BREAKING NEWS Twice as many CA drivers cited for traveling at more than 100 mph this year Full Story
BREAKING NEWS North State Covid-19 updates: 91 new cases in Sutter County Full Story
STREAMING NOW: Watch Now

Why Wall Street's tax party could be short-lived

The tax cuts President Trump signed into law have helped start a ...

Posted: Jan 4, 2018 11:41 AM
Updated: Jan 4, 2018 11:41 AM

The tax cuts President Trump signed into law have helped start a party on Wall Street. But the celebration may not last long.

There's little doubt that the massive business tax cuts will provide an instant and sizable boost to corporate America's already booming bottom line.

The tax law is likely to improve the earnings per share of S&P 500 companies by 10.5% this year, Bank of America Merrill Lynch predicted Wednesday. Most of that comes from a sharply reduced corporate tax rate. The rest comes from companies spending their tax savings on stock buybacks.

Wall Street eagerly anticipated this tax bonanza. Expectations for stronger profits helped send stock prices soaring in 2017, and they've gone even higher early in 2018. Trump himself predicted on Twitter on Wednesday night that the stock rally still has "tremendous upward potential."

That may be true. The bulls are betting that enormous tax savings will combine with the rejuvenated economy to accelerate corporate profits, the engine of the stock market, beyond 2018.

But Bank of America is warning that may be too optimistic.

"We see several reasons you could get the opposite: Strong earnings growth in 2018 marks the peak of growth and it slows down significantly thereafter," said Dan Suzuki, senior investment strategist at BofA.

BofA projects stellar profit growth of 16% this year, but the firm's new forecast for 2019 implies a deceleration to 5%.

Related: Can the stock market bull keep raging in 2018?

One reason: Few economists believe the tax overhaul will create the long-term economic boom that Trump envisions.

Moody's predicts the tax law will only help "modestly," boosting economic growth by 0.1 to 0.2 percentage points. BofA sees a slightly bigger boost, but expects growth to slow in 2019 to 2.2% to 2.3%. That wouldn't be good for corporate profits or the stock market.

Interestingly, one of the reasons BofA anticipates a slowdown in earnings is the tax law itself. "Tax reform could be a headwind to growth in 2019," the report warns.

Why? First, Suzuki explained that companies will find it difficult next year to live up to their stellar growth of 2018 once the tax benefits are phased in.

Another problem: Many of the biggest beneficiaries of the tax law, such as consumer companies and telecoms, are facing "heightened competition as well as disruption." Netflix has led cable subscribers to cut the cord. Amazon has upended brick-and-mortar retailers and now grocery store chains.

Suzuki said basic economic theory suggests that higher returns on investment caused by the tax law will allow companies to cut prices, chipping away at profits of more established companies over time.

Related: Only a small slice of companies have shared tax savings with workers

The other obstacle that Wall Street needs to navigate is the Federal Reserve.

If the tax law does accelerate economic growth, the Fed will come under pressure to scrap its promise to raise interest rates at a gradual pace. Some Fed officials hinted at that risk at the central bank's December meeting, according to minutes released on Wednesday.

Accelerated rate hikes could "eventually weigh on overall economic growth" by increasing borrowing costs, BofA said.

Erin Browne, head of asset allocation at UBS Asset Management, cautioned clients in a recent report that Trump's decision to "launch fiscal stimulus" with low unemployment and solid economic growth is a "recipe for a surge in wage growth."

While higher paychecks would be welcomed by many Americans suffering from years of stagnant wages, Browne said a sharp influx of inflation would likely cause serious pain in the bond market that spreads to other asset prices.

So what does all this mean about the future of the eight-year bull market in stocks?

"We're not making the call that a bear market is imminent," said Suzuki. He pointed to how almost half of BofA's list of 19 "bear market signposts" have not yet been triggered.

Two of the red flags that haven't been raised are signals of excessive optimism among investors.

But Suzuki conceded that the tax cuts could "drive investor sentiment into euphoric levels, which would be very bearish for the market eventually."

California Coronavirus Cases

Data is updated nightly.

Cases: 1160940

Reported Deaths: 18968
CountyCasesDeaths
Los Angeles3783237543
San Bernardino884531129
Riverside836851434
San Diego75305988
Orange731521559
Kern39721447
Fresno37021477
Sacramento35143557
Santa Clara32049470
Alameda28225502
San Joaquin25318504
Contra Costa23146258
Stanislaus21145422
Tulare20352305
Ventura18637175
Imperial15725356
San Francisco14874160
Monterey14354116
San Mateo13707170
Sonoma11712157
Merced11460179
Santa Barbara11166135
Kings1035987
Solano1003681
Marin7621129
Placer622468
Madera604785
San Luis Obispo588535
Shasta460147
Yolo447674
Santa Cruz413228
Butte381259
Sutter305715
Napa290417
El Dorado20914
Yuba194810
San Benito178416
Lassen17153
Tehama156525
Mendocino146822
Nevada11639
Glenn8837
Lake87719
Tuolumne8738
Humboldt8199
Colusa6826
Siskiyou5822
Mono5093
Amador47016
Calaveras46622
Del Norte2981
Inyo28316
Plumas1920
Trinity1360
Mariposa1242
Modoc1190
Alpine470
Sierra190
Unassigned00
Chico
Clear
63° wxIcon
Hi: 64° Lo: 36°
Feels Like: 63°
Oroville
Clear
62° wxIcon
Hi: 63° Lo: 38°
Feels Like: 62°
Paradise
Clear
63° wxIcon
Hi: 57° Lo: 39°
Feels Like: 63°
Chester
Clear
38° wxIcon
Hi: 42° Lo: 26°
Feels Like: 38°
Red Bluff
Clear
63° wxIcon
Hi: 64° Lo: 40°
Feels Like: 63°
Willows
Clear
63° wxIcon
Hi: 65° Lo: 41°
Feels Like: 63°
Your Thanksgiving will be sunny & breezy with mild temperatures.
KHSL Severe
KHSL Radar
KHSL Temperatures

Community Events