The Trump administration’s corporate tax cuts have provided a boost to earnings, which experts say isn’t just a short-term sugar high.
“The corporate tax cuts are supply-side and are long-term in their impact as the additional incentives for productivity work their way through the system for many years to come,” said David Bahnsen, founder & chief investment officer of The Bahnsen Group.
When you tax less of something, you get more of it, Bahnsen said.
Companies have plowed corporate tax cut savings into share buybacks, capital expenditures (CAPEX), and even wage increases.
“After surging by 44% in 2018, buybacks will climb by 22% to $940 billion in 2019,” Goldman Sachs analysts wrote in a note to clients on October 4. “CAPEX will increase by 9% to $780 billion.”
A deeper understanding of buybacks and CAPEX helps explain why the benefit of tax cuts may be longer lasting than some expect. Share buybacks can be effective in lifting stock prices by reducing share count. But it’s a short-term strategy which isn’t enough to meet investors’ high demand for stock growth.
“[Stock buybacks] help, but at the end of the day, it’s about earnings,” Bahnsen said. “Slowing organic earnings growth would be a worse thing for stock prices than a lower share count would be a good thing.”
That’s why CAPEX spending is so important, Bahnsen said. CAPEX can be a key driver of earnings growth in the future (if a company builds a new factory, that raises productivity and profits). The extra cash from the tax cuts has sparked ample opportunities for companies to boost CAPEX spending. And the fact that business investment tends to take years to play out reveals how long-lasting the tax cuts can be.
“Not all companies have figured out what to do with the cuts,” said JJ Kinahan, chief market strategist at TD Ameritrade.
Kinahan also said uncertainty over trade relations between the U.S., China and Europe may prompt companies to take even longer to devise a capital deployment plan.
And that’s not necessarily a problem. The markets need future tailwinds, especially as stock investors come to grips with the Federal Reserve’s waning monetary stimulus, which buoyed the stock market for almost a decade.
Scott Gamm is a reporter at Yahoo Finance. Follow him on Twitter @ScottGamm.