In a last minute agreement, the Administration and Congress fashioned a permanent tax package for Americans. As expected, the higher income tax rate and loss of some deductions for the highest 2% of Americans will likely curtail enthusiasm for many American business owners. Nevertheless, it could have been a lot worse.
The new tax law surprisingly places equities in a very favorable light compared to other investments. Income from corporate dividends will be taxed at less than half the tax rate of income from rent or interest. With dividend rates higher than most interest rates on bonds, the lower tax rate on dividends will probably serve as the catalyst to move investor dollars from bonds to stocks. This all comes at a time when allocations to equities in pension plans are at a multi-decade low, while allocations to bonds are at an all-time high. It will take time for institutional investors to make these tactical shifts as billions of dollars will be involved.
Economic strength has been building slowly for the last quarter and with this new tax law, the odds of recession have diminished. Market strength, however, is emanating from the dividend tax and not perspective corporate earnings or economic growth.
We immediately shifted allocations toward stocks and away from bonds in most client portfolios, as many of you have probably noticed. Accordingly, client portfolios are now “tilted toward equities.” We expect these trends to continue for a while.