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Are US equity markets set for a bumper 2018 on the back of tax reform?


Love him or loathe him, Donald Trump is certainly keeping investment bulls happy. The US equity markets had a fine year in 2017, with the Dow Jones, S&P and Nasdaq rising 25%, 20% and 30% respectively. The approval of his tax plan at the end of last year was the culmination of endless tweets and political posturing which served to help bouy the US equity markets over the course of the year.

Is tax reform paying dividends already?

In simplified terms, the new US tax structure will cut the corporate tax rate from 35% (currently the highest rate in the world) to 21% from the beginning of this year. This represents a significant boost to earnings for US companies.

Apple has responded to these changes in the tax law by announcing that it is looking to expand its operations in the US by creating around 20,000 new jobs, while also repatriating a significant amount of the US dollar it currently holds overseas over the next few years. The numbers are expected to be in the hundreds of billions of US dollars, which will result in the payment of a one-off tax bill of $38bn, the tech giant has announced.

Technology stocks rallied sharply on investor expectations that similar moves by other US companies with large overseas cash piles may follow suit.

“For all the criticism of President Trump, the nature of his presidency and his economic policies, he appears to have got what he wanted in prompting US companies to reinvest their profits back into the US economy.” noted CMC Markets analyst, Michael Hewson

While the multi-nationals look to repatriate their overseas money, US companies that do business a little closer to home will receive an earnings boost in 2018. On top of this welcome leg-up, households from the largest economy in the world are also set to benefit from individual tax rate cuts too.

With more money in their pockets, will the average American be likely to spend more?

“Trump’s achievement of lowering corporate tax rates from 35% to 21% and allowing US companies to bring back their overseas profits at 7.5% tax rather than 28% will have global consequences,” says Philip Smeaton, Chief Investment Officer at Sanlam UK. “If the US does well, we all do well, since most companies count the US as an important market.”

Smeaton says that the prospect of higher interest rates in the US is a key driver of optimism in the American banking sector in particular as they will make more money from their loan businesses. De-regulation will liberate the US financial sector, and tax reform will mean large sums of money coming onshore which should create further demand for banking services.

The US economy enjoyed a positive year in 2017, with healthy manufacturing growth, strong employment and retail sales, an unemployment rate unchanged at a 17-year low and soaring consumer confidence.

Can the tax cuts boost an already bouyant economy further in 2018?

A note of caution for US equity markets

It is well known that price/earnings values for US equity markets are sitting at historic highs. There’s a suggestion amongst investment analysts that there’s little value left in US stocks meaning a correction could be around the corner in 2018.

“Using Professor Robert Shiller’s Cyclically Adjusted Price Earning (CAPE) multiple, US stocks have only been more expensive, post-war, on one occasion and this was in 1999 – and the 2000-03 bear market soon followed. Pre-war, US stocks exceeded the current multiple in 1929 and it’s hard to think of a less encouraging precedent than that.” suggested AJ Bell analyst, Tom Selby

A stellar performance in 2017 on the back of Trump’s tax reform hype machine could mean that any beneficial impact from the tax cuts have already been priced in. Time will show us which of these two scenarios play out.

Tom Selby did, however, provide some cause for optimism though. “…stock markets are forward-looking discounting mechanisms so any guidance given for 2018 will be more important than the 2017 numbers, especially as this will give some insight into how companies see the tax changes affecting them”

Whatever the outcome, 2018 should be an interesting year for US equities.

How to invest in the US markets

If you would like to gain exposure to the US markets in 2018, there are a number of options available to you.

Depending on your appetite for risk, there are a number of active funds available that will pick specific stocks within the US markets, based on the objectives of the fund manager, with a view to outperforming it’s benchmark index. For a cheaper alternative, Exchange Traded Funds, or ETFs, will track the performance of an index and provide returns based on the index’s performance.

For those with a greater appetite for risk, Contracts for Difference, or CFDs, provide leveraged access to the major US indexes. UK investors can take advantage of tax-free Spread Betting for a similar risk-on trade.

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This article does not constitute investment advice. Make sure you do your own research or consult a professional advisor.

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