Taking an Axe to Tax
Doug Walters
U.S. equities were up again this week thanks to progress on corporate tax reform, the announcement of a new Fed chief, and a big boost to job growth. We take a look at how the proposed tax reform will impact individuals.
Market Review
Contributed by Doug Walters
Stocks found higher ground this week, buoyed by the unveiling of the House Republican’s plan for tax reform, a rebound in job growth, and the announcement of a new Fed chief. We use our Economics Commentary section to analyze the proposed tax changes.
Surprisingly as Expected
The administration made the somewhat uncharacteristically conventional decision this week to nominate Jerome Powell to replace Janet Yellen as Federal Reserve chair. As a five-year member of the Board of Governors and a supporter of the Fed’s slow and steady interest rate increases, Powell is expected to follow closely in Yellen’s footsteps. However, Powell comes from investment banking and is believed to favor loosening the Fed’s leash on the financial markets, which should benefit banks. While Powell’s nomination is a relief to Fed-watchers hoping for more of the same, the Board of Governors is still understaffed, and as we first discussed in Three’s a Crowd, the overall makeup of the institution could change meaningfully in the coming months.
Profit Driven
Friday’s jobs report showed that 261,000 jobs were created in October. This was a big bounce from September’s very weak, hurricane impacted print. The headlines around this notoriously volatile monthly datapoint can mask the longer-term trend. For the past two years, we have seen a gradual decline in job creation from an annual run rate of 260,000 in early 2015 to 167,000 today. The challenge is that job growth is pushing against a very low unemployment rate which came in at 4.1% in October. The last time we saw unemployment this low was during the Tech boom of 2000. A big difference between now and 2000 is that job creation is being driven by businesses with real profitability, not profit pipedreams.
| Indices & Price Returns | Week (%) | Year (%) |
|---|---|---|
| S&P 500 | 0.3 | 15.6 |
| S&P 400 (Mid Cap) | -0.2 | 10.6 |
| Russell 2000 (Small Cap) | -0.9 | 10.2 |
| MSCI EAFE (Developed International) | 0.9 | 19.3 |
| MSCI Emerging Markets | 1.4 | 30.6 |
| S&P GSCI (Commodities) | 2.1 | 5.6 |
| Gold | -0.2 | 10.0 |
| MSCI U.S. REIT Index | 0.9 | 0.4 |
| Barclays Int Govt Credit | 0.0 | 0.6 |
| Barclays US TIPS | 0.4 | 0.7 |
Economic Commentary
Contributed by Judith Vicks Sweet , Michael McGraw
Decoding Taxes
Stocks were up this week in part because of the House tax proposal which, if enacted, would see the headline corporate tax rate axed from 35% to 20%. This would be the first major rewrite of the tax code since 1986. While the corporate tax rate is dominating the headlines, we highlight some of the most material changes proposed for individuals.
Tax Bracket Changes
- Tax brackets for individuals will shift from the current seven-bracket system down to a simpler four-bracket system.
Standard Deduction Expansion
- Existing standard deduction and personal exemption will combine into a single expanded standard deduction.
- This represents an increase of $1,600 for individuals and $3,200 for couples.
- 90% of households are expected to claim this higher standard deduction.
Curtailment of Itemized Deductions
- SALT Elimination – State and Local Tax deductions would be eliminated entirely.
- Real Estate Property Taxes – Limited to a maximum of $10,000/year deduction.
- Medical Expense deductions would be eliminated.
- Plug-In Electric Drive Motor Vehicle credit would be eliminated (buy your Tesla before the end of the year to get your $7,500 credit!).
- Mortgage Interest Deduction – Limited to the first $500,000 of primary residence mortgage only (home equity indebtedness would no longer be deductible).
Education Planning Reforms
- Up to $10,000/year can be used from 529 college savings plans to pay for private elementary or high school tuition.
- Student loan interest deduction would be eliminated.
Estate Tax Exemption
- Beginning in 2018, the lifetime estate tax exemption would be doubled ($11.2 million for single and $22.4 million for a married couple).
- Cost basis “step up” would remain.
- The estate tax would be repealed in 2024.
The path to passing tax reform is a long one as we outline in our Asset Allocation section.
Week Ahead
Next Week Will Feel Like DECAF Compared to Last Week
Daylight saving time will begin this Sunday morning on November 5th at 2:00 AM, when clocks shift back by one hour (unless you live in Arizona or Hawaii).
- A JP Morgan study in 2016 showed that daylight savings is responsible for a drop in spending by consumers by 2.2% to 4.9% as they have less daylight to shop. We assume that eCommerce is making up for some of that lost mall time.
Earnings focus next week will be on CVS Health Corporation (CVS) and The Walt Disney Co. (DIS).
- Investors will be seeking any details from CVS about the rumored acquisition of health insurer Aetna (AET).
- Cord cutting will be the major focus for Disney’s earnings release despite the expected blockbuster “Star Wars: The Last Jedi” due out in December.
Consumer Credit is expected to grow by $17 billion in September.
- The report may give additional insight into the consumer’s willingness to spend heading into Black Friday, Cyber Monday, and the Christmas shopping season.
Apple’s iPhone X went on sale November 3rd with excitement and investors will be focusing on sales numbers for the first weekend. Also, the focus will be on the supply of the phones.
- The online order period that started on Tuesday lasted for 15 minutes before running out of the phones that were due for shipment on November 3rd.
Federal Reserve Chairwoman Janet Yellen will be speaking on Monday and may provide some additional guidance about the transition to her announced successor Jerome Powell. New York Federal Reserve Bank President William Dudley will step up to the podium that evening as well.
Strategy Updates
Contributed by Max Berkovich ,
STRATEGIC ASSET ALLOCATION
The Tough Road Ahead
Taxes play a major role in asset allocation decisions. President Trump has stated that he wants Congress to pass the tax bill we discussed in our Economics Commentary by Thanksgiving and is hoping to sign it by Christmas. While it might be possible, the tax bill has several steps to go through before it can reach the President’s desk to be signed.
- The Ways and Means Committee in the House of Representatives will review and initiate the tax bill.
- The bill will be debated in the House of Representatives and possibly amended.
- After the approval in the House, the bill will go to the Senate (hoped for by Thanksgiving), where it is once again debated, scrutinized, and most likely amended by the Finance Committee and then presented to the rest of the Senate, where Republicans have a slim 52 to 48 majority.
- If the Senate approves the bill, it is then sent to a joint committee of both House and Senate members, where each side will attempt to compromise on a final draft of the bill.
- Once drafted, both the House and the Senate must approve the bill for a vote.
- The Congress will then vote on and pass the final version of the bill, and once it does, it will then go to the president. The president can sign the bill into law (hoped for before Christmas) or veto it.
- However, if vetoed by the President, Congress may try to override the veto if it can get two-thirds of the vote from each house.
STRATEGIC GROWTH
Trying to Remain Qualm
Consumer Staples were a laggard on the week. The Energy sector was the leader, but not without Technology giving it a last minute run with news from…
- Qualcomm Inc. (QCOM) is rumored to be a target of a buyout by another semiconductor company, Broadcom (AVGO). The rumored price is $70 per share. This deal would also put into question the offer already on the table for Qualcomm to acquire fellow strategy holding NXP Semiconductors (NXPI). This news comes on the heels of a consensus topping quarter from Qualcomm and a bump in guidance on Wednesday.
STRATEGIC EQUITY INCOME
Just in the Nick of Time
The Technology sector was the top sector thanks to a strong quarter from Apple Corp. (AAPL). Apple reported that it expects next quarter to be the “biggest quarter ever”. We note that Apple’s cash hoard ended the quarter at $268.9 billion and iPhone X was not up for sale yet. In other strategy news…
- A Department of Justice (DOJ) antitrust suit to challenge Time Warner Inc.’s acquisition by AT&T (T) rattled the stock on Thursday of both parties. The deal was near completion and this last minute wrinkle was unexpected. It looks like advocacy groups are finally spurring the DOJ to act. Consumer groups are outlining to Attorney General Jeff Sessions ways that combining a pay-for-viewing company with a content provider is not in the best interest of the consumer. The Wall Street Journal reports that concessions are already being negotiated to appease the DOJ.
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