President Donald Trump and the White House reacted favorably to the passing of the Tax Cuts and Jobs Act by the Senate on Dec. 2. So, too, did anyone who presumes to know what the tax plan means for stocks.
“The Senators who voted for these historic tax cuts did a great service to their constituents as they supported putting America first, growing the economy, and rebuilding our great country,” stated the White House’s Office of the Press Secretary. “The policies in this bill will cut taxes for hardworking families and put our economy on a path of sustainable economic prosperity and job creation.”
What they didn’t say was that the passing of a bill by Congress that cuts taxes will keep the nine-year-and-counting bull market chugging along, putting more money in the hands of investors. Let’s all say it together: “Thank you, Donald Trump, for keeping the gravy train going!”
What a Christmas present this will be for investors of all stripes! It’s a win for everyone who invests in the markets … right?
Not exactly. Here are 10 reasons why the tax plan could be bad for stocks.
What the Tax Plan Means for Stocks: It Doesn’t Help the Middle Class
Care to guess when America was its strongest economically?
From the end of World War II to 1970. At least, that’s true if we’re talking about all income groups doing well.
“In the immediate postwar period, America’s rapid growth favored the middle and lower classes. The poorest fifth of all households, in fact, fared best,” stated Jordan Weissmann in a 2012 article for The Atlantic. “Then, in the 1970s, amid two oil crises and awful inflation, things ground to a halt. The country backed off the postwar, center-left consensus — captured by Richard Nixon’s comment that ‘we’re all Keynesians now’ — and tried Reaganism instead. We cut taxes. Technology and competition from abroad started whittling away at blue collar jobs and pay. The financial markets took off.”
Don’t for a minute think that stocks are going to continue to do well once the 99% figure out they’ve been had.
What the Tax Plan Means for Stocks: Education and Healthcare Will Be Gutted
“Republicans insist this plan will cut taxes for the middle class, but the truth is that any meager savings will be offset by losses elsewhere — in deductions no longer allowed, loss of Medicaid and Medicare coverage, and less funding for education, all of which are on the chopping block in order to provide a tax cut for a few very wealthy people like me,” Abigail Disney, the grandniece of Walt Disney, the founder of the Walt Disney Co (NYSE:DIS) recently wrote in an opinion piece for USA Today.
If you don’t take care of the sick and fail to educate the masses, eventually you run out of workers to fill the so-called “well-paying jobs” American companies are meant to create with this tax windfall.
Some might, but a majority are going to buy back shares and increase dividends, which will only help investors. While this might be good in the short term, the long-term implication is that average Americans are going to continue to lose ground to the rich and powerful — never a good thing for a country that prides itself on innovation.
What the Tax Plan Means for Stocks: More Overpaid CEOs
The average CEO in America is paid 271 times more than the average employee.
“Though CEO compensation has fallen slightly in the past few years, it has increased by more than 930% since 1978,” stated Fortune magazine’s Grace Donnelly in July. “CEO pay has grown faster than the stock market or the wages of the top 0.1 percent.”
CEO compensation is driven in large part by delivering higher profits, something a 20% corporate tax rate will naturally deliver when compared to the 35% tax rate currently in place.
Even if companies put ceilings on the number of stock options and awards available to senior executives, the value of those awards will likely rise as share prices typically follow earnings.
The problem with this windfall is that it artificially hides the true effectiveness of CEOs. Is it the “good work” of the CEO that’s boosting earnings or a lower tax rate? As a result, a lot of bad CEOs are also likely to stay in their jobs long past their due dates.
Eventually, the chickens come home to roost, which would be very bad for stocks.
What the Tax Plan Means for Stocks: No Money for Infrastructure
By now we’ve all heard and read the amount by which the federal deficit is projected to increase over the next decade — $1.5 trillion — as a result of the $6 trillion cut in taxes.
America’s crumbling infrastructure isn’t going to be fixed when the federal government’s revenues are going the wrong way. President Donald Trump promised an infrastructure plan, but with lower revenues expected over the next decade, it will be tough for him to deliver.
And don’t for a minute expect private businesses to jump into the fight to save the day with their new-found wealth.
“Does anyone really believe that corporations, with their tax savings, are going to build or repair roads, bridges, levees, dams, electric grids, internet expansion … or train a workforce for the future?” said a Dec. 3 letter to the editor of Detroit Lakes Online. “Only the government can plan and fund grand projects we need to maintain what we have and push forward.”
Without infrastructure investment, the U.S. is doomed as an economic power. Ultimately, this lack of investment will deliver a crushing blow to stocks.
What the Tax Plan Means for Stocks: A Recession Is Right Around the Corner
The beautiful part of studying history is that understanding the past helps you plan for the future.
Economic historian Robert McElvaine, whose expertise lies in the Great Depression, believes the tax plan can only end badly for America.
“Republican policies in the ’20s … pushed to concentrate more of the income at the top. Nine decades later, Republicans are rushing to do it again — and they are sprinting toward an economic cliff,” McElvaine wrote in a November 30 article in the Washington Post. “Another round of Government of the People, by the Republicans, for the super-rich will be catastrophic. The American people must call a halt before it’s too late.”
He’s not the only one.
Portfolio manager Steve Goldman recently appeared on CNBC discussing the tax plan calling it “fiscally irresponsible” and totally out of character for the Republican party.
At the end of the day, it will add minimally to the economy in the short term and long term could send the U.S. into a recession.
Stocks didn’t do very well in 1929 or 2008.
What the Tax Plan Means for Stocks: The Let-Down Will Be Dramatic
The Republicans have guaranteed job growth like America has never seen. The problem with that theory is corporations aren’t likely to play along. The economy’s doing fine and corporate profits are at or near record levels.
The tax cuts will simply add to the cash piles America’s biggest global companies already hold on their balance sheets, much of which will be redirected to shareholders or to make acquisitions that will result in cost savings, including downsizing.
“The last time Republicans passed a tax holiday for overseas profits, the 15 companies that benefited most ended up cutting more than 20,000 net jobs and curtailing research investment,” stated Justin Miller of The American Prospect. “Instead, they pushed their cash piles into their shareholders’ pockets.”
Miller is talking about the 2004 tax holiday implemented by George W. Bush.
Going back to 1986, Ronald Reagan cut corporate taxes from 48% to 35%, and that resulted in five years of annual investment growth of just 1.6% compared to almost 8% growth between 1977 and 1981.
Companies haven’t been investing in growth since 1982 when gross business investment peaked at 15% of GDP.
When everyday investors figure out that this tax plan isn’t about making America great, but rather lining the pockets of the wealthy, they’re going to lose faith in the country and by extension the markets.
What the Tax Plan Means for Stocks: Share Repurchases at Increasingly High Share Prices
There’s an interesting stat about share repurchases according to a recent article from Bloomberg.
“Before this year, a portfolio of companies that regularly repurchased their shares beat the market in six of the past nine years, sometimes by a wide margin,” stated the November 20 Bloomberg article. “Buyback stocks, for instance, were up 45 per cent in 2013, which was 13 percentage points better than the market in general.”
As companies plow more money into share repurchases, that naturally pushes stock prices ever higher, which is great for shareholders in the short term but it reduces the effectiveness of this capital allocation lever in the long run because it’s wasteful spending.
After a nine-year bull market very few companies should be buying back their stock, but that’s exactly what’s going to happen with the increased profits when debt reduction would be a wiser move at a time when corporate debt is nearing record levels.
What the Tax Plan Means for Stocks: The Bill Always Comes Due
The tax plan would add approximately $1 trillion in additional debt over the next decade after accounting for the incremental growth created by the cuts.
But with the economy strong — 3.3% GDP growth on an annual basis and 4.1% employment — it would seem the sensible thing to do is pay down the debt so that when the next recession comes down the pike, the federal government is in sound fiscal shape.
“It would be a reasonable question to ask, is this the best time to apply fiscal stimulus, when the economy’s already close to full employment?” New York Fed President William Dudley said recently. “It’s probably not the best time.”
Of course, it’s not.
The wealthiest 1% have already had a giant gift given to them over the last nine years and now this tax plan wants to reward them a second time with lower taxes.
It’s a bad move that will come back to haunt stocks.
What the Tax Plan Means for Stocks: Corporate Tax Rate Cut Doesn’t Happen Until 2019
Before you start counting your shareholder rewards from dividends and share repurchases, it’s important to note that the Senate bill doesn’t implement the corporate tax cut until 2019.
A lot can happen in a year.
A recession could sneak up on the country which I discussed earlier. A war could break out with North Korea. Who knows what could happen.
We’ve already seen what happens when uncertainty creeps into the markets over the tax plan. If there’s any change of heart from legislators between now and 2019 on the cut in corporate tax rates — though there are no signs of this — stocks will definitely face downward pressure.
What the Tax Plan Means for Stocks: It’s Bad for America
No, I’m not talking about right vs. left, Republican vs. Democrat, I’m speaking about the underbelly of American society; those on the fringe surviving on the kindness of charities across the country.
By increasing the standard deduction taxpayers can take each year, there will probably be less money going to donations to 501(c)(3)s.
“That incentive to give has been part of the American fabric for a hundred years. Will they still give? Yes,” stated Tim Delaney, the president and CEO of the National Council of Nonprofits. “Will they give as much? The experts say no.”
Some predict that charitable giving could drop by as much as $13 billion annually as a result of the changes to the tax code.
In a country that doesn’t provide universal healthcare to all of its citizens, this drop in charitable giving will be devastating to the least able to cope.
Socially responsible investors will take their money elsewhere. To places where the safety net still means something.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.