People Think Their Taxes Will Be Raised, But They Won’t
It's always interesting when vast swaths of people believe something that isn’t true. One example of this is the FOMO involved in cryptocurrencies. The total valuation of all the coins is $606 billion. It’s difficult to rationalize that valuation, but most speculators don’t care. They want to get into a hot market. The latest example of people believing a falsehood is the reverse of that euphoria. Most people are afraid of the tax plan because it has changed many times. I understand why people are uncertain. The media and politicians make so many partisan points about the plan that it’s hard to know who to believe. Whenever you are uncertain about something, it’s easy to believe the worst. I’m not making a partisan point. I’m trying to objectively understand how this tax cut will affect people. According to the Tax Policy Center, 80.4% of Americans will pay less taxes. The Americans which will pay more are the wealthy who live in high tax states like New Jersey. The table below gives an overview of how the tax cuts will affect Americans in each quintile.
According to a Wall Street Journal poll, 17% of Americans think they will pay less taxes next year. Clearly, 63.4% are wrong about the tax plan if the Tax Policy Center is correct. This is the reverse of what we saw 12 months ago. After President Trump was elected, there was unbridled optimism about the economy even though nothing had changed. I mentioned that the consumer would lose confidence because they’d get impatient. That’s not what happened. Instead, the consumer never got impatient. They’re only becoming more negative lately because of media reports on the new tax plan. There can be a burst in optimism which can boost consumer spending next year when consumers realize the truth about the bill.
In the past two months, the University of Michigan consumer sentiment report showed a decline from 100.7 in October to 96.8 in December. I can see the sentiment polls getting worse in the next couple months now that consumers think a tax increase was passed. Whenever the realization that taxes weren’t raised for most people occurs, I think the pent up demand will be released.
The House Passes Tax Cut
The tax cut was passed by the House in a vote of 227-203, but it turns out that was a dress rehearsal because there was a technicality which is forcing them to vote for it again. The Senate’s parliamentarian stated the provisions in the bill don’t work under the reconciliation process rules. To fix this change, the House will take two provisions out of the bill. The two changes made are about 529 accounts being used for home schooling expenses and colleges with under 500 students being exempt from the endowment tax. When these changes are made, I expect the House to vote for the plan with the same number of votes. Then the Senate will vote for the plan. Finally, the President will sign it right before the Democratic Senator from Alabama is sworn in next year.
Stay Objective
It’s very important for your portfolio’s sake to be objective when it comes to your analysis. It’s easy to make decisions based on if you like the political party that is in charge. That would have been a very bad idea because the stock market has rallied under Democrats and Republicans in the past 9 years. It’s fine to disagree with the plan personally, but recognize that it will positively effect stocks as consumers will have more disposable income and corporate earnings will increase.
Buybacks Exploding
With the concept of staying objective in mind, let’s look at the effect of the repatriation tax holiday. The repatriation tax holiday is going to allow firms to bring back overseas cash to buyback stocks. The table below shows the list of buybacks that have been announced since the Senate passed the tax bill a couple weeks ago. The $95.9 billion in buybacks are just the beginning of what should be a year (2018) which sees record buybacks.
Excessive Long Position In 30 Year Treasury Futures
Previously, I’ve discussed the excessive long positioning in the oil futures market. Even since we’ve discussed that, the oil market has been stable. WTI oil is at $57.73. It’s possible we see a decline, but so far, there has been nothing. This shows how these signals aren’t immediate and they aren’t always accurate. With that in mind, let’s look at futures speculation in the 30-year bond. As you can see, the long position is about as bullish as it has ever been in the past 6 years. The last time the futures got this positive, yields increased from 2.0983% to 3.1741% in slightly more than 5 months. That would mean a similar increase in yields could be coming. There already looks like there is upward momentum as yields have increased from 2.6873% to 2.8073% in the past two days.
In a previous article, I showed that financials do the best when yields are increasing. This goes along with my theme that yields will increase next year. I’ve read that after the Fed raised rates in December, some banks raised their mortgage interest rates, but didn’t raise their deposit interest rates. The reason is that some banks didn’t cut rates as much as they should have for deposits when the Fed had rates near zero because they couldn’t make them negative or else people would have taken their money out of the bank.
Conclusion
Stocks rallied in 2017 even though buybacks declined. 2018 should see a return to the glory days of buybacks that were 2014 and 2015. This along with the increase in consumer disposable income and the lower corporate tax rate should help stocks. At the best, 2018 will be like 2017 and at the worst, 2018 will be the beginning of the end of the business cycle as inflation increases. I think either scenario is good for stocks; there shouldn’t be any major trouble for another 2-3 years.
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