Equity Outlook  |  Q1 2018

An already bullish outlook boosted by tax reform

Daniel Schiff

Daniel Schiff
Portfolio Manager of Putnam Global Industrials Fund

While we are not blind to the risks in today’s equity market, we remain constructive — for reasons that extend far beyond the Tax Cuts and Jobs Act. Although we have not seen a significant market pullback since February 2016, we see many trends that are encouraging for global economic growth, and ultimately, equity performance — for the industrials sector in particular.

A virtuous cycle of spending on the horizon

The reduction in the corporate tax rate will clearly provide a boost to profitability, but there are many more ancillary benefits. For example, I’m not sure investors have considered the cleaner balance sheets we’re likely to see in two to three years. Healthier cash flows and improved credit profiles will likely drive a virtuous cycle of increased spending, leading to higher revenues and an acceleration of growth. This would occur on the heels of an eight-year recovery in which earnings growth was derived primarily from cost cutting, share buybacks, and mergers and acquisitions, rather than from organic growth.

The benefits of U.S. tax reform span the globe

We believe many investors view the Tax Cuts and Jobs Act as a U.S.-centric stimulus, losing sight of our highly interdependent global economic system. U.S. corporate tax reform could be highly stimulative — not just domestically, but for the global economy as a whole. It is likely to benefit overseas suppliers to U.S. businesses — say, a Japanese company selling automation equipment to a U.S. manufacturer that suddenly has more cash to upgrade aged equipment. And the benefits extend beyond “old economy” capital expenditures. We should also see meaningful increases in operational expenditures for service companies by way of greater commitments to research and development, technology, and marketing.

Organic growth poised to accelerate

For the past 15 years, U.S. industrial companies have woefully underinvested in capital equipment. Spending has started to recover as businesses update physical plants with new technologies. However, investment spending as a percentage of GDP remains historically low. Capital spending as a percentage of sales is at its lowest point since the 1980s. And the average age of U.S. manufacturing facilities is well above the long-term average. Businesses recognize the need to shift their focus to internal investment to drive organic growth, reinforcing the notion that we are emerging from a two-year “industrial recession.” This potential uptick in spending is likely to be accelerated further by tax reform.

Next: Japan: Progress and problems

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