Tax reform will make for a 'noisy' earnings season — but stocks should keep surging
Reuters / Brendan McDermid
- The effects of tax reform could stir up some turmoil in what's expected to be an otherwise very strong earnings season, according to Goldman Sachs.
- The two areas to watch are required corporate write-downs of deferred tax items and the hundreds of millions of dollars S&P 500 companies will owe in taxes on overseas cash and earnings.
Fourth-quarter 2017 earnings season is set to kick off at the end of the week and Goldman Sachs is expecting a rocky ride, all thanks to GOP tax reform.
That's not necessarily a bad thing — after all, Goldman estimates that corporate profits will expand by 10% for the period. And since earnings growth has historically been the biggest driver of stock price gains during the 8 1/2-year bull market, that forecast is essentially a call for more record highs.
Goldman's outlook just means that the market may take some unexpected twists and turns along the way. And if you're able to see this potential turbulence coming, you could position yourself to best capitalize on any opportunities that arise.
The firm sees uncertainty stemming from two key areas:
- 1) Required corporate write-downs of deferred tax items — Companies will now be forced to remeasure the value of their deferred tax assets and liabilities at the new 21% tax rate, says Goldman. The largest relative beneficiaries include utilities, telecom services, and energy, according to data compiled by the firm.
- 2) S&P 500 companies will owe more than $275 billion in taxes on previous overseas cash and earnings — Goldman points out that the tax bill's deemed repatriation imposes a tax of 15.5% on untaxed overseas cash and 8% on untaxed overseas earnings. According to the firm's findings, tech stocks have the largest surplus of overseas cash and will own $123 billion, which accounts for 140% of expected quarterly net income. Healthcare stocks will face the second-largest bill, at 130% of net income, according to Goldman data.
Still plenty of share upside
As earnings season beckons, one thing working in the favor of stock investors is favorable analyst sentiment. Goldman points out that analysts have been lagging the market when it comes to pricing in the positive effect of tax reform — implying that expectations could still be recalibrated to the upside.
It's already started to happen, with consensus 2018 earnings-per-share estimates (EPS) rising 2% since the bill was successfully passed. And Goldman thinks that there may be more optimism to come, as evidenced by the 5% total boost it sees EPS getting before all is said and done.
Goldman Sachs
The EPS increase up to this point is simply a "nascent effort," Goldman chief US equity strategist David Kostin wrote in a recent client note.
So with all of that established, which sectors should you be looking at before earnings reports start rolling in? Lucky for you, Goldman has put together a handy guide showing profit growth forecasts by sector.
Energy is expected to be the top performer, which should come as no surprise, given its downtrodden state in past earnings periods, and the boost it's expected to get from deferred tax items. And never one to be deterred, technology is forecast to be third-best, despite potentially hefty taxes from repatriated earnings. Here's the full rundown:
Goldman Sachs