As Tax Cuts Go, So Go Stocks

 

When markets closed Friday, stocks finished with their first down week since September—and you can blame it on tax cuts.

On Thursday, Senate Republicans unveiled their own tax cut plan a week after their counterparts in the House released their blueprint. (I’m calling it a “tax cut” plan, because that’s what it is, not tax “reform,” which, as in 1986, entails a much deeper change.)

The Senate plan preserved most of the essential features of the House’s, especially a new, permanent statutory corporate tax rate of 20%. (It’s now 35%, although the rate companies actually pay is much lower.)

But there was a big “but”: The Senate Republicans’ plan delayed that rate cut until 2019, one year later than the House bill’s start (based on the optimistic assumption Congress acts like a real legislative body and passes the bill by next year).

That was enough to throw markets into a mini-tizzy. The S&P 500 fell 12 points from its Wednesday all-time closing high near 2,600, while the Dow Jones Industrial Average is off roughly 140 points from its own closing peak. Both fell slightly on the week.

Are stock prices that closely tied to tax cuts?

It looks like they are.

The big rally over the 12 months since the 2016 election was driven by three things: 1. Continuing low interest rates. 2. Higher confidence among businesspeople that deregulation and tax cuts will raise economic growth. 3. Increased stock buying from investors (mostly Republican Trump supporters, Gallup’s surveys show), who essentially boycotted equities during the 7 ½-year Obama bull market.

Note how important confidence is, for both businesses and investors. In fact, you might recall that when Republicans failed to repeal and replace Obamacare, stocks sold off, too, as investors worried Congress wouldn’t be able to pull off tax reform, either.

On Thursday, a slightly revised version of the House GOP bill passed the Ways and Means Committee along party lines, and it could come up for a vote in the full House by next week. But there’s a lot of heavy lifting ahead: Republican Congressmen in blue states were freaked out enough about the bill’s slashing tax deductions for state and local income taxes, but after the big Democratic sweep in last Tuesday’s elections, they’re in full panic. Many of them will be “no” votes, so the bill may come down to the wire, even before it reaches the Senate or a conference committee.

“The passage of a tax reform package is an essential component of investor optimism,” wrote CFRA’s Sam Stovall this week. “Failure could trigger a sharp sell-off.” He thinks stocks are overvalued by 10%.

Fasten your seat belts; it’s going to be a bumpy ride.

 

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