Can the New Tax Laws Help to Move Stocks Higher?

By: Tom Madell | Wed, Jun 4, 2003
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Purportedly, the new U.S. tax legislation signed into law last week was designed to stimulate the economy and create new jobs. However, it also appears that the Bush administration is trying to do everything possible to bolster the stock market in advance of the 2004 elections. Naturally, such a boost would certainly lessen the chances that Mr. Bush would have to face the possible disenchantment of the 50% or so of voters who are invested in the stock market in one form or another and have seen their assets fall considerably during the Bush years.

By cutting the taxes due on both capital gains and dividends, while doing very little for most bond (or money market) investors who tend to invest for income and stability, the net effect is that many sophisticated investors may be more likely to halt the urge to go to bonds/cash and instead decide to increase their allocations to stocks. In other words, while income from bonds/cash is treated just like it was part of one's paycheck, income and price gains from stocks are rewarded with tax rates that are less than half of that. And for affluent individuals, the fact that the large savings from the additional lowering of income tax brackets will most likely be invested rather than saved should also help ensure a higher flow of the excess cash into all types of investments.

And here is another thought: Perhaps the Fed's new emphasis on the possibility of deflation rather than the customary concern with inflation will also serve to get more money into the stock market. How? The Fed will not be of a mind to raise interest rates with their new emphasis and could perhaps even lower them again. As a result, already low dividends from bonds and cash will go even lower, possibly discouraging investing in these asset classes. And, of course, lower interest rates are thought in theory at least, to raise the probability of stock gains.

And to speculate on Bush administration motives even further, what about Treasury Secretary Snow's apparent move to disregard, or even more subtly, to actually contribute to the fall of the dollar in international markets? A slowly falling dollar can improve the sales of major U.S. corporations whose products thus become more competitive than foreign manufacturers' products to the former's often large number of overseas buyers. Improved sales would then translate into improved profits and presumably higher stock prices. But perhaps even more importantly, a lower dollar (not to even mention our larger budget deficit from the tax reductions above) will possibly create higher inflation and interest rates, a moderate amount of which will likely help stocks as well. So, as with the tax cuts, the effect may also serve to boost stocks while potentially leading to driving money out of bonds.

Perhaps these factors have been important in influencing the stock and bond markets this past week. Should you be swayed by all the latest inducements to bolster your stock investing? Perhaps to a small degree, yes. However, one needs to keep the remaining fundamentals affecting stock prices clearly in mind. Larger deficits created by lower tax revenues will more likely than not eventually impair stock performance, perhaps some time after the 2004 election or after Mr. Bush leaves office. And just because you get better tax breaks will not help to make money if the economy does not pick up and therefore stocks do not generate any capital gains, or even continue to show long-term losses.

One thing you may want to do is to concentrate your stock investments a little more in your taxable investment accounts rather than your tax-sheltered accounts. For example, if you wish to have 20% of your total portfolio in an actively-managed growth and income fund expected to generate both considerable capital gains and dividends, it makes sense to have it all now in your taxable account to benefit from the low capital gains and dividend rates thus available. Likewise, if you wish to have 30 - 40% of your total portfolio in bonds and cash, it would seem to make sense to keep as much of it as possible in a sheltered account - you will have to pay their taxes at your ordinary rates, sooner or later, no matter which type of account it is in.


Tom Madell

Author: Tom Madell

Tom Madell, Ph.D.
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