TAX REFORM EVENT RISK
Event risk is the danger of surprise that confronts investors. Stocks often rise in anticipation of good news but then tumble when the news turns out to be disappointing. This is a particularly significant risk in today’s stock market, as major indexes have reached record highs on anticipation the Trump Administration will deliver on its plan to chop corporate taxes.
The president’s proposal calls for a corporate tax rate of 20 percent, down from the current 35 percent, a prospect that has Wall Street buzzing with dreams of higher corporate profits. Goldman Sachs strategist David Kostin estimates every percentage point drop in the corporate tax rate will add a dollar to per-share earnings of the Standard and Poor’s 500 Index. RBC Capital is a bit more conservative, predicting the Trump plan could add $10.50 a share to earnings for the S&P 500 whose companies, on average pay, an effective tax rate of 27 percent. That, RBC predicts, could push the S&P 500 up by 200 points, based upon a forward price/earnings ratio of 19. For small capitalization companies the benefit would be even greater since they generally pay higher tax rates.
But what if tax reform suffers the same fate in Congress as other Trump initiatives? Indeed, tax reform may be more complex to push through Congress than the effort to repeal and replace the Affordable Care Act. In return for lowering rates, the president has promised to do away with most deductions and loopholes, tax breaks that impact dozens of industries, which are certain to fight to retain their tax advantages. The New York Times reports the issue will deliver a payday for lobbyists that could exceed $1 billion.
So, as lobbyists battle to protect their interests and try to shape tax legislation to their liking, stocks may be vulnerable. This may be a good time for investors to take some profits from stocks, and put the money into an investment that is subject to less tax reform event risk, like precious metals.
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