What’s Up on Wall Street: Q1 2018
The fourth quarter was positive for stocks, topping off another year of growth for the markets. Large company stocks in the US rose 6.6% for the quarter and 21.8% for the year. Small US company stocks were up 3.3% for the quarter and 14.6% for the year, while foreign stocks rose 4.2% for the quarter and 25% on the year. Bonds were up 0.4% for the quarter and 3.5% for the year.
The drivers that have moved markets all year continued during the fourth quarter: optimism among traders about anticipated tax cuts and deregulation, which they believe will stimulate the economy, at least in the short-term. Positive US and global economic data have also further supported market gains.
Massive tax-cut legislation was passed in the waning days of 2017. The lion’s share of the benefits will accrue to corporations and high-income Americans in the form of lower tax rates. This comes at a time when corporations already have robust profitability; the disparity in US incomes has never favored top earners so much. The story being sold in Washington is that the tax cuts will spur dramatic economic growth, which will benefit the middle and lower economic classes as prosperity spreads, raising the financial boats for all, as it were.
However, there are reasons to doubt that the benefits will find their way into the middle or lower classes. Despite the growth, corporations generally will keep wages flat in favor of rising profits. Economics tells us that wages rise when unemployment falls because employers must compete for workers by paying them more. But in the absence of such tight labor conditions, corporations will generally use added profits for executive bonuses, reducing debt, share buy-backs, shareholder dividends or capital projects, which may include investing in automation as a way to keep their labor costs down.
Worker wages have remained stubbornly low throughout the economic recovery that began in 2008, even though unemployment has declined and is now lower than it was prior to the recession. Research shows that primary reasons for lack of meaningful wage growth include ever-growing automation, applications of technology, and foreign outsourcing—not immigrant labor, as many anti-immigrant leaders proclaim. Corporations did not raise wages meaningfully in 2017 because they were not compelled to do so, although minimum wage increases in 18 states have just gone into effect as of January 1.
Economic growth has been running at around 2% since the 2008 recession, below the rate for some prior recovery periods and below the long-term average of about 3.2%. (It is important to note that the long-term rate was accompanied by jarring boom-and-bust cycles that included growth rates as high as 16% and as low as -10% between 1947 and 2017.)
The Fed is projecting a growth rate for 2018 of 2.5%, reflecting the economic momentum coming out of 2017 and possibly some incremental rise from tax cuts Interestingly however, the Fed’s long-term growth rate estimate remained unchanged at 1.8%, suggesting a belief that potential growth from the tax cut will be temporary in nature. The widely forecasted ballooning federal debt generated by the tax cuts will likely be longer lasting.
As we look forward into 2018, leading economic indicators are generally viewed as relatively strong and forecasts support the expectation of continued growth for the year. Among the risks we are considering is the possibility that growth spurred by tax cuts and deregulation will create an overheated economy, a situation which is likely to end in an abrupt and possibly harsh recession, and may well be accompanied by a decline in the stock market. On the other hand, it is also certainly possible that the tax cuts fail to produce the economic growth promised by the legislation’s sponsors.
Finally, we acknowledge the conclusion of Janet Yellen’s four-year term in February as the first woman Fed Chief. During her tenure, she oversaw the first interest rate hike in seven years as the Fed sought to normalize its rate policy following the tumultuous 2008 recession. She has led the Fed with dignity and poise, and history will likely judge her work at the Fed favorably.