Progress made in Washington in discussions about passing tax proposals put forward by US President Donald Trump may revive “Trump trades” that spurred US equity markets earlier in the year. If passed into law, the changes will lead to significant earnings upside and faster economic growth, Goldman Sachs said.
After strides towards agreement in the Senate on the tax package, Goldman political economist Alec Phillips lifted his estimate of the likelihood of the tax legislation passing in 2018 to 65%, Goldman analysts including Ben Snider and David Kostin said in a note on Wednesday.
They estimated the White House plan as proposed could boost 2018 S&P 500 adjusted earnings by 12% to $156 from their current forecast of $139.
Under the proposals, the US federal statutory corporate tax rate would be lowered to 20%, close to the OECD average and significantly below the median S&P 500’s company’s current 27% effective rate, according to the note. Equities sensitive to tax reform and fiscal stimulus, include high tax rate stocks, cyclicals, small-caps, value stocks, and firms with strong balance sheets, they added.
“Tax reform could boost corporate earnings substantially, but the effect on the aggregate US equity market, and the distinction between winners and losers, will depend on details that remain to be negotiated,” the analysts said. “Recent stock market performance suggests investors are already pricing some optimism regarding tax reform.”
An alternative scenario that would bring the plan closer to the allowance in the Senate budget resolution could lift 2018 EPS by 7% to $148
In addition to the direct earnings benefit, the combination of corporate and personal tax reform could spur faster economic growth, with each incremental percentage point of US GDP growth adding about 3 percentage points, or $4, to average S&P 500 EPS.
Goldman economists estimate tax reform could stimulate US economic growth by roughly 0.2 percentage points in the first year, boosting S&P EPS by less than 1 pp.
On the downside, by accelerating economic growth late in the cycle, fiscal stimulus could also boost inflation and therefore the path of Federal Reserve monetary policy tightening, potentially adding downside risk to equity valuations the analysts wrote.