Following growth of 3.1% in Q1 of this year, U.S. real GDP expanded at an estimated annual rate of only 2% in Q2. The slowdown can be attributed primarily to the effects of the escalating tariff war with China. Another factor at work: strong growth in household and service sector spending was partially offset by a weakness in manufacturing and business investment spending. Although the current U.S. economic expansion is the longest in American history (beginning in 2009), it still is subject to a basic principle of business cycle theory: Expansion cycles do not die of old age but rather because of spreading excesses and imbalances within the economy that undermine the economy’s natural tendency toward growth.

Stock investors have been on a roller coaster over the past two years. As measured by the S&P 500 Index, stock prices rose by 20% during the six months ending in January 2018; declined by 10% over the next three months ending in April 2018; rose by 15% through the end of September; and plunged by nearly 20% through year-end 2018. Since the end of December, stocks have risen by nearly 25% to a level within 2% of the all-time peak reached on September 20.

Despite market volatility in recent months and the resulting dip in investor confidence, the typical investment portfolio is still far more valuable than it was 10 years ago, and the Dow has nearly tripled.¹

Investors can best understand the current equity market sell-off by recognizing that cyclical bull markets are routinely punctuated by temporary intra-cycle corrections. The current sell-off is the sixth such episode since the equity bull market began in 2009, and the intra-cycle decline differs from the previous five in that it was not triggered by fears of imminent recession. In addition, the current episode is occurring in an environment of lofty valuations and greater investor optimism, compared with distinct undervaluation and widespread risk aversion prevailing during previous interim market declines.

Most recent inflation data depict that mild inflationary pressures are building, consistent with a maturing business expansion. However, powerful structural forces that limit business pricing power suggest that the cyclical rise in inflation will be moderate compared with previous cycles. 

The dynamic nature of current economic conditions imply that business and investment cycles will inevitably change, almost certainly in a negative direction. In principle, financial markets are priced at the margin, which means that even small changes in expectations can translate into large changes in asset prices.

World financial markets are at an important inflection point. The extended period of market calm, complacency and record-low volatility has ended for the current investment cycle. The risk to both equity and bond markets is that economic data are too strong rather than too weak, creating a negative environment for inflation, monetary policy and interest rates.

The Internal Revenue Service announced its changes to retirement plan contribution and Social Security limits for 2018¹. These numbers don’t necessarily change annually, so being aware of this year’s tax-adjusted figures could impact how you guide your clients in their financial decisions.

Recently passed and formally enacted on January 1, 2018, the 2018 Tax Cuts and Jobs Act introduces a number of significant changes to the tax code, with about one-third directed to individuals and households, and the remaining two-thirds impacting corporations — notably a tax rate reduction from 35% to 21% and immediate 100% expensing of capital expenditures for equipment and machinery.

In this month’s Economic Commentary, Robert F. DeLucia, CFA and Consulting Economist for MEMBERS Capital Advisors, Inc., shares his perspectives on the potential impact of the changes, the positives and negatives that come along with the tax bill and what it all could mean for investors.