2018 Outlook: From Denial to Acceptance

The first-order and higher-order effects of the US corporate tax cuts will be the big driver of the economy and markets in 2018. The first-order effect – a discontinuous jump in forward after-tax earnings – is already known, but only partially discounted. The higher-order supply-side effects aren’t even being discussed, and the global tax-competition effects are not understood as a positive-sum game. We expect another good year for stocks, with low volatility. Growth and inflation will be higher, and the Fed will hike more than anticipated, but will not effectively tighten. Emerging markets will outperform, and China won’t blow up. Oil will trade at the high end of the range. Our biggest event-risk is the mid-term election, in which the GOP loss of congressional control could reflect a diminishment of pro-growth “animal spirits.”