Authored by: John C. Bailer, CFA, Brian C. Ferguson & W. Charles Cook, CFA
Tax reform has been the cornerstone of President Trump's legislative agenda, potentially providing a new catalyst for U.S. economic and earnings growth in many sectors. We think tax reform will bolster the Financials sector, which already benefits from solid fundamentals, attractive valuations and accelerating business momentum. Now two-thirds through the process, Senate Republicans approved their tax reform plan and sent the bill to be reconciled with the House version in Committee. Politicians tend to be consistent with their initial vote, and the Republican Congress has a majority to pass reform, substantially increasing the likelihood that tax reform will soon be enacted.
We remain bullish about Financials irrespective of tax reform. However, if the tax plan is approved, it would support accelerating domestic economic growth and increase earnings from lower taxes against a backdrop of advancing regulatory reforms. U.S.-focused Financials would benefit most from reform, with some estimates that a 20% federal corporate tax rate would drive earnings higher by approximately 18% on average.*
Financials: Attractive Pillars with Positive Catalysts
Certain initiatives, such as a reduction in the regulatory burden on businesses, are already having an impact on the Financials sector and should continue to positively support earnings. Further, the potential for tax reform has led to strong CEO and small business confidence, and we expect tax reform to support a meaningful uptick in investment spending as businesses have underinvested in capital expenditures this cycle. We believe the Financials sector will benefit from several aspects of tax reform including a steadily improving economy and increased loan growth, along with a backdrop of gradually rising interest rates. The potential increase to earnings and cash flow from tax reform should provide an additional positive catalyst leading to solid relative returns for the sector.