The headline tax rate in America has not changed in the past decade, despite many other developed market economies having cut their headline rates. Lowering corporation tax would therefore deliver an earnings boost to US corporates of all sizes.
What is more, the US currently ranks 51st in the world in terms of the ease of setting up a business. This puts the country behind many other developed market peers, discouraging entrepreneurs and damaging growth prospects. And one of the most discussed taxation changes so far this year has been the implementation of a border adjustment tax – effectively a tax on imports into the US.
Despite a lot of talk on fiscal policy stimulus in Washington, the US has a federal budget deficit of 3.2 per cent of GDP and many in President Trump’s own party are not in favour of increasing it substantially, given the relatively high level of US debt.
A more important question at this stage of the cycle is, how fast can the economy grow without triggering inflation? This depends on the supply side of the economy – particularly labour force growth and the growth of productivity (or output per head) – both of which could be constrained going forward.
Growth in the US working age population is likely to be far lower in the coming decade than in the past. Investment – an important driver of productivity growth – has been subdued, but has picked up slightly in recent quarters.
A pick-up in productivity growth due to higher investment and rising “animal spirits” is quite possible and would allow the US to grow faster than it might have done otherwise. But this is unlikely to happen in a year or two, so investors should have moderate their expectations for US equity market returns going forward.
Returns may be constrained, but the chances of a bear market remain low. The chart below shows a composite of several leading economic indicators vs the S&P 500. Typically, such a composite will decline ahead of a bear market. But, as the leading economic indicator index continues to trend upward, it is likely that there is still underlying support for the equity market.
Recently, investors have also expressed concern about US equity valuations. At 17.7x forward earnings, the S&P 500 is 13 per cent above its long-run average. While no longer as inexpensive as it has been, valuations for the S&P 500 remain well below the levels they reached during the dotcom bubble in 1999.
The long-term growth outlook also looks challenging. The labour market has tightened, leaving further growth dependent on rising output per head, or productivity. This could constrain equity market returns relative to earlier stages of the cycle and to other markets. However, a bear market looks unlikely in the short term, given the relatively low risk of a recession. Valuations are above their long-run average, but are not at worryingly high levels.
Economic growth at this later stage of the economic cycle will be constrained by labour market tightness and dependent on growth in productivity – and this is likely to lead to lower returns for US equities than we have seen over the past few years.
Nandini Ramakrishnan is global market strategist of JP Morgan Asset Management
