Warmest 2018 wishes for each of you, and your families!
The 11th hour tax law change horse-traded into final shape and enacted into law by President Trump in the dwindling hours of 2017 will mark a sea-change in prospects for US stocks going forward. Regular readers of this column will note that we have long-felt that US stocks are overvalued – and still do, but to a lesser degree now- and overdue for a big correction. We still expect the correction, possibly in January. Readers will also note that despite our fears of overvaluation, we have none-the-less expected the record-long US stock bull market to grow yet longer in the tooth, and we now expect these teeth to grow longer, still.
Why? The tax law change, of course. Stock market expectations – even irrational ones – are largely based on expectations of underlying firms’ profitability. US economic activity has been slowly and steadily improving from the 2008 meltdown, nurtured by unprecedented zero-interest-rate free money. The economy had returned to a level of sustainable, though mediocre, growth by 2016, when a real dark-house wildcard dropped – Trump won the election. While legislative accomplishments were elusive for most of 2017 – until the somewhat unlikely passage of tax reform, a huge deal and we think the springboard for a much more productive 2018 for Trump and the Republican-controlled Congress – another very powerful force was unleashed by Trump last year. This force, we think, was largely responsible for the unprecedented rally in US stocks, and will continue as a strong tail wind to company profits for years to come. While very much under the radar, this force – deregulation – is incredibly conducive to business, regardless of how one may feel about its social and environmental impacts. As of late in 2017 – and just as the tax reform drama was unfolding – Trump’s administration had reduced, scaled back, or eliminated regulatory requirements some 29 times. In addition, Trump and Congress had repealed nearly 50 new, restrictive regulations penned and enacted by Obama in his final days. According to the Wall Street Journal, this little-appreciated deregulatory campaign juiced the economy strongly in late 2017, fueled in part by business leaders’ confidence and willingness to spend on new equipment. This force will drive business profits and underpin stock values for some time. It is a game changer. Of note, bucking the deregulatory trend is the tech business, which can be expected to face staunch anti-monopolistic regulations to defang the dominance and growing power of the likes of Facebook, Google, and Amazon.
On top of this comes tax reform, another and more powerful game transformer. While this is a very complex bill (see below for Jeff’s digest) there are two key rocket-fuel drivers for the stock market. 1) the corporate top tax rate has been slashed – and I use that word not lightly – from 35% to 21%. Did someone say this was HUGE? For large, publicly traded companies (i.e., stocks) will save an estimated $200,000,000,000 a year in taxes, money now free to kindle growth and future profitability, and to be returned to investors as dividends or via buy-backs. Surely, as the corporate welfare critics will complain, some of this will be wasted or ill-spent, and the impact on Federal debt is cloudy and concerning. But corporate profits just went up by a BIG number, and stock values are now justifiably higher as a function of profits.
2) some $3,000,000,000,000 of offshore profits will be coming back to the US. Tax-smart companies have for years found ways to avoid “repatriating” foreign profits in order to avoid the 35% tax. They also engineered slick ways of converting taxable US profits to tax-deferred foreign profits. Tax reform now imposes a mandatory, much lower tax, giving companies no real non-business reason to keep this cash overseas. Expect a flood of investable and distributable capital to supercharge the market.
For these reasons, we expect the US market to soar even higher on this afterburner fuel. Beyond this, valuations have become more reasonable, as the profit calculus has changed. Remember P/E means the stock price over earnings, and the lower the better. Well, the E just got lots bigger, dropping the value of the P/E ratio, just as ¼ is lower than ½. While we still expect a correction, we are more bullish on US stocks than we’ve been in a year, and suggest buying into any substantial dips – but with a value bias.
All that said, we still think most non-US markets are better deals, and their economies and stock values have more headroom than US stocks. Even with the value adjustments we foresee for US stocks, foreign stocks are just cheaper and better deals. Plus, given the intense and growing integration of the global economy, the afterburner forces we see propelling US stocks will likewise stoke economies and markets abroad, as the jet engines of US companies, and US consumers, suck in yet more goods, labor and offshore production. The US markets still, we think, have a way to go, but are clearly in the final innings. As Barron’s so drolly put it on January 1st, “…Next Stop, Euphoria!”