Category Archives: Economics

Tematica’s Take on Trump’s Tax Proposal

Tematica’s Take on Trump’s Tax Proposal

This week a one page outline was released for President Trump’s tax plan, which includes slashing the corporate tax rate to 15 percent from 35 percent, reducing and simplifying individual tax rates and a “one-time” lower repatriation tax, (at a rate TBD) for the more than a trillion dollars in corporate cash being held outside the US. While policy proposals such as these tend to be fraught with negotiations and pushback that could ultimately alter the final outcome, it’s already being reported that House Speaker Paul Ryan on Wednesday said Trump’s plan is 80 percent aligned with House Republican proposals. That likely raises the probability of Trump’s plan getting more support than the first attempt at repealing and replacing the Affordable Car Act, but even so, it still doesn’t guarantee passage.

From our perspective, there are several questions left to be answered (the proposal was less than 200 words after all), including the eventual Congressional Budget Office scoring on the deficit potential, but directionally speaking investors should ask, “Who benefits?” There are thousands of companies across the S&P 500 and S&P 1500 as well as the Wilshire 5000, but individual investors are likely to look for a handful of stocks that could see a relatively outsized reduction in their tax burden should the corporate tax rate be reduced.

Said another way, which companies are likely to see a dramatic drop in their corporate tax rate even after some Washington haggling occurs?

Here are a few:

  • Aging of the Population candidate CVS Health (CVS), which derives nearly 100 percent of its sales inside the United State and had reported tax rates of 38-39 percent in 2015 and 2016;
  • Wealth management and online brokerage company Charles Schwab (SCHW), another Aging of the Population candidate, is also predominantly U.S. focused when it comes to its revenue stream and its 2015-2016 tax rate was 36.5-37.0 percent;
  • A third example is Southwest Airlines (LUV), which resonates with our Cash-strapped Consumer investing theme, which recorded corporate tax rates of 35.5-37.1 percent over the last few years.
  • While its reported corporate tax rate was lower than the above three companies, Connected Society company Verizon (VZ) would also see its bottom line vastly improved should the corporate tax rate fall meaningfully from the 31-34 percent rate it paid in 2015 and 2016.

In any of the above cases, a meaningful tax cut would allow a far greater percentage of the company’s operating profit to fall through to its net income line, which in turn would lead to a meaningful improvement in reported earnings per share. The lingering question is whether investors would see through that below the operating line improvement in earnings per share or fall into the trap of “faster earnings growth year over year means greater P/E multiple expansion?”

In our view, it rather resembles a cousin to investors paying stretched valuations for earnings growth that has been fueled by stock repurchase initiatives, especially if reported net income actually fell year over year.

Odds are there will be much back and forth in Washington over the coming weeks and months as even the White House has backed off Treasury Secretary Steven Mnuchin’s goal of passing tax reform by August, setting a new year-end target date in the process.

Getting back to House Speaker Ryan’s 80 percent comment, it means there is some 20 percent that would need to be reworked. One area that has been mentioned is the border adjustment feature, which has been viewed as one way to fund President Trump’s infrastructure program. That spending initiative, which is sorely needed per the latest report card from the American Society of Civil Engineers, would be a boon to companies ranging from Caterpillar (CAT) to Granite Construction (GVA) and other infrastructure related ones.

In its current form, Treasury Secretary Steven Mnuchin has said the border adjustment tax doesn’t work, but as Washington gets ready to haggle over Trump’s tax plan it could mean the border adjustment tax gets rethought as well. If so, we could see investor concern over rising costs for apparel companies that source heavily outside the US as well as those outside the US that derive a meaningful portion of revenue and profits from sales inside the U.S. Examples of the former would include Gap (GPS) and Michael Kors (KORS), while the latter would be companies lie Diageo (DEO) and Unilver plc (UL).

As the back and forth gets underway in Washington,  investors should continue to search for companies that could benefit from lower corporate taxes and do their due diligence on the underlying business. Given our thematic investing strategy, we’d argue that as investors do that they should factor in the various tailwinds associated with our more than 15 investing themes into their thinking.

Looking at the bigger picture, the release of this one-page, sub-200 word outline understandably gave the market pause if only due to the brevity of the proposal, as we close in on the administration’s 100th day. The market rose dramatically post-election because investors believed that the new administration would usher in a more business-friendly regime that would stimulate the economy. The market’s weakness Wednesday was likely along the line of, “That’s it? Nearly 100 days in and that’s all you have for us?” This is one more area in which the market got ahead of itself based on hopes with reality being a bit less encouraging. In time, the administration may very well put together a comprehsive plan that is compelling to Congress, but with less than 200 words and only 7 numbers nearly 100 days in, the market is left scratching its head.

Tematica’s Take on the February Jobs Report, and What It Means for the Fed and Stocks

Tematica’s Take on the February Jobs Report, and What It Means for the Fed and Stocks

This morning the Bureau of Labor Statistics published the February Employment Report. One of the last few indicators economists, market watchers and the Fed will get ahead of next week’s Federal Open Market Committee meeting came in better than expected on several fronts. Over the last few week’s we’ve seen a rising expectation for a March rate hike, but more recently we’ve gotten conflicting signals in a variety of data points. While the February reports for the both the Producer and Consumer Price Indices and Retail Sales will be published early next week, barring any major snafus in those reports the February Employment Report clears the way for the Fed to nudge interest rates higher next week.

 

The details of the February Employment Report how it stacked up against expectations

 

 

Nonfarm payrolls came in at 235K besting expectations for 190K-200K depending on the source, and the Unemployment rate held steady at 4.7 percent.  A nice beat, but job growth slipped month over month compared to the 238K revised number of jobs created in January. Overall payrolls are up around 1.6 percent over the past year as we’ve seen the 12-month trend slowing over the past few years, which is to be expected in the later stages of this cycle. Job gains were reported in in construction, private educational services, manufacturing, health care, and mining, which was offset by job losses in retail.

 

 

In looking at several other metrics in the report, the Labor Force Participation Ratio edged up a tick month over month to hit 63.0 percent in February and we saw another sequential decline in the Not in Labor Force category. The percent of Americans actually working has reached 60 percent for the first time since 2009. In our view, those metrics are moving in the right direction.

 

We also like seeing the median duration of unemployment has been continually declining since its peak in 2010. Today that number has dropped to around 10 weeks.

 

 

Since the recovery, job growth has been concentrated primarily in lower-paying jobs in sectors such as retail, hospitality, education and food service. Recently we have seen higher-paying sectors such as manufacturing and construction posting material gains. While every sector outside of retail and utilities experienced gains, manufacturing grew 28,000, the largest increase in that sector since August 2013. Construction also surged by 58,000 jobs which was the biggest gain since March 2007 and has now added 177,000 to payroll in the past six months, a likely positive sign for housing.

If we were to pick one fly in the jobs report ointment it would be the sharp increase in the number of people with multiple jobs, which climbed to 5.3 percent of total employed, up from 5.0 percent a year ago. To us, this signals that more people are under the gun when it comes to helping make ends meet due to higher health care costs, soaring student debt levels or the need to boost savings levels, especially for retirement. From a thematic perspective, we see the pick up in multiple jobholders as a confirming data point for our Cash-strapped Consumer investing theme. More about that in a few paragraphs.

 

So what do all these employment “tea leaves” tell us about what the Fed might be thinking?

As Team Tematica discussed on this week’s Cocktail Investing Podcast, retail job losses were anticipated given the growing number of store closing announcements over the last several weeks from the likes of  Macy’s (M), Kohl’s (KSS), JC Penney (JCP), hhgregg (HGG), Crocs (CROX) and others. All of these companies are contending with the downside of our increasingly Connected Society that has consumers increasingly shifting toward digital shopping.  Given the relatively mild winter weather, the pick up in construction work likely bodes well for the housing market, which is one we keep tabs on as part of our Rise & Fall of the Middle Class investing theme. From an exchange traded fund perspective, the mix of jobs created in February likely means a higher share price for SPDR S&P Homebuilders ETF (XHB) and PowerShares Dynamic Building & Construction Portfolio ETF (PKB) are to be had while SPDR S&P Retail ETF (XRT) get left behind.

As Tematica’s Chief Investment Officer, Chris Versace, reminds his graduate students at the NJCU School of Business, the Fed has a dual mandate that focuses on the speed of the economy AND inflation. The one item that is bound to catch the Fed’s attention is wage growth, which rose even though hours worked remain unchanged in February vs. January. Per the report, “In February, average hourly earnings for all employees on private nonfarm payrolls increased by 6 cents to $26.09, following a 5-cent increase in January.”

While that wage growth likely reflects some impact from rising minimum wages, the mix shift in job creation toward higher paying jobs in mining, construction and manufacturing and away from lower-paying retail jobs was the primary driver. If we had to guess the one line item that could get some attention at the Fed, it would be the combined January-February wage growth, which equates to a 2.8 percent increase year over year – near the fastest pace of growth during the current expansion, and better than the expected 2.7 percent, but still well below the rate of growth prior to the financial crisis.

However, on a monthly basis, average hourly earnings for private-sector workers rose 0.2 percent during February, which was below expectations for 0.3 percent. If we dig a bit deeper, that 2.8 percent year-over-year growth is an overall number. Wages for nonsupervisory and production employees comprise about 80 percent of the workforce and that group saw their hourly and weekly wages rise by about 2.48 percent on a year over year basis – this group isn’t getting quite the gains that their supervisors are enjoying. Additionally, this metric is not adjusted for inflation and guess what….the most recent inflation rate as measured by the consumer price index was (drum roll) … 2.5 percent. So post-inflation, no real gains. Once we again, it pays to read more than just the headlines when deciphering a report like this.

That being said, in our view, this month Employment Report helps pave the way for the Fed to nudge interest rates higher next week. We expect financials, including shares of banks such as Wells Fargo (WFC), Bank of America (BAC) and Citigroup (C) to name a few to trade higher today and lead the market higher. It goes without saying that means Financial Select Sector SPDR Fund (XLF) shares are likely to trade higher.

As the likelihood of higher interest rates are upon us, we have to consider what the incrementally higher borrowing costs could mean to consumers that have taken on considerably more debt in 2016? Team Tematica touched on this and what it likely means in this week’s podcast. While we’ve seen decent wage growth thus far in 2017, a new study from WalletHub shows that “US consumers racked up $89.2 billion in credit card debt during 2016, pushing outstanding balances to $978.9 billion, which is roughly $3 billion below the all-time record set in 2007.” This would certainly help explain the year over year increase in multiple jobholders we talked about several paragraphs above.

For an economy whose growth is tied rather heavily to consumer spending, higher interest rates could crimp the health of that economic engine when consumers start to look at their credit card interest rates. Add in higher gas prices and odds are Cash-strapped Consumers will be with us once the euphoria of today’s February Employment Report dies down. We’ll be watching credit card transaction levels at Visa (V) and MasterCard (MA) to gauge consumer debt levels and whether average transaction sizes are shrinking.

— Tematica’s Chief Macro Strategist, Lenore Elle Hawkins contributed to this article. 

What We’re Watching This Week

What We’re Watching This Week

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As you probably know, this week is a shortened one following the 3-day holiday that was President’s Day. We still have a number of companies reporting their quarterly earnings this week, and that includes the Tematica Select List’s own Universal Display (OLED). The shares have had a strong run, up just over 28 percent year to date, and that likely has them priced near if not at perfection. Last week, Applied Materials (AMAT) gave a very bullish view when it comes to the ramping organic light emitting diode manufacturing capacity, as the industry prepares for Apple (AAPL) and others switching to this display technology. Consensus expectations for Universal’s December quarter results are EPS of $0.42 on $68.6 million in revenue. We expect a bullish outlook to be had when Universal reports its results this Thursday.

Alongside Universal Display, there will be a few hundred other companies reporting. Among those, we’ll be tuning into reports from Wal-Mart (WMT), Macy’s (M), JC Penney (JCP) and TJX (TJC) for confirming data on our Amazon (AMZN) thesis. Similarly, we’ll be looking at Cheesecake Factory’s (CAKE) for confirmation in the restaurant pain that is benefitting our McCormick & Co. (MKC) and United Natural (UNFI) shares.

On the economic data front, the calendar is a tad light, with the highlight likely to be the next iteration of the Fed’s FOMC minutes. Given Fed Chairwoman Janet Yellen’s two-day testimony on Capitol Hill that we touched on above, we’re not expecting any major surprises in those minutes. Even so, we’ll be pouring over them just the same.

This morning we received the February Flash Manufacturing PMI metrics from Markit Economics and not only did Europe crush expectations hitting a six-year high in February. Across the board, from business activity to backlogs of work and business confidence, the metrics rose month over month. One item that jumped out to us was the increase in supplier delivery times, which tends to be a harbinger of inflation — something to watch in average selling price data over the next few months. Turning to Japan, the Markit flash manufacturing PMI rose to 53.5 in February, its highest level since March 2014, with sequential strength in all key categories — output, exports, employment and new orders. but Japan hit it’s highest level since March 2014.

 


Here at home, the Flash U.S. Composite Output Index hit 54.3 in February, a downtick from 55.8 in January, but still well above the 50 line that denotes a growing economy. The month over month slip was seen in manufacturing as well as the service sector. Despite that slip, new manufacturing order growth remained faster than at any other time since March 2015 and called out greater demand from energy sector clients. No surprise, given the rising domestic rig count we keep reading about each week.

Manufacturers also called out that input cost inflation was at its highest level since September 2014 and we think this is something that will have the Fed’s ears burning.

 


Currently, our view is the next likely rate hike by the Fed will be had at the May meeting, which offers plenty of time to assess pending economic stimulus, immigration and tax cut plans from President Trump. Again, we’ll be watching the data to determine to see if that timing gets pulled forward.

Stay tuned for more this week.

Earnings not boosting Trump Trade, yet markets continue to rise

Just a little over two weeks ago Donald Trump took the oath of office. Since then, nary a day goes by without President Trump dominating the pages of most every major publication. Love him or hate him, the man certainly knows how to command attention.

Yesterday both the Dow and the Nasdaq hit new interday highs, but on valuations that remain stretched as earnings reported so far have been beating less than normal and caution over policial volatility holds the “C” suite back.

Fourth-quarter results have so far eclipsed Wall Street expectations, with 65 per cent of companies beating earnings projections and 52 per cent topping forecasts for sales — both below the five-year average. Corporate America’s guidance for the current year is already coming up light, with BofA noting that twice as many companies have forecast earnings below projections than above.

 

“[Companies] are clearly excited about lower taxes, a lower regulatory environment and more pro-growth policies, but that is offset by the trade policy and immigration,” says Grant Bowers, a portfolio manager with Franklin Templeton. “There was some built-up hype after the election but we have seen a lot of conservative guidance as companies face an uncertain outlook.”

 

At Tematica we suspect that investor expectations, which translate into higher share prices, are getting way ahead of themselves. According to a recent Gallup poll, 53% of American’s disapprove of the job he is doing with only 42% approving. That is the lowest level of any president in history after two weeks in office. So whether you love or hate the job he is doing, he is likely to face significant headwinds pushing through legislation, which means these changes that investors are so optimistic about are likely to come later rather than sooner and may not deliver quite the level of change anticipated.

What has us even more concerned are all the global events that would otherwise be receiving front-page treatment that are relegated to lining hamster cages, without much attention. Greece… still a potentially big problem. Italian banks … still seriously troubled. French elections… one of the front runners is hell bent on exiting the European Union. Were that to happen, the Eurozone would collapse and its currency with it – a very big deal.

We will have a lot more on this in the coming days and weeks, so stay tuned!

Source: Corporate America fails to add gas to Trump rally

Friday’s January Job Report a Blowout, But There’s More You Need to Know

Friday’s January Job Report a Blowout, But There’s More You Need to Know

This morning’s January Employment Report showed the economy added 227K  jobs in January, beating consensus expectations for 170K jobs.  This comes after the surge in January private sector jobs to 246K vs. the expected 165K reported by ADP earlier this week. Great to see some data to back up the uber-optimistic market these days, but there is a bit more to this story.

While the headline number looked great, digging beneath the headline and into the details the report wasn’t as rosy. If we take into account that revisions to the prior two months reduced jobs by 39k, the average is closer to expectations and the 3 month moving average is less impressive.

We also saw a decline in employment in the key working age group of 25-54-year-olds of 305k, which was partially offset by a 195k increase in 55+ employment – more near retirement working and fewer in prime working years isn’t a positive sign. Looking at the bigger picture, job growth averaged 239k in 2014, falling to 213k in 2015 and this report brings the recent 12-month average to 182k. The pace of job growth continues to slow,  total payrolls rose now up 1.6 percent year over year versus 1.9 percent in the first quarter of 2016, which is typical with an economic recovery that is rather long in the tooth.

We also saw an increase in those working part-time because they cannot find full-time work by 232k – we’d obviously prefer to see that decline. Those expecting a Fed rate hike soon should note that this is one of Fed Chair Yellen’s favorite metrics.

 

Along these lines, we saw the underemployment rate (as measured by the U6) rise to a three-month high of 9.4 percent from December’s 9.2 percent.

Along with that increase in part-time workers, we saw the change in weekly hours worked drop to a rate not seen since the recession, which indicates that future strong job growth is less likely.

 

More frustrating is the lack of meaningful wage growth, rising just 0.1 percent month over month and 2.5 percent year over year, the weakest year over year gain since last March. Average weekly earnings saw the weakest gain in six months at 1.9 percent.

 

One of the biggest challenges facing the employment situation is the mismatch between available labor and business needs. Small businesses are finding it increasingly more difficult to find qualified talent for the position they are looking to fill, which clearly negatively impacts their ability to grow – another headwind to the economy. This is also reflected in the record level spread between job openings and hirings we see every month in the JOLTS report. Our next take on that data comes next week with the December report.

 

All this those doesn’t address the much bigger issue the country is facing and this is what investors need to understand far more than the monthly fluctuations.

The growth of an economy is dependent on just two things: the size of the available workforce and productivity levels. For an economy to grow one or ideally both of those need to be rising.

It has become a popular refrain to refer to President Trump as the next Ronald Reagan, implying that his policies will lead to the type of economic boom that the country experience during and after Reagan’s presidency. We’d love nothing more than for the country to see that kind of growth again, but the fundamentals today are very different from those in the 1980s.

When Reagan took office median baby boomers were moving into their prime working age and the percent of women in the workforce was rising significantly.

 

When Reagan took office, less than 50 percent of women were employed. That number peaked in 2000 at 58 percent but has declined to just 54.1 percent in January.

 

The weak employment relative to total population though isn’t all about the baby boomers retiring as the percent of those in the prime working age cohort ages 25 to 54 years rose dramatically from the early 1980s to just over 72 percent to a peak of over 81 percent in 2000. As of January, 78.2 percent are employed, a level we haven’t seen, outside of a recession, since the late 1980s.

You might have heard as well that fertility rates in developed economies have been slowing dramatically. In many European nations the rate has dropped below replacement levels, which means that without immigration, the total population of those countries would be declining. In the U.S. the rate of growth of the working population, either through immigration or native births has been slowing significantly.

 

The potential growth rate of the U.S. economy is materially different today than during Reagan’s era because of significant changes in the dynamics of the labor pool. Today the percent of people choosing to be in the workforce is lower than it has been in decades. Compounding this problem, the growth rate in the working age population has slowed dramatically from where it was in the 1980s.

To increase the potential growth rate for the economy, outside of any handicaps placed on it through legislation, regulation or taxation, the population of those in the workforce needs to increase and/or productivity needs to rise.

When it comes to productivity, it is all about capital investment and for years we’ve seen companies choosing to buy back shares rather than reinvest in their own productive capacity… but that’s a topic for next time!