Changes in the tax code that reward capital expenditures and the repatriation of profits held abroad should boost U.S. GDP as well as corporate productivity.
A Penny Saved is a Penny Spent?
The $1.5 trillion tax package just signed into law will help the U.S. become more competitive with the rest of the world. Importantly, it gives corporate managers the clarity needed to make long-term decisions about operations. Many managers have held off investments in the hope of being able to fully expense them in 2018.
As such, we expect a percentage pickup in capital spending in the high single digits. The most recent December ISM Manufacturing New Order Index, with a reading of 69.4, confirms that this is the case. This is a very strong number: any reading above 50 is expansionary.
Never before in U.S. tax history has 100% expensing of capital expenditures been combined with a repatriation. That combination should fuel a boost of activity, with a potential pickup in productivity becoming a byproduct. GDP growth is a function of population growth and productivity. Productivity growth has been lackluster since the crisis and this development could give U.S. GDP a boost in the upcoming years. Additionally, late-cycle capex increases are a typical market phenomenon, as the bite from high wage growth begins to eat into corporate margins. Investment in capex has historically been a way to help maintain margins in these types of environments. Accordingly, companies that provide productivity-enhancing services should have a tailwind for the next couple of years.
Forced repatriation will allow companies to bring back overseas capital to the U.S. Many consider the actual amount in liquid assets to be close to $1 trillion. As that money comes home, it can be used for capex as discussed, or it can be used for shareholder-friendly activities like M&A, share buybacks and dividend increases. The two sectors that could see an outsized boost from these operations are health care and information technology. Per Strategas, the S&P 500 health care sector has approximately 20% of its market value as unremitted foreign earnings, while information technology garners 18%. These percentages are much higher than most other sectors in the index and represent outsized opportunities for repatriation benefits.
Mid-Term Elections Could Spur Bipartanship
Looking forward, 2018 likely will be dominated by one day: November 6, the date of the next mid-term election. Since 1938, the party holding the presidency has lost congressional and Senate seats in all but two and four mid-term election cycles, respectively. Additionally, presidential approval ratings exceeded 60% in the only years when the incumbent party added congressional seats (President Trump’s approval ratings, for comparison purposes, are below 40%). The deck is feeling increasingly stacked against Republicans retaining House, and possibly even Senate, control.
Consequently, we see the coming year full of potentially bipartisan issues like infrastructure spending and drug pricing as the Republicans attempt to co-opt Democratic influence. Republicans will need Democrats to pass any legislation this year, and the upcoming spending debate should provide real insight into how the year will evolve. Democrats want DACA (Deferred Action on Childhood Arrivals), increased disaster relief funding and budget sequestration relief with a dollar for dollar military/domestic programs spending increase. The Republicans, meanwhile, want stricter immigration control and sequestration relief specifically to boost to defense outlays. President Trump, meanwhile, continues to want his wall. Democrats seem to have both the momentum and the leverage, but will need to restrain the party’s propensity to overreach. Republicans, controlling the House, Senate and the presidency, cannot allow the government to shut down, though it is not clear whether the president agrees with this strategy. There ultimately will be a compromise, but winners and losers are not yet obvious. Nor is it obvious a shutdown will be avoided. The drop-dead date is January 19.
Legg Mason, Inc., its affiliates, and its employees are not in the business of providing tax or legal advice to taxpayers. These materials and any tax-related statements are not intended or written to be used, and cannot be used or relied upon, by any such taxpayer for the purpose of avoiding tax penalties. Tax-related statements, if any, may have been written in connection with the "promotion or marketing" of the transaction(s) or matters(s) addressed by these materials, to the extent allowed by applicable law. Any such taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.