Revisit Tax Reform (with Stock Picks)
I have discussed the stocks which may benefit from Tax Reform exactly 3 months ago. HERE is the link. At that moment, The tax bill was not passed into law yet. Also were not clear the details. In this article, I will summarize what the changes are in the Tax Bill. I will also discuss the performance of the stocks in different sectors and potential buying opportunities.
The law cuts corporate tax rates permanently and individual tax rates temporarily (expire after 2025). It permanently removes the individual mandate, a key provision of the Affordable Care Act, which is likely to raise insurance premiums and significantly reduce the number of people with coverage.
Corporate Tax Rate from 35% to 21%
The law creates a single corporate tax rate of 21%, beginning in 2018, and repeals the corporate alternative minimum tax (AMT). Combined with state and local taxes, the statutory rate under the new law will be 26.5%, according to the Tax Foundation. That puts the U.S. just below the weighted average for EU countries (26.9%).
Individual Tax Rate
The law retains the current structure of seven individual income tax brackets, but in most cases it lowers the rates: the top rate falls from 39.6% to 37%, while the 33% bracket falls to 32%, the 28% bracket to 24%, the 25% bracket to 22%, and the 15% bracket to 12%. The lowest bracket remains at 10%, and the 35% bracket is also unchanged. The comparison of married filing together is shown below.
The law raises the standard deduction to $24,000 for married couples filing jointly in 2018 (from $13,000), to $12,000 for single filers (from $6,500), and to $18,000 for heads of household (from $9,550). These changes expire after 2025.
The law temporarily raises the child tax credit to $2,000, with the first $1,400 refundable, and creates a non-refundable $500 credit for non-child dependents. The child credit begins to phaseout when adjusted gross income exceeds $400,000 (for married couples filing jointly, not indexed to inflation).
The law limits the application of the mortgage interest deduction for married couples filing jointly to $750,000 worth of debt. The law caps the deduction for state and local taxes at $10,000 through 2025.
The law temporarily raises the exemption amount and exemption phaseout threshold for the alternative minimum tax (AMT), a device intended to curb tax avoidance among high earners by making them estimate their liability twice and pay the higher amount. For married couples filing jointly, the exemption rises to $109,400 and phaseout increases to $1,000,000
Pass-through Income
Owners of pass-through businesses – which include sole proprietorships, partnerships and S-corporations – currently pay taxes on their firms' earnings through the personal tax code, meaning the top rate is 39.6%.
The law creates a 20% deduction for pass-through income. Certain industries, including health, law and financial services, are excluded from the preferential rate, unless taxable income is below $157,500 (for single filers). To discourage high earners from re-characterizing regular wages as pass-through income, the deduction is capped at 50% of wage income or 25% of wage income plus 2.5% of the cost of qualifying property.
This 20% deduction is new, I will write another article later on the ways to benefit from it (if you own a small business or rental properties).
Base-line: QQQ +7.44%, S&P 500 +1.86%, Dow Jones +1.26%.
Crude oil: USO +6%; Gold: GLD +3.1%.
Every company has their own situation, which makes it hard to compare based on 3 month return. However, we can look into sector ETFs to find useful clues.
For different sectors, from best to worst
Tech ETF: QQQ +7.4%. Tech had some corrections before tax reform. They bounced back quickly. This is still the fastest growing sector regarding revenue growth. Some big companies are now able to move huge amount of oversea money back to US. One survey shows companies plan to spend 20% tax benefit on employee paychecks, 50% to reward shareholders, and the rest to reinvest business.
Consumer ETF: XLY +6.7%. Benefit from lower tax rate the most.
Financial ETF: XLF +3.1%. Benefit from higher interest rate.
Industrial ETF: XLI +2.1%. Benefit from lower tax rate, but hurt from inflation and trade wars.
----------------- above better than S&P 500 +1.86% --------------------
Transpotation ETF: IYT +1.5%. Airlines are hurt by United Airline's price war.
Healthcare ETF: XLV +0.4%, IYH +0.7%. This sector is tricky and hard to play with. Stock price can swing wildly in short period.
Energy ETF: XLE -3.9%, although USO +6%, but UNG -7.5%
Utilities ETF: XLU -13.2%. This sector is deeply hurt by rising yields as fixed income buyers move to bonds. Similar situation for REITs, IYR -11.1%
For individual companies (Review the ones I have mentioned in earlier article)
Following are a few companies who were paying tax rate > 35% (most in retailers and restaurants). 3-month return >10% highlighted with blue, <-10% highlighted with red.
Restaurant: CMG (+4%), DENN (+15.7%)
Retailers: CVS (-10.2%), LVS (+2.4%), GPS (+6.9%), JWN (+16.6%), M (+25.8%)...
Auto retailers: AN (-9.8%), KMX (-12.3%)...
Healthcare: Anthem (+0.3%), HUM (+4.3%), DGX (+2.3%), DVA (+17.7%)...
Transportation: JBHT (+10.4%), LUV (-3.5%)...
Energy: COP (+4.5%), PSX (-6.3%)...
Industrial: GWW (+17%)...
Financial: SCHW (+6.3%), PAYX (-4.6%)...
Utility: WEC (-14%)...
Big Cash Abroad
These companies can bring back cash to buy back stocks, pay down debts, take-over other companies, hike dividends to give investors better return.
Such companies include: AAPL (+3%), MSFT (+10.4%), CSCO (+17.2%), GOOG (+6.8%), WDC (+11.2%), PFE (-1.1%), CELG (-12.5%), GILD (+4.5%), BIIB (-10.1%), JNJ (-8%), GE (-21%), CAT (+3.4%), V (+9%), MA (+16.8%)...
Individuals just start to see fatter paychecks, and company are giving more bonuses than ever after earnings. Retailers can enjoy further on top of lower tax rate. I am still holding my shares in M, GPS, COST, SBUX, HD. I have also added WMT, BGS, GME
The ETFs and Stocks marked in red may be worth watching. They may provide higher return in the following quarters. For instance, Energy sector might shine if inflation picks up. Auto retailers might bounce back if the headwind is over.
Watch out the next rate hike in March. The next Fed meeting is on 3/20~3/21. A 0.25% rate hike is expected.
Don't bet on Infrastructure yet. In Feb, Trump finally announced his proposal after bragging for more than 1 year. The 53-page document lays out his vision: To turn $200B in federal money into $1.5T for fixing America's infrastructure by leveraging local and state tax dollars and private investment. It is hard to imagine how it works as many local and state have deficit problems.
Recap Tax Reform
President Trump signed the "Tax Cuts and Jobs Act" into law on Dec. 22. The Senate passed the bill on Dec. 20 by a party-line vote of 51 to 48. The House passed the bill later in the day by a vote of 224 to 201.
The law cuts corporate tax rates permanently and individual tax rates temporarily (expire after 2025). It permanently removes the individual mandate, a key provision of the Affordable Care Act, which is likely to raise insurance premiums and significantly reduce the number of people with coverage.
Corporate Tax Rate from 35% to 21%
The law creates a single corporate tax rate of 21%, beginning in 2018, and repeals the corporate alternative minimum tax (AMT). Combined with state and local taxes, the statutory rate under the new law will be 26.5%, according to the Tax Foundation. That puts the U.S. just below the weighted average for EU countries (26.9%).
Individual Tax Rate
The law retains the current structure of seven individual income tax brackets, but in most cases it lowers the rates: the top rate falls from 39.6% to 37%, while the 33% bracket falls to 32%, the 28% bracket to 24%, the 25% bracket to 22%, and the 15% bracket to 12%. The lowest bracket remains at 10%, and the 35% bracket is also unchanged. The comparison of married filing together is shown below.
The law raises the standard deduction to $24,000 for married couples filing jointly in 2018 (from $13,000), to $12,000 for single filers (from $6,500), and to $18,000 for heads of household (from $9,550). These changes expire after 2025.
The law temporarily raises the child tax credit to $2,000, with the first $1,400 refundable, and creates a non-refundable $500 credit for non-child dependents. The child credit begins to phaseout when adjusted gross income exceeds $400,000 (for married couples filing jointly, not indexed to inflation).
The law limits the application of the mortgage interest deduction for married couples filing jointly to $750,000 worth of debt. The law caps the deduction for state and local taxes at $10,000 through 2025.
The law temporarily raises the exemption amount and exemption phaseout threshold for the alternative minimum tax (AMT), a device intended to curb tax avoidance among high earners by making them estimate their liability twice and pay the higher amount. For married couples filing jointly, the exemption rises to $109,400 and phaseout increases to $1,000,000
Pass-through Income
Owners of pass-through businesses – which include sole proprietorships, partnerships and S-corporations – currently pay taxes on their firms' earnings through the personal tax code, meaning the top rate is 39.6%.
The law creates a 20% deduction for pass-through income. Certain industries, including health, law and financial services, are excluded from the preferential rate, unless taxable income is below $157,500 (for single filers). To discourage high earners from re-characterizing regular wages as pass-through income, the deduction is capped at 50% of wage income or 25% of wage income plus 2.5% of the cost of qualifying property.
This 20% deduction is new, I will write another article later on the ways to benefit from it (if you own a small business or rental properties).
Stocks Performance
What have happened in recent three months?- Fed hiked interest rate in Dec 2017.
- Powell replaced Yellen as Fed Chair.
- Dollar becomes weaker, UUP -2.7%.
- Treasury yields jump higher TLT -6.5% (TBT +12.9%, x2 ETF).
- Possible Trade Wars.
- All the companies have reported one earnings. We now have better idea how they are impacted by the Tax Reform. Almost all companies have claimed loss and delayed profit in last earnings so that they can enjoy the lower tax rate on that part. I am expecting they show stronger earnings in the following quarters.
Base-line: QQQ +7.44%, S&P 500 +1.86%, Dow Jones +1.26%.
Crude oil: USO +6%; Gold: GLD +3.1%.
Every company has their own situation, which makes it hard to compare based on 3 month return. However, we can look into sector ETFs to find useful clues.
For different sectors, from best to worst
Tech ETF: QQQ +7.4%. Tech had some corrections before tax reform. They bounced back quickly. This is still the fastest growing sector regarding revenue growth. Some big companies are now able to move huge amount of oversea money back to US. One survey shows companies plan to spend 20% tax benefit on employee paychecks, 50% to reward shareholders, and the rest to reinvest business.
Consumer ETF: XLY +6.7%. Benefit from lower tax rate the most.
Financial ETF: XLF +3.1%. Benefit from higher interest rate.
Industrial ETF: XLI +2.1%. Benefit from lower tax rate, but hurt from inflation and trade wars.
----------------- above better than S&P 500 +1.86% --------------------
Transpotation ETF: IYT +1.5%. Airlines are hurt by United Airline's price war.
Healthcare ETF: XLV +0.4%, IYH +0.7%. This sector is tricky and hard to play with. Stock price can swing wildly in short period.
Energy ETF: XLE -3.9%, although USO +6%, but UNG -7.5%
Utilities ETF: XLU -13.2%. This sector is deeply hurt by rising yields as fixed income buyers move to bonds. Similar situation for REITs, IYR -11.1%
For individual companies (Review the ones I have mentioned in earlier article)
Following are a few companies who were paying tax rate > 35% (most in retailers and restaurants). 3-month return >10% highlighted with blue, <-10% highlighted with red.
Restaurant: CMG (+4%), DENN (+15.7%)
Retailers: CVS (-10.2%), LVS (+2.4%), GPS (+6.9%), JWN (+16.6%), M (+25.8%)...
Auto retailers: AN (-9.8%), KMX (-12.3%)...
Healthcare: Anthem (+0.3%), HUM (+4.3%), DGX (+2.3%), DVA (+17.7%)...
Transportation: JBHT (+10.4%), LUV (-3.5%)...
Energy: COP (+4.5%), PSX (-6.3%)...
Industrial: GWW (+17%)...
Financial: SCHW (+6.3%), PAYX (-4.6%)...
Utility: WEC (-14%)...
Big Cash Abroad
These companies can bring back cash to buy back stocks, pay down debts, take-over other companies, hike dividends to give investors better return.
Such companies include: AAPL (+3%), MSFT (+10.4%), CSCO (+17.2%), GOOG (+6.8%), WDC (+11.2%), PFE (-1.1%), CELG (-12.5%), GILD (+4.5%), BIIB (-10.1%), JNJ (-8%), GE (-21%), CAT (+3.4%), V (+9%), MA (+16.8%)...
Final Thoughts
In my earlier article, I have said "Retailer and Financial Sectors will have a bright future". Indeed, these two sectors are ranking #2 & #3 without counting dividends.Individuals just start to see fatter paychecks, and company are giving more bonuses than ever after earnings. Retailers can enjoy further on top of lower tax rate. I am still holding my shares in M, GPS, COST, SBUX, HD. I have also added WMT, BGS, GME
The ETFs and Stocks marked in red may be worth watching. They may provide higher return in the following quarters. For instance, Energy sector might shine if inflation picks up. Auto retailers might bounce back if the headwind is over.
Watch out the next rate hike in March. The next Fed meeting is on 3/20~3/21. A 0.25% rate hike is expected.
Don't bet on Infrastructure yet. In Feb, Trump finally announced his proposal after bragging for more than 1 year. The 53-page document lays out his vision: To turn $200B in federal money into $1.5T for fixing America's infrastructure by leveraging local and state tax dollars and private investment. It is hard to imagine how it works as many local and state have deficit problems.
Thank you for sharing your insights. It is very informative and helpful. I might use this as inspiration for my projects. Keep it up! I’m looking forward to your updates.
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