US tax reform would give an enormous profit boost to equities

The expected tax reform in the United States could give listed US companies an unexpected Christmas gift. The planned relief to the tune of some 1.4 trillion US dollars would be the biggest overhaul of the nation’s tax code since President Reagan. Should the corporate income tax rate really fall from a nominal 35% to 20%, the S&P 500 & Co. can expect a significant leap in profits.

While the majority of US companies already pay far less than the official 35% tax rate (according to our estimate, 25% to 27% is realistic), with a number of analysts likely to have already factored assumptions on the tax reform into their models, we still consider a profit leap of as much as eight percentage points to be on the cards if one of the two proposals (or a compromise of the two) were to be adopted this year in the form currently known.

According to our latest estimate, the 2018 S&P index gains will rise by 11 percent (i.e. before the tax reform), from 131 to 146 index units. After the tax reform, our calculations point to a further boost of a good eight percent to 155 units.

Furthermore, we expect that – similar to 2004 – assets held abroad could be repatriated to the USA under favourable tax conditions. A repatriation tax is being discussed here of 14.5% (permanent). Particularly the technology giants such as Cisco, Qualcomm, Apple or Oracle currently have very high cash holdings outside the USA. In terms of all US companies, the total of all foreign assets amounts to more than 1.2 trillion US dollars. A look back at 2004 reveals that, at that time, share buybacks temporarily skyrocketed directly after the repatriation.

We also expect a similar scenario in 2018. A part of the tax relief will flow into higher wages and salaries as well as higher investments, but investors are likely to benefit from the lion’s share in the form of share buybacks and dividends. Share buybacks in particular, which have again fallen somewhat of late, are now braced for a significant comeback. The fact that US equities today are considered to be relatively expensive is in our view (unfortunately) unlikely to put companies off from reducing the number of outstanding shares.

This would lead to a complete repositioning of the US equity market in the 2018 investment year and create far greater scope for price gains than previously assumed. However, after the final adoption of the tax reform we expect the US leading indices to directly „process“ most of the expectations and rise noticeably.


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