President Donald Trump is now closer to its major legislative move and investors have turned extremely bullish on the stock market. This is especially true, as lower tax rates would boost earnings, thereby accelerating dividend and buyback activities (read: Senate Passes Tax Bill: 5 ETFs to Buy Now).
Per UBS strategists, overall S&P 500 earnings would increase by 6.5% if the corporate tax rate falls to 25% and by 9.5% if the tax rate is cut to 20%. Republicans expect a tax reform deal by Christmas. According to Thomson Reuters data, the larger, multi-national companies in the S&P 500 currently pay a median effective tax rate of 28%.
While most of the sectors would benefit from Trump’s plan, some are set to explode higher than others due to their highest effective tax rate. In fact, this trend has started to materialize with investors rotating into tax-sensitive sectors like retail, financials, telecom, healthcare services and away from the hottest technology stocks.
Retailers, especially department stores, are the biggest beneficiaries of the tax cut plan as they pay maximum taxes among S&P 500 companies given their large domestic networks. The retail group has an effective tax rate of 35%, per Credit Suisse. Additionally, reduced taxes will provide consumers with extra cash that will lead to higher discretionary spending.
Give huge optimism, VanEck Vectors Retail ETF (RTH - Free Report) hit all-time high of $90.64 following the Senate’s passing of tax reform. This fund provides exposure to the 26 largest retail firms. The product has amassed $59.8 million in its asset base and charges 35 bps in annual fees. RTH gained 1.6% on the day and has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook (read: Should You Buy Retail ETFs Now?)
Macy’s (M - Free Report) , with an effective tax rate of 25.8%, per the MarketWatch's Corporate Tax Calculator, jumped 6.7% on the day. Its earnings are expected to grow 9.14% for this fiscal year. The stock has a Zacks ETF Rank #3 and a VGM Score of C.
The financial sector will enjoy dual tailwinds of lower taxes and rising rates. According to Keefe, Bruyette & Woods, tax cuts would add 16% to median bank earnings in 2018 and 18% in 2019 while AB Bernstein sees earnings per share jumping 12-20% at large banks and 15-25% at mid-caps banks in 2018. Tax reform may result in further rise in interest rates that would expand net margins and bolster financial stocks’ profits.
The ultra-popular Financial Select Sector SPDR Fund (XLF - Free Report) with AUM of $31.6 billion hit the highest level since Oct 2007 and was up 1.5% at the close. The fund charges 14 bps in annual fees and has a Zacks ETF Rank #2 (Buy) with a Medium risk outlook. In the stock world, Bank of America Merrill Lynch (BAC - Free Report) climbed 3.4% on the optimism that the new tax rate would boost its earnings by about 11% in 2018. The stock has an effective tax rate of 28.4% per MarketWatch's Corporate Tax Calculator and earnings growth rate of 20.6% for this year. It has a Zacks ETF Rank #3 and a VGM Score of D (see: all the Financial ETFs here).
Since telecommunications companies pay an effective tax rate of 33.7% per Credit Suisse, they stand to reap some benefits of lower tax rates. In fact, tax cut coupled with Trump’s deregulation efforts has bolstered the outlook for the sector. Vanguard Telecommunication Services ETF (VOX - Free Report) , which offers exposure to companies that provide telephone, data-transmission, cellular, or wireless communication services, could see huge upside potential. The ETF has AUM of $1.3 billion and charges 10 bps in annual fees. It added 0.8% on the day but has an unfavorable Zacks ETF Rank #5 (Strong Sell) with a Medium risk outlook (read: ETF Winners & Losers if FCC Repeals Net Neutrality).
Among the stocks, AT&T (T - Free Report) will likely be the winner given its effective tax rate of 33.2% per the MarketWatch's Corporate Tax Calculator. Its earnings are expected to grow 3.02% this year. The stock added 2.1% on the day, and has a Zacks Rank #3 and a VGM Score of B.
In the healthcare space, healthcare services is one of the most-taxed industries at 30.2% according to Credit Suisse and would be a huge beneficiary of reductions in corporate tax rates compared to pharmaceutical and medical device companies that sell their products overseas. According to MUFG Securities, tax reform could boost managed care companies earnings by 30%.
As such, SPDR S&P Health Care Services ETF (XHS - Free Report) , which tracks the performance of companies in healthcare services, healthcare facilities, managed healthcare and healthcare distributors, rose as much as 1.5% on the day. The fund has amassed $93.5 million in its asset base and charges 35 bps in annual fees. It has a Zacks ETF Rank #3 with a Medium risk outlook.
Centene Corporation (CNC - Free Report) has an effective tax rate of 38.6% per MarketWatch's Corporate Tax Calculator but lost 2.8% on the day. Its earnings are expected to grow 12.4% this year. The stock has a Zacks Rank #2 and a VGM Score of B.
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