Economy : U.S. Tax Reform May Disappoint Trump
10/30/2017 | 10:55pm CET
We admit to not understanding this market. Given the stretched company valuations, central banks edging towards the end of ultra-simulative monetary policy, and geopolitical crises brewing, our only logically conclusion to explain the equity bubble was the Trump tax reform, which supposedly was to create a Big Bang for U.S. firms, seeing their corporate tax rates drop from 35% to 15%. And this would be really positive for U.S. firms.
Seulement voilà. First, it became apparent over the summer that 15% was too aggressive and that Congressional budget hawks would not allow for the tax plan to increase the national debt (by too much). So Republicans compromised on a 20% tax rate and Trump tweeted that this is the perfect number. 15% or 20%, markets didnt seem to care. Fair enough.
Next, as the year progresses Trumps agenda has consistently met legislative failures, capped by the Obama-care replacement bill getting shot down by Trumps Republicans friends in the Senate. Indeed, Trump has gotten none of his agenda through Congress! Yet the markets curiously believe that Tax Reform will be the exception and that Trumps plan will become law. This seems highly unusual that markets arent even pricing in a bit of a chance that tax reform will also get shot down in Congress.
Monday we learned that House tax writers are discussing a gradual phase-in for President Donald Trump and Republican leaders proposed corporate tax-rate cut -- on a schedule that would put the rate at 20% in 2022. In other words, five years before getting to the downwardly-revised 20% corporate tax rate. The phase-in proposal would reduce the rate from its current 35% rate by three percentage points a year starting in 2018. If adopted, it would delay some of the economic effects Trump and his advisers have sought to emphasize from their tax cuts. Moreover, what analyst has not made his/her 2018 earnings forecast incorporating a 20% corporate tax rate for next year?
This is market moving news. Yet U.S. equity markets hardly reacted on Monday to the news. The Nasdaq even finished higher. If it is not the prospect of more free money for U.S. firms through the massive tax cut, what the hell is keeping equities afloat? Should equities not react to a watered down tax bill, we must conclude that the equity rally has lost all contact with reality. Speculating on ever increasing company earnings against an increasing less attractive economic backdrop leaves investors betting on momentum with little else supporting the movement. Investors might as well take their money to Las Vegas or Monte Carlo.