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The U.S. economy is about to get an injection of rocket fuel.

Many economists have argued that “this is as good as it gets” for U.S. economic growth. But President Trump’s $1.5 trillion Tax Cuts and Jobs Act could kick economic growth into high gear and give a further boost to the long, strong stock market rally.

[ibd-display-video id=2641867 width=50 float=left autostart=true] Now in the ninth year of an underwhelming recovery, the economy was long held back by an overhang of debt and speed bumps from China to the oil patch. It’s finally hit its stride and seems set to step up its pace in 2018.

“We’ve got a global synchronized boom with low inflation,” said strategist Ed Yardeni, president of Yardeni Research. He called it an ideal “Goldilocks scenario” for investors, with the economy neither too hot or too cold.

If it continues until June 2019, the U.S. economic expansion will break the record 120-month run of the 1991-2001 expansion.

With the jobless rate at a 17-year-low 4.1% , seemingly the only worry on the horizon is that a Trump tax fiscal boost now may be too much of a good thing, leading the economy to overheat and the Federal Reserve to hit the brakes.

But inflation remains in hiding. Part of the credit goes to Amazon.com ( AMZN ) for injecting intense price competition into one industry after another. Evermore powerful tech titans like Facebook ( FB ), Apple ( AAPL ) and Alphabet ( GOOGL )-unit Google don’t need massive investment, or payrolls, to generate enormous profits. Aging demographics, meantime, acts as a restraint on excessive growth.

There’s even reason to think that the extra firepower from the Trump tax cuts, will reinforce the U.S. economy’s strength, rather than jeopardize its growth streak.

Global central banks are pulling back on massive monetary stimulus while China aims to wean itself off another burst of debt-induced growth. U.S. business investment and productivity growth have been lackluster. Tax reforms like lower corporate levies would help counter these economic headwinds.

IBD’S TAKE:Investors should pay attention to big economic and news events, but don’t let them distract you from how markets are behaving. Read The Big Picture  column every day to stay on top of the major market averages and leading stocks, letting you know when you can be aggressive and when you should move to the sidelines.

The Republican tax plans being merged by the House and Senate would, in addition to cutting the corporate tax rate to 20%, let businesses immediately deduct the cost of new investments. The bills would set rules aiming to create a more level playing field for U.S. multinationals. For individuals, tax reform would lower rates, nearly doubling the standard deduction and hiking the child tax credit. That would be offset, especially for high-tax blue states, by fewer deductions.

Federal Reserve Rate Decision

A year ago, Federal Reserve Chief Janet Yellen seemed to throw cold water on the tax reform plans being hatched by President-elect Trump and the Republican Congress. “Fiscal policy is not obviously needed to provide stimulus to help us get back to full employment,” she said.

Now, with the unemployment rate a half-point lower thanks to 2 million new jobs, the Fed will likely weigh in on Wednesday (Dec. 13) to determine what the tax cuts will mean for monetary policy. Policymakers telegraphed three 2018 increases in its key overnight lending rate in their September projections, and it’s possible that they will update their projections to hint at four hikes next year.

New York Fed President William Dudley, who is stepping down soon, said Dec. 1 that it’s “probably not the best time” for more fiscal stimulus.

Yet Wall Street doesn’t seem concerned. Markets still are pricing in just two quarter-point rate increases in 2018, following a near-certain hike on Wednesday.

The risk of an overaggressive Fed – the usual suspect in curtailing an economic expansion – can’t be dismissed. But policymakers have traveled a fair distance this year in accepting that the Phillips curve – the link between lower unemployment and higher inflation – may no longer be as predictive as they once thought.

Policymakers have long argued that inflation would rise as unemployment fell below 4.5%, but the opposite happened this year, even as growth picked up. The core personal consumption expenditures deflator, the Fed’s favorite inflation gauge, registered just 1.4% in October, down from 1.8% in February. It hasn’t hit the central bank’s 2% target in five years.

Minutes of the Fed’s November meeting revealed that most members of the Fed’s policymaking committee saw a meaningful chance that low inflation will have staying power: “Many participants observed, however, that continued low readings on inflation, which had occurred even as the labor market tightened, might reflect not only transitory factors, but also the influence of developments that could prove more persistent.”

Why Inflation Is So Low

In a way, the Trump tax cuts are a bet that low inflation will endure. While no sure thing, Republicans are putting their chips on some powerful trends.

This month’s megamerger between CVS Health ( CVS ) and Aetna (AET) is a case in point. Spurred by the threat of Amazon joining the prescription drug business, CVS plans to remake drugstores into low-cost medical-service shops.

CVS’s plan is in line with the push to move health care to the most cost-efficient setting. Health care inflation, which historically outpaced overall inflation, has become a moderating force. Growing government budget pressures suggest that will persist.

Marriott International (MAR) CEO Arne Sorenson explained in August why the hotel group has more trouble raising prices than it did in past cycles. While home-sharing via disrupters such as Airbnb has some impact, the bigger issue is “radical transparency in pricing” thanks to the internet.

“With each passing year, it becomes simpler and simpler to know the rates at every single hotel,” he said.

Joachim Fels, managing director of Pimco, cites the rise of superstar tech firms as a key reason why “super-low natural interest rates are likely here to stay.”

Titans led by Facebook, Apple and Google “make higher profits, save more than they invest and pay out a smaller share of their value-added to labor,” he wrote in August. Their growing dominance helps explain the seemingly broken link between unemployment and wages.

The retirement of baby boomers also is curbing wage growth. Higher-paid workers are exiting in large numbers, replaced by lower-paid, younger hires. Aging demographics go a long way toward explaining the persistence of low interest rates, Fed researchers contend.

Stock Market Outlook

If Goldilocks sticks around, even as tax cuts juice the economy and corporate profits, the current bull market in stocks may continue to surprise to the upside.

Solid earnings gains, fueled by the best global economic growth since 2010, could be supersized by a 20% corporate tax rate. The combination of earnings with “the perception that this expansion has a lot longer to go” could lift the S&P 500 to 3150 by the end of 2018, a 20% rise, Yardeni says. The S&P 500 is trading around 2630 now.

His outlook envisions investors bidding stocks to a “meltup multiple” of 20 times earnings. S&P 500 earnings should grow 7.2% to $141 a share, from $131.50, he says. That includes $6 per share via the tax cut (assuming the 20% corporate rate kicks in immediately, as in the House bill, instead of delayed to 2019 in the Senate version).

Economists at Goldman Sachs and UBS are among those who expect the Fed to signal four rate hikes in 2018, but even that is unlikely to derail their bull market thesis.

UBS thinks tax cuts could push the S&P 500 as high as 3300 next year. Its analysts assume the Fed will be done raising rates for this cycle after four hikes in 2018. UBS sees the PCE deflator’s annual gain of just 1.75% by the end of next year. That’s comfortably below the Fed’s 2% target.

Goldman equity strategist David Kostin’s “rational exuberance” outlook  comes with a 2018 S&P 500 target of 2850, assuming the 10-year Treasury yield rises to 3%. Stocks could rise further if yields and inflation undershoot, and Kostin doesn’t rule out a touch of 1990s-style “irrational exuberance.”

Trump Tax Cut Timing

Goldman’s alternative scenario has the S&P falling to 2450 in 2018, about 7% below current levels, if expectations for corporate tax cuts came to naught.

An economy with a head of steam can surely withstand a moderate stock market downturn. But this long-in-the-tooth economic expansion might look more fragile if Republicans weren’t on the verge of a major legislative victory.

However, that’s not the consensus view. Many, if not most economists, have concerns about the Trump tax cuts. Moody’s Analytics calls the GOP tax bill a “fiscal mistake” that will likely push the economy into a “boom-bust cycle” and cut short the late-stage expansion.

Yet Lakshman Achuthan, co-founder of the Economic Cycle Research Institute, told IBD that this is a good time for fiscal stimulus. ECRI’s forward-looking indicators point to “a slowdown that most don’t see coming.” Those include rising junk bond yields and softer industrial commodity prices, he says.

Already the U.S. has been through three decelerations and reaccelerations during this expansion, Achuthan says. He thinks it’s on the cusp of a fourth one, possibly mild.

Yet a timely fiscal boost from tax cuts, which could begin to show up in individual paychecks via lower withholding starting in January, “can bolster confidence, if it’s viewed positively,” Achuthan said.

The roots of the most recent global reacceleration started in China in early 2016 when Beijing unleashed $1 trillion in credit, helping to restore calm to world financial markets, alongside the actions of various central banks.

Now China’s growth is gradually cooling as the government seeks to curb unsustainable credit growth. Meanwhile, the Fed has begun slowly reversing its financial-crisis-driven asset purchases. The eurozone economy has finally gained a little momentum, but the European Central Bank will soon start scaling back its bond buying.

These clouds in the economic outlook look a lot less worrisome with an injection of tax stimulus set to hit the world’s largest economy.

Growth Impact Of GOP Tax Reform

Just how much of a boost the GOP tax cuts will deliver is unclear. Wall Street firms generally have modest expectations. Goldman Sachs predicts 2.6% GDP growth in the U.S. and 4% growth worldwide.

Goldman economists expect a 0.3-percentage-point boost to U.S. growth in 2018 and again in 2019 on the assumption that the bulk of the tax cut tilted to corporations and higher earners will be saved, not spent. Even a modest Trump tax-cut boost could have a significant impact on labor markets, boosting wage gains and drawing more people into the workforce.

Doubts about the tax reform impact reflect the plan’s government debt increase, which could push up bond yields. Economists also are unsure how businesses will respond to lower tax rates.

At least until recently, business investment has been among the weaker aspects of the expansion despite healthy corporate profits.

Herein lies the real test for the Trump economic revolution’s investment focus, says George Mason University economist Tyler Cowen.

The “near-obsessive drive” to cut the corporate tax rate to 20% “will very likely attract a significant amount of foreign investment,” he wrote.

After a long investment drought, he thinks that “supercharging investment might help build clusters of excellence, boosting innovation, wages and eventually tax revenue.”

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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