How could the U.S. tax bill impact markets in 2018?

On the latest edition of Market Week in Review, Consulting Director Todd LaFountaine and Senior Investment Strategist Paul Eitelman discussed the potential effects of the new U.S. tax bill—which was approved by Congress on Dec. 20—on financial markets and the U.S. economy.

U.S. corporate earnings and GDP growth: On the upswing after tax bill clears Congress?

In Eitelman’s view, the passage of the bill was generally a positive development for financial markets, as it was delivered ahead of schedule and was a little more front-loaded with tax cuts than some investors were anticipating. “Markets had been focused on the potential for reductions in the corporate tax rate—and this bill delivered on that front,” Eitelman said, noting that the legislation slashes the corporate rate from 35% to 21%. He predicts that because of this, S&P 500® Index companies could see anywhere from 3 to 5 percentage points of earnings growth—translating into a modest tailwind for markets.

Eitelman and the team of Russell Investments strategists also believe that the new tax bill could boost U.S. gross domestic product (GDP) growth by about two-tenths of a percentage point. “Overall, this looks to be incrementally positive news for the nation’s economy,” he remarked—“at least in the short run.” However, Eitelman said, because the U.S. Federal Reserve (the Fed) is moving away from an accommodative monetary policy at the same time Congress is providing a fiscal stimulus, there’s likely to be a bit of a tug of war between the two institutions going forward. “The Fed could move to a restrictive policy stance by 2019—which could set us up for some turbulence and volatility in markets down the road,” he concluded.

Tax bill optimismAlready reflected in markets?

Zooming in on U.S. equities in particular, Eitelman pointed out that much of the optimism around the new tax bill has already been priced in. “Since late October, when Congress started to move forward on tax reform, the U.S. has really started to outperform its global peers,” he said. All told, Eitelman believes that roughly two-thirds of the new bill has already been priced into markets. “There may be a little incremental tailwind to come, but not a significant chunk,” he stated.

Bank of Japan: An outlier among central banks in 2017

Transitioning to Asia, Eitelman noted that the Bank of Japan (BOJ)’s Dec. 21 meeting was the final one of the year among all major central banks. The BOJ left its monetary policy unchanged, Eitelman said, as the central bank remains committed to an aggressive accommodative stance. “Japan is actually pretty unique in this regard,” Eitelman remarked—“because, by and large, most central banks in developed markets have started to move toward tightening.” Of all the banks, the Fed is probably the furthest along in this stance, he said, noting that others have begun to follow suit, such as the Bank of Canada—which raised interest rates twice this year—and the Bank of England, which hiked once.

“In short, 2017 has seen a gradual step away from peak monetary policy accommodation,” Eitelman said—“and if strong global economic conditions continue into 2018, we’ll probably see this trend continue.”

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