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The Tax Cuts and Jobs Act | February 2018

Thoughts on the Implications of the Legislation

Major tax reform in the United States of America is often one the most widely debated topics in the halls of Congress. The 2017 tax reform bill (officially named the Tax Cuts and Jobs Act) has had its fair share of supporters and opponents, usually rooted along party lines. In an effort to shed some light on the desired outcomes and possible consequences for our portfolios we polled our investment managers to gauge their take on four main items:
• Level of anticipated economic growth
• Implications for inflation
• Impact on US public markets (bonds and equities)
• Changes they are making to their portfolios as a result of the new tax plan.

As we reviewed the results it was clear that an assessment as to what the potential near term and long term outcomes would likely yield depended on the behavior of the actors (Corporations and Individuals). Will they act rationally to maximize utility as economic theory would suggest, or choose some other path due to behavioral biases?

Level of Economic Growth
Most of our managers believe the impact of the tax cuts will result in a net increase of approximately 50bps in new-term GOP growth. The most bullish estimate calls for a 100bps increase if the velocity of money continues to trend upward from its all-time low but with the caveat that inflation stays in check. The tax cut will cost between $1.5 and $2.0 trillion over the next 10 years with the immediate $150 billion being around 70bps for GDP. As one manager noted, “That full value is unlikely directly converted to GDP growth given that large corporations, which receive approximately 40% of the 2018 cuts, will utilize a material amount of tax savings for acquisitions, debt repayment, buybacks and dividends that do not boost GDP”. Moreover, many of the larger companies that have the ability to create growth have seen that their “balance sheets have been flush with cash for some time and this has not spurred investment”. This again brings us back to the point of how the participants will utilize the tax benefit. Furthermore, as another manager observed “The US is currently in the 8th year of an economic expansion and we are in the midst of global synchronized growth. It will be difficult to determine how much of any bump in GDP is due to stronger global demand and how much is due to tax cuts.”

Implications for Inflation
While price stability is one of the primary mandates of the FOMC, our managers believe noticeable and meaningful inflationary pressure is likely to occur in the mid to long term. Inflation will be driven by wage increases as the economy approaches full employment; some would argue we are already there given the tight labor market. Employers will have to offer higher wages to compete for talent and to maintain their existing workforce. In addition “more pressure is likely from commercial markets where purchasing manager indices are showing signs of upward pressure.” The speed in which prices rise and the posture of the Fed under new Fed Chairman Jerome Powell could lead to increased market volatility. While we expect prudent and apolitical action from the Fed, the possibility of rates being held lower for a longer period of time to help shore up capital markets could be a potential risk. One of our managers stated: “if U.S. tax reform plus improving global growth spark meaningful inflation it would put markets at risk.” Market valuations are supported by subdued inflation expectations and low interest rates.

Impact on US Public Markets
There was less of a consensus with our managers regarding the impact on the markets. The responses ranged from moderately positive to already being priced in at the current elevated levels. Yet others felt a bit more uncertain, and harkened back to “it depends” on what the actions of the actors in the markets will be and their level of rationality.

Equities: The consensus is that “the broad impact on U.S. equities will be positive as cash-rich companies will continue to do more of what they’ve been doing the past few years: increasing dividends, buying back shares and buying up other companies” according to one manager. This has the potential to benefit small and mid-cap companies as larger firms look for acquisition targets. Additionally, our managers believe since most small cap companies have great domestic revenue exposure, the lower effective tax rate will have a more meaningful impact in the near term.

Bonds: Rising rates and inflationary pressures will result in lower bond prices across the board. The spread between corporates and treasuries may narrow as caps on the deductibility of business interest and incentives to repatriate offshore earnings may reduce the supply of corporate debt. Meanwhile, the supply of government debt may grow as several analyses of the tax bill indicate that it will not generate enough growth to pay for itself.

Positional Changes to their Portfolios
Most of our managers have made little to no changes to their portfolios as result of the tax reform bill. The few that have adjusted their portfolios prior to passage have done so by increasing exposure to pro-cyclical stocks like Financials (banks), Producer Durables, and Energy while using Technology and Staples as a source of funds.

It is important to note that while we have some highly experienced market practitioners, we are reminded of Laurence Peter’s quote about economists which is easily applicable in this circumstance. Peter stated “An economist is an expert who will know tomorrow why the things he[she] predicted yesterday didn’t happen today.” With that in mind, we reserve to right to revisit these predictions.


This material is provided for information purposes only and should not be used or construed as an offer to sell or a solicitation of an offer to buy any security. Although opinions and estimates expressed herein reflect the current judgment of Bivium Capital Partners, LLC (‘Bivium’), the information upon which such opinions and estimates are based reflects data available as of the date of this proposal, and may not remain current. Therefore, Bivium’s opinions and estimates are subject to change without notice. This analysis contains forward-looking statements, which involve risks and uncertainties. Actual results may differ significantly from the results described in the forward-looking statements. While the information contained in this analysis and the opinions contained herein are based on sources believed to be reliable, Bivium has not independently verified the facts, assumptions and estimates contained in this analysis. Accordingly, no representation or warranty, expressed or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, completeness or correctness of the information and opinions contained in this analysis.

February 2018

Kai W. Hong, CFA
Managing Partner & Chief Investment Strategist

The beginning of February saw an acceleration of the market decline which had begun late the prior month. Concerns over rising interest rates and some profit taking in the high-flying Technology sector, paced the initial declines. Yields on benchmark 10Y US Treasuries hit a four-year high, and volatility both implied (VIX) and observed rose dramatically. However, the passage of another stopgap spending bill in the US along with reassuring comments from central bankers and the IMF (and some amount of FOMO) appeared to assuage investor fears, and the long-lived bull market continued its upward climb by mid-month. Given the market gyrations, there were some concerns over the influence of volatility-linked investment products, but the impacts were mostly confined to the liquidation of a few ETNs and a general realization of the weakness of the VIX as a gauge of market volatility. Economic growth globally continued to be good, not great, while signs of higher inflation began to manifest. Employment metrics in the US were robust which gave support to the US Fed’s plan for several further rate hikes this year.

Although a robust rally in the second half of the month cut losses, the Russell 3000 Index finished the month down with a return of -3.7%. Despite the market reversal, the Technology sector (+0.2%) continued its leadership and was the only positive sector for the month. Energy (-11.2%) was dramatically lower, and defensive/yield categories such as Consumer Staples (-7.5%), Materials (-5.7%), and Utilities (-5.5%) lead decliners. Size was not a significant factor as US small cap stocks were only incrementally worse than large caps with the Russell 2000 Index returning -3.9% and the Russell 1000 Index returning -3.7%. Outside of the US, returns were modestly more negative. The developed market MSCI World ex USA Index returned -4.8%, and the developing market MSCI Emerging Markets Index returned -4.6%.