At the end of September, Trump revealed his much talked-about tax plan, suggesting comprehensive tax cuts for individuals and corporations. Some of the key suggestions are a cut in the corporate tax rate to 20% from 35% and slashing of the number of individual tax brackets to three from seven.
The lowest bracket will increase from 10% to 12%, the middle bracket will be 25%, and the highest tax bracket will fall from 39.6% to 35%. The proposal will now be studied and perhaps altered in the coming days (read: Build Your Portfolio With 4 ETFs in Q4).
The Trump administration is also proposing a move from the current worldwide tax system to a territorial system, letting companies to send their offshore profits back to the United States without extra taxes.
With several failed attempts to enact health-care reform, hopes may not be too high about the recently proposed tax reforms by the Trump administration. But the administration will leave no stone unturned to enact at least a leaner version of a tax (cut) reform to confirm its stay in power. So, the broader market should feel an air of optimism in the fourth quarter.
Goldman sees 2018 earnings for the S&P 500 companies to get a boost of 12% while Bank of America Merrill Lynch believes that the new rate would benefit earnings by about 11% in 2018.
Below we highlight a few ETFs that stand to gain out of this tax overhaul, if it at all gets enacted.
In the face of lower corporate taxes, companies’ profitability would be enhanced. An additional 7% to 12% boost in profits from the current tax overhaul proposal is speculated (by Wall Street analysts) to be realized. This higher profitability may push companies into the act of enhancing shareholders’ wealth.
Since Trump proposes a tax on more than $2.5 trillion in offshore earnings, tax cuts and a one-time repatriation tax could boost share repurchases by companies. PowerShares Buyback Achievers Portfolio PKW and SPDR S&P 500 Buyback ETF can be beneficiaries of this move (read: Buyback ETFs: Trump Beneficiary or Overhyped Bets?).
Dividend Growth ETF
Tax savings may also result in fatter and faster dividend hikes. S&P Global “expects to see a clearly communicated and orderly distribution of capital through share buybacks, dividends, and to a lesser extent, debt repayments,” if repatriation comes.
This puts dividend growth ETFs like iShares Core Dividend Growth ETF DGRO and SPDR S&P Dividend ETF SDY in focus. The stocks making up these ETFs have a history of consistent dividend hikes (read: An Investor's Guide to Dividend Aristocrat ETFs).
Small-Cap Growth ETFs
As per an article published on CNBC, small companies, which are more domestically focused and have less foreign exposure, pay huge taxes in America. This is because these pint-sized companies can’t pile up cash in foreign lands. So, a slash in tax rates would give a big-time benefit to these companies (read: Asset Report of September: Small Caps Rule).
Moreover, due to relaxation in the individual tax structure, Americans will also be able to splurge on economic activities. This in turn should benefit small-cap growth ETFs like iShares Russell 2000 Growth ETF IWO and Vanguard Small-Cap Growth ETF VBK.
Since banks' effective tax rates hover in the range of as high as 25% to 35%, these are likely to benefit more from the tax reform plan. As per an article published on CNBC, a senior analyst at AB Bernstein noted that “large banks likely would see 2018 earnings per share jump by 12 to 20 percent, while midcaps would see growth of 15 to 25 percent.”
Compared with the other sectors, the gain from tax reforms for large-cap banks would be in the 4% to 12% range while small-caps would see a boost of 7% to 17%, according to the article published on CNBC. This puts bank ETFs like SPDR S&P Bank ETF KBE and SPDR S&P Regional Banking ETF KRE in focus (read: Financials ETFs Head to Head).
A tax reduction for repatriation along with a lower corporate tax would bring back a significant portion of that cash. Plus, with the easing of corporate and individual tax rates, more activity in the economy and more portability and cash balances at the corporate level are expected. This makes Pacer US Cash Cows 100 ETF COWZ an intriguing pick. The fund looks to offer exposure to large and mid-capitalization U.S. companies with high free cash flow yields (read: 4 ETFs to Profit Out of Cash Kings).
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