Monthly Archives: January 2017

Trump on corporate income taxes

January 24, 2017 By in corporate income tax reform, income tax rates, Uncategorized Tags: , , , , Leave a comment

I think corporate tax reform is potentially the most significant item on the Trump administration agenda, as far as US stocks are concerned.

The Trump plan appears to have two parts:

–reduce the top corporate tax rate from 35% to, say, 20%.  For a firm that has 100% of its income in the US and which has no substantial current tax breaks, reducing the corporate tax rate would mean a one-time 23% increase in after-tax profit.

–eliminate foreign tax reduction devices.  American multinationals, facing high domestic corporate taxation, have resorted to two general types of tax avoidance devices.  They have: (1) transferred intellectual property (brand names, patents…) to low-tax foreign jurisdictions like Ireland, and (2) located distribution subsidiaries in similar places.  Hong Kong, where the income tax on profits generated by foreign companies is zero, is a favorite.

How this structure works:  a US-based multinational uses a Hong Kong subsidiary to pay a contract manufacturer in China $150 for a mobile telecom device.  The Hong Kong subsidiary sells the device to its US marketing subsidiary for $250.  The US company pays the Irish subsidiary a $100 royalty for the use of the firm’s proprietary technology and brand name.  It sells the device to a US customer for $600, recognizing, say, a $200 pre-tax profit in the US, and paying $70 in federal income tax.  Without Hong Kong and Dublin, the firm would have a pre-tax profit of $400 and pay $140 in tax.

If I understand correctly, President Trump’s intention is to tax this hypothetical multinational on the entire $400 of pre-tax earnings on sales made in the US–no longer allowing cash flow to be syphoned off to foreign tax havens.  At a 20% rate, the firm would pay $80 in federal income tax.

The bottom line:  while tax reform of the type I think Mr. Trump has in mind might leave large multinationals no worse off than they are today, it would be a significant benefit to small and medium-sized firms, which tend not to have elaborate tax departments and to be much more US-focused.  Just as important, it would eliminate the motivation to create offshore profit centers.

As/when the timing of corporate tax reform becomes clearer, I’d expect further rotation on Wall Street away from multinationals and toward domestic-oriented stocks.  A quick-and-dirty way of locating beneficiaries–look for corporate tax rates at or near 35%.

protecting domestic industry

January 23, 2017 By in tariff protection, Uncategorized Tags: , , Leave a comment

If his inaugural speech is any indication, a principal tool President Trump expects to use to enhance US economic performance is to help expand sunset manufacturing industries by protecting them against imports.   More useful action would be to emphasize improving the skill level of the workforce and to encourage innovation.  There may be a place for preventing foreigners from selling at below production cost (dumping) designed to stamp out competitors.  But by itself, and as a principal strategy, protection usually ends up making the economic situation worse, not better.

That’s because:

—it stifles innovation, as we can see from the current parlous state of the Japanese economy, which embarked on a strategy of protection in the early 1990s.  That country still has domestic industry that’s state of the art circa 1980, but little that’s more recent.  The US auto industry, which Washington protected from foreign competition beginning in the late 1970s from the 1970s onward, is another example.

—other countries retaliate when the borders are close to their products.  President Obama placed import duties on Chinese truck tires, effectively barring them from the US market.  China responded by taxing agricultural products sold there by US firms.

—protection typically raises costs to local consumers, lowering their standard of living.  Mr. Obama’s headscratching move simply redirected the source of imported tires from China to Thailand–at much higher cost.  Economists estimate that this unintended (I hope) effect alone cost several thousand US jobs.

 

Let’s hope the president sticks to corporate tax reform and infrastructure spending.

 

confidence and narratives

January 20, 2017 By in consumer confidence, Uncategorized Tags: , Leave a comment

Two recent items coming across my inbox:

I’d known there has been a striking favorable turn in consumer confidence in the US since the presidential election, but I hadn’t focused on how large a jump there has been until I read the latest strategy piece by Jim Paulsen of Wells Fargo.  We’ve gone from being mired deep in the bottom half of confidence readings over the past thirty years to high in the top quartile–over the 90% mark by some measures, and at the highest levels since before the Internet bubble burst in early 2000.

Paulsen’s conclusion:  earnings growth may be higher, and stock market performance in 2017 better, than the consensus expects.  I’m not sure I’d bet the farm on this, but it is at the very least a reason to refrain from selling–and to be wary of becoming too defensive.

 

I’ve also read the Presidential Address for the American Economics Association, titled Narrative Economics, by Robert Shiller, a former Wall Street economist who is now a professor at Yale (he’s also the Shiller from the Case-Shiller Home Price index).

I’ve never been a particular Shiller fan, and this is a weird paper, but it’s relevance is in its attempt to identify and measure the psychological influences that affect economic performance.  Its point is that story lines like those encapsulated in slogans like “Drain the Swamp” or “Make America Great Again” can have an unusually strong positive influence on actual economic outcomes.  This can come well in advance of delivery on the promises being made.  So even though my reading of Donald Trump’s career is that his sole personal success has been as an actor portraying a successful businessman on a reality show, it may be that his being a symbol of the need for change may be enough to energize the US for a while.  If he actually can achieve tax reform and an infrastructure spending program, so much the better.

 

 

a steadily rising Fed Funds rate into 2019

January 19, 2017 By in fed funds rate, Uncategorized Tags: , , , , Leave a comment

That’s the thrust of Fed Chair Janet Yellen’s remarks yesterday about rates in the US.

She said that there would be “a few” increases in the Fed Funds rate in each of 2017 and 2018.  Assuming that a few = three and that each increase will be 0.25%, Yellen’s statement implies that the rate will rise steadily until it reaches 2.0% sometime next year.

In one sense, two years of rising interest rates sounds like a lot–I know that’s what I thought the first time I was facing this prospect as a portfolio manager.  But if the neutral target rate for overnight money is the level that achieves inflation protection but no real return, 2% should be the target.  If anything, it’s a bare minimum.

In my view, two surprises to the Yellen forecast are possible:

–if President Trump is able to launch a significant fiscal stimulus program, the rate rise timetable will likely be accelerated, and

–if the inflation rate rises above 2%, which I think is a good possibility, then the Fed Funds rate may need to rise above 2% (2.5%?) to keep inflation in check.

Typically, a time of rising rates is one in which stocks–buoyed by increasing corporate earnings–go sideways, while bonds go down.  In the present case, earnings growth will likely depend on an end to dysfunction in Washington.

 

 

disappointing 4Q16 sales for Target (TGT)

January 18, 2017 By in department stores, Retail, Uncategorized Tags: , , , , Leave a comment

TGT just announced that its 4Q16 sales (the fiscal quarter ends in about two weeks, on January 31st, which is normal retail practice) will fall below its previous estimate of +1/- 1%.  The company now figures that sales will be down by -1.0% to -1.5%.

Online sales grew year-on-year by 30%+ during November/December, while sales in physical stores fell more than -3%.

In its press release, TGT also gives a breakout by major categories.

The company doesn’t say explicitly what the split is between online and physical store sales, but a little arithmetic will will get an approximate figure.  And that’s the core of the company’s sales growth problem, in my view.

The Commerce Department hasn’t yet released its calculation of the percentage of retail sales in the US that occurs online.  We can safely assume, though, that the number–which continues a steady upward march–will be around 9%.  This is the portion of overall retail that’s growing, and carrying the waning physical store business.  The TGT online figure, in contrast, is just slightly over 1%.