Could the Recent Tax Overhaul Lead to a Bear Market?

By Alan Olsen
Could the Recent Tax Overhaul Lead to a Bear Market?

It took years to get there, but the major tax reform set in motion, and eventually passed into law by Republican lawmakers in Washington has had a profound affect on the stock market. The Tax Cut and Jobs Act (TCJA) has already given a big boost to corporations, as well as powered equity prices forward. For the most part, the stock market has seen positive signs since the tax reform went into affect earlier this year. However, according to some, everything might not be as great as itseems.Morgan Stanley Leery of Long-Term BenefitsCount Investment firm Morgan Stanley be among those who aren’t so bullish on the latest bull market. “Fiscal expansion is near-term growth supportive, but it risks increasing pro-cyclical behavior. The benefits may be ‘in the price’ and investors must account for greater potential market downside at end of cycle,” the firm recently wrote in a note to clients. Morgan Stanley concedes that the bill has been beneficial to this point, but the firm isn’t so sure about the long-term benfits.

IMF Sees Slowed Growth in Two Years

So is it possible the TCJA might have set the market up for an evengreaterfall down the road? The International Monetary Fund (IMF) recently raised its estimates for economic growth in the U.S. for both this year and next. The firm cited the TCJA as a huge factor in that decision. However, at the same time, IMF says that after 2019, it expects economic momentum in the country would actually start to slowdown starting in 2020.

As for its part, Morgan Stanley also wrote, “While this policy supports growth in the near term, it may worsen the next downturn while limiting the fiscal reaction to it. Even if those concerns are unfounded, we think much of fiscal stimulus’ ‘good news’ is already in the price of key markets.”

Has the Earnings Growth Already Peaked?

The reason the stock market has seen a boost so far is mainly because of the corporate tax rate reduction. The sharp reduction gave companies a spikein profits, but it also created some risk. According to the Wells Fargo Investment Institute, earnings growth “may have peaked in the quarter, and the high barof earnings growth that was being set will be difficult to exceedin the future.”

What About Overseas Money?

Another objective of the bill was to encourage companies to bring back more of their earnings from overseas to the U.S. Those who favored the bill claimed corporations would use this additional money for more hiring and investing. However, so far this hasn’t been the case. Instead corporations have been using this money to increase their stock buyback programs.

In fact, in the first quarter, U.S. companies actually reported more than $300 billion in stock repurchases andcash mergers and acquisitions. That number is more than twice the amount in the fourth quarter last year. The problem is, buyback programs can also peak just like earnings, which could be risky for stock markets. Time will tell, but these concerns at least bare watching closely and having a sound investment plan in place.