We don't have enough shares to go around. That's kind of how I feel about the placid year and the reaction to tax reform. There's just not enough stock to meet the demand of the buyers who have had to radically switch their orientation first, because the economy's heating up, and second, because of the tax bill that has suddenly become law. I think the stock shortage has kept the averages from dipping as much as they should and has been responsible for a ton of positive action on days like today.
Now when anyone talks about a stock shortage you should automatically get skeptical because we know there are always bankers ready to pump out stock to meet the demand.
But it's not a shortage per se. It's a shortage of precisely the kind of stock of companies that are high domestic taxpayers that just got a big boost to earnings.
On the one hand Walmart, which has an effective tax rate of 32%, soon to be 21%, has been consistently buying back stock. On the other hand, Amazon which while it has a high effective tax rate of 43% doesn't pay a lot of taxes because it doesn't make a lot of money. Plus it has been issuing shares over the years.
A 10 year perspective is instructive. A decade ago Walmart had 4.1 billion shares outstanding. But through endless buybacks there are 2.99 billion shares as of last count. Amazon had 424 million shares in 2007 but 494 million at last count.
Now when portfolio managers want to reach for a big company that's a beneficiary of tax reform, Walmart certainly comes to mind. Amazon sure doesn't. You can imagine portfolio managers dumping the fast growing e-commerce play for the fast growing-ecommerce play with a huge brick and mortar presence. Walmart's accelerating its on-line business with the buy of Jet.com, a much better website, and a very good buy on line pick up at store initiative.
The contrasts are so palpable. Walmart used to have tremendous turnover at the store level. Now because of its pay raises the turnover, which causes the company to spend far more on training than it would like, a dead weight cost by the way, has dropped dramatically. If Walmart follows suit with the $1,000 payouts that AT&T (T) and Comcast (CMCSA) gave its workers, then the loyalty will grow even stronger.
So because of the buybacks we have a stock shortage of the company that makes a ton of sense to buy and seemingly no limit to the shares of a company that makes little sense to buy.
Now, of course, those who sell Amazon may rue the day when it talks about how great its online sales were over the holidays. Further, I would use any real weakness to buy Amazon because one day there will come a time where the tax code's beneficiaries to Walmart, which includes accounting positives on plant and equipment, will be priced into the stock. But given that the legislation's passage was a surprise and analysts are just now putting pen to paper to assess what it means, there's a good chance that the out- of -amazon- into- Walmart interlude could be longer than people think.
Of course the industrials have been buying stock back endlessly. Why? It's worth tackling because for the most part there hasn't been enough worldwide demand for their products. So they have been shrinking their companies and taking what money they make and purchasing their stocks to boost earnings. Now you have a triple whammy in their favor: the U.S. and the world's economies are getting stronger for these international companies that are based here. They will benefit from the accounting change that makes it faster and easier for clients to buy their goods. And they have been shrinking their shareholder base because of the lack of demand for their products. Remember there is no lack of demand for a lot of the technology companies and some of them are so busy expanding that the don't even care about the cost. They are per se losers in the new regime.
When you couple the hundreds of billions of dollars that come into this market through the year via index fund buying you just don't have enough shares of the tax reform winners to go around.
Now the big and little tech companies aren't losers under tax reform. They just have a lot of supply of stock and won't get the benefits so you can't boost the earnings estimates on them.
But domestic homebuilders are, arguably losers because of the mortgage deduction change and the loss of a lot of the breaks on state and local taxes. Yet Toll Brothers (TOL) , which has a great deal at stake in its California, New Jersey and New York properties, hasn't seen its stock drop on the reform. I think that's because it's been buying back stock at a furious rate: four years ago it had 184 million shares and now it has only 164 million, and while its tax rate varies it's been as high as 37%. So even if tax reform specifically targets a sector if the sector is domestic it might not get hammered or can even go higher.
Once again, I have heard endlessly that the tax code changes are built in already. But I think that's almost impossible given the swiftness of the law's passage as well as the fact that many of the world's exchanges have seen stocks soar and almost none of them have enacted comprehensive tax reform. Plus, let's use the so-called worst case and say that the companies are going to use the additional cash to buy back stock, the shortage will only get worse and the stocks will go higher. If you add that the economies are going to be more robust allowing for higher demand you could have higher earnings without even needing the denominator to shrink to grow earnings.
How dramatic will this all be? I think the single most vociferous and well grounded brief against this market is the valuation. It's high, although not as high as it looks given the paltry competition from bonds.
But with tax reform it is entirely possible that the biggest bear case out there gets neutered. How in heck can you say the market is too high on 2018 numbers when it is entirely likely that the estimates are way too low now. If bears losing the valuation argument they will only have the possibility of a recession because when we get short interest rates that are higher long interest rates it is often an harbinger of a recession. It's far more likely, though, that we will have a boom, not a recession and that inverted yield curve, as the cognoscenti call it, will prove to be a false tell.
So, now given the additional buybacks and the levitating earnings, I believe that analyst after analyst will come up with names to be bought as soon as the beginning of the next year if not next week. I think that these calls will have impact each time because of the desperation of the portfolio managers to find new names and because the companies are being cagey right now about how much they will benefit and what they think the economy will be like next year.
Plus let's remember that some of these companies, namely the banks, aren't able to raise numbers yet because they probably haven't even figured out their tax rates or their net interest margins or their sudden demand because big companies are desperate for advice.
As always there are things that could go wrong. There are exogenous issues, fights in Washington, worries about inflation from a heat-up. But the bottom line is that we are in a different, better and cheaper kind of market than many thought possible and that will bring buyers from the sidelines and a whole sale re-allocation of capital that should allow the market to be bought on any dip for some time to come.