What the Tax Cut Plan Means for Markets

Jim Woods

Question: What’s been the biggest driver of stocks since the election of Donald Trump as the 45th president?

Answer: The hope of tax cuts.

Today, that hope got a little bit closer to reality, as Republican congressional leaders unveiled their plan to reform the tax code.

Long-time readers of this publication and my Successful Investing newsletter know that I’ve constantly written about the “hope trade,” in markets, i.e., the hope that the president’s pro-growth campaign agenda would translate into real-world economic and market stimulus.

And while much of that hope has been dashed on many fronts (e.g. health care reform) the one remaining hope, as well as the most important, is tax reform.

Here are some of the key specifics of the GOP plan released today:

  • A slash in the corporate tax rate to 20% from 35%
  • A cut in the “pass-through” business tax rate to 25%
  • A reduction of individual tax brackets to three, with a top rate of 35%
  • A doubling of the standard personal tax deduction
  • Elimination of the state and local tax deduction
  • Elimination of the estate tax and the alternative minimum tax
  • Expansion of refundable tax credits for childcare/dependent care
  • Allow businesses to accelerate expensing of investments
  • Create a one-time repatriation of foreign earnings

My impression of this proposal is… it’s a decent start.

Of course, that comes from my admittedly radical mindset on the tax issue, one that thinks that, morally speaking, all forms of taxation represent government theft.

Yes, I know I am in the minority here when it comes to my purest view, but being in the minority on an issue never stopped me from holding that view. And, just because a view is in the minority doesn’t mean it’s incorrect.

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Galileo held a minority view of the cosmos, and he was convicted of heresy by the Catholic Church for his belief that the Earth revolves around the Sun. A view, of course, later validated by reality.

As for markets, the tax proposal offered up by the GOP today could be either a bullish game changer or a bearish game changer, depending on whether its key proposals actually become law (or fail to become law).

From a bullish standpoint, a tax cut (particularly a sizeable corporate tax cut) could easily push the S&P 500 up another 4% (about 100 points, or over 2,600), because that will increase expected 2018 S&P 500 Earnings Per Share to (conservatively) $145/share.

From a bearish standpoint, while tax cuts aren’t fully priced into stocks, there is the expectation something does get done, especially regarding foreign profit repatriation.

If tax cuts, like health care, fail, then we’re now sitting with a market at 18 times next year’s earnings with no identifiable future growth catalyst, and with a Federal Reserve that’s committed to raising interest rates and normalizing its balance sheet (not good for the bulls).

My go-to research source, as well as a provider of research for the Intelligence Report newsletter, Tom Essaye of the Sevens Report, summed up the tax cut situation for me nicely. Here is what Tom says the market expects out of the final tax reform legislation, and how it likely will react to the different tax reform scenarios:

  • What’s Expected: Corporate rate cut to around 28%. Likely market reaction: Mildly positive.
  • Bullish If: Corporate rate cut below 25%. Likely market reaction: The “reflation trade” sectors (e.g. financials, banks, energy, small caps) outperform.
  • Bearish If: Corporate rate doesn’t change. Likely market reaction: Modest decline in equities, but not a bearish game changer.
  • Foreign Profit Repatriation Holiday: Expected to pass. Likely market reaction: Positive for super-cap tech stocks and for multi-national consumer companies.
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The one wild card to watch here that both Tom and I were surprised and, indeed, encouraged to see was the “pass-through” rate cut proposal.

This is very important to small businesses (including my own). The reason why is that approximately 95% of American businesses are structured as pass-through tax entities, i.e. they are structured as LLCs, S Corps, etc. In this situation, the business owner is taxed at the individual tax rate, far higher than large corporations are taxed.

A cut in the pass-through tax rate lowers taxes for small business, and that could be a potentially significant (and unexpected) positive for the economy (assuming Congress can get its act together and actually pass at least some version of this proposed tax reform).

The bottom line here is that I don’t want you to let either the positive or the negative headlines regarding the tax reform proposals fool you. The fact is that the tax cut battle has only just begun, but how it works out will have potentially significant consequences for the economy… and for the markets.

As the battle unfolds, I will be there for you to make sense of it all, and to provide a little Galileo-esque perspective.

Upcoming Appearances

Dallas MoneyShow, Oct. 4-6: If you’re in the “Big D” in early October, then come by the Hyatt Regency Dallas and see me, as well as many other great industry speakers, at the Dallas MoneyShow. I will be giving a presentation on Friday, Oct. 6, 8:00 – 8:45 a.m., titled, “5 ETFs to Fight the Fake News.” For your complimentary tickets, go to Woods.DallasMoneyShow.com.

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Remember What Barry Said

“Where is the politician who has not promised to fight to the death for lower taxes, and who has not proceeded to vote for the very spending projects that make tax cuts impossible?”

— Barry Goldwater

The intellectual prowess of the late, great Barry Goldwater cannot be denied, even if you disagree with him on the issues. In this memorable quote, the conservative icon, author, Senator and presidential candidate reminds us that politicians like to make a lot of promises when it comes to tax reform. Yet they also like to spend, spend, spend… which sabotages those promises. Don’t be surprised if that happens again.

Wisdom about money, investing and life can be found anywhere. If you have a good quote you’d like me to share with your fellow readers, send it to me, along with any comments, questions and suggestions you have about my newsletters, seminars or anything else. Click here to ask Jim.

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