Strategist: Without 'game changer' tax cuts we could be in a 'pretty big mess' next year


It’s always difficult to predict the peaks and troughs of the equity market, but Ed Clissold of Ned Davis told priceshall that tax reform could be the linchpin keeping 2018 S&P 500 forecasts high. The analyst shared his market outlook in a exclusive interview with priceshall PRO’s
Mike Santoli.

Central to his calculations is a cycle of “earnings recessions,” or periodic pullbacks separate from more major, economic slumps.

“What we had in ’15 and ’16 was a non-economic earnings recession or a mid-cycle earnings recession as we call it,” explained Clissold. “And there’s a very consistent pattern where the earnings recession lasts about one year and then you get a year of pretty good acceleration because the comps are easier.”

And if Clissold is right, we may be enjoying that year of “pretty good acceleration” before another downturn in 2018. The S&P 500 could see little to no gain by the end of 2018 if this pattern holds.

“Consensus estimates are calling for the earnings peak year over year [now]. And then that means, by the time we get to the end of ’18, we could be close to zero,” he said. “Consensus is around 15 percent – that’s a pretty big gap.”

Clissold is chief U.S. strategist for Ned Davis Research Group. He and his team are responsible for the firm’s U.S. equity, asset allocation, style, sector and equity theme analysis. Previously, Ed worked at Strong Capital Management and as a market strategist at J.C. Bradford & Co.

But Clissold isn’t the first on Wall Street to grow cautious. Longtime “wall of worry” bull Jim Paulsen of The Leuthold Group signaled Monday that he believes the rally could be “running low” on liquidity “juice.”

“Since this bull market began in March 2009, annualized growth in the M2 money supply has been 6 percent compared to only 3.6 percent nominal GDP growth,” wrote Paulsen in a note. “During the last six months, financial liquidity has contracted mildly, signaling the foundation under investors’ feet may be turning to sand.”

For his part, Clissold believes there may be one catalyst in the background that could breathe new life into the exhausted bull: tax cuts.

“The tax cut really could be a game changer and kind of save the consensus numbers,” Clissold told Santoli. “If you took the tax rate down to 20 percent, which is the latest proposal, it could be around a 7 percent boost to S&P 500 earnings.”

“If the effective tax rate goes down to 15 percent, then you could have a 14 percent jump in earnings. So that 7 to 14 percent window is what we think could get from a tax cut. And again, that could be the difference between the numbers coming in where analysts are expecting and a pretty big mess.”

With Republican lawmakers scrambling to pass some version of tax reform before the new year, Wall Street turns its eyes toward Washington. Top GOP legislators joined then-candidate Donald Trump in calling for drastic tax reform during the 2016 campaign, a promise many hope to keep.

Senate Republicans unveiled a plan to cut the corporate tax rate and tweak the individual tax system last week. The Senate proposal retained the reduction of the corporate rate to 20 percent present in the House version, but kept the number of individual tax brackets at seven.

See here for the full priceshall PRO report and interview video.