Sorry, Donald – Corporate Tax Reform Isn’t Going to Fix All Our Problems

My view that stocks are now in a bubble is further bolstered by the fact that the roughly $4 trillion dollars of global bonds still sporting negative yields (down from $14 trillion last year though the figure is rising again with German 2- and 5-year bund yields plunging back into the red) and European and Japanese central banks are still behaving as though the world is in the midst of a financial crisis. Low interest rates provide a bogus discount rate that the stock market uses to justify exorbitant valuations, creating a vicious cycle of irrationality that led to our current situation. All financial assets are trading at values divorced from their ability to generate the cash flows necessary to support them.

The truth is, investors are bidding stock prices to one record after another based on nothing more than fairy tales.

One of those fairy tales is that corporate tax reform is going to cure what ails the American economy, but when you look at the numbers it appears even Jack’s beanstalk wasn’t that big.

With all due respect to President Trump, his proposed reforms aren’t going to be nearly enough to fix our problems.

Here’s why…

 Trump Means Well, But His Hands Are Tied By Conflicting Interests

Since the election, stocks have appreciated by approximately $2.5 trillion. Yet corporations will pay only about $320 billion of taxes in 2017, suggesting that investors are discounting full repeal of corporate taxes (which isn’t going to happen) by a multiple of roughly eight times.

Throw in regulatory reform and you may come closer to this number, but by any stretch of the imagination the effects of Mr. Trump’s economic policies are more than fully priced into the market. Since corporate taxes are not going to be fully repealed and few if any corporations come close to paying the highest statutory 35% tax rate anyway, the likely impact of reform is likely to be far more muted than the market expects.

Furthermore, the road to corporate tax reform is going to be neither smooth nor simple. The border tax idea being bandied about is one of the worst ideas to appear in public policy in decades; if it were adopted (which I doubt), it would seriously harm trade and likely lead to recession.

But Democrats, still clinging to the anti-growth agenda that lost them the election, are going to fight hard to make tax reform as inefficient and ineffective as possible. Unless the Republican Party shows intestinal fortitude and doctrinal strength that was missing from its ranks for many years, we are likely to get only a watered-down version of reform that will have modest impact on the economy.

If this market rally is built on the back of corporate tax reform, it is going to collapse under the weight of its own disappointment.

Maybe we will have more luck explaining the rally if we look to repatriation of the $2.5 trillion of cash that corporations are holding offshore. With respect to repatriation of this money, some of it will be taxed by the government (maybe 10% or $250 billion), some will be used to build plants, hire workers and otherwise grow the economy (my guess is not more than 20% if I want to be a cockeyed optimist, or $500 billion) and the rest will be used to buy back stock, pay dividends and do more M&A deals, or $1.5 trillion. But that assumes that all of the cash comes back home, which is not going to happen since corporations have legitimate reasons to keep cash abroad to fund their non-U.S. operations. Let’s say that 40% of the money comes back into the U.S. That would account for about $1 trillion coming back into the market, which gets us a bit closer to the mark.

In the best of all possible worlds, if you stretch the rubber band as far as it goes, and you combine tax reform, repatriation and regulatory reform, maybe you come close to the appreciation in stock prices. But that assumes a heck of a lot, including the fact that earnings hold up, all of these new policies are actually passed, and nothing else goes wrong. In other words, you are assuming a perfect world that doesn’t exist.

Sorry about that, Mr. Trump.

We Are Far More Likely To Get A Crash Than A Continued Rally

What’s really going on, of course, is that the animals in the circus are running wild. Valuation levels are very extended with the S&P 500’s trailing P/E at 22x and the Shiller Cyclically Adjusted P/E at just under 30x versus a mean of roughly 16x. The Dow Jones Industrial Average gained 183.95 points or 0.9% to close last week at 21,005.71, its fourth straight weekly gain.

While the superlatives go on and on, there is just one problem: Valuations may be supported by hope but are unsupported by economic fundamentals or earnings. The only numbers that are off the charts are sentiment indicators that are usually signals to run in the other direction (which is what sensible people do when animals are charging at them). Investors Intelligence’s (II) highly respected polling shows bulls at 63.1%, the highest reading since 1987. This number has been above 55% for 14 straight weeks, which II calls the “danger zone.” Bears were down to 16.5%, the lowest figure since July 2015, putting the bull-bear spread (i.e. the ratio of how many people are bullish to how many are bearish) at 46.6%, the highest for the current cycle and another contrarian indicator. But technicians are divided; for every one warning that markets are overextended, you can find another one saying they can run further.

The truth is that nobody knows what the immediate future holds. All we can know for certain is that stocks are trading at the very upper end of their historical valuation range and that returns from such levels tend to be lower than returns from lower entry points. With stocks like ExxonMobil (XOM) trading at 44x earnings, investors really need to ask themselves why they are partying like 1999 when Prince is dead, Corporate America is more leveraged than a decade ago when it was heading into the worst financial crisis since the Depression, the global economy is grossly overleveraged, and the geopolitical landscape is as fragile as it’s been since World War II (though the Russians aren’t coming, trust me). Denial is not an investment strategy.

However, if you are looking for some good short ideas, you can find them here, here, and here.

Sincerely,

Michael

8 Responses to “Sorry, Donald – Corporate Tax Reform Isn’t Going to Fix All Our Problems”

  1. Sorry, Michael. Donald doesn’t believe, and has never said, “Corporate tax reform is going to solve all our problems.” That’s a stupid headline for your otherwise reasonable analysis.

    I should also note that “the market” is dominated by giant institutions who pay billions of dollars to maximize their investment returns through research, quant programs, political influence, etc. “The market” is not a group of stupid people who don’t understand money and finance, sitting in a room, telling each other fairy tales. They are rational, well-informed players. The buy and sell every day with other rational, well-informed players. This is “The market.” Right now, this large amalgamation of investors disagrees with you strongly. Every buyer thinks he’s right. Every seller thinks he’s right. I trust, given your incredible insight and acumen, you are a billionaire, yes?

  2. Donald trump cant save America. All he can do is stop the bleeding. He will likely be a 1 term president being blamed for the economic tsunami that is going to hit us as well as failed policies he will be blamed for (rhinocare ) thanks to the Republican congress. Im afraid he will be swallowed by the swamp!

  3. I am extremely surprised that no one (media) is talking about the “Debt ceiling suspension” that will expire on March 15th this year. The calendar for that day seems to be loaded with other news (Fed rate increase, President taking about this and that etc.) It’s as if there is a policy induced distraction in an attempt to draw attention away from a very fundamental problem we as a country are facing at this time in our history. When the term “EXTRODINARY MEASURES” is the only recourse to prevent a government default on it’s obligations to repay debt, combined with foreign countries not participating in buying US treasuries as in the past, and increased gold accumulation by foreign government central banks seems to support the idea/theory that the US dollar will not be the preferred choice moving ahead into the future. That is something all Americans need to be concerned about.

  4. Marcia Simonton

    Instead of tearing President Trump down and our country as well, have you ever given any thought to coming up with a concrete idea as to how to support him and make what he’s trying to do work. That may be a very tall order for you to set aside your pride long enough to realize that he really is in this for the whole country, not just the rich. You seem to have gotten stuck in some kind of state of mind that tells you it’s more important to make a name for yourself than be of real help for our l country’s sake. You aren’t the first to try and subtly knock him down and I doubt that you’ll be the last. Get off the cloud you’re on long enough to see how you can offer President Trump a real helping hand. While you are at it, you might consider bringing one other friend along and just listen to his thoughts before jumping in with any thoughts of your own. He has been told that he was wrong about a number of things since he took office. Fortunately he prooved everyone wrong and he will again. That’s how sure I am if him. Let him be the president and take time to let him put his plan in motion. He isn’t the clown people seem to think he is. He’s a lot wiser and a steady rock.

  5. Nobody said that Donald Trump is claiming tax reform will save the U.S. economy from impending doom. What ML (and others) are saying is that the markets are grossly over-valued by any and every reasonable standard, and potentially beneficial policy changes (such as corporate tax reform) are already priced into those valuation; as if they were a foregone conclusion.

    I do not personally believe that reducing corporate taxes will benefit the country over the long-term, especially if Trump’s spending plans do get any traction…his new Treasury Secretary is already asking Congress for an increase in the debt ceiling which is an acknowledgement that the Administration will have to borrow more money to pay for its make America great again agenda. If they succeed at reducing corporate taxes even further then the borrowing will increase accordingly and the problem of the debt bubble will get even worse.

    We can of course continue our assault on so-called entitlement spending but eventually we will have reduced the vast majority of the population (including the vast majority of those economically disenfranchised Trump supporters) to the status of Third World peasants at which point there won’t be enough consumers to buy cheap Chinese made electronics much less Elon Musk’s $100,000 electric cars or a $600,000 house at which point the econ will crash and burn anyway!

  6. Ms. Simonton,

    If you hadn’t figured it out by now, Mr. Lewiit is rather glad Mr. Trump was elected, given the alternative. But what’s an analyst to do? Ignore the analysis and put on a happy face even as the guillotine starts its downward path?

    As for concrete ideas on how to support Donal Trump, I’d say, don’t run for President. They’ll only hang you with the blame for the worse financial and economic crisis the world has ever seen. But we can’t roll back the clock and give that pearl of wisdom to him, can we?

    Now he’s stuck. He’s in the job. And here’s the thing. He and his people are clearly unwilling to even propose the truly radical measures needed to secure the future health of the country. And I mean future health. We’d STILL have to face the music and pay the price for the debt binge of the last 45 years, even if he managed to miraculously transform the criminal and profligate ways of Wall Street and DC.

    To be pro-people, he needs to be anti-government at least in the sense of being anti-deep state … and he ain;t even close. You faith is tragically misplaced.

    Better than Hillary? Oh hell yeah. Doomed to fail? Absolutely, even if he succeeds in getting his agenda embraced by Congress and his legislation enacted. That was Mr. Lewitt’s rather perceptive point.

    .

  7. Trump has the right idea but he will not be able to pull this off because of the deficit, interest rates, HIS Russian problem and technology. The 2017 deficit is already on pace to be $443B and he wants to enlarge it with his infrastructure initiative. If he cuts drastically the slow down in spending with offset the new job creation related spending and it will have no effect. If interest rates continue up the deficit will get even bigger and the $ will strengthen choking off exports. His Russian problems will only get worst and may remove him from office. This is a problem of his own making. Technological advancements will prevent the return of those assembly line jobs all those working class folks are looking for…they need to go to school like Hiliary told them. Trump deceived them BIG-time and now he will take their healthcare away.

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