Whatever individuals who work in the investment community may have personally thought about Donald Trump’s 2016 election to the presidency, one thing is crystal clear: Their on-the-job persona’s were overjoyed, as reflected in the stock market’s overall strength since then. They expected a better economy due to diminishing regulatory interference, business tax cuts, and a general pro-business sentiment at 1600 Pennsylvania Avenue (and a distinct contrast from you-didn’t-build-that Obama. Deep concerns from potential trade wars, the impact of anti-immigration policies on the ability of businesses to hire effectively, the impact of the drain of higher health care costs on the wallets of customers etc. were not assessed. Corporate profits were expected to fly higher and on Wall Street, that’s what counts.
Since inauguration day, controversy has been the new normal at the White House, but through it all, it succeeded in passing one significant piece of legislation: the massive corporate tax cut of 2017. And on an anecdotal basis, it shows signs of being every bit as excellent as even the most optimistic investment-community participants might have dared to expect. (See, for example, Reuters: US tax cut to deliver corporate earnings gift; USA Today: Exxon Mobile Profit quintupled after President Trump’s Tax Cut).
But in the media in general, it has been viewed unfavorably:
Bloomberg: Wait Before Declaring Trump Tax Cuts a Win
New York Magazine: The Trump Tax Cut’s Unpopularity Is a Crisis for the GOP
New York Times: Investment Boom From Trump’s Tax Cuts Has Yet to Appear
Washington Post: Tax Cuts Were Supposed to Save the GOP From Trump. Oops.
Yahoo! Finance: Why the Trump Tax Cuts Are Flopping
Should we take this seriously? We know Trump and the media have not exactly been enjoying a love fest since the early days of the campaign. Could anybody sincerely expect the Washington Post, CNN or the “Failing” New York Times to report favorably on the tax cut? But consider Bloomberg, Marketwatch, Forbes and Yahoo! Finance. These outlets are hardly apologists for Democrats or the contemporary Left.
The long-term political future of Trump, the GOP and the business community that has chosen to ride their coat-tails will depend on the overall sum of the individually-perceived dollars-and-cents impacts of policies. Father Time will eventually give us the answer, and allow us the see and judge the efficacy of analysts’ and economists’ tools to assess and forecast same. But with the first quarter of 2018 in the books, and with the stock market having had ample time to digest it and think ahead to the next quarter and beyond, we continue to that the anecdotal assessments are not looking good:
Let’s see if we can go beyond the headlines. Table 1 shows calculations I made using Portfolio123 to assess the impact of the corporate tax cuts on financial results and stock price performance. The data-points show the first reporting quarter of the S&P 500 constituent companies. The share price gains are measured from June 1, when I collected the data (thus giving the stock market ample time to have digested Q1 and crystallized forward expectations).
|Average||Median||Cap Wtd. Average|
|Reported Tax Rates||-68.2%||-19.8%||-47.1%|
|Income After Tax||19.6%||22.8%||23.8%|
|# Diluted Shares||-0.8%||-1.0%||-1.2%|
|Cal. Q1 Stock Prices||12.0%||9.1%||18.6%|
Calculated on Portfolio123 using data from Compustat
For Trump and Republicans, the picture is not good and suggests the skeptical headlines are on target. Business-wise, the quarter was not bad at all. Sales and Operating Profit gains within hailing distance of 10% for established blue-chip companies in a time of prolonged disinflation is fine. There seemed to be a lot of oddball non-operating income depressants among the smaller outfits within the S&P 500 but all in all, nothing with which we can’t live. And if Corporate America is inclined to squander the benefits of the tax cuts on share buybacks, as some have suggested, that would still be in the realm of expectation: The reduction in diluted shares outstanding looks to have been trivial in the quarter.
The real financial-statement action, as was to be expected, shows in taxes. As we all know, the headline rate plunged from 35% to 21% and as Table 1 shows, the actual rate (including all the things for which tax accountants get paid and which make effective tax rates different from headline rates), fell pretty substantially. Further taking into account all the other things auditors and CFOs do below the tax line, year-to-year first-quarter gains in EPS were great, way better than what gains in Sales and Operating Profits could have supported. (The only calculation that shows otherwise was the average; the tally that is most prone to distortion by large “outliers” and may have been depressed by large write-offs among smaller S&P 500 constituents.)
But, but, but, two months after the end of the calendar quarter, gains in the prices of the stocks, although quite good, are running well behind the gains in EPS when we calculate medians and market-capitalization weighted averages. More notably, the stock price gains seem to be well aligned with changes in Sales and Operating Profits.
Educated investors are supposed to value stocks based on what they deem to be sustainable, for real, and to eliminate the impact of fluff from their decision making. Judging from Table 1, it appears the investment community, the constituency that one would think would be extremely pro Trump, has already consigned his signature legislative initiative to the fluff bin.
We understand that eventually, the super-comparisons likely to be seen in 2018 will be lapped and that comps are likely to revert to ordinary in 2019 and beyond. But shouldn’t investors at least factor the higher base off which future comps will come into stock valuations. They should — if they expect the base to hold.
Suppose investors expect the base built by the Trump tax cut to be ripped out from under corporate profits. Suppose they expect a future year of sharply negative EPS comparisons from a corporate headline tax rate that goes back to 35% or thereabouts. In that case, we would expect to see — exactly what we have seen so far from stock prices.
There’s no way the tax cuts will be repealed under Trump or under a continuing Republican stranglehold over power within the Beltway. But what if power shifts. What could we expect if power transfers to a Democratic Congress and, perhaps, a Democratic president, such as Elizabeth Warren. Admittedly, she hasn’t declared herself a candidate (yet). But she has the visibility and charisma to win an election campaign waged in a 21st century manner, and Trump’s tax cut may turn out to give her what Hillary Clinton never had; a powerful they-rob-the-poor-and-give-to-the-rich message. (Look how far Bernie Sanders took that theme in 2016 without any support from the Democratic establishment and no prior presence on the national stage.)
We learned from the attacks on and weakening of Obamacare that any policy shoved into the law books exclusively by one party cannot be counted on to survive. Well, maybe not all of us. Trump and the GOP got an “F” on that lesson. But the stock market seems to have scored at least a “B+” and arguably, an “A.”