Late last week, the government deficit reduction commission laid out several areas that will be the focus of cuts to lower the government debt. The plans include ending tax breaks, changing taxes, cutting programs, and changing key U.S. programs that many Americans have come to rely on.
Some key highlights include:
– Cutting $100 billion from defense spending
– Raising the Social Security Eligibility Age to 69
– Raise the national gasoline tax by 15 cents
– Lowering the corporate tax rate to 26%
– Repealing the Alternative Minimum Tax (AMT)
– End the mortgage interest deduction for mortgages over $500,000
– Cutting the federal workforce by 10%
– Cutting farm subsidies by $3 billion
So, what will this do to my investments?
Cutting Defense Spending
If the government plans to cut defense spending, it means that a lot of revenue could be lost for companies that do business in this space. The main companies this could affect include: Lockheed Martin, Northrup Grumman, General Dynamics, Boeing, Raytheon, BAE Systems, Kratos Defense and Security, Rockwell Collins, and Cubic. Already, the stock market has hit these companies hard.
However, if you want to invest in this space, look for companies that are diversified beyond defense. For example, L-3 does a lot of defense, but also does a lot of commercial work. The same is true for SAIC and even Boeing.
The College Investor Verdict: Avoid defense for a few years.
Raising the Social Security Age
I don't think that raising the social security age will have an immediate effect on your investments, I do have a long term project about what this will change in our economy. I think many young adults already don't believe that social security will be there for their future, and as such, are turning to more self-directed investment options, such as 401(k)s and IRAs. This will be beneficial to investment companies over the long run.
Some key players in this space include: Hewitt Associates. Many other providers are private.
The College Investor Verdict: Take care of your own financial future, and look into companies that can help you do this.
Raising the Gas Tax
The government wants to raise the gas tax by 15 cents. I don't think raising the gas tax will impact demand too much, but it could. If this happens, it won't be the oil companies that suffer, but the refiners that turn oil into gas. The major oil companies still have a lot of options when it comes to selling their products (i.e. plastics, composites, other countries, etc.). However, it is the American refiners that don't really have a choice when it comes to selling their product. Furthermore, their refineries are already setup to manufacture one type of fuel, and the costs to change the refinery would most likely be prohibitive.
Some key refiners that could suffer include: Sunoco, Holly Corporation, CVR Energy, Western Refining, and Alon USA Energy.
The College Investor's Verdict: Avoid refineries, but don't avoid the sector as a whole. Oil prices will continue to rise since the cost to extract oil will continue to rise. Furthermore, it is a finite resource, and as such, its value will continue to rise with each drop extracted.
Lowering the Corporate Tax Rate
Lowering the corporate tax rate is the government's attempt to try and convince companies to keep more of their revenues onshore and not setup shell corporations overseas to shelter their income. At best, it will incentivize companies to conduct more business in the United States. Most likely, it will only be moderately effective at generating more revenue for the United States.
For investors, it will most likely have a marginal effect on investment gains and losses. To best capture any effect from this legislation, it is most likely best to invest in the broad index, since it will most likely be every company experience a little gain in economic activity.
The College Investor's Verdict: Diversify your portfolio with a broad index fund to capture any gains from this legislation.
Repealing the AMT & Ending the Mortgage Interest Deduction
Repealing the AMT and Ending the Mortgage Interest Deductions on Mortgages over $500,000 are both designed to simplify the tax code. The idea is that a simple “flat tax” should be enacted. The government would declare a poverty level, and any income over that poverty level would be taxed at a flat rate, regardless of how much you make or if you own a home.
One of the biggest arguments for the Mortgage Interest Deduction is that it encourages home-ownership. However, it really encourages debt. The government rewards individuals for taking on debt, rather than saving (you get taxed on interest for saving, but you get deductions for interest on debt…a little backwards).
What this means for your investments: well, with the elimination of mortgage interest deductions, there will most likely be a decline in mortgages. It will bode well for REITs that invest in apartments and current mortgages (since they will become more scarce), and it will hurt mortgage servicers such as Fidelity National Financial.
The College Investor's Verdict: Look at investing in a REIT that invest in mortgage paper and apartments, and avoid loan servicers.
Cutting the Federal Workforce by 10%
This is another cost cutting measure sought after by republicans in Congress. It seeks to lessen the bureaucracy and save costs at the same time. However, in the short term, if government workers are laid off, it will most likely mean a back-up in government services. So, for companies that require government approval to do business, it will most likely mean a slowdown. This means that drillers, miners, pharma, and biotech could all see slowdowns in government approval for their products, which means lost revenues and higher costs.
The College Investor's Verdict: Avoid companies that require government regulation and approval to do business.
Reducing Farm Subsidies
Last, the government is looking at reducing farm subsidies by $3 billion, which is a drop in the bucket for the deficit but could have a serious impact on your investments. Farm subsidy reductions could impact the entire agribusiness sector. An example of a company that could be impacted is Archer-Daniels Midland, which is a huge farming company that would lose its subsidies.
A winner could be a company like Monsanto, which makes genetically engineered seeds and pesticides. More farmers will turn to these products to increase their yields since they cannot rely on the government to help.
The College Investor's Verdict: Avoid Agribusiness in the mid-term. In the short term, recent gains in commodity prices should prove to generate nice gains for many agribusiness companies. However, as commodity prices decline, and farm subsidies are ended, there will most likely be a middle patch of declining earnings for growers. Over the long term, however, agribusiness is extremely lucrative because the growing world will always need food, and these companies provide this basic need.
Overall, the government does need to reduce its debt. How it does it will have significant impact on your investments. Hopefully this provides some thoughts on what could happen in the future. Do you have any other thoughts on what the government might do and how it could impact your investments?