The Dow Jones Industrial Average could be headed towards 30,000 in the new year after enjoying strong run in 2017 as stocks benefit from a brighter economic outlook and sweeping tax reforms.
Optimism that President Donald Trump’s overhaul of US tax legislation would be approved by lawmakers pushed the US blue chip index past the 24,000 mark in late November.
Now that the US House of Representatives has given the tax bill the final go-ahead, many analysts expect the bull market to continue in 2018.
The deepest rewrite of the US tax code in more than three decades will see the corporation tax rate slashed to 21% from its current rate of 35%.
“Tax cuts in the US could help boost the American economy and stock market which, in turn, will positively impact global economic growth and global stocks,” said Nigel Green, founder and chief executive of financial consultancy deVere Group.
Meanwhile, Barclays estimates that 2018 earnings per share will be raised by an average of 6.3% with consumer staples, financials and industrial companies among the top stocks to be given a leg-up from the tax reform.
Energy, mining, accommodation and food services are also expected to benefit from a tax break allowing immediate expensing for spending on shortlived capital equipment.
Maneesh Deshpande of Barclays said he sees some scope for share prices to increase further since markets have not yet fully anticipated the tax cuts.
Trump’s campaign promise for deregulation would also bring some relief to highly-regulated sectors such as banking and biotech stocks.
US economic growth to buoy stocks
Trump has said he expects US economic growth to reach 4% over the next few years.
The latest official data showed the US economy grew at a 3.3% annualised rate in the third quarter, the strongest since the same period in 2014.
Should economic growth continue to accelerate, stocks could gain further, giving the Dow a good chance of hitting 30,000.
“Strong GDP growth is translating into good corporate earnings growth, which supports share prices,” said deVere’s Green.
Recovery in energy stocks
Energy stocks could pick up in 2018 if the recovery in crude prices continues.
The Organisation of the Petroleum Exporting Countries (OPEC) and 10 other producers led by Russia in November agreed to extend production cuts of 1.8mln barrels of oil until the end of 2018.
The move to curb production is aimed at addressing a global supply glut, which has been blamed for subdued oil prices.
The production cuts, which began at the start of 2017, have seen the price of crude edge higher after a prolonged slump.
Given that energy companies have had a historically higher tax burden than other companies, the tax reform will also provide a further uplift to earnings.
Tech rally set to continue
Technology stocks surged in 2017 and many analysts predict the rally will continue in the new year.
Apple Inc. (NASDAQ:AAPL) is expected to become the first company to reach a market capitalisation of US$1trn on the back of its new iPhone release in November, while Amazon.com Inc. shares are expected to head higher as its rapid expansion continues.
“If you ignore the idiosyncrasies of global index compilation, then the world’s seven biggest-cap stocks are all technology names – Apple, Alphabet, Microsoft, Amazon, Facebook, Alibaba and Tencent,” said Russ Mould, investment director at AJ Bell.
“While valuations may not be as barmy as they were in 2000 they are still lofty and leave little room for disappointment – and it may not even take earnings disappointment for enthusiasm for these stocks to cool.”
Headwinds to consider
While there are plenty of reasons to suggest the Dow will reach 30,000 in 2018, it is not an open-and-shut case.
US market sentiment could be hurt by geopolitical worries over North Korea’s threat to national security, Brexit uncertainty and China’s economic slowdown.
“Concerns, over what President Trump may or may not do, North Korea, China’s economy, the Brexit talks and a gradual series of US Federal Reserve interest rate increases were all swept aside (in 2017) as global stock markets moved higher and bonds did not suffer the accident many had feared,” said Mould.
“Yet such optimism could leave investors exposed to the danger of ‘sliding down the slope of hope’ in 2018.”
The Federal Reserve hiking interest rates at a quicker-than-estimated pace could also impact US equities, he said.
Interest rates have remained low for some time as inflation continues to undershoot the Fed’s 2% target despite falling unemployment.
For this reason the central bank said at its December policy announcement that it expects future interest rate hikes to be gradual.
But it is possible that tight labour markets result in wage increases that lift inflation and prompt the Fed to markedly tighten monetary policy by raising interest rates or withdrawing quantitative easing.
“Any faster-than-expected removal of central bank liquidity could be a shock to a range of asset classes – stocks, bonds, cryptocurrencies, art, you name it – which have feasted off cheap money,” warned Mould.
Stocks that could remain under pressure
Trump’s tax cuts are expected to provide a lift to corporate earnings but some hard-hit industries could continue come under pressure regardless.
Bricks-and-mortar retailers have been affected by the growing shift towards online shopping and by the high level of discounting used to lure customers into stores.
Retail stocks, such as Macy's, JCPenney and Kmart owner Sears, have been under the cosh due to sluggish sales, leading to store closures and job cuts.
Amazon has led the rise of online shopping and is also reportedly considering entering the pharmacy market.
The prospect that the e-commerce giant could enter that space has recently weighed on the stock prices of drug distributors.
The industry has also been hit by Trump’s vow to bring down drug prices.
In October Trump said in a Cabinet meeting that drug prices “are out of control” and repeated his promise to “bring our prices down to what other countries are paying”.