Republicans have been salivating over corporate tax cuts and repatriation of the estimated $2.6 Trillion in cash on US company balance sheets overseas that can’t be brought home due to double taxation. Why would Apple repatriate any of its $252 Billion after tax cash hoard, only to have $88 Billion confiscated by US taxes. Instead, US companies borrow here against their overseas cash elevating our cost of capital.
Until recently the stock market has not been pricing in any Trump legislative success in 2017. However, post November earnings season, stocks are surging primarily on the hope of GOP unity providing a Christmas tax package for investors. Short term, the stock market is very over bought and could stall should the full Senate reject a tax vote. Conversely, equities will rocket higher in spite of the froth throughout December if the Senate approves tax cuts. Note that we are already testing our projected inflection point due December 1st after a test of the 2640’s in the S&P 500 Index.
During a runaway Bull market year such as 2017 with record low volatility (no meaningful correction), sentiment measures like put and call option buying extremes will generate less important Sell signals and fantastic high confidence Buy signals (the only Buy signal of 2017 was in mid-August). Yet optimistic Call buying tops marked by 10 day Put/Call ratios under 61%, still warn that the upside momentum is about to stall. The reading today 11/30/17 = 0.57.
The benchmark S&P 500 Index of stocks has garnered 19% gains for 2017. This marks the strongest return since 2013. To date, the 26% Trump rally the past 13 months has been earnings based and emboldened with record 17 year high Consumer Confidence levels. In spite of optimistic corporate guidance, 71% of companies are still beating consensus estimates this quarter. With the 3rd quarter earnings season fading away, the continued run to record highs into year end should be supported by very strong holiday consumer spending through Christmas and may get a bucket of kerosene on their fire of optimism should tax cuts become certain.
Personal tax cuts are of dubious value in this world of labor shortages, but corporate tax cuts carry the flag for global competition. Business taxes around the globe have been falling each decade except in the US. The UK plans to reduce their rates next year to 17%. Twelve of the largest Irish companies are in reality US based, taking advantage of their 12% tax rates. Cheaper overseas tax rates have encouraged 25 US companies to relocate their headquarters overseas in just the past 5 years and countless foreign based entities have avoided moving to the US due to our 35% tax burden. It’s likely a 20 to 22% Corporate tax rate in the US would cause a wave of US and foreign based firms relocating to our shores, reducing the local cost of capital and reclaiming vital revenue trapped offshore. Should a Tax cut be approved, there are some odiferous aspects less worthy of celebration. A bill passed under reconciliation must abide by the Byrd rule, which says the bill can’t add to our debt outside of a 10-year window. Under the Penn-Wharton Budget Model, this GOP tax bill as currently debated, will sunset in 2027 and all Corporate and Individual cuts proposed would then be reversed. Then again, whomever is in charge in 2027 may be compelled to rally support to extend these tax cuts for fear of hurting the economy. The “estimated” $1.5 Trillion additional debt this Tax bill accumulates over 10 years may also be a bit of hyperbole. Clearly the potential increase in the national debt is not so controversial when our leaders have added on average just under a Trillion to our debt levels in each of the past 9 years. Current nation debt = $20.5 Trillion.
This 2017 stock market, like 1995, has run a year without more than a 3% correction. In the chart above you can see how rare this extreme low volatility has been. We have been expecting an 8%+ correction to begin at some point during the 1st quarter of 2018. While passage of tax cuts should propel prices into one more frenzied leg to the upside before a deeper correction begins, a failure to pass will likely mark the start of a topping phase. Later in 2018 tech stocks will eventually regain a degree of growth leadership after a correction, but for now we expect a shift in favor of industrial, financial and commodity stocks with an eventual addition of energy companies as we move through next year. Investors remain 95% invested with a reduction to 85% medium term should the Tax package fail.