As The Bulls Stampede – We Recommend Caution
The stock market surges higher as the economy continues to expand and news relating to COVID19 diagnostics, therapies, and vaccines gives investors optimism.
Purchasing Managers’ Index “PMI” surveys indicate that both services and manufacturing sectors continue to expand through August. Our note of caution is based on the markets’ high 21x price-to-earnings “P/E” ratio and the potential for a significant change in U.S. tax policy that would reduce corporate earnings and business investment. We recommend clients reduce equity/stock allocation and raise cash to the higher end of one’s cash allocation range.
Possible Tax Policy Changes.
The Tax Cuts and Jobs Act of 2017 included reducing corporate taxes from 35% to 21%, which increased corporate earnings and in our opinion was the catalyst for $1 trillion of capital returning to the U.S. If corporate taxes are increased, as proposed, from 21% to 28%, we believe the change will create the incentive for companies to consider moving their headquarters outside the U.S to lower tax jurisdictions. We estimate a 28% U.S. corporate tax rate would reduce S&P 500 earnings by 12-15% and may be a catalyst for the stock market to sell off by 15-25%. Also being proposed is a capital gains tax increase from 20.0% to 39.6% for taxpayers earning more than $1 million per year. While these taxpayers could “afford” the higher capital gains tax, it would inhibit capital from flowing to early stage, high growth companies requiring capital for growth. If business investment is constrained, so too will economic growth.
Richard S. Lawrence, CFA September 2, 2020SCHEDULE A CONSULTATION
We recommend only to invest in the stock market with a long-term view (3+ years) and have cash available for emergencies and spending needs for the short term (1-3 years).
PLAN FOR THE LONG TERM
PREPARE FOR SHORT TERM STOCK MARKET DECLINES