KEY TAKEAWAYS
- In this Timely Topics, we take a look at a few of the implications of the final tax bill.
- The new law is intended to boost economic activity and simplify the U.S. tax code.
- Given clarity on the new tax law, we are raising estimates for U.S. GDP and S&P 500 operating earnings for 2018.
After more than a year of political posturing and investor anticipation, Congress finally approved a $1.5 trillion tax cut, the most sweeping U.S. fiscal overhaul since 1986. The 2017 Tax Cuts and Jobs Act was signed into law by President Trump last Friday, December 22, meeting his pledge to deliver tax reform before Christmas. The complex 1,000-page bill features changes that are intended to spur economic activity through a reduction in both individual and corporate tax rates, and simplify the tax code by eliminating or trimming a variety of deductions and exemptions. In this special commentary, we look at the likely impact of the final bill on the economy, monetary policy, and the financial markets in the coming years.
As we wrote in our Outlook 2018: Return of the Business Cycle publication, the combination of improved business fundamentals and fiscal legislation should sustain momentum in the economy and equity markets in the coming year and potentially beyond. After years of depending on the largess of monetary policymakers, investors can now focus on fiscal levers that we believe will support consumption and spur new business investment over the next few years. The law has important implications for major corporations, small businesses, and individual taxpayers [Figure 1], and may shift the trajectory for economic growth, the federal budget, monetary policy, and perhaps most critically for investors—corporate profits.
ECONOMY & THE FEDERAL RESERVE
Though much of the political posturing over the past year was a result of the reduction in corporate tax rates, the legislation offers a larger than expected boost to individuals. While higher income earners should experience the largest benefit, the breadth of the individual tax rate reduction may lead to higher levels of consumer spending over the next few years. For example, in 2018, the net tax cut is set to exceed $100 billion, and as the effects of the alternative minimum tax (AMT) changes settle out in 2019, the consumer windfall could eclipse $200 billion, or approximately 1.0% of gross domestic product (GDP). Of course, the goal of lawmakers is that the increase in consumption will have a positive feedback loop, generating increases in output, employment, income, and ultimately, tax receipts. Alas, without an increase in productivity, the gains in personal spending are unlikely to be permanent, which is another reason leadership in Washington, D.C. included incentives for business investment as part of the tax package.
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IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. All performance referenced is historical and is no guarantee of future results. Estimates may not develop as predicted.
All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy.
The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.
Corporate bonds are considered higher risk than government bonds but normally offer a higher yield and are subject to market, interest rate, and credit risk as well as additional risks based on the quality of issuer coupon rate, price, yield, maturity, and redemption features.
Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.
Municipal bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply. If sold prior to maturity, capital gains tax could apply.
International and emerging markets investing involves special risks, such as currency fluctuation and political instability, and may not be suitable for all investors.
Because of its narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.
Gross Domestic Product (GDP) is the monetary value of all the finished goods and services produced within a country’s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is essentially net income with interest, taxes, depreciation, and amortization added back to it, and can be used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions.
There is no guarantee that a diversified portfolio will enhance the overall returns or outperform a non-diversified portfolio. Diversification does not ensure against market risk.
All investing involves risk including loss of principal.
DEFINITIONS
Small cap is a term used to classify companies with a relatively small market capitalization. The definition of small cap can vary, but it is generally a company with a market capitalization of between $300 million and $2 billion. The prices of small cap stocks are generally more volatile than large cap stocks.
INDEX DESCRIPTIONS
The Bloomberg Barclays Municipal Bond Index is a market capitalization-weighted index of investment-grade municipal bonds with maturities of at least one year. All indexes are unmanaged and include reinvested dividends. One cannot invest directly in an index. Past performance is no guarantee of future results.
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The S&P Midcap 400 Stock Index is an unmanaged index generally representative of the market for the stocks of mid-sized U.S. companies.
The S&P Small Cap 600 Index is an unmanaged index generally representative of the market for the stocks of small capitalization U.S. companies.
This research material has been prepared by LPL Financial LLC.
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