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Tax Cuts and Jobs Act Passed the House and Senate

This is a big deal and the largest tax reform since 1986. It includes lots of changes to the current tax code. Most corporations and households will pay less in taxes than before, but some households will pay more. It is a complicated law with uneven benefits, but overall, it does reduce corporate and individual taxes by more than $200 billion, or more than 1 percent of gross domestic product. The $200 billion in cuts is split roughly evenly between individuals and corporations.

The $100 billion of tax cuts accruing to individuals comes via a tortuous route. Congress raised some individual tax provisions by $200 billion and cut other individual tax components by $300 billion. The net $100 billion of corporate tax cuts was even more complicated. Congress raised some corporate taxes by $300 billion and cut others by $400 billion.

Specifics of tax policy aside, this Market Thoughts focuses on our early thoughts about the implications of the new tax structure on investment portfolios.

Stocks

This tax deal is good for stocks. The reduction in the statutory tax rate from 35 to 21 percent takes effect January 1, 2018. It benefits most corporations. Those companies that garner most or all of their revenue within the U.S. will see the most benefit.

Sectors like utilities and finance should be able to invest more or pay higher dividends because they will pay less taxes. Meanwhile, U.S. technology firms with significant global sales could end up paying a higher effective rate. The tax package includes a provision mandating a one-time 15.5 percent tax on profits held abroad, which should result in those monies returning to the U.S. to be used for investment, debt reduction, dividend increases, or additional stock buybacks.

U.S. stocks could outperform non-U.S. stocks if the U.S. dollar strengthens because of repatriation of foreign profits held abroad and if firms use their repatriated profits to buy back even more shares.

Housing

This tax deal could have a mixed impact on the housing market. Higher-priced homes burdened with large local tax bills should be less attractive due to the new $10,000 limit on the deductibility of state and local taxes. In addition, the new bill limits the deduction of mortgage interest costs to mortgage amounts of $750,000 or less—down from $1,000,000. This should render more expensive homes a less attractive investment for potential buyers. We believe, however, that the economic growth benefits and the increased consumer confidence will bolster home prices in the middle and lower price ranges.

Interest Rates

The Tax Cuts and Jobs Act should push interest rates a little higher. The tax deal, which will increase the deficit and boost growth, could lead to higher wage inflation. The combination of these two factors could push rates higher. But we don’t see the 30-year mortgage rate moving more than 1 percent higher (which would bring mortgage rates to nearly 5 percent).

We note, however, that the tax cuts passed in 2003 spurred a 1.5 percent increase in the 10-year U.S. Treasury yield from 3.1 percent to 4.6 percent. If this were to reoccur, then bond prices could suffer mid- to high-single-digit price declines.

More details of the Tax Cuts and Jobs Act will be available in the next several weeks, and we will continue to invest resources in additional analysis. We are long-term investors, and we believe that a sound asset-allocation strategy tailored to your specific needs and a long-term view can provide the confidence to maintain an investment plan. While the U.S. stock market has risen in anticipation of tax reform, we may experience market volatility as the market digests new information.

As always, we will be following developments closely and keep you informed. If you have questions or concerns, please do not hesitate to bring them to our attention.

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