FISCAL STIMULUS, ECONOMIC GROWTH, AND EARNINGS
There was a big and permanent U.S. corporate tax cut passed and signed into law in December 2017, effective in 2018. The corporate tax cut goosed profit growth into the 20% territory for 2018 for many U.S. companies. Companies used the extra free cash flow to buy their stock back, increase dividends, pay down debt, and make acquisitions. A few companies even made some additional capital investments with the newfound money. The stock market was supported, and economic growth picked up nicely in the first half of 2018, although as the impact of the tax cuts wanes, economic growth is decelerating.
In 2019, companies will be facing some tough earnings comparisons, as earnings growth may slow into the 5% to 8% range. Driven by a much flatter yield curve and the trade war, concerns over future earnings deceleration are already playing a role in heightened equity market volatility.
The tax cut also brought forth huge budget deficits, likely to run at $1 trillion for fiscal 2019 and trend higher in the future. Indeed, in the scenarios where the US experiences a recession down the road, then the budget deficit might soar to $2 trillion. The extra bond supply has already helped push yields on the U.S. 10-year Treasury over the magic 3% line. Going forward, though, Treasury note and bond yields are more likely to be pushed up or down based on whether the economy decelerates in 2019 or not.
Chart 2: US Treasury 10-Year Note Yield 3.50%
3.25% 3.00% 2.75% 2.50% Source: Bloomberg Professional (USGG10YR).
Massive budget deficits help power 10-Year Treasuries through the 3% line
25 | ADMISI - The Ghost In The Machine | November/December 2018
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