Taxes Update, August 23, 2017

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What a difference a few days can make. By Thursday’s close, the S&P 500 was at a one-month low, and the prospects for any tax cuts or foreign profit repatriation tax holiday were dim.

Now, thanks to one Politico article, happy days are here  again, as the S&P 500 surged on the idea that the leaders in Washington are actually making progress on tax cuts! Hopefully, you can sense my sarcasm.

The lack of liquidity and attendance in the market is making these tax-related market mood swings worse than they otherwise should be, so I wanted to step back and provide a clear, unemotional update on the tax cut situation.

Starting with Tuesday’s Politico article, there were two reasons it was positive: The “Big Six,” and 22% to 25%. Starting with the latter, you know from this Report that right now, the market is expecting a corporate tax cut in Q1 2018 down to 28%. If that happens, it likely isn’t a materially positive or negative catalyst.

However, the Politico article implied consensus was coalescing around a corporate rate between 22% and 25%, obviously less than 28%. If that happens, it will represent a positive catalyst and a boost to corporate earnings, which will send stocks higher.

Now, on to the former. The “Big Six” is apparently the nickname that a key group of Republican leaders have given themselves in regards to tax negotiations. For clarity, the “Big Six” are: Treasury Secretary Mnuchin, National Economic Council Director Cohn, Senate Majority Leader McConnell, Speaker of the House Ryan, House Ways and Means Committee Chair Brady, and Senate Finance Committee Chair Hatch.

The Politico article implied the “Big Six” have been working much closer than previously thought, and that they have made a lot more progress on the structure of tax cuts (although plenty of details remain).

Bottom Line
The noise on this topic is officially deafening, but I want to cut through it and give you some hard takeaways on the outlook for tax cuts and the impact on the market.

1. Expect more tax-related volatility. If January through August is any guide, we can expect the ever-growing Washington soap opera to fully engulf the tax cut issue this fall. Like healthcare, there are multiple moving pieces, a lot of important, TV happy players (I’m not even including Trump), and a lot of pressure—as this is basically the Republicans’ last chance to get any legislative priorities accomplished before focus on the midterms starts in 2018.

2. The outlook for tax cuts wasn’t as bad as it seemed last Thursday, and it’s not as good as it seems right
now. The Politico article was positive, but it didn’t contain anything ground breaking. To boot, it appears that substantially controversial issues are being discussed in the tax cut package, including: Capping mortgage interest deductions, eliminating the deduction of state and local taxes against federal, corporate interest deductibility and other issues. These and foundational pieces of the current tax code, and removing them won’t be easy.

3. The sector winners from potential tax cuts remain the same as they’ve been all year: Super-cap tech (on foreign profit repatriation), healthcare (on foreign profit repatriation), retailers (they pay high corporate taxes) and oil and gas (high tax rates). FDN/QQQ, XLV/IBB/IHF, RTH and XLE/XOP are all ETFs that
should outperform if taxes surprise to the upside.

4. A prediction: Tax cuts happen in Q1 2018. I’m in the business of generating conclusions and opinions, so I’ll give one about this tax issue. I’d give it about a 65% chance that tax cuts/foreign repatriation holiday gets done by Q1 2018, and about a 50/50 chance those tax cuts positively surprise (i.e. the corporate rate drops below 28%). I do not expect any changes to personal taxes. The reason for this opinion, as I’ve said several times before, is self-preservation. Congressional Republicans are on the ballot in 2018, President Trump is not. If they fail to accomplish anything (no healthcare repeal, no tax cuts) and this Washington soap opera continues, then it’ll be Congressional Republicans who are out of a job. So, they have to get something done if they want to save their jobs. There’s no better predicator of action in Washington than the rule of self-preservation.

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Why Taxes Caused Yesterday’s Selloff, August 18, 2017

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If there was one “reason” for the sell-off yesterday, it was taxes—specifically, the dying dream of tax cuts and a profit repatriation holiday.

That’s why the Cohn headline spooked stocks. It’s not that markets particularly love Gary Cohn. Instead, he’s important because he’s viewed as a key figure in pushing tax cuts through in early 2018, an expectation that market has held on to (until, perhaps, yesterday).

If Cohn resigns, then the prospects for tax cuts (and almost more importantly, the foreign profit repatriation holiday) dim… significantly.

The declining expectations for tax cuts and profit repatriation hit tech especially hard yesterday and it combined with the underwhelming CSCO/NTAP earnings to push that sector sharply lower—and falling tech dragged the whole market down yesterday afternoon.

Now, going forward, clearly there’s been some damage done on the charts (the S&P 500 closed at a one-month low), and momentum indicators are showing warning signs.

And, those warning signs are appearing at a particularly dangerous time for markets (in the short term) as late August is particularly favorable for “air pockets” to form in the markets given that a lot of desks are minimally staffed due to summer vacation. Point being, I don’t think we’re done with the uptick in volatility yet—again due mostly to the calendar.

However, Nasdaq, SOXX and FDN all remain above last week’s lows. So, while Thursday’s trading was clearly painful, I’m not ready to get materially more defensive just yet (although clearly we’re watching those indicators very, very closely going forward).

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Political Update for Investors, April 27, 2017

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Political Update for Investors

Trading yesterday was driven by multiple political-related headlines. Politics reasserted itself on the market narrative on Wednesday, helping stocks initially rally following renewed hopes for an Obamacare repeal/replace bill, and after the Trump Administration unveiled a significant (though expected) tax cut plan.

Yet despite the media focus on those two events, any actual progress with healthcare or taxes remains unlikely (and didn’t get better yesterday). The third piece of political news, an investigation into aluminum imports by the Commerce Department, was the most important (yet underfollowed) political development for markets yesterday.

I cover each issue below, cut through the noise, and get to any likely market influence. The bottom line is that despite generally favorable headlines, all the political news yesterday was a mild net negative for stocks.

Trump Administration Tax Cut Plan.

What Happened: The Trump Administration unveiled a sweeping tax cut proposal that included a 15% corporate rate, just three individual tax brackets, doubling the standard deduction, and repatriating overseas profits.

Why It Matters: Corporate tax cuts remain the easiest catalyst for a stock breakout, but unfortunately the tax plan revealed yesterday is very unlikely to pass Congress, and the reason is simple: There is no offset to the reduced revenue from lower taxes. As such, this plan will increase the deficit, and that likely means Democrats can filibuster the bill. Going forward, unless a tax plan contains some material offsets to reduced taxes (like border adjustments) then passage of any big tax cuts remains unlikely in 2017, and that’s stock negative.

How Markets Reacted: Tax-related headlines can still cause a pop in markets, but only a credible plan that can pass Congress will be a bullish gamechanger. (For more market insights in your inbox by 7am each morning, sign up for a free 2-week trial at

Healthcare Bill (Obamacare repeal/replace).

What Happened: The details were fast and furious on this yesterday, but as of this writing it appears the House will vote on the bill potentially this weekend, and odds of passing are decent.

Why It Matters: Passage of an Obamacare repeal/replace increases the chances of tax cuts also passing, as it will increase Trump’s political capital and provide more revenue to offset tax cuts. However, even if this bill passes the House, the chances of passage in the Senate in the current form remain slim. So, while a potential moral victory, it won’t significantly increase the chance of healthcare reform, and as such I don’t see it as a bearish gamechanger for healthcare ETFs (XLV, IHF, IBB).

How Markets Reacted: Stocks (including health care names) largely ignored this news, as again the likelihood of any Obamacare repeal/replace becoming law remains slim. (For more market insights in your inbox by 7am each morning, sign up for a free 2-week trial at

Tariffs and Trade.

What Happened: Yesterday the Commerce Department announced an investigation into aluminum imports. No tariffs were announced, but it certainly looks to be moving in that direction. This announcement comes one day after Commerce levied taxes on Canadian soft lumber imports. Additionally, a Politico story hit midmorning that President Trump was close to signing a document notifying Mexico and Canada that the US intends to withdraw from NAFTA within six months. The document does not guarantee a US exit (they can change course), but it is a necessary legal step to begin the process. Since yesterday the White House has said it’s not preparing this document yet but didn’t squash the idea all together.

Why It Matters: These trade events yesterday (and this week) are actually the most important political events of the week, not because of their immediate impact (Canadian lumber and aluminum tariffs don’t mean a trade war, and the NAFTA announcement is likely for negotiating leverage), but it does remind markets of Trump’s potentially disruptive trade policies. That matters, because right now markets have not priced in any trade-related headwinds, so this does represent at least a modest risk to the bullish narrative.

How Markets Reacted: All the trade headlines weighed slightly on stocks during the late afternoon, but the current headlines simply aren’t bad enough to warrant an outright reversal in stocks. (For more market insights in your inbox by 7am each morning, sign up for a free 2-week trial at

Bottom Line on the Political Update for Investors:

Material “gaps” remain that must be filled if the S&P 500 can sustain a meaningful breakout above 2400, including 1) The gap between political expectations and political reality, 2) The gap between too-low Treasury yields and very high stock prices (although that’s narrowed some-what this week, but not enough), and 3) The gap between soft economic surveys and hard economic data.

In the very short term, investor sentiment seems skeptical, and the market acts as though investors are more afraid of missing a breakout than they are a break down (similar to what we saw when the S&P 500 broke through 2300). So, the “pain trade” looks higher short term and that’s helping stocks.

But given valuations (the S&P 500 trading nearly 18X 2018 earnings), I don’t think sentiment alone is enough to push us decidedly through 2400 without positive resolution on some of these gaps. That means we need 1) Actual progress on tax cuts (which didn’t happen yesterday), 2) A rally in the 10 year above 2.40%, or 3) Better economic data starting today.

I am therefore sticking with my call that the 2300-2400 broad trading range in the S&P 500 should hold, and I would not be chasing stocks at these levels.

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Tax Cut Primer (What You Need to Know), March 28, 2017

With healthcare shelved, focus now will turn to the truly important topic for markets: Corporate tax cuts. This is an excerpt from today’s Sevens Report. You can sign up for your free trial at—everything you need to know about the markets in your inbox by 7am, in 7 minutes or less.

I’ve covered this a lot so far this year, but I wanted to dedicate a special section today for a tax cut primer that you can refer back to as this process unfolds over the coming months.

Going forward, there are two key points to understand. First, in order for tax cuts to be a bullish gamechanger (i.e. push the S&P 500 materially above 2400) they must drop the nominal rate to 20% or below. That will provide the expected $10-$12 EPS boost for the S&P 500 in 2018 that will help stocks break out, because at $146 S&P 500 EPS (the current $134 2018 expectation, plus an additional $12 from tax cuts) the S&P 500 would be cheap at 16X 2018 earnings.

The Sevens Report - Corporate Tax Reform GuideSecond, tax cuts will be a bearish gamechanger if the market begins to believe: 1) They won’t happen at all, or 2) They will be so small that it won’t make a difference. Point being, tax cuts can be delayed in 2018 and it won’t be a bearish game changer as long as the market still expects that rate to be cut to 20% or lower.

So, to stay ahead of the tape we need to figure out what must happen to get material corporate tax reform passed. To that point, there is one issue that is the key to whether material tax reform gets passed: Border adjustments.

Here’s why border adjustments are key: Dropping the corporate tax rate from 35% to 20% would mean a big loss of revenue for the government, so that needs to be offset otherwise the deficit will explode. A plan that does not have an offset will not be passed despite the Republican-controlled government.

To that point, the Tax Policy Center estimates that implementing border adjustments would generate $1.2 trillion in additional tax revenue over 10 years, which is two-thirds of the $1.8 trillion in lost revenue that would occur if the corporate tax rate drops to 20% from 35%. It’s the key to getting tax cuts at least somewhat revenue neutral.

I’m not going to get into the nitty-gritty details of what border adjustments are, because I’ll put everyone to sleep. But generally, border adjustments have to do with changing the way US corporations are taxed on overseas sales and purchases. To use a simple-but-imperfect analogy, border adjustments are similar to import taxes (they aren’t the same, but for purposes of illustration the comparison makes my point).

The problem for markets is that there appears to be even bigger disagreement on border adjustments within the Republican party than there was on healthcare, so right now there is no credible path to material corporate tax reform. This is especially true after the healthcare fight created additional resentment within the party.

Bottom line, without a border adjustment compromise, there’s very little chance the corporate tax rate can be dropped to 20%, and provide the earnings boost to push stocks higher.

Going forward, a key name to watch is Kevin Brady. Brady is the House Ways & Means Chairman (where tax legislation begins). A compromise on this issue won’t happen without him, so going forward we’re closely watching any comments or articles from Brady.

Sector Winners & Losers of Tax Cuts/Border Adjustments

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Bottom line, for fiscal stimulus to push stocks further, we have to have meaningful corporate tax cuts (20% or lower). For tax cuts to be that powerful, there has to be compromise on border adjustments, and right now, there are no signs of compromise (although again the market will likely give Republicans the benefit of the doubt till Memorial Day).