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How Will The President Finance his Proposals?

Small business confidence has soared after the Presidential election because US business owners and taxpayers are ebullient about a possible reduction in corporate taxes. Many are also excited about his plans to overhaul our infrastructure. But they are concerned about the cost of this. In order to pay for this, President Trump has proposed a Border Adjustment Tax (BAT).

In Europe, the largest source of tax revenue is a value-added tax (VAT), which is levied at various stages where a product or service is sold. Trump’s BAT is similar to Europe’s VAT.

The BAT is a big deal because it will change how corporations in the US are taxed based on what they produce regardless of where it is consumed. This will allow the US government to tax US-based companies regardless of where they sell goods and services.

Because the tax may differ depending on where the product or service is sold, this is not a tax on domestic consumption, but is instead a tax on foreign consumption. This means it can be a subsidy for exports and a tax on imports.

Let’s look at an example. If a US company makes everything in the US and sells everything in the US taxation will remain unchanged. But if a company uses domestic input and sells to foreign buyers it can deducts its costs for tax purposes but its revenues may not be taxable, effectively lower its tax rate and subsidizing exports.

On the other hand, a company using foreign inputs to produce goods but selling goods or services in the US would have a relatively higher tax bill than currently.

If passed, this his will create winners and losers.

The winners will be firms that has the bulk of their costs of production in the US with a lot of revenues in foreign countries (firms that export a lot).

The losers will be firms with the bulk of their costs of production overseas and a lot of revenues in the US (firms that outsource much of their production with relatively low exports).

Of course, this only one variable and it is unwise to broad brush. However, all things equal (a phrase economists use all the time that is never true), losers would include consumer discretionary firms like automakers, clothing and electronics retailers as well as consumer staples companies like food products and retailers.

Winners might include telecom companies, utilities, health care, and industries that rely on domestic production as well as materials and energy companies that rely on domestically sourced oil and gas.

What does this mean for Investors?

Because stock market indexes (and closet index funds in most 401ks) will continue using the same rules to construct portfolios and with no consideration to the fundamental change and because active managers have historically outperformed passive indexes when interest rates rise, we believe this is NO TIME TO OWN A TRADITIONAL INDEX.

While our crystal ball is cloudy (and stocks rarely plummet in an improving economy) stretched US stock valuations could cause prices to come under pressure.

Which means it is important to own the right stocks.

What might this mean for the Global Economy?

Economists (oversimplifying) suggest that the BAT won’t have an effect because currencies will adjust to offset it. But in the real world this is not what happens. No change occurs in a vacuum.

Trade partners will react. But President Trump knows this. Which means this is a game of 3D chess. And one thing we do know is that this is a game where our President has shown substantial skill. If you read his book, Art of the Deal, you shouldn’t be surprised that some of his initial stances may appear to be over the top. But that is what he does, he starts big and then negotiates down.

And because the American Consumer is the engine of the global economy, President Trump has a winning gambit.

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Ken’s focus is on investment strategy, research and analysis as well as financial planning strategy. Ken plays the lead role of our team identifying investments that fit the philosophy of the Global View approach. He is a strict adherent to Margin of Safety investment principles and has a strong belief in the power of business cycles.
On a personal note, Ken was born in 1964 in Lexington Virginia, has been married since 1991. Immediately before locating to Greenville in 1997, Ken lived in New York City.

Categorized: Financial Planning , Global Financial Markets , Global View Commentary & News