The recent passage of tax reform has raised the expected level of S&P 500 earnings. Looking forward, Price/Earnings ratios have declined on a forward or normalized earnings basis, thereby raising the upside potential of the S&P 500. In simple terms, tax reform should benefit markets and provide opportunity for growth. We reckon the initial effects of tax reform will be 2018 earnings growth moving from around 10% to upwards of 18%. This momentum should persist into 2019 and 2020 as lower tax rates and higher depreciation reduce the required breakeven returns on investment. Economic growth should benefit from great capital investment and higher share employee productivity.
What does all this mean for stock portfolios? From our perspective, this configuration creates a chain reaction. Higher growth creates higher earnings; normalized earnings move faster; price to earnings are lowered which remove pressure from valuations. Our opinion is a market with more sustainable upside potential.