Stocks will be just fine even if tax reform doesn’t go through, Credit Suisse says

Stocks will be just fine even if tax reform doesn’t go through, Credit Suisse says


Contrary to popular belief, stocks haven’t really risen on the prospect of tax cuts and they may not see a big bounce higher if Congress ultimately approves tax cuts, according to Credit Suisse.

Even President Donald Trump tweeted this week that he needs Congress to approve taxbreaks and reform to keep the stock market rally going.

But according to Credit Suisse equity strategists, the 20 percent stock market rally since Trump’s election does not appear to be backed by the promise of tax reform, as many believe. To make that point, they note an index of companies that would benefit most from tax cuts has actually lagged.

“The market rewarded firms with high effective tax rates for only three weeks post-election, but not since,” wrote Jonathan Golub, Credit Suisse’s chief U.S. equity strategist. “For that reason, we do not believe that stocks would be at risk if a deal isn’t struck.”

He points to three reasons for the market’s indifference to the prospect of tax law changes. One is that a deal may be too tough to get passed. Secondly, it may become too diluted as it moves through Congress. And finally it might prompt the Fed to hike interest rates faster, which could undermine the benefits of a tax cut.

“At the end of the day a lot of people are attributing the market’s success to tax reform. We don’t really see it,” said Patrick Palfrey, a Credit Suisse equity strategist. “There are other things going on – favorable economic backdrop, ISMs for example, and at the same time, valuations on stocks remain reasonable and should go higher. We see a whole lot of reasons.”

The Trump administration and congressional leaders unveiled a plan that would provide for a 20 percent corporate tax rate. The stock market has already surged $5.2 trillion in value since Trump’s election, and he suggested on Twitter that it would continue to climb with tax cuts.

Perhaps not, says Golub.

“I think you’re clearly going to get an initial market bounce into the optimism around this. The question is will it have follow through? On that, I’m skepitcal,” said Golub in a phone interview. “You’re overheating something…Would we all love to see a three or four percent GDP? Is a stimulus plan in the ninth year of a cycle with a 4.2 percent unemployment rate the best way to go?”

Golub said he’s skeptical because if the economy does overheat, with more demand in an already tight labor market, wages will rise and the output would be limited. The Fed could see stimulus coming in at a time when it is already tightening and that could push it even faster.

To make their case, Credit Suisse analysts looked at the performance of the top third of S&P 500 companies with the highest tax rates versus the bottom third with the lowest rates. Palfrey said they used a tax rate based on a trailing three year basis. The “tax factor” is calculated as the return of the high tax basket minus the return of the low tax basket, according to Credit Suisse.

Some of the companies with the highest rates are Harley-Davidson, which had a second quarter tax rate of 34 percent, Under Armour which expects about a 32 percent tax rate this year, and Nordstrom which sees a 40 percent tax rate for 2017. Aetna, which has been a strong performer, had a 35 percent tax rate in the second quarter.



Source : cnbc.com

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