The House votes on its fiscal 2018 budget Thursday, keeping tax reform on the front burner — and the Trump trade, as well.
"It's sort of the Trump trade 2.0. We think it's worth playing," said Edward Campbell, portfolio manager with QMA. "In the fourth quarter of last year, you saw it in the value stocks, the small cap stocks. These trades are related — financials outperforming, yields backing up, the dollar doing well. That was the story of the fourth quarter last year."
Trump and the GOP Congress's failure to advance their agenda so far this year led to those trades unwinding, he added.
Campbell said he recently added to risk assets because of the move ahead toward tax reform. Congressional leaders and the Trump administration unveiled a proposal for corporate and individual tax cuts last week. While there's a long process ahead before specific tax law changes can be agreed to, there's also a legislative process that needs to be followed.
"Really the good macro we have is tax reform coming back to the front burner as a possible policy catalyst," Campbell said.
The small cap Russell 2000 slipped 4 points to 1,507 Wednesday, but it is still up about 11 percent since Aug. 21. Small caps would be clear winners from a lower corporate tax rate, proposed at 20 percent. Currently, small cap companies pay an average tax rate of more than 30 percent, while multinationals pay about an average 27 percent.
"These trades have started to get new life…we are positioned for a continuation of this trend," Campbell said. "What we started to see in September, we think that's going to continue in the fourth quarter." Campbell said he expects stocks to move higher into the end of the year, but not a large gain since the S&P 500 is already up more than 13 percent year-to-date.
With the promise of tax cuts fueling stock gains, markets will be interested to know that the House vote Thursday will move the ball forward toward a tax debate. But the House and Senate, which has not yet voted on its budget, need to agree on what type of deficit will result from tax reform. The Senate has allowed for a $1.5 trillion deficit, as opposed to the House plan, which would make deep tax cuts difficult without offsets.
"It's an important step. They can't get to taxes without a budget resolution," said Tom Block, Fundstrat Washington policy strategist.
Block believes the conference will come to an agreement and the budget vote will lead to reconciliation, which means the Senate can approve a tax plan with a simple majority, not the 60 votes required for other legislation. He sees tax legislation in the first quarter of next year.
"This is essential. You cannot have a tax bill in this partisan environment other than through the reconciliation process," said Block.
House Speaker Paul Ryan heads to Chestertown, Md. Thursday afternoon to discuss tax cuts at the Dixon Valve and Coupling Co.
There are also a few economic reports Thursday, including jobless claims and international trade at 8:30 a.m. ET. Factory orders are at 10 a.m.
At a time when the market is focused on who might be the next Fed chair, there are a flurry of Fed speakers Thursday. Fed Gov. Jerome Powell, who is in the running for Fed chair, speaks at 9:10 a.m. ET in New York.
Philadelphia Fed President Patrick Harker appears on CNBC at 8 a.m., and then he speaks at a conference on investing in America's workforce at 9:30 a.m. in Austin, Texas. Kansas City Fed President Esther George speaks at that conference at 4:30 p.m.
San Francisco Fed President John Williams speaks at a community banking conference in St. Louis at 9:15 a.m.