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posted on 15 November 2017

Tax Bill Overview And Expectations

Written by , Clarity Financial

Last Friday, I discussed the two current tax bills with Scarlett Fakhar of Real Investment News:

There is a rising, and significant, probability that “tax reform" will fail to pass in the Senate. This would delay the passage of tax reform bill until well into 2018, and possibly 2019 assuming the Republicans can hold majorities in both houses next November. Such is a slim possibility at best.

I encourage you to take a few minutes to review my previous analysis of the effectiveness of tax cuts on the economy.

This past week, Bloomberg produced a very concise comparison of both bills current presented.

(Click HERE For The Full Analysis)

The Committee For A Responsible Budget did a terrific piece of analysis which concurs with many of my assumptions as well. To wit:

“Fundamentally, the Senate bill suffers from the same fatal flaw as the House bill - it tries to cut taxes by $1.5 trillion over the next decade with no plan to pay for these cuts. As recent dynamic scores have shown, there is no way economic growth can pay for more than a fraction of this cost.

In fact, tax cuts that add to the debt do less to grow the economy than fiscally responsible reform and may even hurt economic growth over the long term.

It is frightening that so many members of Congress are willing to believe in fantasy economics based in no historical or mathematical reality.

If tax cuts paid for by debt are signed into law, Congress will have sent a massive, budget-busting tax bill to our children to pay, and it will result only in a short-term sugar high with little to no economic improvement over the long term."

EXACTLY, the point I have repeatedly made.

  • There is absolutely NO historical evidence that “tax cuts" alone lead to stronger economic growth, higher wages, or more jobs.
  • There IS plenty of evidence, however, that shows tax cuts lead to bigger deficits and more debt.

The market WILL figure this out eventually, and the consequences will not be good.

Managing Past The Noise

There are obviously many more arguments for both camps depending on your personal bias. But there is the rub. YOUR personal bias may be leading you astray as “cognitive biases" impair investor returns over time.

“Confirmation bias, also called my side bias, is the tendency to search for, interpret, and remember information in a way that confirms one’s preconceptions or working hypotheses. It is a systematic error of inductive reasoning."

Therefore, it is important to consider both sides of the current debate in order to make logical, rather than emotional, decisions about current portfolio allocations and risk management.

Currently, the “bulls" are still well in control of the markets which means keeping portfolios tilted towards equity exposure. However, as David Rosenberg once penned, the markets are set up for disappointment. To wit:

“So we have a sluggish U.S. economy on our hands with growth revisions to the downside. We have a situation where some investors see the softness enduring long enough that Fed funds futures are now pricing in less than 50-50 odds that Yellen et al make another rate move by year-end. Yet the Fed is signaling that it will begin to shrink the balance sheet by the fourth quarter, with no economic liftoff.

The political backdrop is rife with gridlock - unbelievably, there is still hope among investors that tax reform is coming by 2018. At the same time, evidence is mounting that the Dems have a serious shot of taking the House next year. We have a White House that, with the help of inside leaks and the media, continues to find itself embroiled in controversies. And health care reform, which was always pledged to be the first item to be done, is looking more and more like now a pipe dream. When hasn’t governing been complicated? It took the Gipper five years and endless bottles of scotch with Tip to get tax reform legislated in 1986!"

Currently, there is much “hope" things will “change" for the better. The problem facing President Trump, is an aging economic cycle, $20+ trillion in debt, an almost $700 billion deficit, unemployment below 5%, jobless claims at historical lows, and a tightening of monetary policy and 80% of households heavily leveraged with little free cash flow and surging health care costs. Combined, these issues alone will likely offset most of the positive effects of tax cuts and deregulations.

Furthermore, while “bearish" concerns are often dismissed when markets are rising, it does not mean they aren’t valid. Unfortunately, by the time the “herd" is alerted to a shift in overall sentiment, the stampede for the exits will already be well underway.

Importantly, when discussing the “bull/bear" case it is worth remembering that the financial markets only make “record new highs" roughly 5% of the time. In other words, most investors spend a bulk of their time making up lost ground.

The process of “getting back to even" is not an investment strategy that will work over the long term. This is why there are basic investment rules all great investors follow:

  1. Sell positions that simply are not working. If they are not working in a strongly rising market, they will hurt you more when the market falls. Investment Rule: Cut losers short.
  2. Trim winning positions back to original portfolio weightings. This allows you to harvest profits but remain invested in positions that are working. Investment Rule: Let winners run.
  3. Retain cash raised from sales for opportunities to purchase investments later at a better price. Investment Rule: Sell High, Buy Low

These rules are hard to follow because:

  1. The bulk of financial advice only tells you to “buy"
  2. The vast majority of analysts ratings are “buy"
  3. And Wall Street needs you to “buy" so they have someone to sell their products to.

With everyone telling you to “buy" it is easy to understand why individuals have a such a difficult and poor track record of managing their money.

Trying to predict the markets is quite pointless. The risk for investors is “willful blindness" that builds when complacency reaches extremes. It is worth remembering that the bullish mantra we hear today is much the same as it was in both 1999 and 2007.

Again, I don’t need to remind you what happened next.

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