What Tax Reform Could Mean for Stocks

There’s an old joke that the Founding Fathers wisely chose a patch of land located along the Potomac River as the site of our nation’s capital because it’s a place so miserably humid in the summer and so bitterly cold in the winter that our elected representatives would choose to stay away most of the year, thus have fewer opportunities to make a mess of things.

Alas, centralized heat and air conditioning made the swamp habitable, and Washington, D.C., has been infested ever since.

Most of what our government does is, at best, a waste of time and, at worst, downright harmful. But Congress (mostly) got something right in its tax reform package, which the Senate approved earlier this month.

The bill is by no means perfect. It falls far short of its stated goal of simplifying the tax code, which remains as convoluted as ever. And some taxpayers – particularly high-earners in California, New York, and New Jersey – will get hosed and actually end up paying more of their money to government. For most individual taxpayers, the reform package is a nonfactor, neither much of a positive or much of a negative.

But the corporate rate reduction is a very big deal, with significant implications for the broader market and the recommendations I make to my Peak Income subscribers in particular.

America’s largest multinational companies have close to $3 trillion essentially “trapped” offshore. They don’t bring it home because doing so means giving 35% of it to the government. Instead, companies essentially borrow against their offshore cash by issuing bonds.

What do you think will happen to new bond issuance once all of that offshore money starts making its way back home?

It will pretty much grind to a halt. (In case you’re wondering why so many Wall Street bankers have been lukewarm, at best, towards the bill, here’s your explanation. It will all but kill their lucrative bond underwriting business, as their largest customers will no longer need their services.)

The bill also limits the amount of interest that companies can write off on their taxes, which further disincentivizes them to borrow.

So you’re going to have a major curtailing of new bond issues… at a time when demand for income from Baby Boomers is as strong as ever. That’s a recipe for low bond yields and high bond prices for a long time to come.

The situation isn’t quite as extreme in the tax-free municipal bond market, but you’re still likely to see fewer new bond issues coming down the pipeline.

Congress is removing the tax-free status of bonds used for things like sports stadiums and other “special purposes.” Meanwhile, personal income taxes won’t be falling enough to make munis less attractive to high-income Americans. (Remember, the lower the tax rate, the less important it is to have tax-free income.)

A relatively tight supply of muni bonds should keep prices high for the foreseeable future.

But it’s not just bonds that will be affected. Lower taxes means more cash on hand for dividends and buybacks, particularly for the large multinationals looking to repatriate their offshore cash hoards.

We’re talking about a lot of money that’s likely to get dumped into the stock market one way or another.

Anticipation of corporate tax reform has been a major driver of the Trump Rally. This bull market – like all bull markets – will end, sooner, probably, rather than later.

But I also believe this market has at least one last major hurrah left in it, which is what told Peak Income readers when recommending this month’s addition to our income portfolio.

Normally, I recommend safe, stable income plays that you should be able to hold for multiple years… maybe even decades. But this month I’m presenting an opportunity to profit from one last surge in the U.S. stock market.

I’ve said for months that I expect overseas markets to outperform over the next several years, and that’s still my working hypothesis. But over the next six months or so, I expect U.S. stocks to beat the pants off of pretty much everything else.

And so I’ve told readers to target an all-American fund chock full of some of the biggest names in the S&P 500 Index, familiar names like Facebook, Alphabet/Google, and Amazon.com.

I see this as shorter-term trade. We’ll be out of it long before we see a bear market, but we’ll be in it long enough to enjoy a nice payout. This fund trades at a 10% discount to net asset value and yields 11%. A total return in the 20% neighborhood is doable.