UBS: Expect swift market rally if tax bill passes and Target, Raytheon to lead

  • Only 35-to-45 percent of the tax plan is priced into the market, UBS' Keith Parker says
  • "Past instances in which a tax cut was passed highlight the potential for further gains once the bill gets signed," according to the strategist.
  • Stocks have surged in 2017, with the S&P 500 advancing nearly 20 percent to all-time highs.
A Target store in Culver City, California.
Mark Ralston | AFP | Getty Images
A Target store in Culver City, California.

Investors should expect another U.S. stock-market rally if the Republican tax bill passes since the market has not fully baked it in, a strategist at UBS says.

Keith Parker, a strategist at UBS who has a 3,300 target on the S&P 500 for 2018, said only 35-to-45 percent of the tax plan is priced into the market, noting the index's recent gains have been mostly a product of better-than-expected economic data and strong earnings.

The S&P 500 is up 8.1 percent since August and nearly 4 percent since mid-November.

"Many investors point to the rally in US equities since August as evidence that a tax cut is already priced in," said Parker. And while part of those gains are "likely tax-related, past instances in which a tax cut was passed highlight the potential for further gains once the bill gets signed."

The strategist points out that the S&P 500 rose sharply following the last two major overhauls to the tax code. Parker specifically points to Feb. 26, 1964 — when President Lyndon Johnson passed the Tax Reduction Act — and to Oct. 22, 1986, when President Ronald Reagan signed the Tax Reform Act.

The chart below shows the S&P 500's normalized performance before and after the 1964 and 1986 tax laws were signed:

Stocks have surged in 2017, with the S&P 500 advancing nearly 20 percent to all-time highs as investors await the passing of the new GOP tax plan. If signed into law, the bill — which is expected to be unveiled on Friday — would slash the corporate tax rate to 21 percent from 35 percent.

"As a tax cut gets closer to passage (and assuming it is passed), the potential tailwind to earnings and nominal growth is likely to drive incremental fund flows into US equities," Parker said. "As a result, we're likely to witness a similar influx of funds, albeit potentially more sustained, to what we saw last November immediately following the outcome of the US election and the corresponding spike in confidence."

What to buy

Target and Raytheon could be two of the biggest beneficiaries of the Republican tax plan, Parker notes. He said the benefit of lower corporate taxes hasn't been fully priced into these stocks.

Target shares have fallen nearly 13 percent in 2017 as traditional retailers continue to struggle with competition from e-commerce retailers like Amazon. The stock has cut some of its losses over the past month, however, rising 16.6 percent in that time period.

Raytheon shares, meanwhile, are up more than 34 percent year to date, following the broader defense sector's sharp rise in 2017. The iShares U.S. Aerospace & Defense exchange-traded fund (ITA) is up nearly 34 percent for the year.

Other stocks that could benefit from the bill include Campbell Soup, Lowe's, and Raymond James Financial, according to Parker. These stocks, like Target and Raytheon, have not fully priced in the potentially lower corporate tax rate.

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