With uncertainty swirling in Washington, the public’s tax cut expectations have been fading. The prediction market site PredictIt, has the odds of a corporate tax cut by the end of 2017 at 33%, down from 74% less than three months ago. The odds of an individual tax cut has also fallen from around 70% to 36% in the same time frame.
The financial media has relied on the “Trump Rally” narrative to help explain stocks success since the election. Along with deregulation and other business friendly policies, anticipation of tax cuts are viewed as a source for the bullishness towards the market. Investors reason that along with a lower tax rate, firms will invest more. Trump has proposed cutting the corporate tax rate to 15% from 35%, and while most corporations don’t actually pay that rate, firms in certain sectors will benefit more than others from a cut. Consumer staples and consumer discretionary companies tend to pay much higher rates than sectors such as real estate and utilities, as they benefit from certain tax deductions.
Tax cut expectations – How Stocks Are Reacting
Despite investors’ love for tax cuts, their fading hope in Republican’s ability to achieve them hasn’t seemed to affect stocks negatively. In approximately the same time period shown in the chart below, the performances for each sector expressed through their SPDR ETFs are shown below.
David Einhorn's Greenlight Capital returned -2.9% in the second quarter of 2021 compared to 8.5% for the S&P 500. According to a copy of the fund's letter, which ValueWalk has reviewed, longs contributed 5.2% in the quarter while short positions detracted 4.6%. Q2 2021 hedge fund letters, conferences and more Macro positions detracted 3.3% from Read More
It appears investors haven’t been too fazed by the dwindling expectations of tax cuts. Two sectors are down here, Energy and Financials, and both are on the bottom half of suggested sectors to benefit the most from the tax cut.
While healthcare is a contentious intra-party issue, when it comes to tax cuts, Republicans are basically in unanimous favor of lower taxes. While it may be difficult to get all Republicans on board with a particular health care plan, it’s hard to imagine a tax cut that they will be against.
Note: The majority of this piece was written on Sunday, and on Monday, the odds for a corporate tax cut on PredictIt shot up to 50%, while the odds for an individual tax cut still remain low. Stocks were also up on the day so maybe the financial media will use this narrative again.