As Trump tax comes to floor, fail­ure could spell stocks sell-off

The Star Malaysia - StarBiz - - Foreign News - By DAVID RAN­DALL and CARO­LINE VALETKEVITCH

NEW YORK: In­vestors are in­creas­ingly pric­ing in the ef­fect of a cor­po­rate tax cut into the shares of US com­pa­nies, leav­ing the mar­ket primed for a steep sell-off if the Repub­li­can-con­trolled Congress fails to pass one of pres­i­dent Don­ald Trump’s top pri­or­i­ties.

The bench­mark S&P 500 is up nearly 6% from its Au­gust lows as the Trump ad­min­is­tra­tion has rolled out its tax re­form pro­posal, which would cut cor­po­rate taxes to 20% from the cur­rent 35% and al­low com­pa­nies to bring back some of the US$2.6 tril­lion in cash cur­rently held off­shore at re­duced rates.

Bank of Amer­ica Mer­rill Lynch said that a pos­i­tive boost from taxes “had been priced out of stocks” in July but “has been mak­ing a solid come­back.”

Yet there are signs that the Trump ad­min­is­tra­tion has lit­tle room for er­ror as it gets ready to in­tro­duce its tax leg­is­la­tion next week.

The House of Rep­re­sen­ta­tives nar­rowly passed a bud­get mea­sure last Thurs­day ne­c­es­sary for a vote on a tax bill, with Repub­li­cans from such high-tax states as New York and New Jersey among the op­po­nents out of con­cerns that a bill would elim­i­nate the de­duc­tion of state and lo­cal taxes.

Trump must also stem po­ten­tial re­volts over a pro­posal to scale back the level of tax-de­ferred con­tribu- tions to 401(k) re­tire­ment sav­ings plans, which many mid­dle-class Amer­i­cans rely on for their re­tire­ment.

“The na­ture of the rally over the last two months has been tax-cut led. If we don’t get a cut then the mar­ket is go­ing down” sev­eral per­cent­age points, said Ed­ward Perkin, chief eq­uity in­vest­ment of­fi­cer at Ea­ton Vance.

Such a de­cline would be the first sig­nif­i­cant sell-off of the year, he said, but would not likely be near the 20% de­cline that sig­ni­fies the start of a bear mar­ket.

A col­lapse in the tax mea­sure would likely send the S&P 500 down 5% or more, Gold­man Sachs said in an Oct 20 note.

“Tax re­form will de­ter­mine the di­rec­tion of the S&P 500’s next 100 points,” the re­port said.

Over the last 30 days, roughly 75 com­pa­nies – rang­ing from de­liv­ery ser­vice United Par­cel Ser­vice Inc to ho­tel oper­a­tor Hil­ton World­wide Hold­ings Inc – have dis­cussed how they would ben­e­fit from a cor­po­rate tax cut on con­fer­ence calls with an­a­lysts, ac­cord­ing to a Reuters anal­y­sis of earn­ings call tran­scripts, a sign that Wall Street is in­creas­ingly fo­cused on the tax bill.

The White House’s plan would boost 2018 S&P 500 ad­justed earn­ings per share by 12%, to US$156, Gold­man Sachs es­ti­mates, while lead­ing to an ad­di­tional US$75bil in stock buy­backs.

Peter Tuz, pres­i­dent of Chase In­vest­ment Coun­sel in Char­lottesville, Vir­ginia, said that Trump’s clashes over the last week with mem­bers of his own party could threaten the tax bill’s suc­cess be­cause it could alien­ate other Repub­li­cans.

Be­cause Repub­li­cans hold only a slim 52-48 seat ad­van­tage in the Se­nate, Trump can af­ford to lose only two votes.

“When the pos­si­bil­ity of a de­fec­tion of some Repub­li­can se­na­tors in­creases, that kind of puts the whole tax re­form thing in jeop­ardy. He needs them all,” Tuz said.

At the same time, the 14.4% yearto-date rally in the S&P 500 leaves the in­dex primed for a de­cline of at least 5%, said Barry James, a co-port­fo­lio man­ager of the US$3.1bil James Bal­anced Golden Rain­bow fund.

The S&P 500 trades at a trail­ing price-to-earn­ings ra­tio of 22.6, and a for­ward price-to-earn­ings ra­tio of 19.5, both well above their his­tor­i­cal norms.

“We’re at lev­els to­day that are his­tor­i­cally very risky for stocks and we’re primed for a cor­rec­tion,” James said.

“If there’s not the tax cut that every­one is ex­pect­ing, then the cor­rec­tion could be a whole lot more se­ri­ous.” — Reuters

What’s next?: Gold­man Sachs says that tax re­form will de­ter­mine the di­rec­tion of the S&P 500’s next 100 points. — Reuters

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