New Year, New Tax Law: How Tax Reform May Impact InvestorsSubmitted by Connecticut Wealth Management, LLC on January 24th, 2018
By now you are likely aware of the new tax laws that Congress approved and on which President Trump signed off in late 2017. While most headlines center around how people’s wallets and businesses’ balance sheets will be affected directly by these new provisions, we wanted to offer our thoughts on how we expect these laws will impact various segments of the market as we progress into 2018.
We expect that corporate profits will benefit in the near term from the reduced tax rate and, as a result, we anticipate that economic growth will pick up as well. Research suggests that for every percentage point reduction in the corporate tax rate, we will see a commensurate increase in corporate profitability. This elevated profitability, in turn, can impact employment, wages, consumption, and investment; all factors that can have a real impact on widespread economic growth. Knowing that corporate earnings are ultimately what drive growth over time, we anticipate that lower corporate tax rates should be a catalyst for US stocks. Within this broad category, domestically focused companies and those with the highest tax burdens such as small cap stocks stand to benefit the most. While we do expect a positive impact to the markets in the near term, it is much too early to tell how government revenues will be affected and how that might influence the economy and markets over a longer period of time.
Improved corporate earnings and strength in the economy should result in fewer defaults on debt, and even though the majority of the bonds in client portfolios are high quality holdings, we expect most segments of the bond market to benefit. However, a stronger economy should also encourage further interest rate hikes from the Federal Reserve, which is yet another data point to suggest that we will continue to be cautious with bonds. While stretching for added yield in a rising rate environment can be tempting, it would also leave bond prices susceptible to declines, which is why it is incumbent on us to remain vigilant and disciplined in our approach to managing the bond piece of our clients’ portfolios. We are also looking closely at how municipal bonds will be affected as a lower marginal tax rate for individuals reduces the relative attractiveness of these tax-exempt bonds versus their taxable bond counterparts.
While most experts predict that tax reform will be a tailwind for the market, we are always conscious of succumbing to consensus thought. It is imperative that we analyze the various risks to our thesis, how they could manifest themselves, and what we should do about them. For example, if the economy starts to overheat due to elevated growth, inflation could become a more significant factor than what is currently being forecasted. Our responsibility is to make sure that our target portfolios are well positioned to capture potential upside from tax reform while still providing downside protection against events or market forces that would negatively impact your assets.
We will continue to monitor potential effects and opportunities that may arise as a result of policy changes and market conditions. As always, if you have any questions, please do not hesitate to reach out to us.