Trump Tax Cut Odds Start to Make Waves Again in the Stock MarketBy
Most-taxed companies, small-caps outperforming as hopes revive
Republicans plan to preview tax-overhall bill Wednesday
Amid FANG flu and another trash rally, a trade tied to Donald Trump has come quietly back into vogue with U.S. equity investors.
It’s buying stocks seen benefiting the most from the president’s promised tax cuts. A Goldman Sachs basket of companies that pay the highest rates just beat the market for a fifth straight day.
The rally reincarnates a trade that ascended after the November election and then died. Arousing interest is Trump’s focus on one of his signature campaign promises to domestic businesses. He and Republican congressional leaders plan to preview their bill on Wednesday and the president said he expects the House will approve a version in October and the Senate by year’s end.
“Investor expectations for tax reform are rising,” Goldman strategists led by Arjun Menon and David Kostin, wrote in a note Monday. “The start of tangible activity on tax reform should continue to increase the perception that tax reform is likely.”
Goldman’s basket of the most-taxed companies climbed 0.4 percent Tuesday while S&P 500 was flat. Another group of stocks loosely associated with the program, small caps, have also been higher recently.
The White House and lawmakers have avoided confirming details of their tax-bill framework, but lobbyists citing multiple leaks have said it will target a corporate tax rate of 20 percent or so, down from the current 35 percent.
According to Goldman’s estimates, S&P 500 companies will earn $139 a share in 2018 and 1 percentage point in tax-rate reduction would boost profit by $1.
Bigger windfalls would arrive for companies that are already taxed most. The Russell 2000’s average effective tax rate is almost 3 percentage points higher than the S&P 500 and its domestic reliance makes it unlikely to shift revenue to regions with a more favorable rate.
“The recent improved performance of small and mid-cap stocks has at least in some part signaled increased prospects for something to get done with the administration’s tax agenda,” John Stoltzfus, chief investment strategist at Oppenheimer, wrote in a note this week, adding he remains “skeptical that of prospects for tax reform with so many vested interests and conflicted opinions represented in Congress.”
Investors had been disappointed before. The Goldman high-tax basket rallied with gains double the market in the first month post-election, only to see the outperformance erased as a Republican effort to overhaul health-care failed and controversies surrounding Trump escalated.
But optimists pointed to a deal that Trump worked out with Democrats earlier this month to stave off a potential U.S. default on its debt as a sign of progress that may overshadow the tax overhaul.
“Trump’s legislative chances improved in recent weeks as he reached across the aisle to Democratic leaders, Senate Minority Leader Chuck Schumer and House Minority Leader Nancy Pelosi,” said Jack Ablin, the chief investment officer at BMO Wealth Management. “The three have aligned their sites on tax reform.”
While uncertainty still lingers on the likelihood and timing of passage, JPMorgan Chase & Co. recommends investors buy call options on Russell 2000 and companies poised to benefit from tax cuts to prepare for any “meaningful progress”.
“Now is a good time to position for tax reform,” Bram Kaplan, a strategist at JPMorgan, said in a note.
— With assistance by Felice Maranz