Since the Presidential election, the entire investment community has been scrambling to ascertain what sort of policies will be forthcoming from the new administration. We believe that trying to guess the details at this point around tax policy, trade policy, foreign policy, etc. is almost impossible insofar as President Trump and his advisors have been fairly non-specific with details in these areas. As a result, we have elected to maintain relatively high cash levels throughout this whole period in order to hedge out the uncertainty we feel.
From an investor’s point of view, at least in respect to his pledges to cut taxes and regulatory burdens, it seems we should take the new president at face value. The primary industry that has suffered from a heavy regulatory environment in recent years is the financial services industry, in particular banks and other lenders. Obviously in response to their reckless lending and bad behavior leading up to the 2008-09 financial crisis, some degree of heavier regulation was warranted. However, only the very biggest banks and lenders created the systemic problems of that crisis. Unfortunately though, regulators felt it necessary at the time to cut a very wide swath and apply much heavier regulations across the board, even down to the very small community banks. This will be one area of focus for the Trump administration in relaxing these regulations on the smaller and mid-sized banks and lenders. How far they actually go in removing or relaxing the Dodd Frank regulations on the very large Systemically Important Financial Institutions (SIFI’s) remains to be seen. Our hope is that the regulations end up being simply replaced by higher capital reserve requirements, rather than the tomes of rules and regulations that came out of Dodd Frank. In any case, we do believe that these financial entities represent compelling opportunities at perhaps better prices.
The issue of tax cuts and how they are comprised and who they target is a more complicated matter. In order to better organize this conversation, we will break it down to: 1) Personal tax cuts, 2) Corporate tax cuts, and 3) Dollar Repatriation.
Personal Tax Cuts. The new euphemism coming out of Washington in this respect is “dynamic scoring,” which is just Reagan era supply side economics rebranded for a new generation. The general idea is that by cutting personal tax rates on higher incomes, more money will be spent on consumption and will “trickle down” to all income brackets through a Keynesian multiplier, thereby broadening the tax base and ultimately expanding tax revenues. Calvin Coolidge applied this same tax strategy in the 1920’s. However, under both Coolidge and Reagan, this strategy did not quite work as advertised. Typically, the result of this type of tax policy has been higher savings and investment rates instead, that is the tax cuts wound up more being invested rather than consumed.
Obviously, for stock investors, that would be welcome news. To the extent that valuations can be justified, we would expect there to be plenty of capital available to bid prices higher under such a tax strategy.
Corporate Tax Cuts. We feel that if the Trump administration can effectively and meaningfully cut the aggregate corporate tax rate, the net effect would be that those tax savings would simply fall to the bottom line and boost earnings dramatically, thereby making US stocks at current price levels and valuations relatively attractive. The reason we hedge this statement is that the Trump administration has signaled a sort of carrot and stick approach to the corporate tax rate. That is, it seems that they intend to offer sizable tax cuts to those companies that produce their goods and services domestically (the carrot) while penalizing those that export much of the manufacturing process to then reimport to the American consumer (the stick). So, until we have a better sense of how and where these cuts will fall and the magnitude of the incentives and penalties in question, it’s difficult to make any earnings projections.
Dollar Repatriation. The Trump administration has indicated that a very low one time repatriation tax could be applied to bring back as much as $3 trillion of foreign earned profits of American companies held overseas. The idea is that much of that money could be used to help fund a lot of the infrastructure projects proposed. Our feeling is that a very low repatriation tax would have the desired effect of bringing perhaps $1.5 trillion back home. Ironically, though, the lower the tax rate the more money will repatriate, and the lower the tax receipts will be. So, unless the companies doing the repatriating feel somehow compelled to invest in infrastructure projects, we do not see a whole lot of infrastructure spending coming from this strategy. In fact, we would expect most of the repatriated money to be used more for stock buy backs and higher dividend payouts.
At this point, and to summarize, we are expecting the Trump administration to:
These strategies should all be bullish for stocks in the short to intermediate term in that they all either produce higher corporate profitability or more liquidity or both.
It is important to insert at this point a discussion about the potential negative consequences of cutting taxes and regulations without some very deep consideration. If growth does not accelerate into the +4% range that the new administration is targeting, we would expect massive federal debt to result as the tax revenues simply will not materialize otherwise.
For this reason, and until we see a growth plan that makes sense, we are going to continue to assume fairly low and stagnant US economic growth of 1.5 – 2.0% Real GDP. Therefore, we will likely need to continue our more active strategy of taking profits where individual issues appear over-bought and rolling into issues that appear over-sold. In such an environment for growth,
holding on to over-bought securities awaiting underlying valuations to catch up usually necessitates intolerably long periods of underperformance in those specific issues. Similarly, we will continue or bond strategy of buying lower quality issues (but still considered Investment Grade where required) and short 2-3 year maturities.
As always, please feel free to contact us if you have any questions or if you need to schedule an appointment to discuss your account or financial plan with us. This is particularly important if you have experienced a big change in your life recently (got married, retired, changed employment, bought/sold a business, etc.).
2015 Form ADV Notice and Offering – the firm’s 2015 amended Form ADV Part 1 & Part 2 filings with the State of Colorado Division of Securities and other regulatory bodies were filed timely 03/15/2016 and amended 06/09/2016. If you would like a copy of this important disclosure document, please contact us at (303) 442-3670 or firstname.lastname@example.org and we will be happy to deliver it to you at no charge.
Mark P. Culver
Culver Investment Company, LLC
360 Interlocken Blvd
Broomfield, CO 80021
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