Financial markets have surged in the early weeks of 2018 on the heels of a historic tax reform package passed by the U.S. Congress in December, but lower taxes aren’t necessarily causing rising stock indexes.
In Envestnet’s 2018 Market Outlook, broadcast last week, three investment strategists argued that the markets weren’t fully pricing in the impacts of tax reform – or hadn’t yet priced them in at all.
“Tax reform has not been a big factor driving equities higher,” said Talley Léger, equity strategist at OppenheimerFunds. “If it were, you would expect to see small-cap equities outperforming, but they aren’t. The markets were already set to move higher before tax reform … these pre-existing conditions of strong, synchronized global economic growth, financial conditions, monetary outlook and low inflation (have been driving equities higher).”
Lower corporate and individual taxes could have little impact on financial markets, said Léger, as fiscal policy historically tends to be blunted by monetary policy, or vice-versa, producing little net effect on investors. Yet additional fiscal stimulus, in the form of an infrastructure package, may be coming this year.
Brandon Thomas, Envestnet’s chief investment officer, argues that the market may not have discounted some of the tax reform’s impacts, like the repatriation of corporate assets held abroad and anticipated wage increases -- some recently announced from major employers like Wal-Mart -- may play out over a longer period of time.
“It seems that much of the market’s rise over the last several months has been partly due to the anticipation of the effects of tax reform,” said Thomas. “What happens from here forward remains to be seen as cash from overseas is repatriated.”
Over the longer term, investors should also keep an eye on spending, as tax reform already promises to increase deficits and further run up the national debt, said Christopher Molumphy, chief investment officer, fixed income group, at Franklin Templeton Investments.
“I would urge you to keep an eye on what we see coming out of the government this year, our sense is that there will be a fair amount of spending coming out of both parties,which would pressure the U..S. debt on the margin,” said Molumphy.
Molumphy said that the fundamental underpinnings of global fixed-income markets remain strong, and opportunities abound for bond investors willing to look abroad.
The U.S. grew at about 2 percent last year, said Molumphy, who expects 2.5 percent GDP growth in 2018. Nevertheless, he also noted the end of the U.S. bull market in bonds.
“The bull market in fixed income has ended, it actually ended a year and a half ago going back roughly to the summer of 2016,” said Molumphy. “Interest rates are up roughly 100 basis points over the last year and a half … the question now is where do rates go from here.”