Trump’s Tax Outline Won’t Avert Market Correction

by Michael Pento

Trump’s comprehensive tax plan is keeping investor confidence high, but the proposed changes will be significantly watered down if they ever become law. Since the final plan will be significantly diluted from the proposed form, its effect on the economy (and equity prices) will be subdued, so Wall Street optimism is misplaced.

Trump’s Tax Outline Won’t Avert Market Correction | BullionBuzz

Corporate tax receipts have fallen by 18% in the past six months compared to a year ago. Real GDP only increased by 1.6% last year, and was up just 0.7% in Q1 of this year. Despite this, EPS growth estimates for 2017 are over 10%. How it is possible to grow S&P 500 earnings by double digits when the economy is so weak?

The S&P500 earnings growth rate for Q1 2017 is projected to be more than 12% from last year, primarily because of last year’s oil price plunge. However, when comparing Q2 2017 to Q2 2016, it will look much different. Unless the oil price surges, the earnings boost enjoyed this quarter goes away.

The second-highest growth sector in the S&P is financials. Like the energy sector, the outlook for this sector is muted because the banks’ net interest margin is a crucial driver for earnings growth. However, the yield curve has flattened by 20% from Q1 to Q2. Since banks get a significant earnings boost from the steepness of the yield curve, this doesn’t bode well for continued earnings power.

Unless US and global GDP growth is about to undergo a rapid rate of expansion, it isn’t credible to assume S&P500 earnings can be maintained anywhere near that projected double-digit growth rate.

Nevertheless, the market is trading at an incredible 132% of GDP. The market has one chance left, and it is massive tax cuts that have already been priced into stocks. That is a long shot, and would lead to a huge increase in deficits and interest rates that could offset any benefits.

For now, investors face record-high stock valuations on top of a record amount of margin debt. This equity bubble is simultaneously being undermined by near-zero GDP growth, a tightening yield spread, tepid EPS growth, bank loan growth that is rolling over, a record-high debt-to-GDP ratio, and a Fed that wants to fight inflation. The market is ripe for a big correction, and investors should position their portfolios to protect and profit from the coming reality check.

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