After roughly a year into President Trump's term in office, several key factors in the U.S. economy are pointing to a strong showing, while consumer and business confidence is high.
Equities have been on a tear, corporate profits continue to rise, employment is up, wages are expanding, interest rates are relatively low and liquidity is abundant.
How will the potential for corporate tax and regulatory reform impact investors’ options to earn a decent return in 2018?
James Spiro, managing director of The Spiro Group at Morgan Stanley in New Orleans, says if the current favorable conditions continue into 2018, the outlook remains mostly positive. If tax reform passes, simplifies compliance and untangles some exceptions that have built up over the years, companies in the S&P 500 and the broader equity markets could benefit, he says.
Overall, Spiro says, investors should try not to spend too much time pondering a one-year horizon but instead more carefully consider their own circumstances and appetite for risk when making investment decisions. Keep investment strategies simple, stick with them, be mindful of cost and asset allocation and you’ll be able to sleep at night, he says.
In the context of a mature economic cycle, the types of firms that traditionally would do well should tax reform pass include those in engineering, industrials and large-scale manufacturing, Spiro said. If interest rates start to rise next year, sectors that typically pay high dividends, like utilities and telecoms, might be less attractive.
Jim Paulsen, chief investment strategist of The Leuthold Group LLC in Minneapolis, says that while he’s all for making the tax code more competitive globally, a cut right now in an environment of low unemployment and high stimulus could prove to be a negative and add to inflationary pressures.
“I think the outcome will be far different than what you hear about every day,” he says. Meanwhile, deregulation has already helped the economy a lot, in part by making a huge difference in private sector confidence, and “could continue to be beneficial,” he adds.
Paulsen believes investors will have more of a struggle with stocks and bonds in 2018. This year, the markets have responded to the rise in corporate earnings and the generally positive economic conditions. The global economy also has been expanding, which has provided even more of an upward force.
Next year, even if the economy chugs along and looks OK but investors don’t see many positive surprises, that could hinder upward momentum, he says. Rising wages, inflation and commodity prices, worker shortages, and a tightening dollar are other factors that could weigh on returns.
Meanwhile, bonds aren’t looking attractive to Paulsen and he’s not alone. Nicholas Boyer, chief investment strategist at RKL Wealth Management in Lancaster, Pa., says bonds are approaching the end of a 30-year run.
Samantha McLemore, CFA, co-portfolio manager of Opportunity Equity and Income Strategy at Miller Value Partners in Baltimore, notes that while yields are nearing all-time lows, investors keep putting more money in. Signs of higher wages and inflationary pressures make losing money in bonds a real risk, she says.
Paulsen suggests tilting away from U.S. securities and into better-priced foreign stocks. Many countries aren’t as close to full employment as is the U.S. and won’t face as much interest rate pressure. Investors might want to consider that expensive stocks in sectors like health care, telecoms, utilities and consumer staples are more sensitive to interest rate rises.
Energy stocks at relatively reasonable prices, meanwhile, might be a good defense against inflationary pressures, he says.
Paulsen says he’d also move away from large companies toward mid-cap firms, as smaller firms tend to do better in reinflationary periods. Real assets, like commodities and real estate, also may be good investments next year, he says.
McLemore says despite the nearly nine-year secular bull market run following the Great Recession, the firm doesn’t see a reason it should end in 2018.
“We think we’re still finding lots of opportunities in the U.S.,” she says.
Areas where values are still to be had include legacy airline stocks, where company leaders have recently been more focused on creating returns than consolidating into bigger entities.
Angela Gehman, CFA, partner and chief investment officer with Domani Wealth, which has multiple offices in central Pennsylvania, says she’s seeing an increased opportunity in non-U.S. markets following 10-year high valuations for stocks in the U.S. market. Europe, for example, is lagging a bit behind the U.S. in the corporate earnings and monetary policy cycles, and prices are more reasonable in European stocks, she says.
On the domestic side, Gehman sees good prospects in the tech sector where, despite recent growth, new innovations could buoy the value of many companies.
Thomas Williams, senior wealth adviser and CEO of Domani Wealth, says the banking sector, which hasn’t followed the overall market’s rise this year, could become the beneficiary of rising interest rates by the end of 2018.
Gehman says a potential tailwind for financials next year could be having Federal Reserve chair nominee Jerome Powell carry on departing Chairwoman Janet Yellen’s role of providing gradual rate increases.
Tax reform, including proposals to lower the corporate tax rate to 20 percent and repatriate offshore profits at a lower rate, would benefit corporations, Williams says. Share prices rose on hopes of a tax cut, but fell when the Senate proposed a delay in the cut, he noted.
The risk to businesses in the absence of tax legislation is hard to quantify, but good corporate earnings could certainly help companies going forward.
Gehman says a corporate tax cut would make U.S. firms more competitive in the global marketplace.
Negative trends for next year include volatility, she says, noting that a lack of volatility has been a major factor in equity markets performing so well in recent months.
Unpredictable geopolitical events remain another negative risk that can be mitigated by maintaining a well-diversified portfolio.
RKL’s Boyer says stocks and bonds are priced high from a historical perspective. Finding value in domestic equities is difficult in light of robust economic metrics. Emerging market and European stocks appear to have better value over the medium term, he says.
Boyer sees fiscal stimulus in the form of a tax cut, or a potential infrastructure bill, as positive overall for growth. If and when interest rates rise, this will have a negative impact on bonds, though he doesn’t sense this will have a dramatic impact in 2018.
“Capital is flowing into disruption, and the theme is an important one,” he says.
Companies working on technologies like artificial intelligence, blockchain and the internet of things (IoT) are poised to bring opportunities for investors, Boyer says, while older, more established firms with strong financials are potentially good defensive plays.