Trump's tax plan is here — here's how Wall Street says to trade it
Wall Street has lots of ideas for how investors can trade for Donald Trump and Steve Mnuchin's tax plan.Alex Wong/Getty Images
Corporations aren't the only ones set to profit from the Republican tax plan released on Wednesday.
You can too — if you know where to look.
Just focus on the so-called Trump trade, which involves betting on the areas of the market poised to benefit most from the pro-business policy overhaul being touted by President Donald Trump.
Investors have already started piling back into the trade after a long hiatus, as they start to hope for real progress on the policy front.
But don't worry; you haven't missed much yet. There's still a great deal of upside potential to be realized, especially since these same Trump-linked strategies retraced all of their postelection gains — and then some — as investors lost confidence in the president's proposed policies.
Here's a quick primer on what matters to investors:
- The key measure investors are focusing on involves a lowering of the corporate tax rate to 20% from 35%. Trump has pushed for 15% in the past, but that's being increasingly viewed as unviable.
- The repatriation tax holiday for companies holding trillions of dollars overseas. They'll be allowed to bring that cash back to the US at a lower-than-usual rate. It could spur investment in the US, but it's also very likely to wind up being used to pay dividends and buy back shares.
- Another element that investors could trade on is the ability to immediately expense capital expenditures.
The two most straightforward Trump trades involve buying stock in two types of companies:
- Those that pay the most taxes and
- Those that hold the most cash overseas.
Lucky for you, both Goldman Sachs and JPMorgan have baskets tracking both groups.
For more detail, here's a breakdown of how those two firms, plus two other Wall Street titans, recommend investors play tax reform:
Goldman Sachs, part 1
Overview: The chart above shows a Goldman-curated basket of 50 companies that pay high taxes, spread across a variety of US industries.
After a postelection surge, the index saw all of its gains relative to the broader market erased by mid-March. Now, amid rising optimism around some sort of tax cut, it's been ticking up in recent weeks.
Top recommendation: Figure out which companies pay the most taxes, then buy their stocks and don't look back.
Goldman Sachs, part 2
Overview: The second big component of the tax plan, a repatriation tax holiday, will incentivize multinational companies — which make a large portion of their earnings overseas — to bring cash held internationally back into the US.
The chart above shows another Goldman index containing the stocks with the highest earnings reinvested overseas. After losing their postelection gains, they recovered before spiking in recent weeks on increased policy optimism.
The firm estimates that a lowering of the corporate tax rate would result in multinationals repatriating $250 billion of a possible $920 billion untaxed overseas cash in 2018. In terms of the specific sectors that stand to benefit most, Goldman highlights tech and healthcare, which combine for roughly 85% of the total overseas cash for S&P 500 companies.
Top recommendation: Figure out which companies are reinvesting the most earnings overseas, then buy their stocks and don't look back. Large-cap tech and healthcare are a good place to start.
JPMorgan
Overview: While JPMorgan shares Goldman's view that highly taxed companies will benefit from the tax policy, they will also get a boost from the immediate expensing of capital expenditures (capex). That's expected to benefit asset-heavy industries, most notable energy and industrial companies.
To help better understand the effect of the newly-announced 20% corporate tax rate, take a look at JPMorgan's analysis from last week around a cut to 25%. Such a trimming would boost the S&P 500's earnings by $11.40 a share to $143.40. That, in turn, would add more than 150 points to the index, which is fresh off a series of record highs.
And with the stock market serving as a handy signaling device for the likelihood of policies being introduced, JPMorgan also sees areas of the bond market impacted by the repatriation portion of the tax plan.
"Tax reform that repatriates foreign cash and eliminates interest deductibility would greatly reduce US corporate bond supply and should thus on net tighten credit spreads," analysts led by Jan Loeys, the firm's head of global asset allocation, wrote in a recent client note.
Top recommendations:
- Buy stocks of companies paying high taxes
- In the event of immediate capex expensing, buy stocks of companies in asset-heavy sectors like energy and industrials over those in asset-light sectors
- Keep an eye on the potential for tighter credit spreads
Bank of America Merrill Lynch
Overview: A big part of Bank of America Merrill Lynch's Trump trade analysis focuses on small-cap companies tracked by the Russell 2000 index. The firm notes that small caps, which are more domestically focused, soared after the election on expectations that the president would pass pro-US business policies. BAML also highlights the fact that these same stocks have since dropped considerably, reflecting a mounting lack of confidence.
With these stocks now sitting at a discount to the rest of the market, the firm has a couple of options trades it sees as an effective hedge to further downside now that the tax plan has arrived.
And, as with the Goldman charts above, you'll note that the small-cap Trump trade has recovered slightly over the past few weeks.
Top recommendation: Purchase bullish call contracts on Russell 2000 options, relative to their S&P 500 counterparts, as a tax-reform hedge.
Citigroup
Overview: The Trump trade commentary provided by Citigroup this past week focused largely on the repatriation portion of the proposed tax plan — most notably what the windfall of cash would mean for share buybacks.
In short, it will be very positive for repurchases, which have helped keep the eight-year bull market afloat by generating share gains even during periods devoid of strong fundamentals. For evidence of that, look no further than the chart above, which shows the relative outperformance of companies heavily involved in buybacks.
Citigroup estimates that US corporations are holding a whopping $2.5 trillion of cash overseas.
Top recommendation: Buy stock of the companies with the most cash stashed overseas, because they're the ones with the most to spend on highly lucrative share buybacks.
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