stock market implications of a global minimum corporate tax (ii)

The S&P 500 gained just under 20% in 2017, the year the large cut in the US corporate tax rate was passed. The new law, which took effect on 1/1/2018, boosted US-sourced earnings by about 21%. In 2018, however, the index lost a little over 6%. That’s because, I think, the stock market began to discount the better earnings prospects as soon at it became clear that the law would pass.

The same will likely happen in the case of a global minimum tax as well. Only this time the effect will be negative, and likely most keenly experienced by companies who have placed the greatest reliance on financial engineering, rather than operations, to boost their profit growth.

It’s also possible that this will be the trigger for investors to once again begin to read a low tax rate as a bad sign for a company, and to adjust the PE multiple down because of this vs. full tax rate-paying competitors as they commonly did a generation ago.

It’s thinkable, as well, that deeper consideration of the information in corporate tax disclosures will lead to a more seismic shift in the assessment of company value of the kind that Warren Buffett caused a generation ago in his stress on the value of intangible assets–intellectual property, brand names, distribution networks…–that the market regards as obvious plusses today, but had ignored until Buffett came along.

There’s already a bit of worry in the air about managements losing touch with the nuts and bolts of the industries they compete in, focusing on propping up current earnings rather than on creating cutting-edge products. Witness investor dismay at the apparent loss of operational competence in once iconic names like Boeing or Intel or ATT. At the very least, in my view, the draining of the ocean of monetary stimulus we are now swimming in will force investors to discriminate more sharply between potential winners and losers as the cost of funding operations begins to rise. As I’ve mentioned before, the only environment remotely like the current one that I’ve experienced is the high-yen, low interest rate environment of Japan in the late 1980s. The early Nineties there were particularly ugly for hidebound traditional zaibatsu/keiretsu firms whose greatest merit was their being in the rising tide of the previous decade. I can imagine a similar changing of the guard happening here.

This would tilt the field of play away from factor investing and toward the more traditional skills of analyzing balance sheets and income statements, and projecting them forward.

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