In her second economic speech as a Presidential candidate, Hillary Clinton is set to take on the "tyranny of the next earnings report," a nod to the destructive myopia and pervasive foolishness that dominates the collective mindstate of corporate management teams in the post-crisis world.
Make no mistake, we are no fan of manipulated earnings. In fact, we’ve gone out of our way to detail how the combination of record low borrowing costs and a perpetual bid from yield-starved investors (both symptoms of ZIRP) has conspired with the market’s “what have you done for me lately” mentality and the prevalence of equity-linked compensation to create an environment where companies are encouraged to issue debt and plow the proceeds into buybacks, thus artificially inflating the bottom line at the expense of capex, long-term competitiveness, and wage growth. Here’s what this dynamic looks like visually:
And it’s not as though Clinton is the first person to notice this besides us. Here’s what SocGen had to say earlier this week:
Corporate executives, who are rewarded for achieving EPS and share price targets, typically in the form of stock options, are also experts in the art of creating a short-term positive market impression. And to great effect, given the (literally) incredible performance of some tech stocks last week. Positive price momentum is a powerful force and one that few corporates are likely to readily interrupt with bad news. So while 'prudence accounting' may inform GAAP earnings, it seems largely absent from many of the pro-forma figures corporates would like us to focus on.
For Clinton, the solution to this noxious, productive capacity-sapping, wage growth-impeding, scourge is higher capital gains taxes.
Hillary Clinton will propose a revamp of capital-gains taxes that would hit some short-term investors with higher rates, part of a package of measures designed to prod companies to put more emphasis on long-term growth, a campaign official said.
At the center is Mrs. Clinton’s proposal to change capital-gains tax rates, the details of which are being finalized. The Democratic presidential candidate’s plan would create a sliding scale with at least three new rates that change depending on how long an investment is held, the official said.
Investments held for less than a year would continue to be taxed at regular income-tax rates, which can top out at 39.6% or more for the highest earners. For those held just a little longer—likely two or three years—the current capital-gains tax rate of 23.8% for top earners would rise. The Clinton rate, which hasn’t been finalized, would be higher than the 28% President Barack Obama proposed earlier this year for the highest earners. The Clinton campaign hasn’t ruled out taxing such investments at the regular income-tax rate.
The plan would include additional rates tied to the length that an investment is held, with the lowest rates for investments held the longest.
The former senator and secretary of state is diving into an area of significant debate about which policy steps could or should be taken to discourage what Mrs. Clinton calls "quarterly capitalism," meaning overly focused on the next earnings report.
So, as you can see, nothing too unusual there. A Democrat has proposed higher taxes in an effort to solve what’s being pitched as a Wall Street vs. Main Street problem and the entire issue is going to politicized in the extreme because after all, next year is an election year.
If that were the whole story it wouldn’t be all that interesting other than as a vindication of our contention that the stock market is being held up by a perpetual bid from price insensitive corporate management teams (incidentally, just because we agree on the problem doesn’t necessarily mean we agree with the proposed "fix") who are taking advantage of low borrowing costs to plow money into buybacks.
Fortunately, that’s not the whole story. Let’s go back to WSJ for a moment:
Activist investors, who generally take positions in stocks and then push for changes they believe would boost share prices, have in the past few years gained more influence and won more battles with larger companies. These investors, such as Nelson Peltz at Trian Fund Management LP and William Ackman at Pershing Square Capital Management LP, say they hold weak corporate managers accountable and help lift share prices for all holders.
Detractors, including Laurence Fink, chief executive at money manager BlackRock Inc., and Martin Lipton, a leading corporate-defense lawyer, say the typical activist wish list, including share buybacks, dividends and corporate breakups, diverts cash from long-term investments in plants or people to appease investors who want to sell out quickly.
In a recent paper, Clinton adviser Neera Tanden wrote that activist investors are hurting some companies’ capital investments. Company spending on buybacks and dividends surges in the five years after shareholders start putting pressure on a company, and capital investments fall, she wrote in a paper for the Center for American Progress, where she is president, along with Blair Effron of Centerview Partners.
Ms. Tanden suggested a sliding scale for capital-gains tax rates, where the longer an investor holds the asset, the lower the rate. Mr. Fink of BlackRock has suggested a similar scale, with a three-year holding period for basic capital-gains treatment, among other changes.
Mrs. Clinton appears to be adopting a version of their idea.
Now that is interesting, especially considering last week’s argument debate between Larry Fink and Carl Icahn and it begs the following question: who is really pulling the strings here?
For the answer, look no further than Cheryl Mills.
Mills was chief of staff for Clinton’s State Department and was general counsel to Clinton’s 2008 campaign. As Politico notes, Mills "has worked for the Clintons for years [and] regardless of whether there’s ultimately an official title on the  campaign, hers will be a key voice." Earlier this year, The NY Post (in an admittedly hyperbolic piece) described Mills as Clinton’s "consigliere" who "knows where the [Benghazi] bodies are buried." Mills also serves on the board of the Clinton Foundation.
Ok, so what? Now we know who Cheryl is, but what’s she got to do with anything?
And for the answer, we’ll leave you with the following screengrab which should tell you everything you need to know about why Clinton is now going the nuclear route on capital gains taxes.
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Bonus: BlackRock contributions to the DNC