November 8 will mark the one year anniversary of one of the biggest political shocks in US history: the election of Donald Trump. Since that improbable victory, which so many experts had said would lead to a market crash, the S&P 500 has soared by 21% according to Goldman which calculates that the Trump rally so far ranks as the fourth-best 12-month gain following a presidential election since 1936, trailing only Bill Clinton (1996, 32%), John F. Kennedy (1960, 29%), and George H.W. Bush (1988, 23%).
Of all sectors, the biggest beneficiaries from Trump's election were Financials and Information Technology, which have powered the market with returns of 37% and 39%, respectively. Given its large weighting, Tech contributed 37% of the index gain. Alongside the relentless stretch of all time highs in the S&P, the rise in the index has also been characterized by the lowest volatility in 50 years and has seen just one month in which it did not record a gain (March, -0.04%) although on a total return basis, the S&P has been up every single month since the election, and as Deutsche Bank observed last wek, the S&P has seen a positive total return for all 10 months so far this year, the first time on record. Additionally, October marked the 12th positive month in succession, which equals the record set in 1949-1950 and 1935-1936. This means the S&P has not had a single month of negative total returns since Trump was elected almost exactly one year ago.
Courtesy of Goldman's Kostin, here are some other observations:
- Trump’s election also rippled through the performance of global equity markets. Following allegations of Russian interference in the US presidential election, equity investors initially appeared to believe Mr. Trump would herald a thawing of relations between the two countries. The MICEX index surged by 13% between the US election and the end of 2016 while the S&P 500 rose by just 5%. However, MICEX then plunged by 16% during 1H 2017 before rebounding during the last three months to bring the post-election local currency return to 5% (15% in USD terms). Most foreign equity markets have benefitted from an upswing in global growth. Among major markets, MSCI China has shined, rising 40% in the last year.
- Perhaps the most notable of the many so-called “Trump trades” has been the rise of companies with the highest small and medium business exposure. The median stock in this basket generates 71% of its sales from small-and-mid-sized business customers. Small business owners have been thrilled at the prospect of deregulation under the Trump administration. Following the election, the NFIB Small Business Optimism Index leaped to the highest level in more than 12 years. The share prices of firms deriving revenues from small businesses have rallied by 38% since the election while the Russell 2000 small-cap index has matched the performance of large caps (see Exhibit 2).
- The performance of high tax-rate stocks has been more complicated. The sector-neutral High Tax basket contains 50 S&P 500 stocks with the highest 10-year median effective tax rates (38% compared with 30% for the median S&P 500 stock). These are the firms most likely to experience positive EPS estimate revisions if corporate tax rates are cut. The basket jumped by 5% immediately following the election, but the relative performance has more than reversed since then, falling by 9% (Exhibit 4).
- The High Tax basket’s performance this year has been influenced by exposures other than tax sentiment, notably the US dollar. Because one method that US firms use to reduce their tax burdens is keeping earnings overseas, companies with the highest tax rates also tend to have the highest domestic business exposure. The median High Tax stock generates 84% of sales domestically vs. 73% for the median S&P 500 firm. A weaker USD benefits firms with high foreign sales, and the 6% YTD decline in the trade-weighted USD explains much of the tax basket’s underperformance. Nonetheless, the basket outperformed by 35 bp on Thursday when House Republicans released the details of their tax plan.
What happens next, now that the S&P is just shy of 2,600 - Goldman year end price target for 2019 - depends largely on the fate of the Republican tax plan. According to Kostin, "the Republican tax plan would boost corporate earnings but has a long way to go before becoming legislation."
" The plan would reduce the federal statutory corporate tax rate to 20% from 35%, below the S&P 500 median effective rate of 27%. However, other “pay-fors” would significantly offset the potential boost to earnings – and hit to government revenues – from a lower rate. These include the adoption of a territorial tax system that would effectively place a 10% tax on high profit foreign subsidiaries as well as a tax on some payments to foreign affiliates and a cap on interest deductibility at 30% of EBITDA. This last change would likely have a limited effect on S&P 500 EPS because just three companies accounting for 0.1% of market cap have consensus 2018 consolidated interest expense above that threshold. However, the impact could be greater taking into account intracompany loans that firms deduct against US income. The plan also proposes full equipment expensing for five years, supporting our preference for firms investing for growth rather than buybacks or dividends."
The GOP tax plan also includes a one-time tax on previously untaxed foreign profits at higher rates than those in prior proposals. The deemed repatriation would place a 12% tax on overseas cash and a 5% tax on other permanently reinvested foreign earnings (vs. 8.75% and 3.5% in the prior House plan). S&P 500 firms hold $2.5 trillion of untaxed foreign earnings, including $920 billion in cash. Under the newly proposed tax rates, firms would pay a $190 bn tax bill and access $730 bn of remaining overseas cash.
In a nutshell, Goldman places a 65% likelihood on tax reform in Q1 2018, but believes further changes to the plan are likely. Because it will be difficult to find base broadening measures that can pass the House and Senate, Goldman also expects the final corporate tax rate may be 25%. In summary, the bank estimates that a modified plan with a 25% corporate tax rate could lift its S&P forecast by 7% next year to $148 (15% growth) from $139 (7%). For now however, and with less than 2 months left, Goldman expects the S&P 500 will end 2017 at 2400 (-7.0%).