New Year Rundown

New Year Rundown

This past year was another barn-burner for stock markets around the world.  Of all the major international indexes, every one ended the year in positive territory.  The best performer was the Argentine Mervel Index which increased 78% for the year, while the Russian RTS Index brought up the rear with a positive return of 0.2%.

At home, the S&P 500 Index reached record levels during 2017 and finished with a gain of 19.4%.  Within the index, the information technology sector led the way jumping 39%.  As stock investors, we have nothing to complain about.  Life is good.

But what about 2018 and beyond?  The recently passed Tax Cuts and Jobs Act contains several provisions that will significantly reduce the taxes paid by corporations.  Some analysts are predicting the cuts will increase corporate earnings by up to 15%.  It is not difficult to see how this will lead to improved investor sentiment and higher stock prices, at least in the short run.

However, the long-term impact of the tax legislation is much less certain.  According to the Congressional Budget Office, corporate tax cuts are an inefficient way to stimulate the economy.  This is because companies typically do not use all of their extra cash for domestic capital investment or increased payroll. Instead they spend much of it on stock buybacks and overseas investment.  Here is the CBO’s analysis of fiscal multipliers for different taxpayer categories:

Due to the low fiscal multiplier of tax cuts for corporations and high-income individuals, most economists are predicting a minimal impact on GDP from the new tax scheme – somewhere around +0.1 to +0.3%.

In short, the new tax plan should be beneficial to the stock market, but longer term effects are harder to discern.  There are many other factors to consider that have not been discussed.  Will an increased federal deficit lead to significantly higher interest rates?  Will higher interest rates stall the housing market and crimp consumer spending?  Unemployment is currently at historically low levels.  Will employment conditions tighten further leading to inflation?

Your investment manager believes these things are too difficult to reliably predict and will maintain a conservative stance in all investment accounts.  Equity allocations in client accounts will be held at ten percent below target.  Stock market returns over the last few years have been extraordinary, mainly due to copious monetary stimulus.  Any effort by Washington to further stimulate the economy through tax cuts amounts to pouring gasoline on a raging fire.

There is an old Wall Street adage that was popular during the 1980s: “Pigs get fat; hogs get slaughtered.”  Let’s not be hogs.

1 January 2018     |      Group W Investment Management LLC