GLOBAL WEEKLY COMMENTARY

Tax overhaul winners and losers

Jan 16, 2018

Key points

  • We see the U.S. tax overhaul boosting growth, lifting interest rates and creating winners and losers from lower top rates and closing of loopholes.
  • U.S. Treasury yields hit 10-month peaks and equity markets notched more record highs. Oil prices rose on signs of tightening supply.
  • Chinese fourth-quarter gross domestic product (GDP) data will set the tone for the country’s growth expectations and policy priorities for 2018.

The Tax Cuts and Jobs Act is poised to boost a U.S. economy already running at full capacity. A windfall from lower taxes and incentives for capex could spur more consumer and business spending and corporate deal-making. A likely convergence in tax rates could create winners and losers, rippling across sectors and companies.

U.S. equities effective corporate tax rates, 1980-2017

U.S. equities effective corporate tax rates, 1980-2017

Sources: BlackRock Investment Institute, with data from Thomson Reuters and Compustat, January 2018.
Notes: We take data from financial statements for Russell 1000 companies to arrive at an effective corporate tax rate at the company level (tax expense divided by pretax income). The lines show the effective tax rates of 75th percentile of tax payers and 25th percentile over time. The dotted line shows the federal statutory rate.

A 30-year rewind is informative. In the decade following the 1986 U.S. tax reforms, companies paying a relatively high share of their income in taxes saw their effective tax rates drop. Low effective tax payers saw a small rise as reforms leveled the playing field and closed loopholes. Effective tax rates started diverging again in the late 1990s as globalization, the adoption of territorial tax systems and relatively high top U.S. tax rates encouraged tax avoidance schemes. We believe something similar may play out today. The top quartile of U.S. companies currently pay an effective tax rate of 34% or more, our analysis shows. This leaves plenty of room for relief as the top rate is slashed to 21%. Lightly taxed companies, by contrast, may see their rates go up over time.

Looking beneath the surface

The overhaul of the U.S. tax code includes supply-side reforms and injects significant near-term demand stimulus into a U.S. economy running at near-full employment. A faster-growing U.S. may accelerate global growth, and result in rising inflation, higher Treasury yields and steeper yield curves. Look for a deep dive into how the tax changes and potentially higher U.S. government spending may affect the economy and interest rates in our upcoming Global macro outlook.

The tax cuts create winners and losers in the corporate sector. The drop in the top statutory rate will broadly benefit U.S. companies with high effective tax rates. But some of the benefits for these companies appear to be priced in already, suggesting investors need to look beneath the surface to identify the longer-term winners. There is significant dispersion within industries, sub-sectors and companies. The sustainability of increased corporate profitability derived from tax cuts will also vary. Companies in highly competitive industries, for example, will likely see a temporary profit boost that is quickly competed away. Changes to companies’ spending and investment plans because of the tax law are key details to watch through the fourth-quarter earnings season. We expect U.S. global corporations to scrutinize the new tax code’s complex international rules in an effort to manage any rises in their effective tax rates.

In credit markets, we see investment grade companies benefiting from lower tax rates. Yet we see most of the impact going to shareholders rather than toward paying down debt. High yield companies benefit from lower tax rates and immediate expensing of capex. But we expect more bifurcation between higher- and lower-quality issuers, as ones with large debt loads face limits to interest expense deductibility. This reinforces our up-in-quality credit stance. Municipal bonds emerged relatively unscathed, even as advanced-refunding bonds lost their tax-exempt status. This is set to shrink issuance, a factor we see supporting valuations.

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Date:Event
Jan. 17 U.S. industrial production
Jan. 18 China Q4 GDP, fixed-asset investment, retail sales
Jan. 19 International Energy Agency report

We are watching fourth-quarter Chinese GDP closely for hints on the country’s growth trajectory and policy priorities. The latest set of manufacturing and services data suggests China ended the year on a high note. Official Purchasing Managers’ Index (PMI) readings have caught up with the BlackRock Growth GPS. We expect a mild deceleration in China to a more sustainable growth pace. Inflation remains stable, leaving the central bank enough room to maintain its monetary stance while curbing credit growth and pushing for deleveraging within the economy.

  • Global bond yields climbed, with 10-year U.S. Treasuries hitting 10-month highs. U.S. interest rate volatility picked up, partly on reports, later denied, that China was planning to slow its Treasury purchases. Strong retail sales and inflation data in the U.S. also pushed yields higher.
  • Global equities marched on as U.S. banks kicked off the earnings season. Banks’ projected tax rates were lower than expected, but trading revenues remained sluggish. A breakthrough in German coalition talks and hawkish minutes from the European Central Bank (ECB) underpinned euro strength.
  • Oil prices rose to 2014 highs on U.S. inventory reductions and OPEC commitments to maintain cuts through 2018.

Global snapshot

Weekly and 12-month performance of selected assets

 

EquitiesWeekYTD12 MonthsDiv. Yield
U.S. Large Caps 1.6% 4.2% 22.7% 1.9%
U.S. Small Caps 2.1% 3.7% 18.5% 1.1%
Non-U.S. World 0.9% 3.7% 28.4% 3.0%
Non-U.S. Developed 1.2% 3.7% 26.7% 3.1%
Japan 1.6% 4.8% 25.7% 1.9%
Emerging 0.6% 4.3% 37.7% 2.6%
Asia ex-Japan 0.7% 4.2% 41.5% 2.4%
BondsWeekYTD12 MonthsYield
U.S. Treasuries -0.3% -0.7% 1.1% 2.5%
U.S. TIPS -0.4% -0.6% 1.5% 2.4%
U.S. Investment Grade 0.0% -0.4% 5.3% 3.3%
U.S. High Yield 0.0% 0.7% 7.1% 5.6%
U.S. Municipals -0.4% -0.5% 3.7% 2.4%
Non-U.S. Developed 0.7% 0.8% 10.2% 0.8%
Emerging Market $ Bonds -0.4% 0.2% 8.7% 5.3%
CommoditiesWeekYTD12 MonthsLevel
Brent Crude Oil 3.3% 4.5% 24.7% $69.87
Gold 1.4% 2.7% 11.9% $1,338
Copper -0.2% -1.9% 21.7% $7,110
CurrenciesWeekYTD12 MonthsLevel
Euro/USD 1.4% 1.6% 15.0% 1.22
USD/Yen -1.8% -1.4% -3.2% 111.06
Pound/USD 1.2% 1.6% 12.9% 1.37

Source: Bloomberg. As of January. 12, 2018.
Notes: Weekly data through Friday. Equity and bond performance are measured in total index returns in U.S. dollars. U.S. large caps are represented by the S&P 500 Index; U.S. small caps are represented by the Russell 2000 Index; Non-U.S. world equity by the MSCI ACWI ex U.S.; non-U.S. developed equity by the MSCI EAFE Index; Japan, Emerging and Asia ex-Japan by their respective MSCI Indexes; U.S. Treasuries by the Bloomberg Barclays U.S. Treasury Index; U.S. TIPS by the U.S. Treasury Inflation Notes Total Return Index; U.S. investment grade by the Bloomberg Barclays U.S. Corporate Index; U.S. high yield by the Bloomberg Barclays U.S. Corporate High Yield 2% Issuer Capped Index; U.S. municipals by the Bloomberg Barclays Municipal Bond Index; non-U.S. developed bonds by the Bloomberg Barclays Global Aggregate ex USD; and emerging market $ bonds by the JP Morgan EMBI Global Diversified Index. Brent crude oil prices are in U.S. dollars per barrel, gold prices are in U.S. dollar per troy ounce and copper prices are in U.S. dollar per metric ton. The Euro/USD level is represented by U.S. dollar per euro, USD/JPY by yen per U.S. dollar and Pound/USD by U.S. dollar per pound. Index performance is shown for illustrative purposes only. It is not possible to invest directly in an index. Past performance is not indicative of future results.

Asset class views

Views from a U.S. dollar perspective over a three-month horizon

Table: Asset class views from a U.S. dollar perspective

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Richard Turnill
Global Chief Investment Strategist
Richard Turnill, Managing Director, is Global Chief Investment Strategist for BlackRock, leading the Investment Strategy Function within the BlackRock ...
Isabelle Mateos y Lago
Global Macro Strategist, BlackRock Investment Institute
Isabelle Mateos y Lago, Managing Director, is BlackRock's Chief Multi-Asset Strategist. As part of the BlackRock Investment Institute (BII), she is responsible ...
Kate Moore
Chief Equity Strategist
Kate Moore, Managing Director, is Chief Equity Strategist for BlackRock and is a member of the BlackRock Investment Institute (BII). She is responsible for ...
Jeffrey Rosenberg
Chief Fixed Income Strategist
Jeffrey Rosenberg, CFA, Managing Director, is BlackRock's Chief Fixed Income Strategist and a member of the BlackRock Investment Institute. His responsibilities ...