act to unwind the Obamacare health insurance safety net. But it is a setback.

Being in control of both the House of Representatives and the Senate was big a start. Trump did not have to win any votes, just get the support of his own side to back the legislation, and the numbers would do the job. It proved to be a bridge too far.

The lack of support within his party meant the bill was not introduced. It was dead in a Republican bayou. But the savings to be realised were to provide the funding for promised taxation reform and some of the US$1-trillion infrastructure stimulus.

President Trump will now push ahead with taxation reform and leave healthcare for another day. But financial conservatives within the Republican Party will strongly argue for financial restraint, wanting to see the reform fully funded. Therein lies the dilemma for financial markets.

The pent-up expectations of a fast track to pro-growth taxation reform and fiscal stimulus have been derailed, at least in the short term. The bulls suggest all is not lost as markets continue to climb a wall of worry.

But a quick passage of tax reform is unlikely. A central plank of the reform--the Border Adjustment Tax--has many critics within the party and is the generator of significant revenue needed to pay for the promised sizeable cuts to corporate tax rates.

The US deficit is already large, and unless spending cuts or additional sources of revenue are uncovered, disappointment and frustration could come to the fore.

In the Year of the Rooster, the top rooster may not do much crowing. The body language of a president, used to getting his own way, has visibly changed. The taste of his first defeat in public life sits uncomfortably.

Positive readings on US consumer confidence and PMIs in both the US and the Eurozone are providing markets with the fuel to push higher.

The upcoming March quarter (1Q17) reporting season in the US will need to provide evidence of earnings growth to sustain the S&P 500's price/earnings multiple near 20. This does not mean all stocks are expensive, some are but some are still in the value zone, including healthcare.

The projection material used by the Federal Open Market Committee at their 15 March meeting shows growth in real GDP of 2.1 per cent in both 2017 and 2018, trimming to 1.9 per cent in 2019.

Projections of change in real GDP are per cent changes from the fourth quarter of the previous year to the fourth quarter of the year indicated--so 2017's 2.1 per cent is measured from 4Q16 to 4Q17.

This is hardly economic growth to write home about and markets are expecting a much higher outcome, between 3 per cent and 4 per cent, to justify the S&P 500's elevated multiple.

Are banks sowing the seeds of an economic contraction?

All banks, led by the majors, are into out-of-cycle interest rates on new and existing mortgage and investor loans. They are reacting to the jaw-boning of regulators threatening to introduce macroprudential measures to take the steam out of the housing market.

Such measures would require the banks to hold more capital and so impinge on the sensitive return on equity metric.

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Peter Warnes is Morningstar's head of equities research. Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

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