As we watched the Dow Jones Industrial Average close above the 20,000 mark for the first time ever on January 25th, we could only wonder whether or not that figure would be used as an imaginary springboard to further gains or as a magnet, as some large round numbers often do.
Prior to hitting that milestone, the Dow closed within one percent of 20,000 twenty-five times so one would have thought it would act as a magnet rather than a springboard. However, with the Dow some three percent above 20,000, it is prudent to take time to examine what factors might push this index even higher as well as which ones might send it lower. Certainly, most of these factors are related to the actions taken or not taken by President Trump.
President Trump campaigned on tax reform, both personal and corporate. More specifically and as it pertains to tax reform for the individual filer, much of what he hopes to accomplish is a cut in taxes for the average American. How would this benefit the economy and subsequently the equity markets? A tax cut for individuals, which probably won’t become a reality until late 2017 at the earliest, would put more money into the hands of consumers. Given the recent trend in spending on experiences rather than goods, this might provide a bigger benefit to the hospitality industry such as restaurants, hotel, airlines and rails rather than automobile sales. That said, don’t go spending the tax break just yet as Congress, including possibly the fiscally Conservative Republicans, might drag their feet, pushing any type of legislation into 2018.
Considering corporate tax
reform Trump also campaigned on corporate tax reform. Of the 34 countries in the Organization for Economic Cooperation and Development (OECD), the United States currently ranks first with a 39.1% corporate tax rate. However, more telling is the effective rate, the rate at which corporations actually pay when deductions such as health insurance and pension costs are taken into consideration. That rate is still a high 27.9%, the second highest rate among the 34 OECD countries.
Tax reform that would lower the effective rate of taxation that corporations pay would most likely be coupled with a reduction in the effective tax rate that corporations pay on repatriating assets held overseas. At the current time there is approximately $2.5 trillion (yes trillion!) held overseas. We believe that technology companies, who hold a sizable percentage of this amount, would be the biggest benefactors as it would automatically result in increased earnings. Some CEOs are on the record as to suggesting that a good chunk of any assets repatriated would be used to buy back stock and/or increase dividends. This would most likely not be a boon to employment. However, corporations will most likely respond to lower effective corporate tax rates by purchasing equipment, building plants, and hopefully increasing wages and benefits.
The above—tax cuts for individuals, families and corporations as well as a reduction or perhaps a period of amnesty that will allow to repatriate assets overseas at least in the short-term—is a net positive for the economy and equity markets. However, President Trump also comes with some potential negatives.
The seemingly haphazard foreign policy through President Trump’s first month in office has many investors scratching their heads. There appears to be daily tweets from the President’s Twitter feed, bringing some new, unexpected insult to an ally, American company or even celebrity. This new media with instantaneous delivery is worrisome and seems better suited for barroom negotiations than board room or United Nations discussions. The world is indeed a dangerous place and careful, thoughtful negotiation paramount.
We remain invested believing the market hovering around 20,000 represents more value than the 10-year U.S. Treasury note, which currently yields approximately 2.45%. That being said, the political rhetoric/fireworks that increased volatility last year may be just a little more than the average investor can stomach. For that reason, stay invested but well diversified. The market heroes of today may be the subject of a presidential tweet tomorrow.
Please note that all data is for general information purposes only and not meant as specific recommendations. The opinions of the authors are not a recommendation to buy or sell the stock, bond market or any security contained therein. Securities contain risks, and fluctuations in principal will occur. Research any investment thoroughly prior to committing money or consult with your financial advisor. Please note that Fagan Associates, Inc. or related persons buy or sell for itself securities that it also recommends to clients. Consult with your financial advisor prior to making any changes to your portfolio. To contact Fagan Associates, call 279.1044.