One year after the tax cuts, the market is worse and the economy is a mixed bag

21 DEC 18 13:56 ET By Paul R. La Monica, CNN Business

    (CNN) — President Donald Trump signed sweeping tax cuts into law one year ago. That boosted the stock market and the economy in early 2018, but the initial rush of excitement is fading fast.

The Dow and S&P 500 have each fallen nearly 8% since December 22, 2017 — the day Trump put his name on the Tax Cuts and Jobs Bill Act.

The euphoric reaction to the wave of big stock buybacks and increased dividends from Corporate America has now been replaced by concerns about trade tension with China, worries that the Federal Reserve has gone too far with its rate hikes and the likelihood that earnings growth will slow dramatically in 2019.

The broader economy has held up better. Gross domestic product rose at a 4.2% annualized pace in the second quarter of 2017 and grew 3.4% in the third quarter.

However, the Fed is expecting that GDP will rise at only a 2.3% clip next year. Jobs growth has begun to slow as well, which is another troubling sign. Some on Wall Street worry that a recession could come as soon as 2020.

The tax cuts came at an unusual time. The economy has been growing steadily for nearly a decade, so it arguably didn’t need extra stimulus. Tax relief for companies and most taxpayers created a sugar-rush effect, temporarily jolting the economy. But most expect the rush to wear off.

“The tax cuts helped initially but the impact is starting to fade in the distance. The evidence from recent months is that tax cuts don’t change long-lasting corporate behavior,” said James McCann, senior economist with Aberdeen Standard Investments.

“There has been no major boost to capital expenditures, and the US economy is now naturally slowing,” McCann added.

Why the ‘sugar rush’ could end

Critics of the tax law say its benefits haven’t been fully realized because most of the money has gone to investors. Corporate America has given out $1 trillion in stock buybacks this year.

The argument is that average Americans don’t really gain much from rising stock prices since many are not investing in the stock market. Companies might be better off using tax savings to hire more workers, build plants and do other things that could have longer lasting impacts to boost the real economy.

But there may be good news, at least for a little while. Consumers are likely to continue spending thanks to lower taxes, even after the holidays. Falling gas prices may make people feel more confident as well.

Frances Donald, head of macroeconomic strategy with Manulife Asset Management, predicts that retail sales will be better in the first half of 2019 because of lower tax rates and potential refunds.

Even so, she said she is worried that there could be a big pullback later on.

“The drop-off is precipitous,” Donald said. “There are about three quarters left of the sugar rush from tax cuts.”

Some strategists said people shouldn’t be so quick to write off the tax cuts as a one-time economic and markets boost.

Joe Quinlan, head of CIO market strategy for Bank of America Global Wealth & Investment Management, said that big tech companies in particular still have money sitting overseas that they can bring back to the US at a lower tax rate.

“Lower taxes, to a degree, helped the market earlier this year because share buybacks gave stocks a boost,” Quinlan said. “But there is a lot of cash that can still be brought home. The tax boost may fade next year, but it won’t end.”

Another investment strategist expects that businesses will also start to use their savings for more than just buying stock and raising dividends.

“This is economic reform that is pro-growth. Lower taxes are a gift that keeps on giving because it gives incentive to the business community to take on more risk,” said Douglas Coté, chief market strategist with Voya Investment Management.

Coté also had some words of advice for investors who may be panicking due to the market slump of the past three months: Get over it.

“What I am telling people is that if you can’t handle one quarter of volatility you should be looking for another business. I remember 2008 and 2001. That’s real volatility,” he said. “This is not quite a yawn but it sort of feels like that. This is not a bear market. It’s a storm now but I see calm ahead.”

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