Holy Cow!

Equity income

Holy Cow!

2017 was another wonderful year for dividend increases and we continue to expect dividends to rise in line with corporate earnings.


"With the rising payouts we have seen, we believe future dividend growth will more closely follow earnings growth."
Hersh Cohen

Phil Rizzuto, Hall of Fame Yankee shortstop and later a beloved announcer, used the phrase Holy Cow! to express amazement. We can’t think of a better one for this year. What a year it was on so many fronts!

Trump effect

It would be disingenuous to comment on financial markets of 2017 without a mention of President Trump, who dominated headlines. Daniel Henninger of the Wall Street Journal gave a good description. He referred to the past year as having a parallel presidency. One president made harmful and spiteful tweets, and picked feuds that left observers shaking their heads. The other president was adamant about stimulating the economy.

Whether it has been hopes for tax cuts, which have now materialized, or the effects of prolonged monetary stimulus coupled with ultra-low interest rates courtesy of Janet Yellen, the economy is doing better than it has been for many years. Unemployment is at a 17-year low, consumer confidence has remained high and spending by individuals and corporations has begun to tick up. Corporate earnings continue to rise and cuts in corporate taxes promise sharp rises in 2018. One can argue forever about the causes of the market’s strength, but the reality cannot be denied.

A year ago, we were mildly positive on stocks, but did not expect the relentless upward march we saw in 2017. We believed the ultra-low interest rates would prevent any major declines, but as the fiasco over attempts to repeal Obamacare unfolded, we thought that the dramatic polarization and fighting in Washington would preclude successful legislation toward a tax bill.

Tax reform complexity

Some thoughts on the tax bill just signed — it is far from the promise of tax simplification; the complexity is beyond comprehension. It does give almost everyone some cut in taxes, the exception being high-wage earners in high-tax states. It does not close loopholes. It will likely put a damper on home prices in many areas. Workers with children get some benefits. Corporate taxes for many companies will come down a lot and incentives to invest in plant and equipment should kick in. It can potentially help jobs and wages, but that is not certain. Overseas profits can be brought back at favorable rates, a move that has been an obvious need for many years.

This bill is neither a windfall for the wealthy nor a panacea for the working poor. It does put a few more dollars in family finances because of the higher standard deduction. However, payroll taxes, unaddressed in this legislation, remain the highest tax on most workers. This bill does nothing to address the single biggest social issue we see, which is income and wealth inequality.

Business is good

Following the strong performance in 2017, the stock market is pricing in the rise in corporate earnings that will come from corporate tax cuts. The markets are further supported by an overall expansion in economies in virtually all major countries. Business is good. We don’t see the giddiness sometimes associated with long bull markets, so the psychology is not yet creating excessive risk, which is a positive.

Interest rates have aided and abetted stock prices, and now, economic revival. Since the Great Recession of 2008, inflation has been contained by an excess workforce and more recently the “Amazon effect” on prices. The Internet has had a deflationary effect on many things. If employment continues to grow and wages indeed rise, there could be some upward pressure on inflation. We believe the stock market can handle a moderate increase in inflation and interest rates. The Federal Reserve is likely to maintain a slow pace of rate increases.

Dividend outlook

This was another wonderful year for dividend increases, and we continue to expect dividends to rise in line with corporate earnings. While there are many positive factors supporting valuation (earnings growth, interest rates, consumer confidence, etc.), the sad fact is there are no asset classes that are not expensively priced. Pension funds and endowments are struggling to meet long-term needs without taking on excessive risk. Stocks, while at full valuations, remain attractive relative to other assets, and they should benefit from the corporate tax cuts. There are still risk factors that could affect markets. We reiterate our opposition to trade wars with Latin America and China. And tax cuts on top of an economy that is already functioning at a high rate carry the risk of overheating.

 

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Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

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Yields and dividends represent past performance and there is no guarantee they will continue to be paid.