How is the US Equity Market Pricing Trump’s Tax Reform?

What is President Trump’s tax reform plan about?

The Trump Tax Reform Plan, presented on April 26, was missing many details and left the market with many unanswered questions.

In our view, the plan’s five major elements are as follows:

  1. A proposed corporate tax rate cut from 35% (currently the highest among OECD countries) to 15% (among the 5 lowest rates of OECD countries);
  2. A reduction in the number of personal tax brackets from seven to three: 10%, 25% and 35%;
  3. Taxing the pass-through businesses at 15% (it was not mentioned in the document, but discussed by Steve Mnuchin, US Secretary of the Treasury);
  4. A tax on repatriated profits (the only compensating item in the plan);
  5. The introduction of a territorial tax system. However, no reference to the Border Tax Adjustment.

All in all the economic impact of the plan is not easy to estimate given the lack of detail, but we believe it is set to be significant and should boost the US economy in the short-term, although will likely worsen the deficit outlook. The medium-to long-term evaluation of such reform is much more complex to assess. In fact, this expansionary plan fits in an economy already running close to full employment, with the consequence of putting further pressure on inflation and increasing debt to a level that could weigh on future growth potential. In short, we expect significant changes to the final version of the plan.

Have financial markets already priced in Trump’s tax reform?

In general, we believe markets have priced in higher inflation and a stronger US economy since Trump’s election in November. This reflation trade lost some steam recently amid evidence of weaker economic data and lower oil prices.

The initial market reaction to Trump’s tax reform plan was muted. In our opinion, the market has not priced much of tax reform yet as very few details are known and the proposal will have to pass through Congress, where Trump’s record of success has not been strong so far.

In fact, this initial document is essentially the wish list of the President, but many of the proposals are unlikely to find support in Congress, because they are not budget neutral and could significantly expand the deficit. Our view is that the market has priced in no more than 10-20% of the value of the proposed cuts and we tend to agree with the market since there is not room to price more than that at this point.

If Trump succeeds with these reforms, how could they impact US equities?

A huge reduction in corporate tax would naturally be beneficial to the equity market in the US. If the reforms are approved as proposed, we could see as much as 25%-30% growth in earnings over the next three years. Consequently, we believe that the equity market could go up by a similar amount. If enacted, the tax plan will benefit not only US equities, but also many global multinationals with large US businesses. It may also set a trend – for instance, Macron in France is now talking of tax cuts.

How is the market reacting to President Trump’s first 100 days?

We believe that the market is correctly pricing Trump’s first 100 days. He has already started to move domestic investments in the energy sector and to reduce the negative impact of excessive regulations. But this is only the appetizer. The real question will be: can he succeed in enacting his proposed tax reform? More clarity on the size of the plan and his ability to deliver could be the trigger for further market appreciation. Until then, markets may remain cautious, focusing on current earnings perspective and fundamentals. While we wait, the first quarter of 2017 is shaping up to be one of the best quarters in the last five years, in term of earnings growth.

About Marco Pirondini

Marco Pirondini is Executive Vice President, Head of Equities, U.S. for Pioneer Investments. Marco also oversees the Fundamental Research Department and is Portfolio Manager of Pioneer International Value Fund and Pioneer Global Equity Fund. He joined Pioneer Investments in 1999.
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