The House plan would cut the corporate tax rate to 20% from 35%. It also includes a lower, but mandatory, tax on offshore earnings designed to encourage companies to bring home a chunk of the more than $1.3 trillion they’re estimated to have parked overseas.
The president and congressional Republicans took a few victory laps after unveiling a long-awaited tax-cut plan Thursday, but investors and analysts argue that it’s far too early to pop the champagne corks.
“That they have some terms on the table is a step in the right direction, but other than repatriation and a reduction in corporate taxes, everything else is up for negotiation”, said Bob Doll, chief equity strategist at Nuveen Asset Management, in a phone interview Friday. “I think the market is saying, ‘they’re making progress, but I want to see the final bill before I do anything.’”
On the individual side, the plan would compress the number of income tax brackets and fully repeal the estate tax by 2024.
Stocks put in a mixed performance Thursday in the wake of the unveiling. On Friday, the S&P 500 SPX, +0.31% Dow industrials DJIA, +0.10% and Nasdaq Composite COMP, +0.74% all ticked up to record closes following another round of strong corporate earnings and a strong reading from a gauge of service-sector activity.
Meanwhile, the rollout saw a mixed reception from business groups, drawing criticism from small business and housing groups and support from manufacturers. A significant number of business deductions were repealed in an effort to keep the size of the cuts at no more than $1.5 trillion over the next decade, noted Lewis Alexander, chief U.S. economist at Nomura, in a note.
Overall the announcement “was more disorganized and contained more controversial provisions than expected”, he said.
As a result, Nomura lowered its assessment of the likelihood of “comprehensive reform” passing from 30% to 20%, but left the probability of “simple tax cuts without significant reforms” at 60%.
Stocks have been on a tear since Donald Trump’s election victory in November last year, extending a bull market that began in 2009. Analysts and investors have debated how much of the rally can be attributed to policy expectations and how much is down to a continued economic expansion, synchronized global growth and, most of all, strong corporate earnings.
Doll estimated that a tax package could ultimately add around $6 to $8 a share to S&P 500 earnings. Assuming a price-to-earnings ratio of around 18, that would add another 100 points or so to the index.
But some of that is already baked in, he said. That means stock prices have room to wax and wane somewhat as a bill moves toward passage and investors update their assessment of its prospects.
Ultimately, tax cuts, specifically repatriation and the reduction in the corporate rate, are a potential positive for equities, but they still take a back seat to earnings, Doll said.
“It’s not going to make or break us. You tell me what the economy is going to do next year, then we’ll talk about earnings, then we’ll talk about the market”, he said. “This is important, but it’s secondary.”
