over the Next Decade
May 8, 2012
Corporate profits are fairly high now relative to history. Is it going to stay that way? If it doesn’t, how will that effect valuations?
One of the reasons why the stock market has done as well as it has over the past three-plus years has been that corporate profits are now the largest percent of GDP ever. The corporate sector has disproportionately benefited from this recovery. We all know that the household sector has not advanced tremendously, although it has improved. But the corporate sector has done great.
It is inevitable that the household sector will regain some of that national income. You are seeing it right now in the extremes of both parties: the Tea Party and Occupy Wall Street. The fact that the corporate sector is such a big part of this gain is unsustainable, as are the disparities of wealth that a lot of people talk about. When people question me about that, I say, “Just ask Marie Antoinette.” There are a lot more voters among the 99% than the 1%. Things are going to change and we should be prepared for that.
It means corporate profit growth will slow. There is no doubt about that.
What does it mean for valuations? It is going to depend on what happens in the rest of the world. I am a firm believer that the valuation of US assets will become dearer. In other words, multiples will expand, and interest rates will go lower as people begin to realize the risk outside the US is much greater than they anticipated.
People are underestimating the risk outside the US and overestimating the risk inside it. Over the next several years, there is going to be a reevaluation of those risks, and we should get higher multiples in the US.
I will come back to the emerging markets, but one of the things that people fear is the expiration of the Bush tax cuts and the fiscal drag that will supposedly come at the end of this year. What are your thoughts?
That is the biggest risk; the fiscal cliff is a big deal. You’re going to have the sequestration of spending and the Bush tax cuts will expire. We are going to cut spending and raise taxes all in one day.
I don’t care what side of the aisle you come down on. There is no way that is good for the economy.
The issue with the dividend taxes is one of the most interesting things, because for the highest-income tax earners, the dividend tax rate goes from 15% to about 43%. There are also changes to inheritance taxes and capital gains taxes. Everything is going up, and the likelihood of that happening is probably pretty good. In terms of dividend stocks – which are very, very popular these days – you could have some of what I like to call “dislocations.” All dividends are not dividends. Investors generally tend to talk about dividends as any form of equity income. That is not true. MLPs don’t pay dividends. MLP closed-end funds pay dividends. MLP ETFs pay dividends, but a MLP does not. So maybe a K-1 doesn’t look so bad anymore. I’m not even sure REITS pay dividends, technically.
Some dividend-paying stocks may therefore get better treatment than others, and investors may adjust accordingly. I personally think that the dividend tax increase is not going to happen. They are going to come to some agreement about some of these issues, but the fiscal cliff is the biggest risk sitting out there. The politics are such that nobody wants to get anything done. They don’t have to pass a single bill, and the fiscal cliff occurs.
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