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A common question among investors these days is: “Why is the stock market going up?”
Granted, the question is no t being asked by many President Trump supporters, who feel it is quite logical that the market has been so bullish.
While no one can know for sure why the stock market goes up or down on any given day, much less over a short period of time, it can be helpful to examine the possible reasons why this occurs if for no other reason than to dispel any myths.
Before we do that, however, a bit of background is appropriate.
You may have heard that the stock market is usually six months ahead of the economy. Put another way, the direction of stock prices up or down is reflective of how investors expect the economy to be in the near future.
This makes sense because investors buy stocks with the hopes that the price will go up. A better economy means higher profits and with that higher stock prices.
Conversely, investors do not want to lose money so they sell stocks when they think bad economic times are coming.
Uncertainty in where the economy will be in the near future does not typically bode well for the stock market. If investors have trouble gauging where they think the economy will be, they are more likely not to buy stocks and may even choose to sell their stocks.
A great deal of uncertainty is quite a powerful decision maker for investors even when current economic news is good.
The current political environment appears to be fraught with uncertainty. I will refrain from detailing the almost daily list of items contributing to this uncertainty, as you can open the newspaper or turn on the television and see for yourself.
However, there are several agenda items the current administration is working on that appear to be overriding all the other uncertainty and are being viewed as optimistic for the economy by investors: namely, taxes and deregulation.
The strongest, in my opinion, is tax reform and, in particular, corporate tax reform. Lowering corporate tax rates and allowing companies to repatriate earnings back into the United States at lower tax rates is a bullish sign for investors.
More money to spend should spur economic growth and, as a result, create more jobs. Whether corporations will do that or not remains to be seen.
The second agenda item which already has been taking place is reducing business regulations to allow businesses to spend more time and money directly on growing profits. The hope is that more profits will lead to expansion and, as such, more jobs.
Cutting regulations is a tricky thing, though. Clearly some regulations are necessary and should not be eliminated while others may be antiquated, or should better conform to the different types of businesses, even within the same industry.
It remains to be seen whether the administration will give careful consideration to regulations it deems unnecessary.
If either or both of the agenda items do not come to pass, investors’ views of the near-term economy may change, which would likely not be good for the stock market.
From a probability perspective, it is hard to tell the likelihood for tax reform and deregulation. Even if they come to pass, it likely will come in a form different than what investors expect.
So, with tax reform, for example, if investors do not think it is enough, the market may pull back. Similarly, if deregulation goes too far, and injures or damages people in some way, investors may react by selling their stocks — particularly those in the industry where the deregulation caused the damage.
Howard Hook is a Certified Financial Planner and CPA with the wealth management firm EKS Associates in Princeton, N.J.
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