by Peter Jones, CFA
Vice President, Research

Week in Review

After eight consecutive weeks of positive returns, the S&P 500 declined by 0.25 percent as investors digest another solid earnings season and evaluate the implications and likelihood of the “Jobs Act” becoming law. To add to the confusion, there are substantial differences between the House and Senate version of the bill released on Thursday. Although the 10-year Treasury was flat for the week, financial stocks underperformed on fears that a flattening yield curve will compress the spread banks earn by borrowing at short-term rates and lending at medium- to long-term rates. Through the political noise, strength in economic data continues to be resilient and estimates now call for the highest global GDP growth rate since 2010.

Taxman

The overhaul of the tax code, or “Jobs Act” proposes many controversial changes such as the elimination of state and local tax deductions and decreasing the cap on mortgage interest deduction from $1,000,000 to $500,000. Far less controversial is the Act’s inclusion of a one-time “deemed repatriation” of overseas cash for multinational corporations.

Under current tax policy, when U.S. companies book profits overseas at a lower tax rate, the cash cannot be returned to the United States without paying the difference between the tax rate of the country where the income was earned and the U.S. statutory tax rate of 35 percent. Because the U.S. has a significantly higher tax rate than other countries, multinational corporations have avoided paying additional taxes simply by keeping their cash overseas in the hopes of an eventual tax break or foreign investment opportunity. The avoidance of bringing cash back to the U.S. has led to a massive cash hoard for many prominent U.S. companies, mostly in the Technology and Healthcare sectors. For example, Apple has $240 billion dollars held overseas and Microsoft, Cisco and Google have a combined $232 billion dollars.

The Jobs Act allows corporations to return their overseas cash after paying a one-time 12 percent fee. Of course, the $1.2 trillion cash accumulated by S&P 500 companies could then be returned to the U.S. and used to repurchase shares, increase dividends, pay down debt, acquire a business, invest in a high-return project and so on. Given that the repatriation measure is largely undisputed, one would think that companies with high overseas cash relative to market cap would be outperforming the market as investors anticipate a boost to earnings resulting from this change in the tax code. However, these companies have sharply underperformed the S&P 500 in 2017 and especially since the Jobs Act was released. Such underperformance ahead of a tailwind to earnings may create an attractive investment opportunity if the market begins to price in an increased probability of the proposed change becoming law.

Takeaways for the Week

Any tax bill is likely to include a break for companies repatriating cash held overseas
The market consolidated gains after increasing for eight consecutive weeks

Disclosures