Q4 Outlook: A Look at Key Issues, Sectors as 2018 Approaches

The stock market continued to hit new highs through the third quarter, confounding those who focused on the rapidly changing headlines in the U.S. and throughout the world. We believe there still are a number of key issues that investors should watch as we enter the final quarter of 2017. We also have updated our views on several key stock sectors. We believe there are opportunities in companies that continue to demonstrate strong fundamentals — despite the occasional distractions of the global news cycle.

Tax reform leads the agenda

Since President Donald Trump’s election in 2016, there have been varying expectations for a change in U.S. tax policy. A broad tax framework with the goal to make American companies more competitive recently was released by the “Big Six”: Speaker of the House Paul Ryan, Senate Majority Leader Mitch McConnell, House Ways and Means Chairman Kevin Brady, Senate Finance Committee Chairman Orrin Hatch, Treasury Secretary Steve Mnuchin and National Economic Council Director Gary Cohn. That group represents a wide swath of both the legislative and executive branches of the federal government.

Overall, we believe this plan is a positive move. It consists of a reduction in both individual and corporate tax rates and eliminates many deductions. Under the proposal, the corporate tax rate would be reduced to 20% versus the current federal rate of 35% and an average of 22.5% for other industrialized countries.

The proposed tax plan also calls for an incentive to increase capital spending. Republicans plan to pass this legislation under rules allowing a simple majority in the Senate, meaning no support from Democrats would be needed. We are cautiously optimistic that some version of tax reform will be signed into law.

Trump has continued to seek improvements in infrastructure across the U.S., as he did during his presidential campaign. We believe the focus of his administration will turn to infrastructure only after tax reform is completed. The discussion, however, is likely to focus on how to pay for infrastructure projects. We don’t think there will be broad support for large deficit-financed infrastructure spending. We think a more likely solution will come via a focus on public-private partnerships.

Trump also has been active since his election in pushing for deregulation as a way to support U.S. businesses. We believe this will continue to be a focus of the administration and think it will provide a positive impetus for business confidence and economic activity.

Changing tone of monetary policy

Global monetary policy continues to diverge. Even so, it is clear that more central banks are moving away from their crisis-induced policies that were prompted by the global financial crisis that began in 2008. We believe this divergence should be watched carefully as different parts of the world begin to exit extremely easy monetary policies.

The U.S. Federal Reserve (Fed) has hiked interest rates four times since late 2015. We think the Fed will raise rates again in December and two more times in 2018.

The Fed also has announced that it would begin to reduce its balance sheet starting Oct. 1 by allowing maturing Treasury and mortgage-backed securities to roll off. The drawdown will initially be capped at $10 billion per month and will increase by $10 billion each quarter until it reaches $50 billion per month. We think most financial markets already are pricing the drawdown into their projections and do not expect major volatility as a result of the Fed’s actions.

The European Central Bank (ECB) continues to purchase 60 billion euros per month in securities. We expect the purchase amount to wind down throughout 2018 until it reaches zero, with interest rates remaining at current levels.