What Type of Reaction to Tax Cuts Should Investors Cheer?

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Once we had an idea of how the tax bill would look, but before any reaction or real effects could be gauged, the debate about its impact revolved around one thing. Most people, both on the left and right, agreed that it would be stimulative in some way, but differed on how. Some said that the extra profit retained by corporations would result in more jobs and wage hikes for existing employees, while others insisted that it would all be used for share buybacks, bigger dividends, and even higher pay for senior executives.

So, on the evidence so far, which has it been, and, more importantly, which is potentially more beneficial to investors?

At first, the skeptics had the upper hand. Even before the bill was signed, AT&T announced that when it was it would pay a $1,000 bonus to eligible employees and others followed suit, which gave the illusion of the benefits going to workers. Those, however, were one-off payments, and there was no word as to where the rest of the billions of dollars corporations will save every year in perpetuity will go.

Then, gradually, some companies began to announce actual wage hikes. The latest came today, when Walmart (WMT) announced that they would be raising entry level pay to $11 per hour as well as giving the now seemingly requisite $1k bonus to employees.

So, it seems so far that, as is usually the case, reality will fall somewhere between the two extremes. AT&T CEO Randall Stephenson has averaged over $5 million in annual bonuses over the last few years and it would come as no surprise if he, and other C-suite occupants there and elsewhere, become even wealthier as more after-tax cash becomes available. But wage hikes further down the food chain down are coming, too. The labor market is tightening, and in that environment wage increases at the bottom of the scale tend to spread quickly.

As to returning the cash to shareholders, no major new share buyback plans have been announced since the bill passed into law, but as pointed out here that is because many were announced pre-emptively, and we will have a clearer picture as to dividend increases in a few weeks, once earnings season is in full swing. For now though, if Walmart’s plans are anything to go by, higher wages are more likely than yet more buybacks.

It is likely, therefore, that it will be a bit of both. CEOs will get richer, investors will be rewarded, and workers will see more pay. From a general perspective, though, it is the last of those, increased wages, that will most benefit the general investor.

That may seem counter-intuitive at first. Corporations retaining more cash and returning money to shareholders would seem on the surface to be the best thing for investors, and that will almost certainly be true in the short term. That was evidenced this morning, when Delta Airlines (DAL) increased their 2018 profit outlook by twenty percent as, they said, a direct result of the tax cut, and their stock responded positively.

In the long run, however, as we have seen all too well over the last eight years or so, corporations hoarding cash can only take you so far.

Stock pricing is based on a corporation’s wealth, but it is also about their prospects for growth, and for that to be a positive, generating wealth is not enough; that wealth must circulate.

This is a concept that has been around for a long time; Henry Ford famously said that there was no point in making cars unless his workers could afford to buy them. Wage hikes, particularly at the lower end of the scale, get spent, and that is what fuels economic growth over time.

Investors should, therefore, be cheering when corporations announce that they are raising wages. Offering one-time payments and then buying back shares, increasing dividends and looking for buyout targets may seem like it gives the biggest boost to share prices, but over time creating a vibrant economy depends on more than just making the rich richer.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , US Markets , Investing Ideas , Stocks , Taxes
Referenced Symbols: WMT , DAL

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Martin Tillier

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