As this issue was going to press, the U.S. Senate passed a tax-cut bill that, should it become law, will almost certainly energize the animal spirits of American corporations. Republicans in the Senate and the House still have a bit of cloakroom legerdemain to do before there’s a final 500-page piece of legislation for the President to sign. But in the end, businesses will surely get a grab bag of goodies, from a dramatically reduced corporate tax rate to more favorable rules on expensing capital investments—much of which they’ve been pining after for years.
For investors, the people who actually own these public companies, the news ought to be just as rosy. After all, if corporations are paying less to Uncle Sam, then there will be more profit to parse out to shareholders. Companies might choose to do that indirectly, by reinvesting the extra cash in a new factory or business that will generate future growth—or they might boost their share price by buying back stock. (A number of firms have already suggested they’ll do the latter.)
But before you race to your broker with a buy order of your own, please take a few minutes to read Shawn Tully’s sobering feature in this issue, “When Will the Profit Boom Fizzle?”. Indeed, as much as tax-cut giddiness may fill the market’s sails for a while, there are long-term factors that are likely to keep stocks moored. It comes down to earnings, says Tully, a sage and seasoned reporter who has long been Coins2Day’s economy whisperer. A rare confluence of factors, from stagnant labor costs to rock-bottom interest rates to (at least in 2017) a falling dollar, has juiced corporate profits so that their share of America’s economic pie “has swelled while the slice going to labor has shrunk,” he explains. As a percentage of GDP, corporate profits have paced well above their long-term average, just as wages and salaries have tracked well below theirs.
Only now, the rubber band is snapping back, Tully writes: “Labor costs are rising, interest rates are poised to trend higher, and the greenback is starting to strengthen.”
If Wall Street has noticed, it doesn’t seem to care: It keeps bidding up share prices with the expectation that companies can keep growing profits at a rate much faster than the economy as a whole—as if somehow they could “break loose from economic gravity,” says Tully, quoting the late Milton Friedman. The price-to-earnings ratio for the S&P 500 is now a precarious 24.3, up from 18.9 in September 2014. Imagine that index as one big company, Tully says. “Investors who three years ago paid less than $19 for $1 of earnings now pay $24.30”—a nearly 30% premium for the same buck of profit.
That’s not to say there aren’t investments well worth making right now—and you’ll find 31 of them in “The All-Tech Portfolio.” (Last year’s Coins2Day picks returned 34%, trouncing the broader market.) Features editor Matt Heimer, who has once again masterfully shepherded this year-end guide, also leads a fascinating and informative conversation with five top investing pros.
Yes, they’ve got some views on the tax cut too—but you may be surprised at what our experts say matters to the market perhaps even more.
A version of this article appears in the Dec. 15, 2017 issue of Coins2Day with the headline, “A Market Sobriety Test.”