First Quarter 2018

2017 was a banner year.  

By year-end, real gross domestic product (GDP) was growing at a 3% pace … the fastest pace since 2005.  Corporate earnings had grown by 9.6% … the biggest winners being energy, materials and information technology.  Unemployment stood at 4.1% … the lowest level in 17 years.  Wages and benefits were climbing.  Consumer confidence remained near a 17-year high.  The Tax Cuts and Jobs Act of 2017 was signed into law.  And, the stock market was hitting new highs.  
Several key factors are driving the good news
• Regulatory Reform
Many studies have shown that excessive regulation negatively impacts businesses and consumers.   High compliance costs stifle the ability of businesses to grow and add jobs, especially small businesses.  And, they increase the prices consumers must pay for goods and services.  
In recent years, regulations have been added that have cost businesses and consumers more than $100 billion annually.  Two industries that have become especially burdened by regulation are financial services and health care. 
Love him or hate him, Trump’s drive to streamline regulation took a boot off the neck of business.  The first six months of his administration saw 800 regulations relaxed or axed, and others postponed or withdrawn. To date, the annual cost savings for business is estimated to be $570 million with more to come.  
Ultimately, this regulatory reform has inspired business confidence and investment, and the economy.  And, the stock market has responded.  
Regulations in 1960 and today.
• Tax Cuts and Jobs Act (TCJA)
TCJA represents the broadest tax reform since 1986.  Although it lowers tax rates for all taxpayers, businesses receive the greatest direct benefits.  While criticized by some, this is not a bad thing and here’s why.  
A lower corporate income tax rate makes the U.S. business environment more competitive globally.  TCJA lowers the rate from 35% (one of the highest of all developed countries) to 21%.  Most analysts forecast this will add 8-10% to corporate profits in 2018.   
A lower repatriation tax makes it reasonable for U.S. corporations to bring untaxed profits onshore.  TCJA lowers the repatriation tax from 35% to 15.5% for liquid assets and 8.0% for physical assets.  Although it is unlikely all offshore assets will be repatriated, major companies have announced they will repatriate significant sums.  For example, Apple (AAPL) announced it would pay around $38 billion in repatriation taxes to bring $245 billion of previously untaxed profits onshore.    
Ultimately, these (and other) tax reform measures will translate into more jobs, and better wages and benefits for individuals.  Already, some corporations have paid bonuses to employees and others have increased their corporate minimum wage to $15 per hour.  And, over the long haul, rising corporate profits and stock values make retirement plans more secure.  
• Low Rates
In 2017, the Fed remained abundantly cautious in terms of “normalizing” interest rates.  Specifically, it raised its key short-term funds rate by ¼ of 1% in March, June and December, ending the year at 1.25% to 1.50%.  Also, it began raising longer-term rates by allowing bond holdings to mature off of its balance sheet.  The result … rates remain well below historical norms at year-end.  
2018 outlook.
Although the S&P 500 closed 2017 at 2,673.61 (↑ 19.4%), performance was quite uneven across the broad market.  Led by software, semiconductors and peripherals, Information Technology (↑ 36.9%) was the primary driver of market performance with its 23.76% market weighting.  Not surprisingly, portfolios over-weighted in technology did quite well while more diversified portfolios lagged.  

Broad market participation is characteristic of a healthy market, whereas narrowing participation is characteristic of one that is becoming higher risk. 

Moving into 2018, stock market values are somewhat above average.  For example, the current PE ratio for the S&P 500 is 18 versus  an historical average of 16, and its current dividend yield is 1.9% versus an historical average of 4.4%.  However, we do not believe that it is hugely over-valued.  In mid-December 2017, CFRA forecast 2018 earnings growth of 10.7% before the recent tax cuts, which will add significantly to forecasted growth.  Accordingly, we plan to maintain target allocations and proper diversification, which is a critical risk management tool.      


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