“All In” on Tax Reform
It’s debatable whether President Trump has accomplished more during his first 100 days in office than any other president, as he has boasted. But much less debatable is the extent to which many investors believe that his pro-business agenda will boost the U.S. economy.
The S&P 500 Index on May 8 traded above 2,400 for the first time ever, powered by sizable gains in tech giants Apple (NSDQ: AAPL), Microsoft (NSDQ: MSFT) and Alphabet (NSDQ: GOOGL), the parent company of Google.
It’s no coincidence that those three companies would be among the biggest beneficiaries of Trump’s intention to reduce corporate income tax rates. They also would benefit if Trump makes good on his promise to allow U.S. corporations to repatriate cash held overseas for a reduced domestic tax rate.
According to Moody’s, Apple holds $230 billion of cash overseas, accounting for more than one-fourth the total value of all its stock. Microsoft has about $110 billion parked offshore, while Alphabet looks puny in comparison with “only” $52 billion or so sitting in foreign bank accounts.
Even if Trump is successful in getting his tax plan approved, that doesn’t necessarily mean most companies will suddenly achieve outsized profits. A few of them will, but for many the gain will be relatively minor and short-lived. However, what they do with that money could lift the overall stock market by triggering a wave of stock buybacks, special dividend payments, and mergers and acquisitions.
Here’s the rub: If most of that cash is only used to pay down debt, the specific stocks would benefit but the overall economy would be deprived of stimulus.
Given the lack of progress in the other elements of Trump’s economic blueprint, it appears the stock market is betting the ranch that major income tax reform will happen, and soon. However, if tax reform gets delayed or derailed, it’s not clear what else can underpin the market’s lofty valuation.
This week’s firing of FBI Director James Comey adds another layer of uncertainty regarding Trump’s ability to gain congressional approval for his ambitious legislative agenda, including tax reform. At this point, investors are essentially gambling that Trump will manage to get his tax cuts passed before the fallout from his ties with Russia escalate any further. He still may be able to pull it off, but if he doesn’t then a swift stock market correction is most likely in the cards.
As every successful gambler knows, “you gotta know when to hold ’em, and know when to fold ’em.” We do not advocate getting out of the stock market altogether, but we do recommend mitigating downside risk through a combination of asset allocation, portfolio diversification and using stop limits to limit losses if a correction occurs as discussed in the next edition of Personal Finance.