With concerns rising that the market has gotten well ahead of itself over the practical reality of Trump tax cuts - most recently voiced by Goldman which over the weekend said that "we are approaching the point of maximum optimism and S&P 500 will give back recent gains as investors embrace the reality that tax reform is likely to provide a smaller, later tailwind to corporate earnings than originally expected" - Barclays decided to look at one of recent history's most notable tax regime changes: the Reagan tax cuts.
What it found was interesting.
First, the market wastes no time in factoring in any to corporate taxes and according to Barclays calculations, corporate tax cuts get 85-90% priced in very short order. As an example, Barclays points out that the Reagan 1986 tax cuts showed that equities price in the benefits quickly. Perhaps too quickly.
There were some other notable similarities between the current tax-regime transition and 1986, namely "the oil collapse and growth cycle were also issues in 1986." In any case, a harbinger of the current market rally driven by Trump tax cut hopes, "the S&P 500 rallied 40% pricing in the tax plan before it was really even implemented in July 1987."
The S&P then infamously crashed in October of 1987, for a variety of reasons, one of which, Barclays suggests, was the rapid pricing in of the Reagan tax cuts. In fact, seen this way, the infamous Black Monday crash may have been - in addition to all the other noted catalysts - a very vivid example of "sell the news."
There was also good news: for those who survived the 30% drawdown, though the post-1987 period was marred by the crash, S&P 500 EPS actually rose 55% compared to 1986 levels. Barclays foresee a similar dynamic likely playing out whereby the market multiple prices in the first order effects of a tax plan very quickly, once known.
One could perhaps add that the market has already priced most of the tax cut without even knowing the details. On the other hand, Barclays notes, second order effects such as rates and growth will also affect the multiple. Two notable difference between the Reagan and Trump tax cuts, as the level of government indebtedness - far greater now than it was 30 years ago - and the Fed's tightening cycle, which for the time being are seen as bullish although inevitably the market will realize that tighter financial conditions inevitably lead to lower risk prices.