Year in Review
2017 has been a year of surprises. An anticipated market pullback did not materialize this year. Instead, we saw a year of above average growth in market price. The S&P 500 (a widely followed basket of 500 U.S. company stocks) ended at 2673.61, a gain of 21.83% on the year. A round-up of statistics shows GDP remained at a steady rate with the third quarter at 3.2%1. Unemployment is at historically low rates, with December’s figure at 4.1% per the Bureau of Labor Statistics (BLS). Lastly, foreign companies did well in 2017. The International Monetary Fund (IMF) shows most mature economies with slow growth, while developing countries typically saw higher growth rates that bode well for their economies.2 2017 markets reflected this growth as the international sector posting its biggest gain since 2009.
What can we expect of the new year? A recent issue of a research service we subscribe to summed up bull vs. bear market conditions in a helpful manner. The market tends to contract when we see a combination of tight money, rising rates, high inflation, and rapid growth. We do not currently meet these criteria. The Fed is slowly scaling back measures taken during the recession at a measured pace. Money supply is slowly tightening as the Fed increases interest rates. Rates are inching up and do not have us in an era of either tight money or truly rising rates. Inflation remains low, with the personal consumption expenditure (PCE) price index at 1.5%3. GDP continues at measured rates in the 2-3% range each quarter. The outlook for 2018 real gross domestic product (GDP) is in the 2-3% range as well. All of this together shows a picture of slow, steady grow rather than the beginnings of a pullback. There remains the possibility of a correction in the market, with analysts looking towards a temporary event like we saw in early 2016 rather than a sustained bear market.
There is an expectation of greater earnings due to the recent corporate tax cut, although much of this is seen as already priced into the market. Increased earnings will largely result from balance sheet reshuffling in the form of debt reductions, stock buybacks, and mergers or acquisitions4. These will be one-time events that will solely enhance 2018 earnings. Analysts expect the resulting gains to be temporary, lasting perhaps 12-18 months. This, in conjunction with historically high consumer sentiment, bodes well for the 2018 market.
It is helpful to pick a company benefiting from the tax changes in order to see the details. Bank of America has been in the news recently as they announced an additional employee bonus of $1,000 for about 145,000 employees5, a total cost of $145 million. Goldman Sachs estimates that Bank of America will see earnings grow by 14% due to the cut. That would translate into earnings increases of about $2.5 billion. Roughly 6% of the $2.5 billion received by the corporate tax cut will go towards employee wages.
Bank of America also noted a $5 billion increase in stock buybacks, above the $12 billion repurchase amount announced earlier in the year.6 Stock buybacks are used to increase earnings per share, which results in higher stock prices. In summary, Bank of America will spend an extra $145 million on employee wages and spend $17 billion on stock buybacks in 2018.
The real world results from the tax cut will become clearer in 2018 as accountants have more time to delve into the provisions. As with any change, there will be winners and losers due to the changes. The overall effect does appear to be a boost for a number of companies that will increase near-term earnings.
Foreign markets saw meaningful progress in 2017 from both consumer spending and corporate profits. We believe many international markets are 3 or more years behind the U.S. in their economic activity. We expect to maintain a fair degree of international exposure in client accounts in order to capture this growth.
There are a number of fiscal unknowns due to the changing of the U.S. tax code. Accountants all over the country are working hard to analyze the impacts. However, the bottom line for stock market growth is always corporate earnings. Earnings have been rising and are expected to continue to do so. There will likely be a modest boost to corporate earnings and overall economic activity this year due to the cuts. The full impact of these changes will become clearer as we move through the year.
We agree with analyst expectations of low level growth within the domestic market next year. We will continue to posture client accounts to capture some of this growth, while protecting against downside events. It is important to maintain downside protection in portfolios given that growth is expected to be limited. We may see a pullback in the markets in 2018 or an unplanned outside event that causes disruptions. We would view these events as acquisition opportunities. Overall, we expect 2018 to be another year in the plowshare economy.
The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. The information provided is not written or intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a solicitation of the purchase or sale of any securities