Friday, February 10, 2017

Traders don't understand the impact of Corporate Tax Reform.

I've been spending some time thinking about how Corporate Tax reform might impact equity valuations.  I think Wall Street remains clueless as to it's impact.  They erroneously believe Corporate Tax reform will be an across-the-board benefit to all companies.  I beg to differ.  I think it will get structured so that there are some winners,  but many losers.  And the overall net effect will be that the annual total tax paid by Corporate America will be unchanged.

Currently,  our system is bifurcated.   The big, international companies take advantage of international loopholes to park their profits in countries with extremely low corporate tax rates.  The net effect is that these companies typically pay out only 7 to 12% of their profits in annual cash tax payments.   But,  here's the thing that most traders simply don't understand.  These companies still book a much large income tax expense that impacts bottom lines.   They'll book an expense equal to 20 - 25%, or more.  The difference gets added to the balance sheet as a deferred tax.   That liability line on the balance sheet is an ever growing line.

Then, on the other side of Corporate America,  we have many companies who don't,  or can't,  take advantage of international loopholes.   These companies pay taxes much closer to the 36% statutory rate.  They may have some expense items that are accelerated for income tax purposes,  allowing them to pay cash tax at a rate smaller than the 36%,  but not by much.   So,  they will also have deferred tax liabilities on their balance sheets,  but not much relative to their more international oriented brethren.

The big,  international players will be net losers in Corporate Tax reform.   While their income tax expense may not change all that much,  the amount of cash tax they pay will grow,  dramatically.   They will now have to start paying out cash that is closer to any new rate set under tax reform.   So,  their cash flows will take a hit.  On the other end,  the more domestic based companies will see a drastic decline in their cash tax payments.

In theory,  corporate equities should be valued based on a discounted value of future cash flows.  Corporate Tax reform will likely be reducing the cash flows of big,  international companies.  And,  these companies should be trading lower.  It will increase the cash flows of domestic companies.  These companies should be trading higher.  And,  I simply don't think that Wall Street traders understand the cash flow impact of Corporate Tax reform.   When the realization hits,  we may see some concerted selling in the big names,  and concentrated buying in the domestic names.

My trade idea?  $RVT.   It's a closed-end fund concentrated in small cap,  domestic companies.   It currently trades near a 14% discount to NAV.   It's one of my bigger positions.  I firmly believe it goes higher when Wall Street finally understands the impact that Corporate Tax reform will have on cash flows.


Xi wins. President FUBAR loses.

The market is tacking on even more gains today,  from the headlines that President FUBAR had a phone call with President Xi of China.   The market's takeaway is that this is good.  I disagree.

So,  what really happened?  After President FUBAR made public his disdain for the One China policy,  months ago,  Xi simply chose to write him off.  Xi stopped talking to our President.  Months went by,  Xi wouldn't pick up the phone.  So,  President FUBAR sent his Secretaries of Parties and Dresses (Jared and Ivanka) over to the Chinese Embassy,  to apologize,  profusely.  Then our President wrote a letter to Xi,  once again,  apologizing for his error on One China. Our President had to crawl on his knees over to Xi.  For all his tough talk on China,  trade,  trade imbalances,  currency manipulation,  South China Sea,  island occupation,  our President is a weakling. 

President FUBAR just got his ass kicked,  by Xi.  Badly. And,  this is good for our financial markets?

No,  its not.  We have zero leverage over China.  And this call with Xi just proved it.

Thursday, February 09, 2017

The economy will get worse from here, says $MTRX.

$MTRX reported today.  They disappointed.  This is a construction company specializing in work in the Energy industry.   In reading through their press release,  a bit of common sense comes to mind.  Put yourself into the shoes of a CFO in corporate America.  If you need to spend money on a fixed asset,  would you do it now,  or later?  If you do it now,  under the current income tax code,  it might take you 5, 10, 30 years of depreciation expense before your expenditures realize the full tax benefit.   If you push that work or expenditure out just a tad longer,  you might find yourself in a situation where you can take an immediate expense for every dollar invested.

Light bulb going off yet?  CEOs and CFOs across American are now going to clamp down on any expenditures for plant, property or equipment,  until there is certainty about the new tax laws.   As a result,  there will be economic weakness coming our way in the near term.  I suspect we'll start seeing it in March's numbers.   And,  we'll start hearing more and more about it in April/May.   The longer it takes to get this tax package hammered out,  the more damage its going to do to our near term economic activity.

No one is talking about this.  But,  its just plain common sense.   And $MTRX gave off those signals in their earnings report today.   Listen to the signals.

Do you have a clue how the GOP tax plan will impact you?

Like all Americans,  I'm in the dark as to how the GOP plan to overhaul our income taxes will impact me.   I did take some time out of my schedule today to look at the 2016 tax plan that Paul Ryan endorsed.  You can find a nice summary of it at this link.

The major changes that caught my eye:
  • Number of tax brackets reduced,  simplified.  Basically,  for married people: 12% up to $75 K,  25% to $231 K, 33% thereafter.
  • Standard deduction for married to $24 K
  • Personal exemptions:  Gone
  • No itemized deduction for anything but charitable contributions and mortgage interest.
  • The real hurt is non-deductibility of state income tax,  personal property tax.
  • Dividends and interest receive a 50% exclusion before added to income.
I pounded away to determine the impact on my tax bill.  Net, net?  Zippo.   My tax bill stays about the same.

So much for a tax cut.

The one thing about this plan that is going to really shock some taxpayers is the lack of deductibility of medical expenses.  Think about getting really old and facing that decision of selling your home and going into a full-time nursing facility.  At that point,  your main source of income is likely earnings on your savings.  One thing that makes this transition a little more affordable and tolerable is the ability to write-off all your nursing home costs against other income, wiping out tax liability for many.  In essence, the government helps subsidize a move into nursing home facilities. No longer.  And this is going to come as a shock to many families.

It will be interesting to see how all of this plays out.  But,  don't bank on a tax cut coming your way.  There will be lots of noise about how great this will be for all taxpayers.  But,  in reality,  there will be winners,  and losers.  And many,  like me,  may see no impact at all.

Will the Trump tax plan be a huge shock to Wall Street?

President FUBAR uttered something this morning about a tax plan he would release within the next 2 to 3 weeks.   Without having a clue what he really meant by his comments,  the market chose to take this "news" as a positive,  and quickly ramped to the upside.  

What did President FUBAR really mean?  No one has a clue.  He may very well been referring to some new tax that will be levied on the traveling public,  the proceeds of which will be applied to upgrading our nation's airports.   He was,  after all,  meeting with airline CEOs when he uttered these comments.

He could also be talking about a Steve Bannon version of a comprehensive tax plan.   I have this feeling that Bannon is behind closed doors,  pounding out a tax plan that is drastically different than anyone on the Street,  or in Congress, currently believes will be coming.   The Bannon plan likely targets all the breaks to the middle class,  while layering higher taxes onto the top 5 to 10% of taxpayers.   Even worse,  the tax cuts the Street thinks are headed the way of Corporate America will likely not be in Bannon's plan.  Or,  if they are,  they won't be near as lucrative as expected.

Why do I think this?  Bannon managed to get an idiot elected President.  That makes Steve Bannon one of the most brilliant men in Washington DC.  He's smart enough to understand that the real political power in our county lies in hands of the rural, middle class workers.   These are the people who must receive the bulk of the benefit of any new tax plan.   And,  Steve Bannon knows it.

But,  the Wall Street traders?   They've pushed the market higher on expectation of huge tax benefits going to upper income tax payers,  and to Corporate America.  When that doesn't materialize,  watch out below.  A sharp selloff is on the horizon.

Friday, November 18, 2016

Review of Economic and Market Stats. Week ended 11/18/2016

  • The great Trump rotation
  • Interest rates spiked, 10 yr moved from 2.15 to 2.34
  • Yield curve blows out to 128, high for yr
  • 10 year tips at 1.95%
  • Interest rate sensitive stuff crushed
  • US Dollar index continues climb, past 100
  • Financials ramped, continue to set new highs
  • Health Care bounced
  • Massive short squeeze in shipping stocks,  DRYS up 10x 
  • Still stuck below all-time highs in Spoos.  Closed at 2185
  • Small Caps ramped
  • Russell 2000 closed at all-time high 1315,  up 22% YTD
  • International Mkts flat for week
  • Emerging mkts show signs of leveling out, bottoming
  • Gold trending down on higher interest rates, higher dollar
  • Playbook suggests we may be in early stage of economic growth cycle
  • Put/Call fell below 1.0
  • VIX hitting lows @ 13
  • Expect money flows stats next week to show massive inflows to equities
  • AAII Bulls hitting annual high @ 46.7 - bad sign
  • CRB Index slight increase @ 182.5
  • Oil trading mostly flat, waiting on OPEC meeting results
  • NatGas getting crushed on warm weather @ 2.83
  • Other commodities mixed, some up, some down
  • Atlanta Fed Forecast ticks up to 3.6%
  • ECRI going in opposite direction, decline to 6.2% from 7.3 two wks prior
  • Housing starts surprise to the upside by 200 K,  big move
  • Continuing employment claims hit lows for the yr @ 250 K
  • Citi economic surprise index turns positive,  inflection point in economy?
  • Nothing unusual being signaled in credit default swaps
  • Mortgage application activity surprisingly low, @ 436 K
  • Avg 30 yr Mortg Rate creeping up,  now at 3.94%, massive weekly move
  • Weekly retail sales still moribund.
  • Rail traffic now turning positive YoY,  but down 344 K loads from PY
Action this past week was defined by a massive shift in investor sentiment.  And,  a massive rotation between industries.   There was a wall of money sitting the sidelines just waiting for election uncertainty to be resolved.   Its easy to understand this issue by looking at the ICI Money Flows into and out of mutual funds.  Year to date,  there had been $224 Billion taken from domestic equity funds.  In the week prior to the election,  a record $17.4 Billion was withdrawn.  These are stunning numbers.  Post the 2008 financial crises,  the most withdrawn from domestic equity was $149 Billion in 2012.  This money will now be rushing back into the market.

So,  where is it going?  Who are the winners?  Anything financially oriented went of a major romp to the upside.  Anything fixed income oriented got slaughtered as interest rates spiked.  Stuff that sold off prior to the election in anticipation of a Clinton win got bought after the Trump win.  Health care,  especially,  had a nice bounce.

Given that Trump is planning to cut income taxes,  putting more money in consumer hands,  and is also planning a massive infrastructure program,  there is an expectation that interest rates are headed much higher. We're already near peak employment.  Putting stimulus into the economy should push up demand for labor and goods,  across the board,  leading to inflation.   When interest rates go higher,  the financials benefit greatly from expanded profit margins.   So,  the biggest winner,  by far,  have been the financial stocks.

The other big winners came from health care and infrastructure related stocks.   Health care bounced back from sever, pre-election selling pressure from expectations that a Clinton administration would force cuts to profits margins.  And infrastructure stocks are expected to benefit from the nation embarking on a building program.

The expectation is for the market to push beyond new highs before the end of the year.   I expect the market to trade relatively flat from now until mid-December,  then ramp into year-end.   The S&P closed the week out near 2180.  It will flatten out as we hit a period of locking in YE gains and losses. After this tax related activity passes,  it will likely push into the 2250 - 2300 range before YE,  driven by a massive wall of money coming off the sidelines.

Longer-term,  I am not as positive on the market outlook.  I don't believe Trump's plans will work.   Interest rate rises will wind up knee capping all the industries that were of great benefit to current economic activity.  Autos and housing will be especially hurt.   These are two industries with fairly massive domestic employment.   There will be an increase in infrastructure related employment,  but it will be more than offset by auto and housing losses.   The other problem we will face comes about via a strong,  and growing stronger,  US Dollar.   The strengthening of the dollar will crimp US exports,  and hurt US profits of our international companies.   So,  overall,  there will be little improvement to employment or economic activity,  just a rotation and churning.

I think we top out in the market around mid January,  then suffer a brutal bout of selling that will take us down 10 - 15% into early 2017.  All the new money rushing into the market post election will get burned badly.  At the same time,  the massive capital that has been buying up fixed income investments over the last eight years ($1 Trillion in LT mutual funds alone) will get hammered hard.   We will start off the new Trump administration with an appreciable number of middle class families losing major money in their 401 K and college savings accounts.   And, it will only get more ugly from there.   Trump will wind up the least popular President in US History.   So,  sharpen your market timing skills, and learn how to bet against the entire equity and fixed income complex.   If you can bet to the downside,  you will survive,  and thrive.

Monday, November 14, 2016

Review of Economic and Market Stats. Week ended 11/11/2016

  • Surprise election results drove massive money rotation
  • FROM:  tech, anything fixed income oriented
  • TO: financials (major ramp), small caps
  • Bounce back in health care - relief rally off expected Clinton win
  • Anything expected to be impacted by Trump Presidency had massive moves 
  • We're still stuck in very tight trading range 2050 - 2100
  • Massive ramp in interest rates, interest sensitive names crushed
  • 10 yr moved from 1.78% to 2.15%
  • Gundlach interview,  calls for 2.35% by YE,  2.5 - 3 in 2017
  • Put/Call closed at 1.11 for the wk,  down from previous wk of 1.41
  • Unwinding of pre-election hedging drove much of the snap-back
  • Technology, Transports and Small Caps continue to be YTD return leaders
  • Emerging mkts getting crushed on US interest rate rise
  • Gold trending down on higher interest rates, higher dollar
  • Playbook suggests we may be in early stage of economic growth cycle
  • Investor Confidence terrible
  • Mutual Fund outflows peaked at $16 B WE 10/28
  • Outflows still happening.  Record $191 B from Domestic Equity YTD
  • Domestic Equity outflows $350 B past 2 yrs.
  • Reversal from consistent domestic equity outflow to inflow may signal new bull leg
  • VIX @ 15,  low of 11 for yr,  high of 27.
  • CRB index closed at 180,  down from 189 in mid-Oct, 193 high for yr, 159 low
  • Crude at $43, stories continue to point to significant glut in world mkt
  • China Iron Ore spot hitting highs for yr at 79, off 41 low
  • Copper also ramping to $251 from $194 low of yr.
  • Construction commodity move portends better economic outlook in China 
  • Lumber at $319, off a good 20% from same time in 2015
  • Housing outlook uncertain, rate spike is a concern
  • Atlanta Fed GDP outlook now at 3.1%
  • ECRI GDP outlook trending down to 6.7 from 8.8 in mid-Oct
  • AAI Equity Bull hits a yr high @ 38%.  Caution.
  • Nothing unusual being signaled in credit default swaps
  • Employment indices flatlined
  • Mortgage application activity surprisingly low
  • Avg 30 yr Mortg Rate creeping up,  now at 3.57%
  • Weekly retail sales still moribund.
  • Rail traffic now turning positive YoY,  but down 340 K loads from PY
The TRUMP win was out of left field.  As was the market reaction to the win.  Most professional money managers expected a 5 - 10% market pullback if Trump were to pull off a surprise win.  While futures initially plunged 800 points on DOW,  the mkt opened flat on Wed and then moved higher.  Up about 4 to 5% for most indices for the week.

Most of this move was likely driven by taking off the downside hedges put on for the election uncertainty.  Market direction ST is highly uncertain.  Market commentary though is positive, with some calling for new highs by YE.

I am more reserved,  prepared to sell into any ramps and put on hedges if we do move to new highs.  The expectations of large tax cuts are misplaced.   Our budget deficits are already in the range of $500 Billion and trending higher.   There is no way we can cut taxes without doing significant damage to our fiscal situation.   Am hoping we do push to new highs where I can get aggressive in downside bets.  At some point early in the new administration,  reality will sink in,  in-fighting between Trump and Congress will take over,  all risk assets will head lower.   Timing this will be tricky.

Stories that caught my eye:
Gundlach says 10 year could hit 6% in 5 years


Domestic Equity Mutual Fund Outflows Hit $191 Billion YTD

2016 Total Domestic  World Hybrid Total Taxable  Muni 
Date Equity Equity Equity   Bond Bond Bond Total


11/2/16 (7,611) (5,779) (1,832) (1,904) (1,332) (1,263) (70) (10,847)
10/26/16 (6,947) (5,337) (1,609) 60 2,758 2,191 567 (4,129)
10/19/16 (16,422) (15,825) (597) (1,306) 3,897 3,754 144 (13,831)
10/12/16 (5,101) (4,255) (846) (888) 3,173 3,015 158 (2,815)
10/5/16 (11,658) (7,549) (4,109) (1,569) 5,483 4,696 787 (7,745)
9/28/16 (4,557) (2,236) (2,320) (546) 4,949 3,895 1,054 (153)
9/21/16 (2,656) (2,128) (528) (561) 2,877 2,123 754 (339)
9/14/16 (4,238) (3,558) (680) (1,577) 3,413 2,735 679 (2,401)
9/7/16 (6,084) (4,547) (1,536) (901) 6,114 4,654 1,459 (870)
8/31/16 (5,508) (3,780) (1,728) 27 1,321 174 1,148 (4,160)
8/24/16 (6,094) (4,572) (1,522) (113) 4,816 3,501 1,315 (1,391)
8/17/16 (7,578) (6,308) (1,270) 190 6,260 4,618 1,642 (1,128)
8/10/16 (6,164) (4,375) (1,789) (79) 5,750 4,286 1,465 (493)
8/3/16 (8,960) (7,429) (1,532) (123) 7,980 6,582 1,398 (1,103)
7/27/16 (11,163) (8,220) (2,943) 475 4,904 3,377 1,527 (5,784)
7/20/16 (12,613) (10,343) (2,269) (779) 7,612 6,156 1,457 (5,779)
7/13/16 (7,982) (7,213) (770) (1,106) 6,115 4,344 1,771 (2,974)
7/6/16 (2,880) (4,315) 1,435 (275) 1,212 109 1,104 (1,942)
6/29/16 (4,990) (1,927) (3,064) (2,586) (2,411) (3,587) 1,176 (9,988)
6/22/16 (3,840) (3,902) 62 (611) 3,272 1,402 1,871 (1,179)
6/15/16 (5,855) (4,284) (1,572) (887) 1,481 (99) 1,580 (5,261)
6/8/16 (3,807) (3,416) (391) 207 5,034 3,599 1,435 1,434
6/1/16 (6,423) (6,147) (276) (614) 1,938 940 998 (5,099)
5/25/16 (6,256) (5,240) (1,017) 304 3,480 1,992 1,487 (2,472)
5/18/16 (1,169) (2,013) 844 (221) 3,676 1,494 2,183 2,286
5/11/16 (4,447) (4,877) 430 (313) 4,140 2,127 2,014 (620)
5/4/16 (3,030) (2,371) (659) (309) 3,531 2,034 1,497 192
4/27/16 (8,123) (5,682) (2,442) 171 8,223 6,358 1,865 271
4/20/16 (3,931) (3,145) (785) 196 4,250 3,248 1,003 516
4/13/16 (4,631) (4,325) (306) (142) 2,794 1,884 910 (1,979)
4/6/16 (5,841) (5,286) (555) 373 6,667 5,208 1,459 1,199
3/30/16 (4,893) (3,736) (1,157) (2) 1,192 (207) 1,399 (3,704)
3/23/16 (2,144) (2,035) (108) 1,774 4,673 3,087 1,586 4,303
3/16/16 (2,087) (1,528) (558) 225 4,921 3,858 1,063 3,060
3/9/16 1,472 (240) 1,712 1,406 5,939 4,906 1,032 8,816
3/2/16 45 (2,189) 2,234 987 4,100 3,166 934 5,132
2/24/16 4,429 2,087 2,341 1,601 (99) (1,120) 1,020 5,931
2/17/16 (1,237) (2,271) 1,034 (3,562) 963 107 857 (3,835)
2/10/16 (1,373) (3,625) 2,252 (1,044) 690 (729) 1,419 (1,727)
2/3/16 8,057 2,313 5,744 1,706 (4,289) (5,490) 1,200 5,473
1/27/16 (4,920) (6,263) 1,344 (3,468) (907) (1,760) 853 (9,295)
1/20/16 (3,780) (4,895) 1,115 (2,660) (1,930) (2,933) 1,003 (8,370)
1/13/16 (1,549) (4,751) 3,202 (3,564) (534) (1,853) 1,319 (5,648)
1/6/16 (2,405) (3,957) 1,553 (2,147) 43 (1,337) 1,380 (4,509)

  Total Domestic  World Hybrid Total Taxable  Muni 
Year Equity Equity Equity   Bond Bond Bond Total
YTD (206,944) (191,474) (15,468) (24,155) 138,139 85,242 52,902 (92,957)
2015 (76,323) (172,511) 96,178 (16,575) (23,940) (40,447) 16,506 (116,839)
2014 31,376 (59,149) 90,536 33,376 34,708 6,192 28,441 99,391
2013 149,947 14,935 135,012 76,724 (84,669) (21,100) (56,206) 149,368
2012 (149,057) (156,451) 7,433 45,263 313,249 261,281 51,962 209,494
2011 (120,590) (141,591) 7,318 31,738 132,989 146,789 (13,804) 30,453
2010 (47,767) (98,696) 50,929 25,713 266,646 251,865 14,781 244,596
2009 (27,397) (53,081) 25,689 20,875 387,118 316,312 70,804 380,601