Bill Schmick | @TheMarket: Why Congress disappoints the financial markets

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PITTSFIELD — We had the largest one-day decline in the markets this week since who knows when. Investor sentiment has been running red hot in favor of the bulls while underneath the surface of the averages, large-cap stocks have been starting to decline. All we needed was a catalyst.

Thank you Congress for giving it to us! Readers of last week's column were treated to my rampage against the House bill, which was sold as a "Middle Class Tax Cut". I was having none of that. Anyone who took the time to read this bill (economists, financial analysts, politicians and even the media) quickly realized that this was the swindle of the century. Taxes would be first lowered (for some), and then raised, in order to finance a huge tax cut for mega corporations and their owners — the American one percent.

This week the Republican-controlled Senate released its version of "tax reform," which increased the number of tax brackets back to seven, postponed any corporate tax cut until 2019, doubled the estate tax deduction, instead of eliminating it, and scrapped all tax deductions for state and local taxes. Is it any wonder that investors sold down the market?

Now that our leaders have made a shambles of their second effort at passing legislation this year (the health care failure being the first), what's next, maybe an infrastructure program? I wouldn't count on it.

The facts are that until Congress is willing to develop a bi-partisanship approach to legislation, nothing that gets done will stay done. As an example, let's say that the Republicans can get their act together by the end of the year (or next) and pass a tax bill. As soon as the House and/or Senate change hands, whether that happens next year, or in two-to-four years, the Democrats will undo any legislation not to their liking. They had no hand in making those laws, so they will have no compunction in throwing them out. Think back to the Democrats' unilateral passage of Obamacare. Republicans are still trying to reverse and destroy that legislation.

Now consider the way U.S. corporate managements make rational investment decisions. Let's say they do get a permanent tax cut from 35 percent to 20 percent this year. Will they take those tax savings and invest it, as the Republicans claim, growing the economy and adding jobs? Or will they hold back and wait and see if the Democrats regain power next year or in 2020? Since they have been burnt time and again by our fickle legislatures, their most likely course of action will be to continue to do what they have done in the past. They will stash the money away, buy back stock with it, or pay the money out as dividends to their shareholders.

RICH WILL GET RICHER

How would any of those actions create jobs or raise wages for Americans? Instead, the wealthy will get wealthier while paying fewer taxes, the income disparity will worsen as middle and lower-income taxpayers pay more taxes over time. Better that we forget about tax reform or tax cuts until both sides of the aisle embrace the concept that made America what it is was — a nation of compromise.

But what of the markets, how will they take this disappointment? It depends on how much of the markets' recent gains came from anticipation of tax reform/cuts. Analysts have been making the case all year that tax reform could add on average $5/share or more to earnings growth for companies in the S&P 500 Index. Have investors bid up stock prices based on that theory? If so, we are in for some rough weather ahead.

We could see that long-awaited, always elusive, pull-back despite the fact that November through December is supposed to be the best time of the year for stocks. It is too early to tell, but now that Washington has given us an excuse, profit-taking may be once again permissible. If so, I have done all I can to prepare you for such an event.

On a separate note, happy Veterans Day and Semper Fi to all fellow vets out there.

Bill Schmick is registered as an investment advisor representative with Berkshire Money Management. Bill's forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquires to Bill can be made by calling 1-888-232-6072 (toll free) or via e-mail at Bill@afewdollarsmore.com

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