Whether They Meant To or Not, Stock Funds Positioned for Tax Cut

(Bloomberg) -- Donald Trump’s plan to cut corporate taxes seem like a done deal to at least one group of investors.

While it may not have happened on purpose, mutual-fund mangers are set up for that outcome. According to Bank of America Corp., they favor companies poised to benefit from lower taxes while shunning those that may suffer.

Assigning intent is always tricky in the stock market. Given the industries in question, it’s possible that fund managers bought for reasons other than an outright bet on government policy -- earnings growth and valuation come to mind. Yet at a time when tax cuts are on everyone’s lips, the study indicates at least a de facto bullishness toward them among investors, and may explain why stocks dipped twice this week at hints of trouble.

Whether They Meant To or Not, Stock Funds Positioned for Tax Cut

The S&P 500 fell 0.3 percent as of 10:39 a.m. in New York, with losses building after House Republicans released details of their plan that had investors speculating on the chances of passage. 

The index had pared gains Wednesday amid bets that the bill may be postponed into next week. Two days earlier, the measure reversed to losses as House writers were said to be discussing a gradual phase-in for the corporate reduction. That proposal was called “a terrible idea” by Strategas Research Partners because it would prompt companies to delay business investments.

In a way, the reaction is at odds with views that the market has priced in little if any tax reform yet -- although again, it’s not clear if the positioning is intentional. More straightforwardly, going by the relative returns by small-caps and most-taxed companies, a case can be made that investors are reducing expectations anything will get passed.

After surging initially following the November election, both smaller companies and high-tax stocks have erased almost all their outperformance after Congress failed to pass a health bill to overhaul Obamacare. Meanwhile, controversies surrounding Trump continued to build, from his dealing with Russia to the spat with GOP members.

Whatever the cause, the data shows mutual-fund managers are exposed to losses given their positioning.

Whether They Meant To or Not, Stock Funds Positioned for Tax Cut

These funds hold 10 percent more stocks poised to benefit most from a low tax rate than what their benchmark indexes suggest. At the same time, they’re 9 percent underweight companies that could be hurt most should the tax reform lead to an end of a policy that allows firm to deduct interest expenses from income before tax bills are calculated.

“The buy-side is ready for major policy change,” Bank of America strategists led by Savita Subramanian wrote in a note Wednesday. “While the market may not be pricing in a high probability of tax reform, large cap funds are well-positioned for it.”

©2017 Bloomberg L.P.