Week in Review
This week the S&P 500 was up slightly as investors focused on the passage of the Tax Cuts and Jobs Act which was signed into law by President Trump on Friday morning. Conversely, bonds sold off with interest rates moving higher with the 10-year U.S. Treasury increasing in yield from 2.39 percent to 2.48 percent, which is a substantial move in the span of a week. Bond investors are anticipating an increase in Treasury bond issuance with expected increased deficit spending due to the tax law.
This week our clients focused on the impact on individuals regarding the proposed tax changes leading into 2018. There is still a great deal of uncertainty and controversy on how this will impact individuals, however, it is projected that collectively the tax law will save consumers $122 billion in taxes.
Relative to the broader economy, the Tax Cuts and Jobs Act has provisions that investors like. In 2018 the changes will provide approximately $205 billion in tax cuts that could have a material positive impact on the earnings of U.S. companies which in turn should be a positive for the stock market. Domestic companies with high tax rates would be the largest potential winners as the changes are projected to decrease tax rates by 5-to-7 percent. In addition, the change in the tax structure will incentivize companies to invest in property, plant and equipment by allowing 100 percent expensing of these investments. There has been a lack of capital investment by companies whereby excess cash flow has disproportionately used for stock buybacks and dividends. The theory is that this capital spending will both drive the economy as well as worker productivity.
The “losers” of an approved tax law are companies that have been shielding income from taxation by being incorporated overseas or have been using other strategies to keep profits abroad in more tax-friendly countries. These tax management strategies, which made sense in the past due to the noncompetitive U.S. corporate tax structure, are not as advantageous. The Tax Cuts and Jobs Act now allows companies to make decisions based on investment opportunities and not taxes. This change can hopefully lessen the friction of taxes on economic growth.
The major criticism by investors regarding the tax law centers around the timing and the magnitude of the potential increase in the deficit. While GDP growth has been relatively slow in the long economic expansion since the economic crisis at between 2 percent to 3 percent annually, it has been a durable expansion with no recession in sight. Projections are for a 0.5-to-1 percent increase in GDP growth based on the proposed tax law changes. The cost of this incremental growth is projected to be $1 trillion in incremental debt due to the tax cuts. By all metrics, the economy is doing well without the added stimulus the Tax Cuts and Jobs Act provides. Many investors are questioning the need for this stimulus at the later stages of an economic cycle where the economy is already in good shape.
Takeaways for the Week
- Despite the uncertainty surrounding the impact of the Tax Cuts and Jobs Act on individual tax payers, there are plenty of provisions within the law that are good for the economy and capital markets
- It is important to communicate with your tax professional regarding the changes to tax code and how they might impact you