Ok, so it’s official:
- TRUMP SIGNS REPUBLICAN-BACKED BILL TO OVERHAUL U.S. TAX CODE
We’d be remiss if we didn’t remind all of our middle class readers that this means you’re screwed – or at least you will be over time. On the off chance you haven’t read it yet, the implications of this across income groups can be found here.
Ok, but leaving aside the fact that this will never pay for itself (i.e. it will balloon the deficit) and the even more inconvenient fact that it will exacerbate income inequality (see Ray Dalio’s latest), the discussion continues on exactly what it means for markets.
On Thursday, Wells Fargo (which, according to Goldman’s estimates, will itself be one of the biggest bank beneficiaries) was out upping their S&P target based on the tax bill. Well to close out the week, Goldman has released a new note suggesting that “stock pickers should rejoice.”
Why should stock pickers “rejoice”, you ask? Well apparently because there are some opportunities to be had among small-caps. Here’s Goldman:
The Russell 2000 outperformed sharply post-election and acted as an index-level proxy for tax reform odds for most of 2017. However, it has barely outperformed the S&P 500 in recent weeks. Although small-caps tend to pay higher effective tax rates and are typically more domestic-facing than large-caps, the Russell 2000 has been hampered by the risk posed by limiting interest deductibility as well as the fact that nearly one-third of index constituents have zero or negative pre-tax income, and therefore would reap little benefit from the rate cut.
Ok, so the enterprising among you might come to the conclusion that given everything said in that excerpt, drilling down into the Russell might reveal some compelling opportunities. If that’s what you think, Goldman thinks you’re thinking like they’re thinking. To wit:
A list of 103 potential tax reform beneficiaries within the Russell 2000 has actually underperformed the broad S&P 500 since the start of December by 100 bp as the likelihood of tax reform rose and our S&P 500 High Tax basket outperformed. These stocks, which have many of the same qualities that have outperformed among large-caps, suffered en masse with their index constituent peers as investors moved away from the Russell 2000 index as a “tax trade.” Now they represent opportunities for investors willing to sift through the chaff.
The rub there is that you don’t get the list, but what you do get is the criteria: high effective tax rates and domestic sales, low interest expense relative to EBIT, and low DTA.
That shouldn’t be too hard to screen for. Now you’ve got a fun activity for the holiday weekend. Assuming your idea of Christmas fun is sorting the Russell 2000 for tax cut beneficiaries.