In this past weekend’s missive, I stated:
“Following the election, the market has surged around the theme of ‘Trumponomics’ as a ‘New Hope’ as tax cuts and infrastructure spending (read massive deficit increase) will fuel earnings growth for companies, stronger economic growth, and higher asset prices. It is a tall order given the already lengthy economic recovery at hand, but like I said, it is ‘hope’ fueling the markets currently.
As you can imagine, I received quite a few comments from readers suggesting that each percentage of tax cuts will lead to surging corporate earnings and economic growth. This was a point made by Bob Pisani recently on CNBC:
“The current 2017 estimate for the entire S&P 500 is roughly $131 per share. Thompson estimates that every 1 percentage point reduction in the corporate tax rate could ‘hypothetically’ add $1.31 to 2017 earnings.
So do the math: If there is a full 20 percentage point reduction in the tax rate (from 35 percent to 15 percent), that’s $1.31 x 20 = $26.20.
That implies an increase in earnings of close to 20 percent, or $157.”
I don’t entirely disagree considering my recent prognostication of the S&P melting up to 2400 in the next few months.
However, I also want to take a step back for a moment and look at the reality of corporate tax cuts and their potential impact on the economy, and ultimately, corporate earnings.
First, of all, since estimates historically are on average 33% overestimated, such would suggest that future earnings per share will be closer to $106/share which suggest an S&P price of 2438 at 23x earnings. In line with my current estimates.
Secondly, and most importantly, changes to corporate earnings will come primarily from share buybacks and lower effective tax rates. This point should not be overlooked as long-term earnings growth, and a healthy market, is driven by changes in actual top-line revenue driven by a stronger economy and higher levels of consumption.
This is the focus of today’s analysis.
During the Reagan administration tax rates were cut in order to boost economic growth and activity along with a surge in deficit spending. The chart below shows the top tax brackets from 1913-Present.
Importantly, as has been stated, the proposed tax cut by President-elect Trump will be the largest since Ronald Reagan. However, in order to make valid assumptions on the potential impact of the tax cut on the economy, earnings and the markets, we need to review the differences between the Reagan and Trump eras. My colleague, Michael Lebowitz, recently penned the following on this exact issue.