Investors began 2018 with high hopes for a surge in business profits and stock prices. A sharp cut in the corporate tax rate signed by President Trump late last year — from 35% to 21% – all but guaranteed a juicy year for earnings.
The profits have materialized. But nearly 10 months in, the S&P 500 stock index is a big disappointment, essentially flat for the year. It spiked at the beginning of the year, spiraled into a 10% correction and crawled back to a new high in September, before a sharp October selloff. Stocks are still up about 26% since Trump got elected, but it seems increasingly likely the first two years of Trump’s presidency might be the high-water mark for investors.
No single factor explains the October selloff, which has occurred amid rising interest rates, the gradual tightening of monetary policy, an intensifying trade war with China and some forecasts of lower corporate earnings on the horizon. “These worries are likely to get worse over the next 12 months or so,” Capital Economics said in a recent research note. “Our forecasts are for stock markets to fall much further.”
Others think stocks will recover, and end the year up. Plus, the underlying economy remains strong, with unemployment at a super-low 3.7%. The economy grew by 3.5% in the third quarter, and might hit overall GDP growth of 3% for the year. If so, it would be the strongest growth since 2005.
Trump’s bold predictions
Yet Trump has made bold predictions about the effect of his economic policies that don’t seem close to panning out. He predicted his tax cuts and deregulatory efforts would unleash a boom in business spending that would push growth rates above 3%, indefinitely. Yet business spending decelerated in the third quarter, growing by just 0.8%. Such spending–known as nonresidential fixed investment–grew by 8.7% in the second quarter and 11.5% in the first quarter. That looks like a slowdown. Forecasting firms such as IHS Markit and Moody’s Analytics see overall growth slowing, not improving, in 2019 and 2020, with a recession possible. GDP growth in the second quarter of this year, which hit 4.2%, may turn out to have been the peak.
The White House claims the Trump tax cuts, passed with zero Democratic support, will raise take-home pay for the average household by at least $4,000 per year. But pay is only rising 2.8% so far this year, which is roughly the rate of inflation. Most ordinary people haven’t noticed a pay bump from the tax cuts, which is why the law remains unpopular and a liability for Republicans in the upcoming midterm elections.
White House economists argue that the supply-side effects of the tax cut will take several years to work their way into the economy and benefit workers through more private-sector investment that creates new jobs and boosts pay. It’s possible. But the evidence that this is beginning to happen is sketchy.
Several key indicators show that business investment is growing, but not by more than what was prior to the tax cuts. New orders for capital goods, for instance, have grown this year. But the pace of growth was stronger last year, and stronger still in 2010 and 2011. The percentage of small businesses making capital expenditures has been drifting up since 2011, and in February hit the highest level since 1997. It has fallen since then, however, with the overall trend in 2018 looking unexceptional.
Moody’s Analytics believes the Trump tax cuts have helped boost equipment purchases by businesses. But it sees no increase in spending on structures, which would indicate new plant or office openings. It could still materialize, but concerns about slower growth in the future and a business cycle that’s in the late stages could make CEOs reluctant to break new ground.
The tax cuts, meanwhile, helped swell the government’s annual deficit by 17% in fiscal 2018, which ended in September, to $779 billion. The increase came mostly from a 31% decline in revenue from business taxes. Individuals, by contrast, paid more in income taxes in 2018, contributing to voter skepticism of the tax law. The last time the economy was this good, in the late 1990s, tax revenue surged, leading to four years of federal surpluses.
Running large deficits during boom years leaves less room to stimulate the economy during recessions, when it’s needed most. Trump, of course, seems to think there’s no chance of a recession on his watch. We should all hope he’s right.
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Rick Newman is the author of four books, including “Rebounders: How Winners Pivot from Setback to Success.” Follow him on Twitter: @rickjnewman