The Republican tax plan now working its way through congress has far-reaching implications for investors, companies and the economy, and could have particular effects on value stocks.
President Trump and the GOP are proposing $6 trillion in cuts, including $2.5 trillion for corporations over 10 years and a reduction in their tax rate to 20% from 35%. The exact impact on the economy is hotly contested, with some estimating that the plan could raise GDP growth to 3% from 2%, and others, like Moody’s Analytics’ chief economist Mark Zandi, arguing for a more tepid growth to 2.04% from 2%. In a piece for Yahoo Finance Monday, Zandi said that with full employment, the plan will usher in stronger inflation and higher interest rates.
“The higher rates wash out the economic benefit of the lower tax rates on investment, and the economy ends up no bigger than it would have been without the tax cuts,” Zandi wrote.
Studies show that stock markets have reacted about equally to corporate tax cuts and tax increases. In both cases, they tend to go up. Since 1927, the government has cut corporate taxes 10 times. In the year following the cuts, U.S. stocks have risen six times. The average rate of increase was 11%.
Tax increases have occurred 13 times since the same year, which resulted in stock market increases nine times. The average annual gain was 12.5%, David Hryck, a tax lawyer and partner at Reed Smith said.
Value stocks stand in an unique position. Those that have seen share price dips due to business setbacks could benefit heartily from the tax breaks, though investors should think long term about the beneficial effects and not expect immediate results.
“If some businesses that are currently teetering between success and failure can get the needed relief necessary to push them over the edge in developing their product better -- or in mass producing their product -- or to just turn a profit and get to the next level of growth, then you could see some value stocks skyrocket in the next few years,” he said.
The difference in how companies act with the funds will also make a difference in the direction their stocks go with the Republican tax plan in its current state. One way it could influence the stock market is that investors will buy more popular stocks, expecting them to bring money back from oversees, pay fatter dividends and put the extra cash toward new products and incentives, FitSmallBusiness investors and legal analyst Jeff White said.
“The activity isn't likely to pick up in response to the tax plan until the final details are released, and the vote is expected to pass,” he said.
But concern about the deficit that may result from the tax plan could drive down part of the market. Since the recession, many companies have failed to put additional profits to work, which deflates the lawmakers’ idea that tax cuts will be covered by increased spending. These companies have adjusted to operating more efficiently and with fewer employees, and may not immediately translate tax breaks into spending.Â
“Even companies that have seen profits increase, have failed to give out increases, but instead, sat on much of their profits,” he said.
Most importantly for investors, though it may have negligible effect on the market, a decrease in capital gains rates will help them temper expenses when buying and selling.
“If you’re a value investor, the best advice I can give you is to purchase stocks of strong companies,” Hryck said. “You shouldn't let a possible tax change impact your investing strategy all that much.”