Just when investors thought they were out, President Donald Trump is pulling them back in.
Months after the so-called “Trump trade” fizzled, traders are once again being enticed by the possibility of a pro-business policy overhaul — and piling into the areas of the market that could benefit the most from the new president’s plans.
The latest trigger is a tax proposal that’s set to be released on September 25 — one that’s expected to reveal specifics around a lowering of the corporate tax rate, as well as a one-time repatriation tax holiday for companies holding trillions of dollars overseas.
The renewed willingness to trade on this is a big change of sentiment for investors. After pumping up stock prices on the hopes that Trump and a Republican legislature would push through tax cuts and infrastructure spending to boost economic growth and fill corporate coffers, they were eventually worn out as the promises repeatedly failed to materialise.
Once able to create or erase billions of dollars of market value with a single tweet, the president’s influence looked to be waning.
Investors are now snapping back to attention, seduced by the possibility of further gains, even with major US stock indexes already resting confidently at record highs. But it must be noted that the Trump trade’s recovery is still in its early stages, perhaps indicating greater reservations this time around.
Here are two areas drawing the most renewed interest. We’ll be tracking these to see how investors feel about the plan’s prospects as it approaches and after it is unveiled next week.
The companies paying the most taxes
Since 2015, Trump has been adamant about cutting the federal corporate tax rate from its current 35% to 15%. While he doesn’t appear to have much support from his fellow Republicans, who have called a decrease all the way to 15% unworkable, there’s no denying that investors are feeling increasingly confident about the most highly-taxed companies, which would benefit most from such a measure.
As indicated by the chart below, a Goldman Sachs index tracking the group saw all of its post-election gains relative to the broader market erased by mid-March. Now, amid rising optimism around some sort of tax cut, it’s been ticking up in recent weeks.
It’s important to note that even if Trump’s desired 15% rate ends up being slightly higher, these companies will still see a material benefit to their bottom line. JPMorgan estimates that if the statutory tax rate is cut just 10 percentage points to 25%, that would boost the S&P 500‘s earnings per share by $US11.40 to $US143.40 — and add more than 150 points to the index, which closed at a record high of 2,500.23 on Friday.
“Investors were initially sanguine on tax reform post-election but optimism quickly faded as political focus was diverted to other issues,” Dubravko Lakos-Bujas, JPMorgan’s head of US equity strategy, wrote in a client note. “As long as headlines continue to indicate political traction, we believe investors are likely to start pricing in higher probability of tax reform.”
The companies holding the most cash overseas
Another area of the Trump tax agenda that’s expected to be included in the upcoming tax plan is a repatriation tax holiday. The measure would incentivise multinational companies who make a large portion of their earnings overseas, and then hold that cash internationally, to bring it back into the US.
Strategists at Citigroup estimate that US corporations are holding a whopping $US2.5 trillion of cash overseas.
As the chart below shows, investors who were initially enticed by the prospect of a repatriation tax holiday gave up on the trade midway through January. The subsequent recovery over several months can be more attributed to the fundamental performance of large US multinationals who do big business internationally — Google, Facebook, Amazon — than to anything relating to tax measures.
However, the recent spike in a Goldman Sachs-maintained index of companies with high overseas earnings is best explained by policy optimism.
So how exactly would the influx of cash drive share appreciation? Equity strategists at both Goldman and Citigroup are forecasting that high cash balances for corporations will lead to share repurchases. While stock buybacks have slowed in recent quarters, they still remain a good way to push shares higher absent other positive drivers, making them a safety net of sorts for a continued bull market.
While stock performance can serve as a handy signalling device for the likelihood of policies being introduced, JPMorgan also sees areas of the bond market vulnerable to new political developments.
“Tax reform that repatriates foreign cash and eliminates interest deductibility would greatly reduce US corporate bond supply and should thus on net tighten credit spreads,” analysts led by Jan Loeys, the firm’s head of global asset allocation wrote in a client note.