Virtually every U.S. business and investor has been looking for, hoping for and/or betting on a major tax-reform package under President Trump. Obamacare repeal and other items on the Trump agenda might attract a lot of attention, but it's the possibility of tax cuts that really revs up the masses. But what exactly has the market already priced in and how do we handicap how far stocks still have to run? Will there be a "sell the news" event when rumor turns into fact?
Let's check it out:
Trump's coming tax plan remains shrouded in some mystery as Congress squabbles over how to pay for it, but the markets seem to expect something "phenomenal," as our "cheerleader in chief" has described it. For example, Trump has called for reducing the U.S. corporate-tax rate from its current 35% level -- among the highest in the developed world -- to a meager 15%. Huzzah!
Jurisdiction over these matters resides with Congress, and with both the House and the Senate in Republican hands, you'd think that there'll most likely be a tax cut enacted at some point this year. That's not all well and good, though. After all, any navigational detour from actually adopting tax reform will slow down Trump's agenda -- and potentially put the market in peril.
Editors' pick: Originally published March 2.
For instance, dealing with Obamacare first (as the White House has promised to do) would be just such a distraction. And if lawmakers want to rip up the Affordable Care Act (as Obamacare is officially known), dealing with health care will be a necessary evil. Why? Because as a stand-alone item, tax reform would require eight Democratic senators to cross party lines to avoid a filibuster.
By contrast, passing a new budget only requires a simple majority. But to write a new budget, Congress must resolve the costs and tax implications of any new health-care laws. Then, lawmakers can pass tax reform under said new budget. Complicated? Yes, but this is the only way that one party can get things done in Congress without the other party's help.
Most analysts expect Trump's plan to arrive with a proposed corporate tax rate of 20% or so, which would be a boon for corporate America. However, the plan will also probably come with some thorns -- most likely a border-adjustment tax, or worse yet, a value-added tax that would basically tax all consumption. Think "sales tax on steroids," as a VAT might literally tax steroids (and everything else that you buy).
Fortunately, the more likely proposal of the two to actually come to fruition appears to be a border-adjustment tax. This would probably subject imports to a 20% tax but cut taxes on exporters' profits to zero (perhaps in anticipation of retaliatory moves by foreign countries).
Is that bad? Well, most countries already have something like this in place -- and by design, a border-adjustment tax would encourage narrowing America's trade deficit. That's a positive. And perhaps more importantly, a BAT would also make America more attractive to foreign corporations looking for a tax haven, reversing a trend that up until this point usually worked against U.S. interests. Another positive.
So what's the problem? Well, a border tax could put upward pressure on the U.S. dollar and force consumer prices higher. So, there's no doubt that this is a tricky limb to go out on. If it works, the masses end up with higher consumer prices, but better jobs. If it doesn't work, you just end up with higher prices.
The Play to Make
What should equity investors do in this environment? We'll, you're going to have to defend yourself from headline-driven political risk to your portfolio. There's much potential for heightened volatility as we close in on spring and head into summer. We'll likely know some time around August if we'll really see tax reform this year -- and either way, the market's initial reaction might be negative.
Common sense dictates that you look for corporations that currently pay close to the top 35% effective tax rate and that generate the majority of their income domestically. These firms should benefit the most from a corporate-tax cut while suffering the least from any trade tensions with foreign countries. The rising interest rates and stronger U.S. dollar that a border tax could exacerbate would only amplify into this theme.
You can find many such stocks in the Russell 2000, as small-cap names tend to pay about 33% effective tax rates vs. the roughly 28% that big-caps in the S&P 500 pay. (And of course, some big-caps like General Electric (GE) pay much, much less.) For that reason, you might want to look at a Russell 2000 ETF like the iShares Russell 2000 ETF (IWM) or the Vanguard Russell 2000 ETF (VTWO) .
Those who like to do their own hunting might want to move into regional banks. I have long liked KeyCorp (KEY) , while another name known for its above-average effective tax rate is Bank of the Ozarks (OZRK) .
Areas to avoid could include retailers, which seems pretty obvious due to the sheer amount of imported goods that they sell. But less obvious areas to avoid include information-technology stocks. Sure, techs could enjoy a cash influx should Trump's plan include a proposed tax holiday on repatriating foreign-held corporate cash. You probably want to be there for that. But after that one-time trick, you'd be left with firms that already have fairly low effective tax rates thanks to ample research-and-development tax credits.
Even still, tax credits or a tax holiday could be a huge windfall for companies with huge hoards of cash overseas. Those include Apple (AAPL) , Microsoft (MSFT) , Cisco (CSCO) , Alphabet (GOOGL) , Johnson & Johnson (JNJ) and Oracle (ORCL) .
A full rundown of TheStreet's guide to trading in March can be found here: