Sunday, February 12, 2017

Trump and the Upcoming Phenomenal Tax Cut: Economic Nirvana Just Around the Corner?

Trump said last Thursday (2/9/17) that he had a "phenomenal" tax cutting plan that would be ready in two or three weeks. The Press Secretary, the Alternate Fact Guy, later referred to that plan as an outline. Trump says ‘phenomenal’ tax announcement coming in weeks - MarketWatchWhite House: Cohn-Led Tax Plan Is Real and It’s Phenomenal - BloombergWhite House Aims to Send Tax-Plan Outline to Congress Within Weeks | Fox Business

The Stock Jocks reacted by increasing stock prices by $175 billion that day and another $100 billion on Thursday. 

Tax cut mania has been driving stock prices up since the election.  

S & P Closes
11/8/16 = 2,139.56
2/10/17 = 2,316.1
Point Gain 176.54
Percentage Gain = 8.25%

As of 2/10/17, Birinyi Associates calculated the SPX TTM GAAP P/E at 24.48 and the 12 month forward NON-GAAP P/E based on current operating earnings estimates at 17.75. P/Es & Yields on Major What is more unnerving to me than those numbers is that these multiples exist almost 8 years into an economic recovery and investors accept the forward estimated non-GAAP earnings estimates even though they have been way too optimistic for years. (see tables here)

I have set an alert for March 2nd  to set aside time to review Trump's tax plan in outline form which may take about five minutes. 

Rational investors are aware of Trump's generous use of superlatives and know that the existing GOP tax plans have several negatives and positives for earnings.

Yes, I know. He will be the greatest job creator in the history of the United States and the universe since the big bang. He is after all Unbelievable in so many ways. 

Border Tax Adjustment

A large number of major U.S. corporations and donors oppose this idea. 

The border tax adjustment, which is an integral part of cutting the statutory corporate rate to 20%, could be extremely disruptive by taxing imports by 20%. Taxing Tax Changes - Barron's

Yes, I know that is not a "tariff" but those who pay it and foreign nations who are disadvantaged by it may not see the difference between a 20% tariff and a 20% border tax. So the argument is that foreign nations will not "necessarily" respond negatively because the border tax is similar to value added taxes. Wishful thinking IMO. 

If the USD rises to offset that tax, as economists claim (and when have they ever been wrong?), then that will negatively impact multinational earnings.

A 20% rise in the USD would have severe impact on countries and companies that have U.S.D. denominated debt. 

A relatively fast 20% rise in the USD could easily cause stress in the world's banking system. The Emerging Markets' Dollar Problem - Bloomberg GadflyBIS Flags Emerging-Market Risks as $340 Billion of Debt Matures - Bloomberg 

Even if there are not defaults sufficient to cause a domino risk to the financial system, debt servicing problems can lead to lower demand and slower growth unless we have already forgotten that lesson. The EM market in particular has been a major contributor to U.S. multinationals revenue and earnings.

Didn't Trump say he wanted a weaker dollar? He allegedly had to call Flynn at 3:00 A.M. to find out whether a strong or weak dollar was better. President Trump: Is a Strong Dollar Better than a Weak One? | Money

My best guess is that 75% to 100% of the increase in import prices caused by the border tax will be paid primarily by consumers. The Middle Class will be hit by a phantom tax hike to pay for lowering corporate taxes. Initially, the USD will probably gain in value however. 

Some of the increase may have to be eaten by the importers who can not pass off to consumers the full amount, thereby lowering their profits. Spending more for gas, clothing and other imported goods is a negative for consumer spending which is not good for a consumer led economy.

There are estimates all over the place on how the existing House GOP tax plans will impact earnings. 

A Barclays' economist opines in the Barron's article cited above that earnings will increase 12% due to the tax cut for corporations and that will be halved by the border adjustment tax. 

Other parts of the GOP plan could knock off more of that gain such as eliminating the deductibility of interest. That kind of change would cause widespread bankruptcies for highly leveraged companies IMO that would negatively impact job growth. That kind of provision would also give a powerful incentive for solvent corporations to use the tax savings to pay down debt. If not used solely for that purpose, the other uses would include dividend increases, share buybacks and acquisitions of other companies that lead to job losses.

Merrill Lynch estimates that eliminating the deductibility of interest would shave 4% off 2018 earnings.

Corporate tax cuts will have a net positive impact on earnings, but the market is probably overly optimistic on the overall impact. 

Possibly, some of the bad effects could be mitigated by a ten year phase-in of this kind of tax. 

Tax Cuts: GDP and Job Growth 

Importantly, lower taxes and increases in earnings do not translate evenly into higher GDP growth and more jobs unless you believe in voodoo economics of course. 

The Bush tax cuts were supposed to generated one of these make believe perpetual growth cycles, but his eight years had the worst job creation record on record. The jobs created during the  four years of Jimmy Carter's presidency were substantially higher than those added during eight years of Bush. Bush On Jobs: The Worst Track Record On Record-WSJAughts were a lost decade for U.S. economy, workers

I adjusted the BLS to credit Bush with the job losses during 2009 and to subtract the job losses during his first year. The country was in a recession when Bush became President and when he left. The rationale is that any President can not do much in his first year to change the hand dealt to him. (him also means her when there is a her).  The result was 185,000 jobs lost during his 8 years.  FED's Jihad Against the Saving Class/ Bush Tax Cuts and Jobs 

The job creation and GDP growth numbers after Bush's tax cuts contained significant amounts of what I would call phony growth based on the housing bubble. Economic Impact of Home Building and Remodeling on the U.S. Economy 

The job creation and growth created by a parabolic increase in new home sales and all of the economic activity that goes with it skyrocketed during Bush's eight years and then plummeted to levels unseen in modern American history after the housing bubble burst.  

The Near Depression had as its epicenter improvident home mortgage lending and clearly excessive new home builds. 

As shown in the previous chart, new home sales remained below prior recession lows for several years and consequently did not play its normal role in an economic recovery. New home construction remains tepid almost 8 years after the last recession ended compared to prior recoveries. 

So can anyone really say that the Bush tax cuts led to any sustainable job creation and GDP growth? Just food for thought. 

It is interesting, perhaps coincidental, that supply side, trickle down economics dovetails nicely into rewarding GOP mega donors. At least the rich know what is in their self interest.  

The GOP believes that the 1981 Reagan tax cuts set in motion the stock market rally and the growth spurt in President Reagan's 8 year term. CRS Taxes and the Economy Top Rates.pdfNon-Partisan Congressional Tax Report Debunks Core Conservative Economic Theory-GOP Suppresses Study-Forbes Magazine 

I am grateful to Reagan for the 1981 tax cut, since I was then paying federal income taxes at a top marginal rate of 50% of my earned income (higher on dividends and interest income) and another 7.5% to Maryland. That was long overdue since the tax rates then created disincentives to work harder. 

However, even you disagree with economic reports showing no or minimal impact, how do you separate out other substantial positive economic factors that came together when Reagan started his term from the impact of the tax cuts? 

Interest rates had been a major problem for almost 15 years and were sky high when Reagan took office. 

The Federal Reserve successfully squashed the problematic inflation bogeyman and interest rates started to decline in 1982, the start of a long term secular bull market in bonds. The trend toward lower interest rates were a powerful secular economic force for both the U.S. economy and stock market.  

Productivity started to improve in large part due to the computer revolution and technology. 

The stock and bond markets started to add to wealth after subtracting from it adjusting for inflation.  

The country was coming out of a recession and a job loss period where consumers had postponed buying goods, creating pent up demand. 

The American consumer started their love affair with debt as did the Federal government. Spending ever increasing sums of borrowed money will spur job growth and GDP growth. 

We were told back then by David Stockman and others that the Reagan tax cuts would pay for themselves. The national debt increased from 907 billion to $2.8 trillion. 

The government was spending more borrowed money but so were consumers who discovered the credit card in growing numbers: 

The Age of Leverage began in earnest during Reagan's 8 years in office. 

The problem with GOP tax cuts is that they primarily benefit the wealthy who do not spend anywhere near their annual incomes while throwing scraps to the middle class and nothing to the poor who do. Through a sophisticated process of disinformation, the GOP has convinced millions of middle class voters that their tax cuts are for them.  

Unless you are a firm believer in trickle down economics, tax cuts for the wealthy are not going to translate into job and GDP growth that can be clearly isolated from other factors, and one of those factors is spending more and more borrowed money.   

What happens to demand when the GOP gives tax cuts to the rich but then takes away from safety net programs for the poor? Their belief is that the tax cuts will create jobs for the poor who then need less government assistance. We shall see in the fullness of time. 

Or another thought, what happens when the middle class receives a small tax cut and their incomes plummets due to abnormally low interest rates on their risk free savings? 

One thing is certain. If trickle down does not work, the result will not be accepted by the GOP politicians irrespective of evidence. Their money sources says it works---for them. Those who question the effectiveness of these policies will be playing whack a mole for generations to come. The question is whether the middle class will cease listening to the Republicans' path to prosperity through tax cuts to corporations and more tax cuts to the wealthy.  

Will Corporations Spend Tax Savings to Create Jobs and GDP Growth

One of the canards frequently expressed by supply side disciples is that corporations will open up their wallets to spend on plant, equipment and research when they have confidence in the future under a pro-business President.  

What happened under the last pro-business President, Bush Junior or during Daddy's Bush's reign. Forget about that.  Just make than much bigger and economic nirvana will surely follow.  

Personal consumption expenditures and job creation numbers have been good since the last recession ended in June 2009.  

I would just point out that corporations have been flush with cash for years and their investments in new plant, equipment and research as a percentage of GOP has lagged past recoveries. Corporate Profits After Tax (without IVA and CCAdj)-St. Louis Fed

Cash is being used freely to increase dividends and to buyback stock. In many cases, money is being borrowed to buyback stock. Will that spur job and GDP growth or just pump up stock prices and dividends? It is important IMO to be skeptical of those claims and to look at past history as well.  

Corporations do not behave as GOP politicians predict. If you give them a lot more cash to spend, some will invest to create new jobs while others will use the cash to buyback stock, increase dividends and for other purposes that can result in job losses.  

There was a repatriation tax holiday under Clinton. The corporations promised to create jobs with the cash. Most of them cut jobs and used the cash to increase dividends, buyback stock and increase executive compensation. 

What About Businesses That Operate as Pass Through Entities

What do you do with 80% of the businesses that are pass through entities like Subchapter S corporations, partnership, and LLCs? Will the plan address individual and corporate tax issues at the same time and how will that bog everything into a morass of disagreements".

Is Trump going to lower the individual tax rate to 20% to make those businesses equal to corporations?

If that is done, what is going to happen to the budget deficit as Trump spends more to "modernize" the military and on infrastructure projects.

What will happen when interest rates rise to normal levels and the national debt is soaring past $30? Will interest rates go further up? Will the USD plunge in value in response?  

I am certain as any human can be about the future that the national debt will continue to soar under Trump. 

 Will The Senate Accept the House's Dynamic Scoring

These articles describe what is meant by dynamic scoring or why it is relevant to the GOP's tax plan. What are dynamic scoring and dynamic analysis?-Tax Policy CenterDynamic scoring-WikipediaDynamic Scoring May Not Be Enough to Fulfill Tax Promises-Bloomberg; TFEconomics.pdf (describes dynamic scoring as another effort to revive Voodoo economics.  

How has voodoo economics worked in the past? That is irrelevant of course. Before Trump’s tax plan, there was ‘voodoo economics’ and ‘hyperbole’ - The Washington Post 

Democrats are never going to accept voodoo economics and trickle down economic theories written down on a napkin at the Two Continentals restaurant in 1974.  


The market is going to be disappointed by the (1) slow pace of tax legislation moving through Congress, (2) the fierceness of the debate where major republican donors join Democrats to fight off aspects of the plan, (3) the impact after passage on the real economy and (4) the fact that recessions still exist and can not be outlawed by a Trump Executive Order. 

So there are a lot of unknowns and potential negative impacts, but that has not stopped the Stock Jocks from going into a frenzy since the election, seeing only blue skies into the distant future and the a near certain U.S. entry into a golden age of GDP growth exceeding 4% per annum and massive job gains. 

The Stock Jocks are mostly Trump supporters anyway (maybe over 90%), and Trump told them this would happen.  It will be "huge" and will be passed in a GOP controlled Senate and House in a jiffy in line with that outline which will be presented in two or three weeks. 

The stock market’s Trump rally has just begun - MarketWatch (2,600 by year-end)

The rest of us need to take a deep breath, look at the facts and history, and at least look skeptically at the assumptions being made by the GOP and their supporters. This rally may not end well. 

In any event, I do not need to take risks and will continue selling stocks and stock funds into this last robust move and will slowly meander down at turtle speed the long ramp leading to my bunker.  

1 comment:

  1. "Poll: Does Trump’s support have a ceiling — or a floor?
    The range of Trump’s potential support - both to the high and low side - is actually bigger than you might think"