Small-Cap Slump Echoes Yellen Doubt on Tax Cut's Economic Impact

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(Bloomberg) -- Fed Chair Janet Yellen may have an ally in the stock market when it comes to projecting what impact the Republicans’ proposed tax will have on the economy.

Small-cap stocks, seen as closely tied to the domestic economy and a harbinger for future growth, have fallen in all but three days in the past two weeks as the Russell 2000 trailed the S&P 500 Index by 2.5 percent during that stretch. The group led the market’s decline again Thursday, with the index sinking as much as 1.3 percent.

Michael Purves, chief global strategist at Weeden & Co., sees the the decline pointing to skepticism about the prospects of the economy as the most-taxed stocks continue to outperform those with the lowest tax burden. Tax reform gaining traction could mean other fiscal policies promised by President Donald Trump may be less likely, he said.

“It could be a suggestion that the market is expecting higher earnings but not necessarily factoring in higher economic growth from the tax reform,” Purves wrote in a note to clients.

Yellen, at a press conference Wednesday after the Fed raised its benchmark interest rate, suggested that policy makers generally see the tax plan as having a modest and mostly short-term impact. “It’s not a gigantic increase in growth,” she said.

The assessment is at odds with Trump, who has argued that his tax cut package will lead to a significantly stronger, sustainable expansion of the economy.

©2017 Bloomberg L.P.

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