US tax reform's impact on global markets
The US$1.5 trillion US tax overhaul has several implications for international investors, including those in Australian stocks.
US tax reforms have delivered a sugar hit to equities, lifting corporate profits in the world's biggest economy and boosting the outlook for global growth. But the US$1.5 trillion (A$1.85 trillion) tax overhaul also has implications for international investors, including those in Australian stocks.
On 23 December, US President Donald Trump signed into law the biggest tax changes since the 1980s. Under the reforms, the US corporate tax rate has been slashed from 35 per cent to 21 per cent, along with other changes including temporary cuts to individual tax rates.
In signing the bill, Trump said: "We are making America great again. Ultimately what does it mean? It means jobs, jobs, jobs."
The International Monetary Fund (IMF) expects the US tax cuts to deliver for the global economy too. In its latest World Economic Outlook report, it upgraded its forecast for world economic growth this year by 0.2 percentage points to 3.9 per cent, reflecting "increased global growth momentum and the expected impact of the recently approved US tax policy changes".
The effect on US growth is expected to be positive through to 2020, with the IMF also suggesting that exporters to the United States will benefit, including China and Australia.
Credit Suisse expects the reforms to deliver a double-digit gain for US company earnings, which are now expected to rise by around 10 per cent on average for the S&P 500 compared to 6 to 7 per cent previously. It noted that the average tax rate for S&P 500 listed companies was previously 27 per cent.
The US tax changes will increase the attractiveness of the United States as an investment destination, as well as reducing the incentives for US companies to move profits offshore, Credit Suisse said.
US corporate winners from the tax changes include automakers, asset managers, banks, pharmaceuticals and retailers, along with companies with large cash stockpiles overseas such as Apple, which are now incentivised to repatriate such profits.
A number of US companies have responded to the tax changes by handing out bonuses to employees, including Bank of America, Walmart and Walt Disney.
However, there are also expected losers from the reforms, including health insurers and hospitals that have been hit by healthcare changes, along with renewables, affected by changes to electricity tax credits.
Morningstar's head of equities research, Peter Warnes, has warned that the "unfunded" tax reforms will add to an already stretched US budget deficit, which together with planned infrastructure spending has the potential to trigger wage inflation.
"The reaction by the Fed [US Federal Reserve] will, or should be, more aggressive tightening of monetary policy via higher interest rates on a highly leveraged economy. Should this scenario play out, equity markets would need to adjust," Warnes said.
International impacts
Internationally, the lower US corporate tax rate has troubled Asian economies such as Hong Kong and Singapore, which have long used low taxes as a drawcard for multinationals.
Already, US semiconductor company Broadcom has announced plans to shift its legal base from Singapore to the United States, bringing home US$20 billion of annual revenues.
Hong Kong's 16.5 per cent corporate tax rate and Singapore's 17 per cent still remain lower, but others might be forced to respond. Across Asia, those with higher rates than the United States include Malaysia (24 per cent), China and Indonesia (25 per cent) and India (30 per cent), according to the Nikkei Asian Review.
Japan plans to cut its corporate tax rate to around 20 per cent from 30 per cent, providing companies hike wages and meet investment spending requirements. The reforms would bring its effective tax rate closer to the OECD average of 23 per cent.
Bucking the trend towards lower taxes, South Korea recently raised the rate on companies with taxable income exceeding 300 billion won (A$349 million) to 25 per cent from 22 per cent, along with hiking taxes on wealthy individuals.
European lawmakers are also concerned about the US tax changes having a "major distortive impact on international trade". Corporate tax rates in Europe vary, ranging from France's 33 per cent and Germany's near 30 per cent to 19 per cent in the United Kingdom, according to KPMG.
However, the US tax changes will boost the profits of Asian multinationals with substantial US operations, including Japanese automakers such as Honda and Toyota.
Daiwa Institute of Research expects Japanese corporate profits will rise by 400 billion yen (A$4.54 billion) due to lower US taxes, benefitting Japanese trading houses, transport equipment and services companies. The benefits could be even higher depending on the impact on US consumer spending, according to the Tokyo think tank.
In Australia, Credit Suisse has projected a $620 million increase in profits for ASX-listed companies exposed to the United States. It nominates 21 direct beneficiaries, including BlueScope Steel (ASX: BSL), Computershare (ASX: CPU), Incitec Pivot (ASX: IPL), Janus Henderson (ASX: JHG) and Macquarie Group (ASX: MQG).
Yet it also notes the impact on Australia's international competitiveness, with the nation now having the third highest corporate tax rate in the OECD compared to the United States, which has dropped to 20th.
"A potential longer-term implication for Aussie companies is a lower local corporate tax rate," Credit Suisse said in its 18 December report.
Yet it also noted the potential for rising bond yields in the United States, which it sees reaching 2.9 per cent by year-end.
John Vail, chief global strategist at Nikko Asset Management (Nikko AM), says investors already factored in the tax changes last year, "but the market still seems excited by the large amount of the earnings estimates upgrades".
"The beneficiaries are very widespread, both directly and indirectly (via the macroeconomic impulse). Small-cap stocks, on average, have the highest effective tax rates, so they benefit quite a lot," he said.
Nikko AM expects the US S&P 500 index to reach 2,941 by end-June 2018 and 2,994 at year-end, with most of the gains in the first half of the year.
With the benchmark US index showing a one-year return of around 27 per cent as at 24 January, US investors have already enjoyed strong gains compared to the 13 per cent rise of Australia's benchmark S&P/ASX200 index.
Yet Morningstar's Warnes predicts both US and Australian equity markets will end 2018 "at a lower level than the exit level of 2017".
In the meantime, though, US companies and investors are still enjoying their Christmas tax present, with the pressure on Australia and other higher taxing countries to respond.
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Anthony Fensom is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does not have an interest in the securities disclosed in this report.
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