INSIGHTS

ONE FINAL SURPRISE FOR 2017

Mark Lister, 18 December 2017

With just a handful of trading days to go this year, the US sharemarket might have one last trick up its sleeve for 2017.

The tax cuts President Trump has been talking about all year might finally be confirmed shortly. Having found enough middle ground to allow a compromise, Congress is expected to vote on a tax bill this week.

This will reduce the US corporate tax rate from 35 per cent – one of the highest in the developed world – down to 21 per cent. This compares with the 28 per cent corporate tax rate here in New Zealand and a corresponding 30 per cent in Australia.

The bill will also reduce tax rates for many individuals (at the expense of some key deductions that will be lost), which could mean a tax cut of around US$2,000 per year for a household on the median income.

Finally, the bill will allow companies to fully expense capital spending, which might encourage firms to invest in plant and equipment.

Growing prospects of tax reform have seen a major rotation across the US market during recent months. Investors have sold companies with less to gain from these changes, and moved money into those expected to benefit most.

Sectors that have come under pressure include those already paying lower levels of tax and with a greater proportion of international revenue, such as technology. The effective tax rate for tech is 23 per cent (second lowest across the market), while 59 per cent of sales come from outside the US (higher than any other sector).

Consumer staples and financials have been better performers. Both have current tax rates of closer to 30 per cent, and three quarters of revenues are from within the US. The energy sector could also do well, given an effective tax rate of 38 per cent tax rate and high capital spending requirements.

In general, these moves should be very good for the corporate sector and US shares. The effective tax rate for the S&P 500 overall is about 27 per cent, and for the Russell 200 index (which represents smaller companies) its 32 per cent.

The lower tax rate will mean a bump in profitability of about 10 per cent, on average, which should mean higher share prices and bigger dividends. It’s just a question of how much of that is already priced in.

Some have questioned whether tax cuts are sensible when US government debt is already above 100 per cent of GDP, and rising. A fair question, but that’s a discussion for another day.

In the near-term, all of this is likely to be a positive for the US economy. Lower individual tax rates will give consumer spending a boost, while increased capital expenditure could be the real highlight of all this.

Here in New Zealand, we’ll need to keep a close eye on what it all means for US interest rates and the US dollar. On the face of it, one would think we could see a bit of upward pressure on both as the impact of the tax changes is felt.