Corporate tax rates and valuation metrics

One of the central components of Trump domestic campaign policy is lowering corporate tax rates while creating additional tax incentives for US firms to repatriate overseas income. Republican control of both Houses of Congress makes tax reform likely and is one of the significant reasons US stocks have rallied post-election. The S&P 500 is at an all-time high led by Financial and Infrastructure companies who have been out of favour for years.

One of the ostensible reasons for lowering corporate taxes is stimulating corporate investment. In practice, however, corporates are already flush with free cash while borrowing costs are at record lows. So, what will companies do with the additional cash generated from lower taxes rates and repatriated overseas income? The answer, in our opinion, is twofold. First, companies will continue to buy back their own stock. Second, acquisition activity, now at record volumes will continue at an accelerating pace. Privately held tech companies will benefit as public companies stocks move higher. Competition among public companies for private assets will be fierce as they arbitrage public vs. private valuation.

Additional clarity on tax policy should be expected in the weeks leading up to the January State of the Union Address.  In our opinion US equity markets will continue to move higher under these conditions. Regulatory reform is emphasized as a condition for economic growth. International corporations considering entering the US market have been concerned about high legal and consulting costs. Significant regulatory reform combined with lower corporate tax rates will accelerate an already vibrant middle market in mergers and acquisitions. Valuations will rise as lower taxes and less costly regulations benefit technology firms. Mergers and acquisition activity will increase as the financial arms of strategics and private equity firms reallocate resources due to enhanced metrics.

Steve Malin

November 22, 2016