Fed to Move Against Economy?

Written by Dennis Slothower
Posted November 4, 2017

Congress Begins Tax Reform Debate

Stocks finished mixed on Thursday following the announcement of the Republican tax overhaul plan and the official appointment of Jerome Powell as the next Federal Reserve Chairman to replace Janet Yellen in February.

It was a "buy the rumor, sell the facts" type of day as investors attempted to sort through the implications of the tax plan coming out of the Ways and Means Committee that will soon be considered by Congress.

From a corporate perspective, if approved, the top corporate tax cut would be reduced from 35% to 20%, and companies would be able to write off investments in new equipment immediately, rather than spread over several years. The plan also creates a new 25% rate for small business owners, sole proprietors, and partnerships that report business income on personal tax returns. The plan allows corporations to repatriate capital overseas at a 12% tax rate.

For individuals, the plan calls for four tax brackets: Single filers making up to $24,000 a year will pay no income taxes, but those earning $24,000 to $90,000 will pay 12% on that income. From $90,000 to $250,000, the tax rate is 25%, and from $250,000 to $1,000,000, the rate is 35%.

If you’re making a million or more a year, your top tax bracket is unchanged at 39.6%, but you are going to likely lose deductions you previously had in some ways.

For example, under the new tax plan, all will lose the ability to deduct state and local taxes, which hits places with high state and local taxes, like New York and California, especially hard. Being wealthy in these coastal blue states will see taxes go higher.

Also under the new tax law being proposed, future homeowners will lose their mortgage interest deduction above $500,000. Existing homeowners get to keep deducting their mortgage interest as is, but if you are looking to build a new home in the future, any interest above a $500,000 mortgage is not deductible.

This caused the homebuilder companies to nosedive today, as you might imagine.

There are other parts of the bill that remove the deductions for medical expenses and phase out the estate tax, but these are the key elements. The bill will not seek the repeal of Obamacare’s individual mandate.

The Republicans hope to have this bill on the president’s desk by Thanksgiving.

There isn’t much doubt the bill should pass the Republican-dominated Congress, but it is very hard to not be skeptical about its chances in the Senate, where key legislation has been shot down by dissenting Republican senators.

Fed to Move Against Economy?

In the meantime, keep your eye on the bond market. The bond market believes if the tax plan becomes law, the Federal Reserve will move against the economy by raising rates more aggressively, even with the new appointment of Jerome Powell, who has been on the Federal Reserve for the last five years.

71102-yield-curve

The cake is baked for another rate hike in December. The current play is for the Fed to “gradually” raise rates three more times in 2018 (March, June, and October, most likely).

We continue to get a steady stream of corporate earnings that shows growth is decelerating in spite of the glorious reports you hear on the news. Growth will come in under 5%, with the biggest spike from the energy sector.

This is especially true when you look at corporate earnings spread over the last two years for the S&P 500 companies.

71102-corporate-earnings

Notice that over the last two years, total corporate profits (in red) and domestic profits have not grown much, not justifying an exponential explosion in share price. How many years in advance do you pay for growth? Does anyone care anymore?

To your wealth,

Dennis Slothower Signature

Dennis Slothower
Editor, Wall Street Underground Profits

Dennis Slothower has been leading a small but profitable group of investors to some extraordinary profits in both good markets and bad over the course of a 38+ year investment career, starting as a stock broker in 1979. In 2011 Dennis was named the top performer by Hulbert Financial Digest for avoiding the Crash of 2008. Now, he is bringing his extensive experience to the public through Outsider Club and Wall Street Underground Profits. For more about Dennis, check out his editor page.

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