Traders don't want to get burned again by tax reform promises

  • Trader positioning ahead of the Republican tax plan doesn’t suggest much confidence in the measures becoming law.
  • It’s possible that investors are simply waiting to see signs of progress before buying the stocks of companies seen benefiting the most.

The details of President Donald Trump’s tax plan are expected later this week. This is the full-blown plan, being released by the House, and it’s the biggest step that Republicans have taken to date toward meaningful tax reform.

Even before the news broke Tuesday night that the plan’s rollout would be delayed by a day, stock traders were sceptical. It’s easy to see why: investors betting on big changes in the corporate tax code — by buying shares of companies expected to benefit the most — have been burned on this before. So rather than bid up the likely winners, they’re in wait-and-see mode.

That’s a change from past behaviour. Most notably, in the months immediately after the presidential election, investors piled into the stocks of the nation’s most highly-taxed companies. They did it again, although with a little less enthusiasm, in June and September, as the tax plan took priority over Obamacare replacement.

You can see all those bumps in the chart below, which shows the performance of an index of stocks tracking highly taxed companies, relative to the S&P 500. It’s intended to serve as a proxy for the market’s confidence in the proposed policies. The most-taxed group should get the biggest boost from a tax cut.

And as you can see, it’s now at a post-election low.

UntitledBusiness Insider / Joe Ciolli, data from BloombergThe positive effect of tax reform on US stocks is a long ways from its heyday in the months after the election. A measure of confidence now sits at the lowest in at least a year.

Of course, this is just one measure. There are other ways to bet on tax reform. For example, rather than focus on the most highly-taxed companies, an investor can zero in on one specific sector, then make options bets on an exchange-traded fund that tracks it. If implemented correctly, this type of positioning could limit the risk of disappointment, or position a trader to profit from upside moves.

If the low level of trader confidence persists, two factors will likely be to blame. One is the sudden appearance of opposition from homebuilders, who are fighting to defend tax provisions that encourage people to buy houses. As my colleague Bob Bryan explained, this is a clue to kinds of individual battles the administration is going to face as it tries to sell the plan.

Also, Bloomberg News reported this week that lawmakers are considering phasing in the corporate tax cuts, as they grapple with the impact of the plan on deficits.

The specifics of this are still up in the air. Traders, it seems, aren’t taking chances anymore.

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.