Since our last quarterly commentary, the stock market has continued to increase without much pause. Here’s a report card detailing the spectacular returns we saw in investment markets in the fourth quarter and the full year:
One of the items propelling U.S. equity prices higher is a major Federal tax overhaul bill that went into law, effective January 1st of this year. We have analyzed the tax changes and, while there are some adjustments at the individual income tax level, the only change we’d consider “major” is the permanent corporate tax rate cut from 35% to 21%.
Since U.S. economic growth is largely consumer spending driven, individual tax rates typically have a larger influence on the economy than corporate tax rates. However, corporate tax rates have a bigger impact on the stock market. An increase in corporate profits, due to lower expenses (i.e. taxes), should lead to higher stock prices. And this, of course, benefits you and anyone else who owns stocks.
If corporations use their newfound wealth to increase employee’s wages or invest in capital projects that create jobs, or if foreign companies, enticed by lower tax rates, decide to invest in the U.S., economic growth could certainly increase. However, if recent history is any guide, the majority of these tax savings will be used to buy back stock and/or pay dividends, benefiting shareholders. Stocks have increased in anticipation of the tax bill and while it remains to be seen what companies will actually do with their winnings, increasing equity prices cast a vote toward shareholders reaping the rewards.
With regard to individual tax changes, tax rates are being reduced marginally (and temporarily through 2025) and standard deductions are going up significantly. These two things lead to lower taxes, all else equal. However, certain exemptions and deductions are going away which can mitigate tax savings. Bottom-line, some tax payers will be paying less and some, especially ones with substantial state and local taxes (SALT), may end up paying more. We don’t expect any of these changes, on the whole, to be a “game changer”.
When assessing our outlook for the economy, the mix and direction of monetary and fiscal policy is a key component. Typically, when monetary policy is loose (i.e. the Fed is reducing interest rates and/or buying financial assets), economic growth tends to pick up. Conversely, when monetary policy is tight (i.e. the Fed is raising interest rates and/or selling financial assets), the economy tends to slow down. Fiscal policy can also be either loose (cutting taxes and/or increasing government spending) or tight (raising taxes and/or reducing government spending) and can have an influence on the economy.
For the majority of the most recent economic recovery, monetary policy has been loose and fiscal policy has been tight. However, that is now flip-flopping. Monetary policy is starting to tighten and fiscal policy is starting to loosen. This will likely cause economic growth to be higher and/or last longer than would have otherwise been the case without the new tax bill. One concern with enacting fiscal stimulus when the economy is already doing well, is that the government won’t have as much “ammo” to combat the next downturn when it comes. Unfortunately, fiscal stimulus is often politically driven and politicians don’t seem to think much beyond the election cycle. Fortunately, monetary policy, which is typically apolitical and far outpaces fiscal policy in importance to the market and economy, is starting to tighten, allowing room to stimulate in the next downturn.
Putting this all together, we think the economy will clip along just fine this year (perhaps slightly higher given the new tax bill), yet we believe the stock market has already taken this into account with returns more than doubling historical averages in 2017. As always, we will continue to rely on our economic indicators to guide portfolio allocations and communicate any changes to you. If you have any questions, please don’t hesitate to reach out to your Advisor.
Wishing you health and happiness in 2018!
Cash is represented by the Bloomberg Barclays 1-3 Month T-Bill index, U.S. Bonds are represented by the Bloomberg Barclays US Agg Bond index, U.S. Stocks are represented by the S&P 500 index, Developed International Stocks are represented by the MSCI EAFE index, Emerging Market Stocks are represented by the MSCI Emerging Markets index. Indexes are unmanaged and unavailable for direct investment.
This information is provided for general purposes and is subject to change without notice. The information does not represent, warrant or imply that services, strategies or methods of analysis offered can or will predict future results, identify market tops or bottoms or insulate investors from losses. The information has been obtained from sources considered to be reliable, but it is not guaranteed. Past performance is not a guarantee of future results.
Securities and advisory services offered through Geneos Wealth Management, Inc. Member FINRA/SIPC. Advisory Services offered through TPG Financial Advisors, LLC, a Registered Investment Advisory Firm.
