Stocks have largely priced in a US corporate tax cut but US equities aren't yet seen as highly expensive by the private bank, which also updated a number of its asset allocation positions.

Citi Private Bank is cautiously optimistic that last week’s House bill on US taxes (see article here) will - once differences between members and the Senate are hammered out - be enacted into law in 2018, albeit with some compromises.

Data suggests that US corporate earnings have already priced in corporate tax cuts and other changes, the US-headquartered private bank said in a regular note. But the bank said it does not see US stocks as greatly overvalued.

“Global markets recently moved on expectations around tax changes in the US and the private bank noted that US corporate earnings are tracking near +11 per cent in 2017-to-date.  However, US shares have risen about 12 per cent more than EPS since 2016, with two bursts of outperformance when tax cut prospects seemed most likely,” the bank said.

A standout part of the Republican tax proposals in Congress is slashing corporate tax rates from 35 per cent to 20 per cent. By some calculations, US corporate rates can be as high as 40 per cent and double the OECD global average, encouraging international US firms to park overseas earnings abroad. Another tax measure of the GOP in both the Senate and House is to double estate tax exemptions, although the bodies are split on whether to repeal the tax entirely. 

Citi Private Bank said that “high tax rate payer” shares have “dramatically outperformed” those with low tax rates, suggesting the market has discounted the prospects of a corporate tax cut. 

“We would still expect US earnings per share to rise 6-7 per cent in 2018 before tax cuts.  US equity valuations are not as astronomically high as some argue. We remain neutral on the asset class,” the bank said.

In November, the firm’s Private Bank Global Investment Committee further raised its allocation to non-US equities, with clearly stronger allocations to Asian and European (ex-UK) equities.  It added a deeper under-weight to developed markets fixed income, outside the US. 

“Leading indicators of global growth are broadening and strengthening to the greatest extent seen since the rebound period of 2010,” it continued. 

The bank said that even with the European Central Bank likely to continue printing money through most of 2018, it said very low yielding bonds are likely to post slightly negative returns. “While we cut European and other DM [developed market] bonds, we added to short- and intermediate-US Treasuries as an alternative to cash, even for non-US investors. US T-bills now yield more than average DM 10-year bonds (ex-US),” it said.  

China 
The private bank went onto argue that tighter capital discipline means slower growth in China will likely yield higher corporate profits than in the past.  

“As financial policy tightens, Chinese growth is fortunately showing signs of becoming less credit-sensitive.  In the coming five years, global benchmarks are likely to add much higher weightings to Chinese stocks and bonds than their current near-zero allocations.  We comfortably overweight China and North Asia broadly. Even dedicated EM investors are underweight,” it said. 

“US high yield markets caused a scare among global investors in the past week. Media again speculated over the demise of the asset class.  While there were some legitimate (if overstated) concerns regarding US tax reforms, the greatest impact was driven by a single telecom services issuer, Sprint Corp, which fell sharply on M&A woes,” it added.