Tax reform is causing cross-currents in the stock market. There are five likely moves ahead that are of special note. The best way to know if buyers or sellers are winning as a result of those five moves is to look at money flows.
So let’s look at money flows and then examine the cross-currents.
Money flows
Please click here to see money flows in three popular ETFs: S&P 500 ETF SPY, +0.63% Nasdaq 100 ETF QQQ, +0.84% and small-cap ETF IWM, +1.35% Money flows in Dow Jones Industrial Average DJIA, +0.57% stocks are similar to the SPY flows shown in the chart.
Please click here to see money flows in FAANG stocks. FAANG stocks include Facebook FB, +0.36% Apple AAPL, +1.41% and Amazon AMZN, +0.97% The chart also includes money flows for popular tech stocks AMD AMD, +6.71% Alibaba BABA, -0.10% Microsoft MSFT, -0.54% Nvidia NVDA, +3.31% and Tesla TSLA, -1.33%
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FIFO is out
A provision that would have required “first in, first out” when selling stock lots was previously proposed. This would have prompted intense selling this year. In the final law, this provision will not be there. This is lifting the pressure on stocks and is bullish.
Lower rates in 2018
Many people will pay lower taxes if they sell securities in 2018. Such tax payers are likely to hold off on selling securities this year. This is bullish for the short term.
Tax deferral
By selling in 2018 instead of 2017, tax payers will be able to defer paying taxes by one year. Who doesn’t like holding on to their money longer? This is bullish.
Smarter players
Smarter players try to get ahead of the masses. They already know the three factors stated above that will lead to some selling early next year. Often when selling occurs, there is only a small door to exit and many participants are not able to exit at their desired prices. Smarter players know this.
With the foregoing knowledge, smarter players are likely to devise strategies that involve selling this year. Depending on how aggressively some strategies are employed, this selling may negate the bullish effect of the tax reform in the very short term.
Impact on individual companies
The impact of tax reform has already been fully discounted in the shares of some companies. Such companies are likely to be sold. On the other hand, the companies where impact of the tax reform is not discounted in their stock prices will be bought. This will create further cross-currents. As an example, it appears that the impact of tax reform is not fully discounted in the financials, such as Bank of America BAC, +1.52% J.P. Morgan JPM, +0.77% TD Ameritrade AMTD, +0.65% and Schwab SCHW, +0.90%
What to do now
It is worth repeating that the best tool to know who is winning, buyers or sellers, is to keep an eye on money flows. For the long term, please see “Get ready for Dow 30,000, but beware of ‘buy the rumor, sell the news.’”
At The Arora Report, for timing, risk control and allocations, we depend on the highly complex adaptive ZYX Global Multi Asset Allocation Model. In plain English, “adaptive” means it changes itself with market conditions. The model is comprehensive in that it has inputs in 10 categories that truly matter. Investors ought to pay attention to those inputs; you can see details here. We simply leave out other data that do not reliably determine the course of the markets.
The Arora Report timing model went to all cash and then inverse ETFs and short positions during the crash of 2008. That not only protected investors but also made large profits from the market decline during a time when many investors lost half of the value of their portfolios.
The model turned aggressively bullish in February and March of 2009 right at the beginning of the current bull market.
Since then the model has stayed bullish but has often called for hedges. Based on the ZYX Global Multi Asset Allocation model, we answer for our subscribers the key question: “What to do now?” We specify appropriate cash levels and appropriate hedges. Currently the model does not see a crash but advocates protective measures as risks are rising due to overbought conditions of the stock market and the cross-currents described above, among other risk factors.
Please keep in mind that you cannot take advantage of dips in the market and new opportunities if you are not holding enough cash. Investors ought to pay attention to how much cash is warranted based on current market conditions and new opportunities ahead.
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. All recommended positions are reviewed daily at The Arora Report.
Nigam Arora is an investor, engineer and nuclear physicist by background, has founded two Inc. 500 fastest-growing companies, is the developer of the adaptive ZYX Global Multi Asset Allocation Model and the ZYX Change Method to profit from change in trading and investing. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.