No, Tax Reform Didn’t Drive Massive Business Investment, and That’s Fine for Stocks

While US Q1 GDP slowed across the board, one category held up pretty nicely: business investment, which rose 6.1% annualized, a shade slower than Q4 2017’s 6.8% advance. But still a fine figure. Rather than cheer the good news, though, headlines found a cloud in a silver lining, bemoaning that the tax cut didn’t fuel a surge in business spending. Politicians piled on, grousing that tax cuts helped Wall Street investors in multinationals, not the people working for them—or unemployed folks who would benefit from, say, a new plant being built. For markets, this debate is largely sociological, but it also misses a broad point: Taxes aren’t a huge driver of business investment. That is a big reason why we warned readers last year not to expect a huge economic boost from the tax cuts—and reminded folks one wasn’t necessary for the bull market to keep going. Our view hasn’t changed: Stocks can still do great without a massive, tax-cut-induced business investment surge.

It was always a stretch to presume tax cuts would juice business investment. While statutory tax rates fell, corporations’ effective tax rates haven’t changed nearly as much—closed loopholes, scrapped deductions and limited exemptions offset some if not all the gains from headline tax cuts. Besides, taxes generally aren’t a major business driver. Companies plan and invest based on growth opportunities they see and their projected long-term results. Taxes are part of that calculus, but the underlying demand for their products and services matters a lot more. They also have to balance risks, like preventing bloat. Unproductive investments do much more harm than good long term. Companies are particularly aware of this in the wake of 2008’s deep recession, when they had to get super lean and mean overnight to stay afloat.

This also isn’t the economy of the 1950s or 1960s, when business investment may have meant a massive outlay in building a new factory that brings scads of jobs. The modern, services-and-Tech heavy economy requires less machinery. It can be more remote (and on cheaper land). It may have few employees, like a data center. And even building a data center is getting cheaper over time, as technological advances drive down prices for computing hardware and software. That said, these investments may carry a massive return despite the relatively small investment needed—exactly the kind of scenario stocks love.

Surging business investment isn’t necessary for the expansion to continue anyway. Judicious business investment—not spending for its own sake—can aid growth. This is especially true given we are in an environment where many fear overheating. If companies threw caution to the wind and invested willy-nilly, the risk of bad investment generating big losses later would rise.

The crestfallen reaction to positive-if-moderate Q1 investment figures seems mostly telling about investor sentiment. And it is quite bullish, in our view, as a neither too-hot nor too-cold reality seems set to overwhelm expectations. This strikes us as another example of people seeking causes for volatility, which they have done repeatedly since the correction started in January. That is unlike typical early bear market sentiment, when it is common for punch-drunk investors to explain away negatives and paint pictures of permanent positivity. Count today’s oddly mixed reaction to Goldilocks investment figures as yet another brick in the wall of worry for stocks to climb.