We just closed the door on an impressive year economically. A quick synopsis finds that most major market indices posted returns around 20% U.S. GDP grew by about 3% after the first quarter, and unemployment stayed under 5%. We’ll go into more detail on this in our next letter which will accompany our client’s end of the year portfolio reviews. These numbers though are now behind us and so let’s briefly touch on a few things to think about as we turn the corner into a new year.
Tax reform is perhaps the single biggest element we’ll have to confront in the new year. The massive tax overhaul that was signed into law in December is effective for 2018, so it will have an immediate impact on the economy. Lost in the political rhetoric is that many Americans will see money back in their paychecks this year as a result of lower tax brackets. If this extra cash isn’t gobbled up by states and local governments, as seems to be the case in Illinois, then that extra money is likely to find its way back into the economy.
Corporate earnings have been high, and should likely grow as businesses see their tax rates cut from 35% to 21%. This has the potential to add an extra thrust to the bull market. Stock valuations have been high, and a surge in corporate earnings might make values look more reasonable if the earnings increase from the expected tax savings.
Some say that tax reform will only boost corporations, however, so far we are seeing corporations use some of this new found savings into benefits for their employees in the form of wage increases or bonuses. As an example, just look at what Walmart is doing. Walmart is the largest U.S. private employer with over 1 million workers. It announced a few days ago that it would be raising starting wages nearly 22%, from $9 to $11 dollars an hour and would hand out employee bonuses from $200 to $1,000. They acknowledged that at least some of that raise was a result of the recently passed tax plan although a tight job market likely influenced their decision as well. Either way, Walmart is deeply embedded in many smaller towns and cities that the modern economy has passed by. In a lot of these places a raise of $2 an hour and the potential of a $1,000 dollar raise can have a significant impact in both spending and savings rates.
A negative effect of the new tax law is that it will likely increase the Federal deficit, potentially adding to what many feel is an already unsustainably high levels of national debt. The jury is out on this as some economists argue that the growth spurt from the additional money in consumers pockets, as well as future repatriation of corporate cash deposits held overseas, may offset the loss of current revenue from the cuts. If this rosier scenario turns out to be incorrect then higher debt could be an impediment to economic growth and restrict long-term growth potential. Tax reform also contains provisions that may weaken Obamacare, possibly increasing health care costs. While this won’t have a great impact on the overall economy, it could impact certain individuals significantly.
Overall, economic factors point towards continued growth in 2018. That also means that the Fed will likely continue raising rates as they have been doing recently under our tight job market and our low inflationary environment. Some worry that increased rates could put a cap on stock prices as higher rates make savings instruments like bonds and CDs more attractive. I think this doesn’t impact stocks until we see rates somewhere between 3-4%. Most of my career 10 year bonds yielded close to 5% and rates were significantly higher when I started in the business in the 1980s. If stocks could rise in that sort of an environment then rates at these levels or slightly higher shouldn’t be much of an impediment.
Though the markets have the potential to advance in 2018, we will probably see more volatility in the coming year. Last year’s saw some of the lowest market volatility ever recorded, so it would likely be hard to repeat that accomplishment for a second year in a row. We’ll touch on this more in our next letter to you but it bears repeating that if you think you’re less willing to tolerate the inevitable ups and downs in the stock market then we should review your portfolio and reassess your tolerance for risk going forward. Currently there don’t seem to be many economic indicators pointing towards a pullback or market correction this coming year. However, geopolitical tensions, outside events like a terrorist attack or natural disasters could still trigger a market correction, especially if they come out of nowhere. However, it bears repeating that barring a major catastrophe or war these events would probably not trigger a recession.
As always there will be some ups and downs, but 2018 seems to be shaping up to be a good year for the economy. It is important to make sure your portfolio is positioned to take advantage of continued economic growth and your portfolio is matched to your current goals and risk profile. If you have questions about your portfolio or if you don’t work with us and would like to understand how we invest for our clients than please call my office at 708.488.0115 or email us at lumencapital@hotmail.com for a second opinion and complimentary review.
About Chris
Christopher R. English is the President and founder of Lumen Capital Management, LLC-a Registered Investment Advisor regulated by the State of Illinois. A copy of our ADV Part II is available upon request. We manage portfolios for investors, developing customized portfolios that reflect a client’s unique risk/reward parameters. We also manage a private partnership currently closed to outside investors. Mr. English has over three decades of experience working with individuals, families, businesses, and foundations. Based in the greater Chicago area, he serves clients throughout Illinois, as well as Florida, Massachusetts, California, Indiana, and other states. To schedule a complimentary portfolio review, contact Chris today by calling 708.488.0115 or emailing him at lumencapital@hotmail.com.
