MITON’S HUGH GRIEVES: WHAT WILL US TAX REFORM REALLY MEAN?

• Financials, industrials and consumer discretionary set to be biggest beneficiaries
• Wall Street analysts awaiting company specific guidance
• Room for stock price appreciation as estimates rise in the coming weeks                                                                                     

Hugh Grieves, manager of Miton’s US Opportunities Fund, comments:

“To assess the real benefit of Trump’s tax reform investors need to look beyond the reduction in headline rate and consider the impact of state and local taxes, tax credits for items like R&D and capital investment, and the impact of taxed foreign earnings. In the first year, the new lower tax rate could be completely offset by the need for companies to write down deferred tax assets and/or pay tax on any repatriated profits from prior years.

“Due to this complexity, Wall Street analysts have been hesitant to amend individual company estimates without explicit guidance from the companies’ management. The best top-down guestimates we’ve seen so far have come from Wolfe Research, stating S&P 500 earnings could increase by as much as 11%.

“So far, the only company to give such guidance is FedEx, historically a 35% tax rate payer, implying a permanent lift to earnings per share (EPS) of around 15%. Clearly, they’re at the high end of the range of companies in the S&P 500 but they’re by no means an exceptional case, giving confidence to the expectation that the average short-term benefit is likely to be in the mid to high-single digits range, given that many companies in the S&P 500 will receive zero benefit.

“The sectors which will benefit most in the near-term should be financials, industrials and consumer discretionary, as they are generally more domestically orientated, higher taxpayers. Sectors likely to benefit the least are technology, energy and consumer staples as they have international sales and already low tax rates, and utilities, an explicit exception from the tax reform. These winners and losers are also expected to be those that benefit most/least from the higher near-term GDP growth that the tax cuts will drive, including higher consumer spending, business investment and loan growth.

“There’s considerable debate on what is already “in the price” for US equities. Given that Wall Street analysts have yet to start incorporating the lower tax rate into their EPS forecasts, there’s likely to be further room for stock price appreciation as estimates rise in the coming weeks. As we move further into 2018, there will be further potential upside from stronger-than-expected nominal GDP, driving earnings forecasts higher still (Wolfe Research expects a 0.40% lift to nominal GDP).

“The sustainable benefit from the reforms will depend on whether companies can retain the higher profitability without it being competed away. But also the impact these tax cuts will have on the long-term growth rate of the US economy. The former will vary by sector. Railroads for example will likely be able to retain the benefit, being local monopolies, but banks may struggle, given the fungibility of money.

“The macro impact is up for debate. Some economists, and President Trump, argue that the lower tax rate will spur an investment and hiring boom that will sustain many years of faster growth. Others suggest that any boom will quickly end in an inflationary, Fed-driven bust or, that it will quickly peter out with GDP growth returning to its pre-tax cut rate. It’s still too early to make definite long-term predictions but we are overweight the sectors that will be the near-term beneficiaries and underweight those with less to gain. We remain vigilant and will be nimble with our positioning as events unfold.”

• Financials, industrials and consumer discretionary set to be biggest beneficiaries
• Wall Street analysts awaiting company specific guidance
• Room for stock price appreciation as estimates rise in the coming weeks                                                                                     

Hugh Grieves, manager of Miton’s US Opportunities Fund, comments:

“To assess the real benefit of Trump’s tax reform investors need to look beyond the reduction in headline rate and consider the impact of state and local taxes, tax credits for items like R&D and capital investment, and the impact of taxed foreign earnings. In the first year, the new lower tax rate could be completely offset by the need for companies to write down deferred tax assets and/or pay tax on any repatriated profits from prior years.

“Due to this complexity, Wall Street analysts have been hesitant to amend individual company estimates without explicit guidance from the companies’ management. The best top-down guestimates we’ve seen so far have come from Wolfe Research, stating S&P 500 earnings could increase by as much as 11%.

“So far, the only company to give such guidance is FedEx, historically a 35% tax rate payer, implying a permanent lift to earnings per share (EPS) of around 15%. Clearly, they’re at the high end of the range of companies in the S&P 500 but they’re by no means an exceptional case, giving confidence to the expectation that the average short-term benefit is likely to be in the mid to high-single digits range, given that many companies in the S&P 500 will receive zero benefit.

“The sectors which will benefit most in the near-term should be financials, industrials and consumer discretionary, as they are generally more domestically orientated, higher taxpayers. Sectors likely to benefit the least are technology, energy and consumer staples as they have international sales and already low tax rates, and utilities, an explicit exception from the tax reform. These winners and losers are also expected to be those that benefit most/least from the higher near-term GDP growth that the tax cuts will drive, including higher consumer spending, business investment and loan growth.

“There’s considerable debate on what is already “in the price” for US equities. Given that Wall Street analysts have yet to start incorporating the lower tax rate into their EPS forecasts, there’s likely to be further room for stock price appreciation as estimates rise in the coming weeks. As we move further into 2018, there will be further potential upside from stronger-than-expected nominal GDP, driving earnings forecasts higher still (Wolfe Research expects a 0.40% lift to nominal GDP).

“The sustainable benefit from the reforms will depend on whether companies can retain the higher profitability without it being competed away. But also the impact these tax cuts will have on the long-term growth rate of the US economy. The former will vary by sector. Railroads for example will likely be able to retain the benefit, being local monopolies, but banks may struggle, given the fungibility of money.

“The macro impact is up for debate. Some economists, and President Trump, argue that the lower tax rate will spur an investment and hiring boom that will sustain many years of faster growth. Others suggest that any boom will quickly end in an inflationary, Fed-driven bust or, that it will quickly peter out with GDP growth returning to its pre-tax cut rate. It’s still too early to make definite long-term predictions but we are overweight the sectors that will be the near-term beneficiaries and underweight those with less to gain. We remain vigilant and will be nimble with our positioning as events unfold.”