President Donald Trump has proposed cutting the top line corporate tax rate to 20%.
What stocks might get a boost from any anticipation of that proposal becoming law?
First, recognize that until very recently the stock market wasn’t doing a very good job at pricing in a cut in corporate tax rates. From last December a basket of 50 stocks from companies that pay the highest effective tax rate put together by Goldman Sachs underperformed a basket of 50 stocks from companies that pay the lowest effective tax rate by 11%.
In the last week the high-effective-rate basket has outperformed the low-effective-rate basked by 2.3%.
Second, please note my careful inclusion of the term “effective rate.” While the United States has one of the highest marginal corporate tax rates in the world on paper (35% is the highest federal bracket and the total marginal rate comes to 39.1% once you include state taxes), almost no company pays that. The average effective tax rate–that is what the average company pays–was 18.6% in 2016, according to the Congressional Budget office.
Overall, that effective tax rate isn’t all the much lower than the 20% statutory rate that the Trump administration is proposing.
So it stands to reason that the biggest benefits from a cut in the statutory rate to 20% would go to the companies now paying the highest effective tax rate.
Those companies aren’t in the technology sector–where the effective tax rate is just 23%, according to Deutsche Bank. And it’s not in healthcare–where the effective rate for the sector averages 24%.
How about energy? The effective tax rate for the energy sector is 38%, Deutsche Bank calculates. The anticipation of a tax cut boost to earnings isn’t likely to be enough to keep energy stock prices high if the price of crude starts to tumble, but it is enough to keep the current energy rally humming along for a while yet.
Meanwhile back in the general market, Goldman Sachs figures that every one percentage point drop in the statutory tax rate is enough to add $1 to earnings for the Standard & Poor’s 500 in 2018. If passed by the end of 2017, the proposed tax cut would add about 11.5% to expected earnings for the S&P 500 forecast at $130 for 2018. That would be one time boost to earnings expectations since after the cut is enacted Wall Street analysts would certainly add the effect into their calculations for expected earnings.