The New Year is off to a roaring start with the Dow Jones Industrial Average bursting through the 25,000 level for the first time. The surprising exuberance that carried us higher during 2017 seems to be alive and well, and as 2017 drew to a close, most of us were surprised to find that President Trump and Congress had pulled off a Christmas miracle and passed the Tax Reform bill.
We are still learning what all the implications for the markets may be, but the tax package appears to make several changes that could be very beneficial to the economy, and by extension, to the markets. In addition to cutting the corporate tax rate from 35% to 21%, the tax package contains several incentives for business spending, such as allowing the write-off of capital investments in the year they are made, instead of requiring the deduction to be spread over several years and giving incentives to companies holding cash overseas to bring back that money to the U.S.
While many news organizations made it sound like this tax reform package was a windfall for the wealthy, we believe that it could be the catalyst that extends this secular bull market that we believe has several more years to run.
In this week’s annual edition of the Barron’s Magazine’s Roundtable, nine of the top investment minds in the industry discussed tax reform at length. The general agreement was that the tax reforms have reversed the mindset of corporate CEOs with regard to where they locate their businesses. According to Henry Ellenbogen, Chief Equity Investment Officer at T. Rowe Price,
“Over the past ten years, American companies made an inordinate effort to think about how to move people or structures outside the U.S. for nonproductive purposes – basically to increase earnings. Now we can get back to having managers focus on productive investments, greater efficiency, and value creation. This will unlock the strength of America and drive GDP growth. Simply, the absence of a major negative is a positive. This is a generational change.”
Whether the companies that make up the market decide to take the tax savings and invest in their business, to buy back their own stock, or simply to pass along their new profits to their customers in lower prices, the tax reform package could be very beneficial to many Americans. Let’s look at what it means for investors.
WHAT DOES TAX REFORM MEAN FOR INVESTORS?
“Peeling back the onion”, asking several additional questions and posing plausible answers to those questions may provide some insight into how this affects the average investor.
What will companies do with their tax windfall? We believe the answer to that question will determine, to a great degree, what to expect from the stock market.
Passing it along to employees. We are already hearing about some companies giving their employees $1,000 bonuses and some giving $1 per hour wage hikes. That money will get spent rather quickly providing a small boost to consumer spending.
Passing it along to stockholders. Raising the dividends and increasing stock buybacks will benefit stockholders directly and will also likely boost stock prices.
Additional capital spending. The action that would be the most beneficial to the economy and to Americans as a whole would be to invest in new equipment and machinery that would increase production and productivity and bring our manufacturing industry back to the United States. We expect many companies to do this, additionally benefitting companies that make the vehicles, machinery and equipment.
What industries will benefit the most? Again, a very important question for investors. Companies are affected in several different ways. Let’s consider some examples.
Retail Stores. While we do expect almost 100% of the tax cut to flow through to company bottom lines in 2018, it is our opinion that retailers will gradually pass along these savings to their customers over the next three to five years. So, other than a general boost to the economy, the boost to retailers will probably be relatively short-term.
Banks. Although economist have been predicting higher interest rates for years, 2018 may finally see enough economic growth to produce the increase in rates that banks have been hoping for. Although no one I have seen is concerned about a big increase, the new Fed Chairman could stir things up somewhat differently than Janet Yellen, holding firm on short-term rates but unwinding the Fed’s bond-buying program much quicker than previous efforts, providing a boost to 10-year bond yields…increasing interest rate “spreads” which would be very beneficial to the banks.
Red State real estate developers, homebuilders, and office building owners. Amazon’s announcement of their move to establish a second headquarters away from Seattle may just be the first of many we hear about. Redfin CEO Glenn Kelman says Silicon Valley will soon see a mass migration of tech companies and talent. (Maybe an exaggeration?) Kelman is predicting an “accelerating shift out of coastal cities as homeowners seek to avoid the higher tax rates of the recently passed tax bill. Cities like Denver, San Antonio and Houston “ (and probably Nashville)” are primed to be the next hubs.”
Machinery and equipment manufacturers. Although analysts have not yet released updated numbers since passage of the tax bill, we believe these kinds of companies will be some of the biggest beneficiaries of the tax reform bill. In addition to the tax savings most companies will experience, these companies sell the equipment that benefits most from the accelerated writeoff deduction. We believe this will cause many companies to act on plans that have been on hold during the slow economic times of the past few years.
Truck manufacturers. Like machinery, trucks will provide the accelerated writeoff that business owners love, and almost every business owner likes a new truck. Saving from the tax bill will likely provide many businesses with the funds to replace their older trucks.
Analysts have just begun to factor in the effects of the tax bill into their earnings estimates. We believe there will be some significant increases in expectations for many companies. The biggest winners should be companies with strong pricing power that sell capital equipment. Many other companies will enjoy significant tax savings that will boost their earnings. Stay tuned!
“In the business world, the rearview mirror is always clearer than the windshield.”
It is a new year and we are anxious to sit down with our clients and review 2017 and make plans for 2018. Kim will be in touch soon to schedule appointments but if you want to speed up the process, please give us a call. We’ll be glad to see you.
Please give us a call if there is any way we can be of assistance. We always enjoy hearing from you!
Any opinions are those of David Crouch and not necessarily those of RJFS or Raymond James. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk including the possible loss of capital. Past performance may not be indicative of future results. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person's situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax matters. Please consult your tax advisor for your particular situation.
The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.