Tax reform could drag earnings growth in 2019, Bank of America says

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  • Equity strategists at Bank of America Merrill Lynch,
    like many others, expect the corporate tax cut to boost company
  • But BAML thinks the boost will be short-lived, probably
    not beyond 2018.
  • More profits would mean more competition that could
    drive down margins, and the Federal Reserve could speed up
    interest-rate hikes, the bank said in a note on

Equity strategists at Bank of America Merrill Lynch raised their
forecast for corporate profits this year, thanks to the expected
boost from a lower corporate tax rate.

But they’re not anticipating a boost to growth far beyond

In a note Wednesday, a team of strategists led by Dan Suzuki said
it had raised its 2018 S&P 500 earnings target by 10% to $153
a share. The team had already lifted the target late last year,
just before President Donald Trump signed the
Tax Cuts and Jobs Act
into law.

“The biggest impact on earnings from tax reform comes from the
lowering of the federal tax rate from 35% to 21%, making up
roughly $10 of the $14 increase,” Suzuki and his team wrote.
“Buybacks represent another $3 of the increase, with some modest
offsets from the minimum foreign tax rate and the cap on interest

This boost, however, is less than the full tax-cut benefit the
team estimated last year, as some companies have already
announced how they plan to spend their windfall, including with

one-time employee bonuses

And beyond 2018, the strategists think the new tax law could in
fact be a deterrent to earnings growth.

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They cited three reasons. First, companies would be able to
compete better with higher returns. While that’s usually good for
consumers, the downside is that the drive to increase market
share could hurt company margins over time. Some industries like
retail are already facing this predicament.

Second, BAML argues that stronger growth could prompt the Federal
Reserve to raise interest rates faster than it is expecting,
which could then turn around and be a drag on the economy.

One of the biggest criticisms of rate increases has been low
inflation, the reasons for which Fed Chair Janet Yellen has said
. But with most major economies around the world
expanding, and in a tight US labor market, many strategists have
said 2018 could be a year when inflation becomes an issue to deal
with again.

BAML also recalled that a tax overhaul was passed in 1986, one
year before the slump into a bear market and shortly before the
savings and loan crisis. Sure, the stock market got double-digit
earnings growth from the tax law, but it didn’t stop the descent.

“Our economists expect only a modest lift to GDP growth from tax
reform over the next couple of years, with growth slowing from
2.6-2.7% in 2018 to 2.2-2.3% in 2019,” Suzuki said.