If Tax Reform Fails, Will Stocks Suffer?

If you had to boil down the performance of the stock market over the past year, during which the S&P 500 (^GSPC 0.26%) has climbed 24%, then you should look first and foremost at the proposed tax reform bill that is making its way through Congress. If the corporate tax rate is cut from 35% down to 20%, as laid out in the version of the tax bill in front of the Senate, corporations will make more money. And if corporations make more money, it should buoy their stocks.

But what if tax reform fails? Does that mean that stock prices will suffer? No one knows the answer to this for sure, but logic would seem to dictate that the answer is yes. I say that because the impact of lower taxes is already, at least in part, seemingly baked into the stock market. If you take it away, then it would seem to follow that stocks would respond by falling.

For investors who are buying stocks today, this is a good thing to keep in mind. You'll want stocks that can not only benefit from a tax cut, which is the case for virtually all stocks, but you'll also want stocks that can weather any correction in the market that could come about if tax reform fails, as was the case with the Affordable Care Act.

Image source: Getty Images.

Will tax reform pass?

To be clear, the odds seem to be stacked in favor of tax reform making its way through Congress. Analysts at KBW, an investment bank that caters to the financial services sector, puts the odds of passage at 70%-75%. Grover Norquist, president of Americans for Tax Reform, a conservative organization that lobbies for lower taxes, believes the odds of passing are even higher, at 90%.

Whether these estimates are accurate will boil down to the votes of six Republican senators, all of whom have expressed varying degrees of discomfort with the tax reform bills making their way through Congress. This list includes Ron Johnson, Lisa Murkowski, Susan Collins, Jeff Flake, Bob Corker, and John McCain.

We need real, fiscally responsible #TaxReform that doesn't explode the nat'l debt. https://t.co/h0iBN2wcoD

— Jeff Flake (@JeffFlake) November 9, 2017

Excluding Sen. McCain, who is considered more of a wildcard than an ardent opponent of the bill before the Senate, it seemed as if the other five were all "no" votes in the bill's current form. But yesterday, Sen. Murkowski published an op-ed in the Fairbanks Daily News-Miner that suggests she may be in favor of the bill.

Like Sen. Collins, Murkowski's original issue with the bill was that it repealed the individual mandate, a portion of the Affordable Care Act that penalized people without health insurance. In her op-ed, however, she seems to have taken this issue off the table insofar as her vote is concerned:

I believe that the federal government should not force anyone to buy something they do not wish to buy in order to avoid being taxed. That is the fundamental reason why I opposed the Affordable Care Act from its inception and also why I cosponsored a bill to repeal the individual mandate tax penalty starting as early as 2013. And that is why I support the repeal of that tax today.

Murkowski's position on this moves the bill one step closer to success, as there can be only two Republican defections before it drops below the necessary majority vote that's needed to pass it. Nevertheless, for risk-conscious investors who are buying stocks today, it would behoove you to consider stocks that would weather a correction in the market if Republicans are not able to muster the requisite majority.

3 stocks to own if tax reform fails

Three stocks that come to mind are Wal-Mart (WMT 0.02%), AT&T (T 0.22%), and JPMorgan Chase (JPM 1.12%).

• Wal-Mart is a discount retailer, so it is the type of business that could see its sales climb during hard times.
• AT&T's services are utility-like and are therefore less vulnerable to a downturn than a company that sells discretionary products and services.
• And JPMorgan Chase is the biggest bank in the country, as well as one of its safest, structuring its business around the concept of a fortress balance sheet.

On top of this, all three of the stocks trade at reasonable valuations and pay healthy dividends, two additional traits that tend to limit a stock's downside. Shares of JPMorgan Chase and AT&T are priced at significantly lower valuations than the broader market, while Wal-Mart comes in just below the average price-to-earnings ratio on the S&P 500.

Data source: YCharts.com

Furthermore, shares of these three companies all yield more than the typical large-cap stock. AT&T leads the way, yielding 5.63%, followed by Wal-Mart at 2.11% and JPMorgan Chase at 2.07%. To put that in perspective, the S&P 500 yields just 1.93%.

In short, while it's impossible to say with any degree of certainty that Congress will succeed at passing tax reform, in the event that it doesn't, it seems prudent for investors to own stocks that could weather any ensuing correction.