It's not a rally. It's a re-distribution. It's not a bet on the future. It's a wager that some earnings estimates are going to go higher while others stay the same.
That's why you get such a bifurcation in stocks. It's 100% about tax reform with the domestic companies paying fewer taxes while the international companies-which, of course, includes tech, pay the same amount. Sure they can repatriate at a better rate. And some will.
But we know that a magic wand has been waved at every cable company, railroad, retailer and restaurant as well as a smattering of industrials that have great domestic businesses and that magic wand has radically bumped earnings for 2018.
On days like today it is worth it to remember what exactly moves a stock: the notion that earnings estimates are either too high or too low. If you know that estimates are too low, you can expect a bump in the price of the stock even if its business is no better than it was, say, Thursday.
The stock market doesn't care how those earnings get to be better than expected. It can be because of a shrinking of the sharecount, which is often the case for the consumer packaged goods companies with no real growth but a ton of cash flow. That makes the denominator, the number of shares, smaller, which therefore when divided into the earnings gives you a bigger earnings per share. It can be because an international company has a big swing in currency: the dollar gets weak versus the euro or the peso or the ruble and when the earnings are translated back they produce a bigger number per share. The market doesn't care that it's currency. The investors are just looking at that final number, seeing it is better than expected, and the stock jumps.
And now it is doing the same thing for domestic companies that are pretty full taxpayers. The ultimate rate for these companies is coming down. We aren't sure what that rate will be but they will all be more profitable than they were before the Senate passed the tax bill. Again, you may think that investors will see right through this and recognize that it's the lower tax rate that's driving things and not a pick up in business. But that's simply untrue. Investors do not care how a company arrives at its earnings. They only care about those earnings. So every largely domestic tax payer that was paying at the full rate, as many retailers and banks and transports were, is now paying appreciably less. So, when the dust settles and the analysts put pen to paper they will all have to raise numbers. Now it is possible that at that point we will get a selloff and the proceeds will go back to the international companies with break out earnings. However, we haven't even had the estimate bumps yet so there's no assurance that the formerly hot stocks are going to turn around yet.
I know this is a ridiculous way to judge stocks. Nothing happened to these companies other than prospective legislation.
But big time investors are constantly trying to assess which companies will have the biggest boosts to their earnings. Right now many of the tech stocks that are selling off are going to have the same predictably good gains.
However, retailers could have sharply better than expected earnings and it is the rate of that increase that matters.
Now you can have a double whammy positive and a double whammy negative here.
So let's take the double whammy positive. Let's pick Home Depot (HD) . Right now this largely domestic chain of 2,200 stores has an effective tax rate of 36%. Now, it is understood that in the new world its rate could fall to perhaps as low as 20%. So all of that money that flowed to Uncle Sam now flows back to Home Depot.
The company puts up very few stores in the U.S. What then, will it do with its money? It can buy another company, but that's not been its way. It can offer a greater dividend. It might do that. Most important, though, it can buy back stock and shrink that denominator. Remember, no one will ask "how did they have that gigantic earnings gain." They simply will see a number that is substantially better than what analysts are looking for and they will bid the stock up. Of course it genuinely helps that Home Depot's doing better than expected anyway. Same goes for a Costco (COST) . Or a Dollar Tree (DLTR) . Or a Ross Stores (ROST) or Children's Place (PLCE) which have all reported better-than-expected earnings, meaning they would probably be going up by themselves anyway.
Now let's consider the double whammy to the downside. Last week Morgan Stanley's Katy Huberty suggested that Western Digital (WDC) could miss its estimates. Sixty-eight percent of this company's earnings, according to 2016 numbers, come from overseas. So not only does Western Digital not see the big bump in earnings from a resurgent consumer as the retailers are getting, it also doesn't benefit that much from the lower tax rate. Just like the retailers being win/wins, many techs are like Western Digital, basically in a lose/lose mode.
Now what you need to look for right here are anomalies. For example, the transports are, for the most part, hitting all-time highs because they are, on average, max tax payers. They will see big boosts in earnings. But what if the numbers aren't there? What if coal traffic slows, or crude by rail, or agriculture. Then you are at risk. I think the rails, AFTER Wall Street raises estimates on taxes might come down. They have come too far too fast and, unlike Costco or Home Depot or perhaps Macy's (M) , they may not make their numbers anyway.
Similarly if there is a technology company that will substantially beat numbers it can go higher. But we have to be careful as VMW (VMW) , Adobe (ADBE) and Salesforce (CRM) all blew away the numbers and are getting clobbered anyway. The rotation's not over. However it is also hard to say it's just starting. I think that we are closer to a bottom than a top on tech but we have to wait until investors who don't have any new money coming in finish selling their tech to buy the domestics.
What's fascinating for me to see is the banks. Here's a full paying tax group that is exploding higher even as there are very few people who genuinely believe they are doing better than expected. Take the stock of Goldman Sachs (GS) . It is a few points off its 52-week-high. Nevertheless, because there is very little volatility in the Fixed Income, currency and commodity businesses, it is entirely possible that it may not have the earnings blowout that the stock is telling you it will have. Do you want to be in the stock of Goldman Sachs if it doesn't beat numbers despite the tax rate? How about JPMorgan (JPM) ? Sure the government is going to give them a regulatory break. However, the earnings may not be as robust as the stock.
No matter for now. They aren't about to report. If anything, we are going to get a Fed rate hike which will allow analysts to raise numbers anyway.
I just don't for a second want people to think that because a tax rate is coming down the new earnings are assured.
For the most part many of the companies' stocks that are going higher have already reported. That makes them far less dangerous. An ATT (T) or a Verizon (VZ) has very little earnings risk for the moment. But six weeks from now?
One more point to consider. On Friday at midday we thought that the tax bill might fail and we heard from ABC news that during the presidential campaign President Trump directed Michael Flynn to make contact with the Russians.
By the end of the day we discovered the ABC report was erroneous. And then on Saturday we knew the bill had passed. We climbed 650 Dow points from the moment the ABC report came out. That means a tremendous number of investors were out of position. Today they got in position. I don't know how much is left in the rotational tank unless analysts get ahead of the earnings estimates and raise them tomorrow. If they don't, I think the money starts flowing back to the techs. If they do raise them? My prediction? More of the same.