Dear Valued Clients and Friends,
The Senate and House have now each passed their own respective tax bills, and as of press time are going to conference to see where the two plans can be reconciled. We address where we see this ending below, and cover a few other topics that need coverage. So with all that said, take a break from holiday shopping and join us in the Dividend Cafe …
How will the tax plan play out from here?
As we have been writing for quite some time, a signed tax reform bill is going to be a reality quite soon. There are open questions, but from our vantage point, one of them is certainly not whether or not the President will sign the bill put before him. The question is what the bill will look like after conference (as the House and Senate bill do have some differences to be reconciled). I lean towards the view that says the Senate bill will serve as the foundation of what comes out of conference, not the House bill, but I do not believe that the House will sign the exact Senate bill; in other words, I suspect some tweaks (modest ones) to come out of conference. Some of the areas awaiting clarification include:
– When the new corporate tax rate will kick in (2018 or 2019)
– What the corporate tax rate will be (20% or 22%)
– Whether or not some marginal rate reduction will be added to offset the impact of SALT deduction removal
– What exactly will become of the AMT
– Whether the House plan for eventual estate tax repeal, or the Senate plan of merely doubling the exclusion amount (but no repeal) will become law
These are issues of interest and significance, but they are not cliff-hanging suspenseful. The basis shell of the plan is known, and this final inning will reveal the final details. The market now believes it will happen, has rallied behind corporate tax relief, and is creating some investable opportunities from our perspective.
How does the final bill change things?
The benefit to multi-national corporations has compressed a bit in recent days as the one-time repatriation cost has increased, making the move to bring cash back on shore marginally less appealing. But for those small and mid-cap domestic companies with high effective corporate tax rates (they did not benefit from many of the loopholes and deductions), their cash flow and earnings per share stand to benefit tremendously. We do believe the bill will result in higher interest rates (more government debt to finance deficits before growth kicks in), yet not more corporate credit (the bill limits tax deductibility of debt interest). These conclusions force us to call for MORE selectivity in equities, and MORE selectivity in bonds.
Teaser of that selectivity
We would suggest that besides the small and mid-cap equity advantage we think has not yet been priced into stock prices, the Financials Sector and Energy sector are likely to be bigger beneficiaries than has yet been appreciated (the financial sector on two fronts: the lower tax rates growing their cash flow and earnings, plus the benefit to their revenue that a steeper yield curve will command if, indeed, the aftermath of the bill includes modestly higher interest rates).
And disadvantaged by the bill should be High Yield bonds, companies who have done a lot of tax avoidance silliness (like inversions), and certain maturities of Treasury bonds.
And how will companies use this new cash?
Whether we are talking about increased cash flow due to a lower tax liability, or large cash balances repatriated to the states under the tax holiday provisions of this bill, many companies are going to have more cash on hand because of this tax reform bill – period. The big question for markets will be how that cash gets deployed. Economically, the desire of policymakers is that companies use it stimulatively to generate growth, build factories, hire laborers, increase wages, etc. Indeed, I fully expect all of that to happen, and then some. Politically, there is some “fear” that companies may instead just buy back stock and pay out dividends. I would point out that while I wholeheartedly disagree that even that would be counter-productive economically (wealth creation and shareholder value are net positives vs. redistribution confiscation in a free enterprise economy), the fact of the matter is that from an investment standpoint, if that “negative” were to happen, it would be extraordinarily positive.
Regret as Primary
Though I’m heavily borrowing from my mentor, Nick Murray, this warrants sharing. The primary driver of investor mistakes is not fear, and it is not greed, though both are up there, and both are connected. Rather, I believe, it is regret. When one does not pare down risk, and then markets make them wish they had, their regret often leads to incredibly bad decisions. More commonly, and more relevant, when one exits markets prematurely, or delays entry, and then markets punish their decision, the consequent regret is generally catastrophic. The only solution is to seek the best decisions at all times, disciplined, balanced, sensible decisions, divorced from emotions – especially the emotion of regret.
Doesn’t tax loss selling crush losers further?
MLP’s enjoyed their strongest week since June last week, a notion previously thought impossible in a space that has struggled in price performance throughout the year. One of the most often used excuses in November or December price pressure is “tax loss selling is exacerbating the downside,” which makes it difficult to explain why a sector may be rallying in the same months despite a bad calendar year. The reality is that tax loss selling is such a small part of total trading volume, that while it can always be impactful if it is the top technical activity at play, it also is highly subject to being outranked by big fundamental news (when such surfaces).
Currency and Stocks
One of my biggest pet peeves is when the media or an investor (or frankly, sometimes actual investment professionals) repeat the mantra that as a permanent truism, a weak currency is good for a country’s stock market, and a strong currency is bad for it. Frankly, it defies prima facie levels of intelligence or empirical fact to assert such, but stems from the pedestrian analysis that in certain windows, and in certain situations, a weak currency has boosted stock prices. What gets missed in this analysis whether in a particular situation or just broadly is that the reason for the currency movement matters. Currency strength behind a growing economy can be very bullish. Currency strength impairing export competitiveness can be very bearish. Currency weakness in a sugar rush of monetary stimulus can be temporarily bullish. Currency weakness behind geopolitical tension can be bearish. I could go on and on (but won’t) – just avoid simplistic assertions about currency/equity relationships.
We wrote about this with specific attention to the Japanese Yen and Japanese equity market at our Market Epicurean site here this week.
Choose your poison
The good news is that total household debt used to represent over 200% of total government debt (as recently as 2001), and now is only 100% of the amount of total government debt (meaning, they are about the same). The bad news is that, well, while household debt has de-levered substantially since 2008, the reason for the huge spread coming together is that government debt has increased $17 trillion in that same time period. Government deficit spending has been in hockey stick growth since 2007; household debt is lower. You can decide which is more potent – the good news of controlled household spending or the bad news of government spending.
Disappointment abounds in 2017
How could anyone be disappointed by 2017 (as an investor)? Stocks are up, Bonds are up, Real Estate is up, Emerging Markets are up, and even Alternatives are up. Don’t we celebrate positive returns? Of course, and I get it. But this is crucial to understand – in periods of high volatility, expected returns into the future go higher (because of the basic economic laws of volatility); the low volatility of 2017 has not created some of the buying opportunities that most years create. Is this disappointing? Probably not psychologically, but it is mathematically.
Chart of the Week
A reminder as to why corporate tax reform is so needed from a global competitive standpoint:
- Strategas Research, Policy Outlook, p. 7, Dec. 4, 2017
Quote of the Week
“Predictability and gradualism may not be a virtue.”
– Hyun Song Shin
* * *
As 2017 draws closer to an end, please think over the things that ought to be re-addressed at bare minimum once per year. Where has the portfolio activity of 2017 left your financial plan? Are there any changes in your estate plan warranted by the new tax bill (or by changes in your life and family circumstances)? Are your risk management plans up to date? Do cash flows or cash reserves need to be discussed? Have you had a review done lately for your Property & Casualty insurance coverages? Are you happy with your tax planner as you enter 2018 and prepare for the 2017 tax year?
All of these things (and more) are at the heart of what each of the advisors at The Bahnsen Group are doing day in and day out. These conversations are important. We aim to be an accessible wealth management team for our clients, no matter the situation! Let’s sit and chat.
And in the meantime, go enjoy some holiday candy. USC gave us a Pac-12 championship. Christmas lights are up everywhere. This really is a festive season!
David L. Bahnsen, CFP®, CIMA®
Chief Investment Officer, Managing Partner
The Bahnsen Group is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.
This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.
All data and information reference herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary, it does not constitute investment advice. The team and HighTower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.
This document was created for informational purposes only; the opinions expressed are solely those of the team and do not represent those of HighTower Advisors, LLC, or any of its affiliates.
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