Last week, my friend Lee Adler titled his usually spot-on, widely read Sure Money Investor “Here’s What Shah Gilani Got Wrong About Trump’s Tax Cuts.”
Lee might be right about one thing, but he’s wrong about this.
We had gotten into (in his own words) a vigorous conversation about the impact of President Trump’s tax cuts on the markets at an incredibly fabulous holiday party attended by a bevy of beauties and Wall Street legends.
Subsequently, in Sure Money, one of Lee’s readers, Jesse, wrote: “Hi Lee. Enjoy your articles. Your views about tax cuts and the market still tanking seem to conflict with what Shah Gilani says. Can you expound on how a tax cut will be bearish?”
I’ve been saying, right here in WSII, in my Zenith Trading Circle, and on global TV that tax cuts will boost the economy and drive markets higher. For argument’s sake, I’m also on record on Fox Business News’ Varney & Co show telling host Stuart Varney the market will double in five years, or less.
In Lee’s response to Jesse, he wrote, “I have no doubt that Shah will quickly adjust his outlook when the market proves him wrong on this issue (INSERT BIG SMILEY HERE). But all kidding aside, when views are this far apart, it’s obvious that one of us will be proven wrong, and we will need to make the adjustment in outlook as soon as it becomes apparent that our considered outlook isn’t playing out as expected.”
This Bearish Reasoning Proves My Bullish Case
Lee started his response to my bullishness with, “There’s no doubt in my mind that tax cuts will goose the economy for a time.”
That’s bullish in my book.
He then followed that with, “But eventually the corporate CEO and CFO class will find ways to divert the extra cash into their own pockets, just as they did with QE. Ultimately, the long run beneficial effect to the economy is questionable, and more importantly, irrelevant.”
Sorry, Lee. While you’re right about what’s going to happen, you’re wrong about it not being a bullish opportunity.
When – and make no doubt about it that “when” means right away – CEOs and CFOs divert extra cash into their own pockets, it will be by granting themselves stock options and conducting massive share buybacks to put a floor under and raise their stock prices, making their options profitable. That’s bullish for stocks.
Yes, they did it with QE. QE lowered rates so the cost of capital was practically nothing. Companies borrowed money, because they weren’t making much during the Great Recession, to buy back their shares and create demand for them. They wanted to raise earnings per share metrics to push their stock prices higher. That was bullish for the market.
That’s going to continue as tax cuts generate more cash to plow into more buybacks. Once again, bullish.
[SPECIAL REPORT] How the Fed Controls the Stock Market
Lee says, “Federal tax revenues will decline, and the deficit will grow. The US Treasury will be forced to sell more debt to cover the shortfall. That will put supply pressure on both the bond and stock markets.”
He’s right and wrong.
Yes, the deficit will grow – it’s been growing regardless. And, initially, tax revenues could fall. But they may not fall if tax cuts stimulate consumption, which stimulates production, which stimulates profits and increases tax receipts.
Still, the Treasury selling more debt won’t necessarily put pressure on both the bond and stock markets.
It might put pressure on the bond market. If it does, and rates rise faster than expected, there’ll be an exodus of money sitting in low-yielding bonds as their prices fall and investors experience capital losses on their holdings. That’s supposed to trigger the “Great Rotation” when bond investors get out of losing bond positions and rotate into stocks.
That was supposed to have happened by now. It hasn’t because rates haven’t risen by much if you look at U.S. ten-year Treasury prices and yields. If the Great Rotation finally comes to pass, all that money has to go somewhere.
If it goes into stocks, and it will, that’s bullish for the stock market.
The Year of the Bull and How to Play It
Lee’s fundamental argument says, “By next October the Fed will be draining $50 billion in cash from the market. That will force the buyers of new Treasury debt to liquidate something at the margin. It could be either other Treasury paper, or stocks or both. This will only add to the supply pressure. As stock and bond prices fall, margin calls will follow. That will both destroy cash as it is used to retire the margin loans, and it will also add to supply pressure.”
He then advises, “Markets top out when the news is good. So, I think that this tax cut will prove to be a quintessential case of sell the news. Markets don’t top out on a dime, however. We don’t have to sell everything all at once. That’s why I’ve been recommending selling small amounts of stock at regular intervals to reach 60-70% cash by the end of January, or the end of Q1 at the latest. If by then the market hasn’t signaled weakness, I’ll have to consider whether to redeploy cash. If my analysis is correct, it won’t come to that, and we’ll be well positioned to protect against and take advantage of the decline I expect to come.”
Holy cow, Lee! What if you’re wrong? 60% – 70% cash is huge, especially by the end of January or even the first quarter.
If Lee’s right about the market tanking, then a big cash stash is smart. But if he’s wrong, and stocks continue to barrel higher, that much idle cash will be a huge mistake.
I’m not wrong about tax cuts. Historically, tax cuts stimulate consumption, production, the economy, and the stock market.
While Lee may be right, and there may be a selloff, it won’t be because of tax cuts and there will be a better way to protect yourself and raise cash.
[EXCLUSIVE MEDIA APPEARANCE] What’s Next? Ask the Man Who’s Been Right All Year
While I’m a raging bull (and I must be if I think the market is going to double in five years), my bullishness isn’t blind.
Of course, I see where there are hurdles and possible tsunamis that could flood the market with sell orders. I write about them all the time.
But there have been hurdles around while the market has still rocketed higher, and raising a ton of cash just because they’re out there like bogymen isn’t a wise move.
I get cautious at times, and when I say so, I say why.
What I don’t say is to go to cash. Though in my 35-year career I did say that once; I screamed to go to 100% cash in the late summer of 2008. And I was 100% right.
The smart way to ride the bull market and protect yourself from any big selloffs is simply by raising the stop-loss orders you should always have on all you stock positions as you build up your profits.
That way, if Lee’s proven wrong, we can wink at him and thank him for reminding us to use stops.