Sophisticated investors know that the main reason why stocks are near all-time highs is that record low interest rates have caused most asset classes to boom.
Today, however, most companies are struggling to achieve even modest topline growth and are running out of costs to cut. For the next market move up, companies must improve their net income. Which candidate’s tax policy can help deliver that?
Donald Trump has proposed reducing the business tax rate from 35 percent to 15 percent. This means 85 percent of pretax earnings would come through to post tax net. This is opposed to today’s 35 percent federal corporate tax rate that permits only 65 percent to come through to post tax. That 20 percentage point increase above 65 percent is a 30 percent increase across the board in net income.
How many stocks in your portfolio are expected to show 30 percent earnings growth in 2017? How high do you think your stocks would go if every one of them exceeded analysts' earnings expectations by 30 percent next year? If future years' earnings all would be 30 percent higher than the present outlook, wouldn’t that mean more cash flow, more dividends, and higher stock prices?
In contrast, Hillary Clinton has promised to raise business taxes by $275 billion to fund her proposed infrastructure plan. America’s businesses taxes are already the highest in the world. Clinton’s tax hike would make our companies even less competitive on domestic soil, accelerate offshoring, and reduce job growth. Of course, this tax hike would significantly reduce net income as well, with the expected downward pressure on stock prices.
Under Trump, tax rates for individual investors would also go down – with two favorable implications. First, more earned income would be available for consumption and investment. A married couple with two children and a nanny would enjoy more than a 30 percent tax reduction – a growth stimulant.
Second, while higher brackets would get relatively less tax relief under the Trump plan, there would still be some. Because people with earnings of $75,000 or more are the mainstays of stock market investing, there would be additional savings – a strong growth and market plus.
In contrast, Hillary Clinton proposes fining investors for any gains they realize over less than a six year time period – as opposed to the one-year holding period under current law. Duration means added risk and lower returns, especially now that we are in the uncharted Never-never land of zero interest rates and unprecedented geopolitical uncertainty.
More broadly, our economic recovery, feeble as it has been, is now seven years old. It has been very rare historically for our economy to keep growing for more than seven consecutive years. Thirteen years would be off the charts altogether.
In today's world of low yields on stocks, capital gains are more important than ever, and one of the great aspects of capital gains has been their favorable tax treatment. Hillary Clinton would change all that.
Think how hard it is to find a stock that will outperform the market every year for six years. Most investors find it hard enough to find stocks that will outperform for more than the one-year holding period now needed for capital gains treatment.
With stocks near all-time highs, what do you think is the likelihood that a bull market will continue for six more years? We would say slim to none.
Peter Navarro is a UC-Irvine business professor and author of stock market classics like “If It’s Raining in Brazil, Buy Starbucks.” He is a member of the Trump transition team.
Wilbur Ross is a private equity investor.