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Economic Outlook | Spring 2017

Change, Growth and Uncertainty

from Anthony Chan, PhD, Chief Economist for Chase


The election of Donald J. Trump has ushered in the most pro-business administration in recent American history. The markets responded appreciatively—and enthusiastically. The S&P 500 ended 2016 up 9.5% for the year (or 12.0% including dividends), most of which came after the surprising election result in November.Footnote 1 Investors took a fresh look at Trump’s agenda and saw the potential for substantial economic and earnings growth. Business and consumer confidence soared.

But along with President Trump’s pro-business agenda came a host of unanswered questions. How many of Trump’s proposals will actually be enacted by Republicans in Congress? Will his pro-growth fiscal policies be offset by a protectionist trade agenda? How will the Fed respond to rising deficits or renewed inflation? Is there heightened geopolitical risk? These uncertainties caused investors to pause after the initial post-election surge and adopt a wait-and-see attitude.


What most excites investors about President Trump’s agenda may be a pair of proposals that directly affect earnings and stock prices: corporate tax cuts and the repatriation of foreign profits. Repatriation provides an incentive for U.S. companies that have not transferred corporate profits earned abroad to avoid paying our higher U.S. corporate tax rate of 35%, to bring them back at a one-time low rate of 10%. Together, repatriation and corporate tax cuts have the potential to boost S&P 500 earnings by as much as 25%.Footnote 2

As a candidate, Trump proposed slashing corporate tax rates from 35% to 15%. Wall Street analysts estimate that each 1% in tax cuts will increase the earnings of S&P 500 companies by about $1.25 per share.Footnote 3 These tax cuts are consistent with Republican philosophy and are likely to be well-received in Congress. However, Congress may not bring down tax rates by the full amount, or make the new rates retroactive to the beginning of the year, so this year’s actual benefit to U.S. corporate profit growth could wind up smaller.

Trump also proposed a tax holiday enabling U.S. corporations to bring home their overseas profits at a rate of just 10%. Companies are currently parking about $2.6 trillion abroad.Footnote 4 If they bring back 60% of this cash, as they did in a similar tax holiday back in 2004, this would equal more than 5% of the entire market cap of the S&P 500.Footnote 5 Approximately $7 of every $10 was used for dividends, stock buybacks, mergers and acquisitions, and similar uses that boost stock prices, the last time we had a repatriation holiday in 2004.Footnote 6 Dividends go directly into investors’ pockets. Stock buybacks and mergers increase earnings-per-share ratios by reducing the number of shares available.


Energy and telecom companies pay the highest effective tax rates and would benefit most from corporate tax cuts. While tech firms will benefit less from tax cuts, they have large pools of overseas capital and stand to benefit more from repatriation.

Federal Corporate Tax Rate: 35%. Source: Bloomberg, J.P. Morgan Private Bank. Factset. Data as of 01/26/2017.


Other Trump policies are designed to accelerate economic growth by putting more dollars in people’s pockets and boosting consumer demand. Consumers drive twothirds of the economy, and fiscal austerity at all levels of government has held back growth since the Great Recession. As a candidate, Trump proposed to end austerity through stimulative policies such as personal tax cuts, infrastructure rebuilding and increased defense spending. The prospect of lower taxes and higher spending caused business confidence to rise immediately after the election, which in itself helped stimulate further growth.

However, longstanding Republican opposition to government spending and deficits might not vanish overnight. Personal tax cuts are the most likely to be enacted by Congress, although the amount remains uncertain. But tax cuts are a less effective fiscal stimulus because a large share goes to affluent taxpayers who typically use some of it to increase their savings, rather than spend it all. Defense spending is also likely to rise somewhat, although it’s already at very high levels. The biggest challenge could lie in getting Trump’s proposed $1 trillion infrastructure plan approved by deficit-averse Republicans as well as Democrats who support infrastructure rebuilding but would rather see it come through direct government spending instead of public-private partnerships.


On the other side of the ledger are Trump’s trade policies, which pose substantial risks to global business. Restricting free trade was a cornerstone of the Trump campaign, including such proposals as a 45% tariff on Chinese imports, tearing up NAFTA, labeling China a currency manipulator and imposing a border adjustment tax.

Some of these proposals would be easier to implement than others. President Trump has the legal authority to impose tariffs unilaterally, or withdraw from NAFTA with six months’ notice.Footnote 7 But a border adjustment tax would require Congressional approval. And labeling China a currency manipulator would be difficult under current law, which requires that countries have a 3% current account surplus and have bought foreign currencies worth 2% of their GDP in the past 12 months to hold down the value of their domestic currencies. China recently reported a current account surplus of just 2.4% and has sold—not bought—nearly $1 trillion in foreign currencies over the past 12 months.Footnote 8

Any unilateral trade restrictions run the risk of retaliation by our trading partners, or at worst a global trade war. However, despite President Trump’s aggressive rhetoric, we expect his experienced economic team to use his threats of unilateral action as a lever to renegotiate trade agreements in ways that benefit U.S. companies and the U.S. economy in the global marketplace.


Another counterweight to the President’s pro-growth agenda could come from a different branch of the U.S. government: the Federal Reserve. The economic expansion is already eight years old, and the case for fiscal stimulus is not as strong as it was during the recession. More than two million new jobs were created last year.Footnote 9 With the jobless rate below 5% most of the year, the U.S. economy is close to full employment, although there is still some slack in labor force participation (as shown by the recent rise in the labor force participation rate for two consecutive monthsFootnote 10). If job creation continues at this pace—or even accelerates from all the fiscal stimulus—the economy risks overheating and the Fed could be forced to slam its foot on the brakes.

After the election, the Fed raised its expectations for 2017 from two interest rate hikes to three. The market is skeptical, though, that all three increases will occur. For two years in a row, the Fed signaled multiple rate hikes but delivered only one. This year could be different if President Trump succeeds in enacting most of his stimulus package. Core inflation is already approaching the Fed’s 2.0% target rate,Footnote 11 and further stimulus could cause the Fed to implement all three rate hikes. Chair Yellen indicated in Congressional testimony in February that it might be “unwise“ to wait too long to raise short-term rates, given the healthy ongoing economic recovery. But the U.S. central bank is likely to remain cautious for the time being, especially with the lingering uncertainties in U.S. policy and the world economy. In the long run, we expect the Fed to continue its policy of gradual tightening as it returns to “normal” interest rates.


After flirting with record highs after the election, the stock market paused its upward trajectory and began trading within a narrower range. However, we believe the market still has significant room to grow. Consumer and business confidence reached their highest levels in 13 years after the election.Footnote 12 The economic expansion, already eight years old, still shows no signs of reaching its limit. We believe it will last at least two more years, which would make it the longest expansion on record.

Given that U.S. markets typically outperform in the first year of a new presidency, we project baseline S&P 500 returns in the range of 6%–8% this year,Footnote 13 with a potential upside of more than 10% if all of President Trump’s proposals (except the border adjustment tax) are approved and made retroactive to the start of this year.Footnote 14 However, the outlook is less promising overseas, which is why our portfolios still overweight U.S. equities. We are seeing a global pullback from monetary policy as central banks in Europe, Japan and China ease up on quantitative easing. Britain faces a “hard Brexit,” and growing populist movements on the Continent could further weaken the European Union. We expect to continue overweighting U.S. stocks until international markets show additional signs of improving fundamentals.

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