At about 3:00 yesterday afternoon, the President presented an outline for his income tax plan. Here is a copy of the document which is just one page long. Of note, there is no border adjustment tax and the document is clearly light on details.
It seems the memo did not excite any enthusiasm by investors. This is quite predictable. The elements of the planned that are outlined by the memo is no different than what has been discussed during the campaign season and the first 100 days of the administration. The market reaction suggests to us that investors want more specifics and would have liked to see more specifics. While things like “Eliminate tax breaks for special interests” and “Eliminate targeted tax breaks that mainly benefit the wealthiest taxpayers” are admirable goals, we really do not know what that means. Since these things represent uncertainty, it is predictable that the market would sell off.
Since a lower corporate income tax rate will increase after-tax profits, this tax package will certainly help valuations. The bigger question we have is “how much of a tax rate cut has been priced into stocks already?” With PEs in the low 20s and interest rates likely to move higher in the back half of the year, today’s share prices may incorporate a big rate cut, maybe one as large as the one the administration is advertising. If this is the case, we might be in the “buy the rumor, sell the news” kind of situation. It is entirely possible that even if a compromise plan passes in a few months and that plan meets expectation, equity prices may still be vulnerable to a sell-off.
We have argued on these pages that the process of democracy and the writing and passing of legislation is a slow and unseemly process. Eventually, a bill gets passed. But this process takes far longer than one might expect. We contend that an income tax bill will pass. What is less certain to us, is when it will pass. The risk to the economy is that entrepreneurs and business managers may hold off on investments, hiring and other important decisions until they get some clarity. Indeed, we think this may be happening right now as the “Flash” GDP estimates from the Fed are coming in below 1% a the moment.
