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Economic Outlook for 2018

By Elliott H. Gue on Jan. 31, 2018

A year ago, we called for the US economy to expand by 2 to 2.5 percent in 2017, with a bias toward the upper end of this range—an acceleration from the 1.5 percent increase in gross domestic product (GDP) logged in 2016 and the 1.8 percent uptick in the final quarter of that year.

Our bullish forecast hinged on two key data points.

The Conference Board’s Index of Leading Economic Indicators (LEI), the Institute for Supply Management’s Purchasing Managers Index for manufacturers and other forward-looking indicators that we follow had started to point toward a tentative acceleration in economic growth.

These improvements, which emerged in summer 2016, caught our attention because these same indicators had warned of an elevated risk of recession in late 2015 and early 2016. This economic soft patch had catalyzed a 14 percent correction in the S&P 500 between May 2015 and January 2016.

Moreover, we expected the incoming Trump administration to pursue fiscal stimulus measures—tax reform and/or infrastructure spending—to make good on campaign promises, giving the tentative recovery that had begun in mid-2016 a boost.

These calls proved correct. Although the US economy grew at a sluggish pace of 1.2 percent in the first quarter, this rate of expansion surged to 3.1 percent in the second quarter and 3.2 percent in the third quarter—the first time in three years that GDP had increased by more than 3 percent in successive quarters.

Although the official numbers aren’t in yet, the US economy likely expanded by about 2.3 percent last year, the midpoint of our forecast.

Handicapping political outcomes is always a fraught enterprise, particularly in an administration’s first year. The failure of two Republican-led efforts to reform the Affordable Care Act in the first half of 2017 prompted some observers to conclude that President Trump’s legislative agenda had stalled and that tax reform, especially changes to the corporate tax code, would struggle to secure Congressional approval.

However, we stood by our view that the stakes were too high for the president and Congressional Republicans to fail on tax reform. In the final months of the year, expectations shifted.

(Click graph to enlarge.)SPX vs High Tax Rate SPX

This graph compares the quarterly total return posted by an equal-weighted S&P 500 and an equal-weighted basket of the 20 percent of its index members with the highest effective corporate tax rates. As you can see, the shifts in performance track the market’s view on whether tax reform would pass.

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