Yogi Berra coined the phrase, “It’s déjà vu all over again.” This saying could apply to the investment markets for 2018. This New Year may mirror the previous, with continued moderate growth, steady employment, and low inflation.
Looking back at 2017, the S&P 500, (a broad measure of the U.S. stock market), ended a healthy year with a fourth-quarter gain of 6.6%. Positive macroeconomic data supported these stock gains, including a better than expected 3.0% annualized third quarter increase in the US Gross Domestic Product (GDP), a measure of economic performance. Hurricane season partly distorted employment data over the period. However, non-farm payrolls rose by a stronger than expected 228,000 in November with wage growth remaining subdued. The muted impact on wage growth is important as wage growth is a precursor to inflation. As has been widely anticipated, the US Federal Reserve (Fed) lifted interest rates by 25 basis points (0.25%) in December. The Fed raised its growth forecast for 2018 to 2.5% from 2.1%. The quarter saw robust corporate earnings, particularly in the technology sector. Cyclical areas of the market performed well, with gains led by the consumer discretionary sector, technology, and financials. The utilities sector underperformed.
Tax reform was a focus for Washington and Wall Street during the fourth quarter. The equity markets celebrated the December passage of the most significant tax changes in 30 years by reaching new all-time highs. The Tax Cuts and Jobs Act (TCJA) likely stimulates some sectors of the economy more than others. From a macroeconomic and investment perspective, we are focused on the additional growth stimulated by TCJA. Total fiscal stimulus coming from TCJA is expected to be about $1.5 trillion; with more than 60% slated for individual tax cuts and the remainder for corporate and international tax reform. The good news for individuals is that the Internal Revenue Service (IRS) announced that worker paychecks adjust in early February and no action will be required by employees; which means nearly every American employee will see a bump in their take-home pay at the same time.
The last time this occurred was in mid-2003 when then President Bush’s Jobs and Growth Tax Relief Reconciliation Act’s tax cuts went into effect. It led to an immediate boost in consumer spending and economic growth. Real GDP (Gross Domestic Product adjusted for inflation) jumped from less than 4% in the second quarter of 2003 (just before the tax cuts hit paychecks) to nearly 7% in the third quarter and 5% in the fourth quarter. It subsequently dropped back below 3% in the first quarter of 2004. As the adage goes, history doesn’t repeat itself, but it often rhymes. We believe there is a good case that we will see a similar pickup in economic activity as a result of TCJA.
The passage of TCJA is not all roses. The Joint Committee on Taxation (JCT), the official Congressional scorekeeper, estimates that the TCJA will reduce government revenues (a euphemism for taxes) by about $263 billion. Without a corresponding reduction in government spending, this loss of revenue will exacerbate the Federal budget deficit.
The bottom line for TCJA is the net impact of the tax cuts already being felt by millions of workers, with the vast majority of the remainder getting a bump in their paychecks next month. More broadly, we should get a boost in consumption, GDP, capital expenditures, and corporate earnings; but some important offsets and considerations suggest enthusiasm-curbing may be in order given the later-stage in the cycle in which the TCJA passed namely higher inflation.
We anticipate steady growth into 2018 and don’t see a recession on the horizon. However, with markets priced for ongoing moderate growth and low volatility, the risks we see include the potential for higher inflation and more central bank tightening than expected. We believe there are three critical actions for investors to consider for 2018:
- Stay invested as the potential global stock market gains remain in the double digits.
- Stay global as international stocks may outperform U.S. stocks in 2018.
- Rebalance back to target allocations as gains in stocks may result in higher risk asset allocations ahead of a potential recession and bear market.
The views and opinions expressed are of White Horse Advisors, LLC. This commentary is provided for educational purposes only and should not be construed as investment advice. White Horse Advisors is an investment advisor firm located in Atlanta, GA.