By David Nelson, CFA
Last week was another reminder that the order in which President Trump attacks his agenda is very much on the mind of both institutional and retail investors. In my end of January article Trumped Up Market I discussed the direct parallel of market performance to the rollout of administration policy.
[“Obviously, Wall Street is not the President’s only concern but tax reform, a rollback of regulatory overreach and infrastructure spend are at the top of any portfolio manager’s list of issues we’d like to see addressed in the coming year.”]
Market Reaction
After a brief push higher post the inauguration markets stalled on the heels of a dizzying couple of weeks of executive actions culminating in a poorly launched travel ban that seemed to catch even the administration off guard. Rather than marching to the Supreme Court, still with an open seat the prospect of a 4-4 tie seemed unappealing.
The President has suggested he may issue another order Monday or Tuesday looking to counter some of the legal arguments made. The outcome of this event will have long term implications regarding executive power not just for this President but those that follow.
Maybe sensing a stall in momentum, the President was able to put the train back on track with a single word “phenomenal” describing the announcement of a tax plan coming in the next couple of weeks. Right on cue markets pushed to a marginal new high with the S&P 500 (SPY) now up nearly 9% since Election Day.
Of course, it’s going to take a lot more than talk to sustain these moves and like most things in life the devil is in the details. There’s no shortage of issues investors need to see addressed but tax reform, regulations and infrastructure spend would certainly make the short list.
Tax Reform
It’s no secret that Tax Reform enjoys bi-partisan support but that’s where the Kumbaya moment ends. Yes, a modest cut in the corporate tax rate would be relatively easier to pass but can we really call it tax reform? At 77,000 pages and counting the tax code needs a complete re-think. The only real winners in such a complex system are the accountants and tax lawyers who weave through the loop holes for their high priced clients. It’s not surprising they are fighting hard to maintain the status quo.
Real reform is going to take something radical and of course big changes need to be thoroughly vetted. No, I don’t mean analysis paralysis where the discussion drags on for years but an in-depth review of the benefits and liabilities.
DBCFT
The proposal getting the most press right now is a cut in the corporate rate paid for by a border adjustment tax or (Destination Based Cash Flow Tax). In other words, you’re taxing based on where the product is consumed not where the company is headquartered.
Those in the GOP pushing the President in this direction point out that a tax on imports and no tax on exports would not only go a long way toward bringing manufacturing back home, it would pay for itself. To be fair many countries have something similar.
The big question: Is this a zero sum gain? Critics point out that for every winner there will be a loser. At the top of the list are retailers in particular the biggest Walmart whose fortune has been made importing cheap goods manufactured in China and Mexico. Walmart (WMT) defenders point out many at the bottom of the income pyramid are helped by the lower prices. Of course the other side of that argument is; many of those they help, lost their jobs to China long ago.
Economists to the rescue
Stepping in to support those in favor of the plan are economists who point out that a border adjustment tax would drive the U.S. Dollar higher leveling the playing field for importers and exporters. Importers would benefit from the stronger purchasing power of the greenback and exporters might see lower sales as the strong dollar could make our exports a little less attractive.
So in the end, putting this all in perspective is an industry that has trouble predicting anything. Economic forecasts tend to herd together and have an unblemished record of failure to predict recessions.
When first asked about a “border adjustment tax” in a Wall Street Journal interview President Trump said; “Anytime I hear border adjustment, I don’t love it… usually it means we’re going to get adjusted into a bad deal.” Deficit hawks on the hill will probably support a DBCFT looking for a plan that is revenue neutral.
After 25 years in financial services I find myself leaning the other direction. Every policy has unintended consequences and for me to get comfortable with a plan dependent on which way the dollar is going to move, it’s going to take a lot more than reassurance from those in an industry with a track record of failure.
Even if correct and the dollar does move higher, what are the second derivative consequences from such a policy? How will it play out in emerging economies that could be hurt by a strong greenback not to mention the obvious implications for the commodity markets?
While I’m convinced our tax policy needs a complete overhaul, I need to see a lot more evidence that the border tax could work as intended. For now, even though it isn’t Real Tax Reform, a straight up CUT in corporate tax rates is the way to go. I’ll echo the words of Steve Forbes Editor in Chief at Forbes who said in a recent CNBC interview “if Trump and Congress botch the tax cuts the GOP could lose its majority in the House in the 2018 midterm election.”
*At the time of this article some funds managed by David Nelson were long SPY
