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Corporate tax cuts and P/E ratio


tede02
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Last year's tax cuts increased corporate profits by about 21.5% (all things equal) with the stroke of a pen. It seems to me this would really distort Shiller's PE10. Stock prices in the US had looked expensive relative to history for quite some time and then over-night, things changed. Am I over-thinking this? The market obviously reprices the new earnings so perhaps it doesn't matter. I just wonder how different something like the PE10 would look if the denominator were replaced with a pre-tax figure or operating income. 

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Last year's tax cuts increased corporate profits by about 21.5% (all things equal) with the stroke of a pen. It seems to me this would really distort Shiller's PE10. Stock prices in the US had looked expensive relative to history for quite some time and then over-night, things changed. Am I over-thinking this? The market obviously reprices the new earnings so perhaps it doesn't matter. I just wonder how different something like the PE10 would look if the denominator were replaced with a pre-tax figure or operating income.

 

I think this is a MAJOR threat to the market in the years going forward.  Sure, tax rates are low right NOW, but what happens in 2-3 years or so?

 

What happens if a Democrat gets elected to the Presidency? and/or they pick up more seats in the House and Senate?  As a party, they've said they want to raise taxes across the board.  Some Democrats have also voiced concern that the employment rate is too high.  That the economy as a whole is "overheated" and needs to be brought down or cooled off.

 

I think that is VERY dangerous thinking.  Here in Michigan, the economy is good, maybe even very good, but not great.  Of course, the economy here has been depressed for a LONG time.  It would be terrible if the economy here had 8 bad years, 2 good years, and then went back down again.

 

I am also surprised that people are NOT upset that tax rates were not lowered BEFORE now.

 

Whatever happens, the future is certainly going to be interesting!

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It’s something to keep in mind for sure.

 

I personally think there’s a reasonably good chance that the tax cuts get reversed at some point.  The federal government’s budget deficit does not look sustainable, and taxing corporate income is a relatively easy way to raise revenue, both politically (“let’s make those rich corporations pay their fair share!” + you essentially get to tax foreigners’ income too as an added bonus) and administratively (corporations are easier to monitor/audit than individuals). 

 

And even if tax rates stay where they are, the gains will likely be competed away over time in a number of industries where economic moats tend to be weak.

 

So I’m operating under the assumption that US stocks are actually somewhat more expensive than what their TTM or forward P/Es might suggest.  It certainly matters on the margin.

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