New policies, New preferences

President Trump has been quick to act on his campaign promises, by pulling the US out of the Trans-Pacific Partnership trade agreement, which to many has been seen as a move that gives China increased leverage in establishing itself as a key hub for global trade, notably with the remaining Asian pacific nations.

What implications such a move will have will be interesting to follow going forward, more so, once further clarity emerges on the actions the US also undertakes with the North American Free Trade Agreement, which includes Canada and Mexico.

Furthermore, the reassurance of lower corporate taxes towards US manufacturers on the premise they keep production operations on US soil, against the threat of increased US bound border taxes, has also taken centre stage of the President’s agenda.

There will be mixed opinions as to the benefits and detriments such tax policies can bring. What is sure is the likely change investor and corporate sentiment and confidence may undertake as a result.

Dividends, for example, are a means of income for equity investors who buy a stock for a specified minimum period. The source of income serves as additional returns on a stock investment other than through capital gains and the selection of these stock positions are often the result of a preference for dividends whereby analysis would typically be carried out on the various dividend yields available across the market or segment.

A change in taxation policies could change the preferences investors have towards dividend income. A company can generally distribute its income to shareholders in a number of ways, notably via cash dividends on shares or through share repurchase programs.

When a company pays dividends, the market expects such payments to be sustained in the long run and take it as a signal of positive future earnings expectations.

Share repurchases on the other hand have no long term payment expectations in the eyes of investors though repurchases are often perceived as a signal of the company considering its own shares as undervalued and an attractive investment.

Hence, lower taxes on corporate profits in the US, taxed at the corporate level, may make share repurchases or earnings re-investment more attractive going forward over dividend income, taxed at the individual’s personal income tax rate.

Although individual tax rates in the US differ across age and income brackets, the lower the corporate taxes as a result of President Trump’s proposed policies, the higher percentage of personal income tax brackets that may switch preference from dividend income to capital gains (share repurchases or earnings re-investment)

Whether capital gains come in the form of share repurchases or the re-investment of earnings varies across market sectors and also depends on whether companies are growth or value stocks. Though for the companies that do pay dividends, lower corporate taxes have the potential to see ‘special’ dividends and/or extra earnings from hereon paid out more in the form of share repurchases alongside their regular cash dividends, should the new proposed tax policies take effect.

So whatever the new presidency has to bring, US corporate Treasury departments will surely be kept busy analysing and calculating the benefits and/or detriments Trump’s proposed policies will bring to them as investor preferences look set to sway.