Doing the Tax Cut Valuation Math

Those much-anticipated tax cuts appear as though they soon may become a reality.

That???s very good news for the markets, as the gains in the equity markets over the past 12-plus months have largely been built on tax reform — particularly corporate tax cutsĀ — becoming the law of the land. Yet assuming tax cuts do pass (an assumption we should never take for granted given the Washington swamp), just how much of an impact will tax reform have on the markets going forward, and what will the impact of tax reform be on equity market valuations?

It is an interesting question, and one that requires the analysis of one of the smartest guys I know in this business, my friend and colleague Tom Essaye of theĀ Sevens Report.

Going into my conversation with Tom about tax cuts and the impact they likely will have on equity market valuation, we both agreed that on a historic basis, the stock market is richly valued. In fact, most valuation metrics today are reminiscent of periods in the market such as 1929 and 2000, two periods that obviously strike fear into the hearts of equity investors the world over.

Here???s an excerpt of the conversation I had with Tom about the tax cut valuation math. I think you???ll find it sheds some interesting light on this market???s future prospects.

Jim Woods: I know you???ve said in the past, and I agree, that high valuations alone do not kill bull markets. In fact, markets can stay highly valued longer than most people think reasonable, or even possible. We know that because for the past year or so, the S&P 500 has traded around 17.5-18 times next year???s S&P 500 earnings per share (EPS) estimates. But now that tax cuts are almost here, what impact will that have on the valuation math?

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