What a day in terms of news!
- Trump announces a tax reform plan.
- The Freedom Caucus caves in and announces its support for the new Obamacare reform bill. The Freedom Caucus (far right) bombed the last bill.
- Trump might issue an executive order next week to withdraw from NAFTA.
Here are our thoughts on these new developments.
The tax reform plan is very bullish for equities
Trump’s tax reform plan is very ambitious. Here are the 5 main parts of the plan:
- Cut corporate tax rate from 35% to 15%.
- Reduce the income tax brackets from 7 to 3, with the top bracket at 35%.
- Tax U.S. companies ONLY on their U.S. generated income.
- A one time tax on U.S. companies’ funds held overseas (foreign cash repatriation). Trump has not decided on a tax rate yet.
- Cutting down on all tax loopholes.
As you can see, this is a very ambitious plan, and is most certainly dead on arrival. However, having a ridiculous opening plan is part of Trump’s strategy. In the “Art of the Deal”, Trump said that you should always start out with a very ridiculous “ask” during a negotiation. Then you slowly work your way to the middle on an agreement that both sides can stomach.
We’re not going to speculate on what exact parts of this tax reform plan will be passed and what parts won’t be passed. Who knows. But the key here is simple. Some parts of the plan will be passed, even if the tax cuts are smaller than anticipated. E.g. the corporate tax rate might be cut from 35% to 28% instead of 15%. The Republicans know that if they pass no tax cuts or any pro-growth policies, they will get killed in the midterm elections next year.
Some bearish investors argue that this will be a “sell the news” event. They say that if the market isn’t impressed by whatever tax cuts Congress does eventually pass, the market will fall.
Perhaps they are right in the short term. Perhaps they are wrong in the short term. It’s impossible to predict how the market will react to fundamental news. For example, the S&P 500 fell on news of Obama’s 2009 recovery plan, even though that plan had a very positive impact on the U.S. economy and stock market in the medium-long run!
The key point to remember is that regardless of how the stock market reacts to this news in the short term, tax cuts are inherently bullish for the U.S. economy in the medium-long run. Perhaps tax cuts won’t generate as much growth as the Administration predicts, but it will generate SOME economic growth. Any extra growth is better than no extra growth.
More importantly, tax cuts directly increase earnings for U.S. companies! The medium-long term outlook for the stock market is driven by the state of the U.S. economy and corporate earnings growth. Every 1% decrease in the corporate tax rate equals to $1 increase in earnings-per-share (EPS) for the S&P 500! 12 month forward EPS for the S&P currently stands at $135.9, so a mere 7% decrease in the corporate tax rate will lead to a 5% increase in earnings across the board for U.S. stocks! This is very bullish indeed.
Click here to learn why the U.S. economy is so strong right now.
Perhaps healthcare reform plan will be passed
*Let’s get this straight. “Healthcare reform” is basically just a euphemism for “let’s repeal Obamacare”.
As we’ve mentioned before, Trump needs to repeal all or part of Obamacare. None of his tax reform plans include any tax/revenue raising mediums, which is what will make the plan hard to pass. It’s easy to pass a budget neutral bill but hard to pass a bill that will add trillions of dollars to the federal debt.
Repealing Obamacare would have saved the U.S. government $100 billion each year, thereby funding Trump’s tax plans. But unfortunately, the far right Freedom Caucus bombed the last Obamacare repeal bill.
Keep in mind that the Freedom Caucus wants to repeal Obamacare – they want to repeal ALL of it. But in their weird logic, they would rather repeal NONE of it than repeal some of it. That’s why they bombed this bill a few weeks ago.
Today, the Freedom Caucus announced that it will cave in and agree to repeal some of Obamacare instead of all of it. In other words, the Freedom Caucus is finally willing to work with moderate Republicans.
This bodes well for Trump’s tax reform plan.
A White House official has confirmed that Trump is considering an executive order signalling the U.S.’ intention to withdraw from NAFTA. Perhaps the S&P will fall a few percent if Trump signs this order. Who knows. But this is irrelevant.
It’s one thing to “sign an executive order SIGNALLING the U.S. intention to withdraw from NAFTA”. Everyone knows that this is a joke. Congress will not approve of this.
It’s another thing to “sign an executive order TO withdraw the U.S. from NAFTA”. Such an action would be immediately blocked by a federal judge, rendering this executive order useless. Trump simply cannot argue a NAFTA withdrawal on the grounds of “national security”.
In short, this executive order might cause a short term dip in equities, but will have no impact on the market’s medium-long term outlook.
The future for the U.S. stock market is indeed bright and sunny. We are 100% long stocks.