Happy New Year Wishes.
The final Congressional Budget Office (CBO) scoring of the tax bill was submitted to the House Ways and Means Committee on December 15. A summary of the scoring is available here in PDF form: https://www.cbo.gov/system/files/115th-congress-2017-2018/costestimate/53415-hr1conferenceagreement.pdf.
Mike Englund of Action Economics (http://www.actioneconomics.com) had this to say about the CBO analysis:
“The CBO Score of the new tax bill shows a bigger 2018–19 GDP fiscal boost than in the earlier Senate scoring. We expect year-end tax arbitrage, as corporations pull expenses into 2017, while individuals delay receipt of bonus income to Q1 and pre-pay January state tax in December. Asset sales will be delayed to Q1 given higher AMT limits (and no corporate AMT), leaving a likely January stock market pullback. The new tax code has lifted the value of corporate income, leaving a big ‘wealth effect’ for 2018, while consumer inflation will be restrained by lower corporate tax costs. Finally, disposable income will be boosted when new withholding tables are applied, while after-tax corporate profits will surge, leaving a likely 2018 boost in real GDP to the 3% area.”
We think Mike has it right on the mark. Taxes matter. Most folks and businesses view taxes as expenses. For nearly all of America that expense just dropped.
Forget the “postcard” metaphor. The tax code is now more complex than ever. And you cannot deduct the higher accountant fees and tax advisory costs that you will need to incur in order to sort through it. So much for political fixes!
Once the transitional shock of yearend is absorbed, we think the tax bill will raise the valuation of US stocks. Simply put, the tax bill will generate a permanent shift upward of somewhere between $10 and $14 in the threshold of S&P 500 earnings. Once you adjust for that permanent shift, you may continue to factor in the earnings growth rate that you expect from a US economy that is going to grow at 3% instead of 2%. We believe that growth rate is likely for a couple of years.
So, S&P 500 earnings should range up to and then above $150 by the decade’s end. They will do so while the Fed is still engaged in a gradualist restoration of interest rates to something more “normal,” whatever that word means. And those earnings will occur while a repatriation effect is unleashing $1 trillion of stagnant cash in some form of robust redistribution (dividends or stock buybacks) or as productivity-enhancing capex spending. Bottom line is no recession in sight for at least a few years; and low inflation remains, so interest-rate rises will not derail the economic recovery, nor will they alter rising stock market valuations.
Years ago we projected a 3000 level on the S&P 500 Index by 2020. Those writings are archived at www.cumber.com. We stick to that forecast.
We still like the tax-free bond, as we have for a considerable period of time. And now we know the tax bill effects, which make Munis even more attractive to the American individual tax-paying investor. However, blindly buying Munis is a mistake. Credit-risk research is important. We’ve written on that subject many times – again, refer to the archives at www.cumber.com.
“Aren’t you worried about the federal deficit?” readers ask. Of course we are. But for the next few years the impact will be benign. Over time – and that means years – the expanding deficit will raise the interest burden of the nation and will become more visible in the federal budget. For now, a national interest bill of $500 billion in a $20 trillion economy doesn’t stop the momentum of growth. That might change if Bitcoin were to replace the US dollar as a world reserve currency. But sorry, crypto fans, that just ain’t going to happen.
In 2018, the US growth rate picks up, and the US adds to worldwide growth. So we are projecting a global expansion and a rising trend in global asset prices.
Bitcoin remains a fascinating chapter to be added to the next edition of Charles Mackay’s famous classic, Extraordinary Popular Delusions and the Madness of Crowds. Other modern chapters include one about the bowling-alley stocks of yesteryear. The casino stocks (remember Resorts International?) and the dot.com bubble of 1998–1999 also make Mackay’s list. With regard to bitcoin, please remember that there are now about 1200 cryptocurrencies floating about, and that they may be created in near-infinite numbers. Thus attributing a “value” to a millennial fantasy is impossible. We think that a crypto gold-tied exchange medium (there is one now) or a crypto fiat currency will ultimately become accepted. There are plenty of folks in the world who wish to make payments in a form that bypasses government sanctions and scrutiny. For them, a cryptocurrency is an efficient substitute for a suitcase filled with cash.
We are a little worried about real estate. On November 8, 2017, Bloomberg reported that,
“In the U.S., retailers announced more than 3,000 store openings in the first three quarters of this year. But chains also said 6,800 would close. And this comes when there’s sky-high consumer confidence, unemployment is historically low, and the US economy keeps growing. Those are normally all ingredients for a retail boom; yet more chains are filing bankruptcy and rated distressed than during the financial crisis. That’s caused an increase in the number of delinquent loan payments by malls and shopping centers.” (“America’s Retail Apocalypse Is Really Just beginning,” https://www.bloomberg.com/graphics/2017-retail-debt/. This sobering report by Matt Townsend, Jenny Surane, Emma Orr, and Christopher Cannon belongs in your reading pile.)
In the new tax law, note that the preservation of the despised “carried interest” tax break is an example of a how politics get manipulated by a special interest when the heat of scrutiny is replaced with the sense of political urgency. But we do not believe the special tax treatment for certain real estate and other venture-capital agents will be enough to offset the pressure discussed in the Bloomberg report.
We start 2018 with optimism for markets. We expect households to spend some of their tax cuts. We think the boost to the economy is front-loaded. We’re bullish in the nearer term.
Longer-term risks remain and are serious. A partial list includes rising protectionism, political turmoil in the US as the midterm elections approach this year, and rogue governments from North Korea to Venezuela. And the Middle East remains a cauldron of pressure-cooked factional forces.
Lastly, the US seems to have trouble getting its emergency-funding act together. Congress fiddles (they did just pass a bill in the House) while California burns, Puerto Rico and the Virgin Islands struggle to recover, and Texas and Florida slowly recover, though they are relatively wealthy states with wounded areas. We saw the evidence of this halting recovery on our research trip to Key West and Big Pine Key.
America can do better when it comes to looking out for many of its citizens. That challenge still remains before us.
We’re scheduled for a visit with Scarlet Fu on Bloomberg TV tomorrow (January 2) afternoon at 4 PM.
Happy 2018. We start out nearly fully invested.
David R. Kotok
Chairman and Chief Investment Officer
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