Washington and Your Portfolio



We often hear sound bites from political wonks and then watch for a response in the equity markets. It’s worse than usual right now because this is an election year in the U.S.*, and European political leaders are still struggling with a severe economic crisis.

Due to the commotion, one is led to believe that the only thing important to investment managers is what is happening or will happen in Washington, Bonn, or Paris. But events prove that this is not the case. For example, this summer’s rally in the equity markets occurred despite the gridlock in Washington and Brussels, or the gloomy comments coming from Democrats and Republicans running for election. Politicians tell us that this is the most important election of our lifetime. Perhaps if you or I were running for president, it would be.

The truth is, regardless of which party wins, BWFA will be able to position clients’ portfolios to pursue investment gains. The policies of each political camp will affect economic growth and spawn winners and losers in the equity markets. But we control our own destiny when it comes to building the investment portfolios to take advantage of those policies.

Economics 101 tells us that quickly raising taxes or cutting government spending will reduce economic growth in the short run. So how do we reduce our massive debt and return to full employment at the same time? Since you have not yet elected me president, my lips are sealed. In the meantime, here are a few economic policies that might be affected by who wins the presidency and which party controls Congress.

Corporate Tax Rate

There has been much discussion about lowering the corporate tax rate to save or attract jobs to the United States. Canada has gradually lowered its corporate tax rate to 15% this year from 21% in 2008. This is far below the U.S. rate of 35%. We wouldn’t want to lose jobs to Canada so we will probably respond. (OK, my lips are not sealed. My recommendation is to lower the U.S. corporate tax rate to 15%. Owners of stock benefit, so raise the tax on capital gains and dividend income to a point that is revenue neutral.) This protects U.S. jobs.

With a lower corporate tax rate, the real winners would be clients whose assets are primarily in IRAs. Their stocks would go up in value, and the higher tax rate on dividends would not affect them. BWFA would consider investing in companies that are actually paying the 35% tax rate today (their taxes would fall), rather than the companies that already have low effective tax rates (e.g. General Electric) and will not benefit. To the extent we can identify these companies, investments in both taxable and tax-deferred accounts could benefit.

Health Care Laws

Health care offers similar winners and losers. Under current law, medical device makers are paying higher taxes (losers), and drug makers are not required to negotiate with the U.S. government on Medicare prices (winners). This could be reversed if the current health care law is revoked or revised. Companies that automate medical records for doctors and hospitals should be winners under almost any scenario because improving medical data is seen as a way to control costs and improve outcomes.

Inflation

What if we inflate our way out of our problems? Politicians have long favored this response to the economic crisis because it gradually reduces the value of our debt as the U.S. dollar declines. Unfortunately, it also gradually pushes taxpayers into higher tax brackets as their incomes rise with inflation. This would make more middle-income Americans subject to the Alternative Minimum Tax as they become “wealthy.”

The losers would be those on fixed incomes or those with large bond or CD portfolios. The winners would be those who own stocks of companies that can raise their prices to keep up with inflation, such as Colgate-Palmolive. We always pay up for toothpaste!

Conclusion

Here at BWFA, our job is to adapt to the policies that the leaders in Washington give us. We all have opinions when it comes to politics, but it’s our opinions on individual stocks or bonds that will make us money-no matter which direction the elections take us.

This November, exercise your right to vote. But if you are on the losing side, take heart that there are still opportunities in the markets for long-term price performance.

* – This article was originally published in a 2012 BWFA newsletter