@theMarket: Earnings Up; Stocks, Not So Much
Earnings season kicked off last Friday with the bank results. The numbers were stellar, but the stock prices of those companies fell hard. Since then, the same thing has occurred to any number of companies. What is going on?
At first, you might think it's classic "sell on the news" behavior where traders bid stock prices up prior to the earnings announcement and then take profits immediately after. However, a closer look reveals something different going on.
For months, investors were expecting a boost to corporate profits from the tax cuts passed by Trump and the GOP last year. Boy oh boy, we said, just wait and see how great earnings will be in the first quarter. Wall Street analysts came to a consensus that corporate profits could be up by 20 percent or more year-on-year. The stock markets roared to life in January, discounting much of these expectations.
Since then, stocks have dropped and only recovered about half of those losses year to date. But there's more. Investors are also discounting these 20 percent earnings pops because the earnings gains from tax cuts are of a much lower quality than the day-to-day profit gains generated from their business.
Traders and investors alike are ignoring the headline numbers and delving deep into the results. If earnings beats are simply a function of tax savings, down goes the stock price. So, this time around, first-quarter earnings are not what they seem.
And what the government giveth, so the government can taketh away. In my previous column "Why tax cuts are unpopular with Americans," I worry about the durability of these partisan tax cuts. Like the passage of Obama Care by a Democrat-controlled Congress, the tax bill was also a partisan action. If Democrats regain control of either house of Congress, we can expect an effort to roll back these tax cuts.
Until we see the lay of the land in November, why should investors assume the tax benefits for corporations are here to stay? Company managers are acutely aware of these risks as well. It might explain why, rather than commit to a multiyear investment plan in their core business or the hiring of extra labor, they would rather buy back stock and increase their dividends to shareholders with the money.
That, of course, creates a vicious circle. The Democrats (and some Republicans from income tax states) will use this to argue that the tax cut was never intended to grow the economy, but rather reward Republican donors and Trump's political base. Budget hawks will point to the exploding deficit as another reason to raise taxes. If that tactic works, it will convince companies to delay any tax-fueled investment plans even further.
The moral of this tale is that partisan politics doesn't work. It didn't work under Obama and it won't work under Trump. Unfortunately, most Americans fail to understand this today.
The era of compromise in this country is long gone. Instead, we choose chaos and crisis. Last week, I warned that we were not quite through this period of volatility. We had three up days this week, and two down days. That should continue, but with an upward bias.
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The Independent Investor: Why the Tax Cuts Are Unpopular Among Americans
Despite spending big money and all the marketing they can muster, the Republicans are still not able to convince most Americans that the tax cut benefits anyone but the rich and the corporations they own. Maybe, we are not as dumb as they think we are.
An April poll by Gallup indicated that 51 percent of Americans disapproved of the tax cut, versus 39 percent who approved of the cut. Another poll, conducted by NBC News/Wall Street Journal, found that 36 percent of the people they polled thought the tax cut was a bad idea, while only 27 percent believed it was a good idea.
Normally, you would think that a tax cut that benefits "all Americans" and "especially the middle-class working man," according to president Trump and his party, would be greeted with great enthusiasm. Even more confusing are polls that indicate that more of us (by a slim majority) believe that middle-class taxes are fair.
I believe there are a couple of conflicting cross-currents that are shaping our view of taxes. For one thing, the tax bill was cobbled together quickly and passed unilaterally to give the president legislative victory before the end of his first year. As a result, few really know what's in it, or how all the changes will impact the individual taxpayer.
We've been given, for example, a new set of tax brackets for individuals, but, at the same time, most of the itemized deductions have been removed. There are also more questions than answers regarding who can file and benefit for the new 20 percent pass-through tax rate. Most accountants I have talked to still have no idea how to plan for their client's taxes this year and don't know when they will.
Given that the federal tax code has experienced its most significant changes in decades, it will take time to analyze its ramifications. As such, the majority of individual taxpayers are still uncertain if the new law will help or hurt them over the long run.
The controversial limit of how much state taxes can be deducted from your federal bill (capped at $10,000 from all sources) will most likely mean that in states with income taxes many taxpayers will either experience a minimal benefit from the tax bill, or in some cases, be paying more taxes. Given that large segments of the country's population live in these states, their disenchantment with the tax bill is understandable.
Democrats (all of whom voted "no" for the bill) have been quick to point out that the tax bill was nothing more than a vast re-distribution of wealth from the middle class and low-income Americans to the wealthy, rich CEOs and big corporations. What's more, whatever benefit the average Joe might receive now will expire by 2025. At that point, not only will your tax rate go back up, but there will be no itemized deductions to ease the blow!
These accusations just fuel the anger of 6 out of 10 Americans, who feel upper-income people pay too little in taxes as it is. In addition, prior to the tax cut, a large majority of Americans had already believed that corporations pay too little in taxes. Now they pay even less. It also doesn't help much that our congressmen and senators stand to make a huge windfall personally from the tax cut, as does the president and his family.
As we head into the mid-term elections, there is a growing expectation that the Democrats will retake the House, if not the Senate. If so, many of these tax cuts could be reversed. You can bet those lawmakers from income tax states will certainly be pushing for major revisions.
In the meantime, Corporate America isn't helping the GOP cause. Instead of using their windfall tax profits to invest in America and hire more workers, they are using the money to reward their shareholders by raising their dividend payouts to historical levels. In the first three months of 2018, dividends have increased by $18.8 billion — that's a 13.9 percent increase over last year. At that rate, dividend payout increases could total more than $56 billion this year.
In addition, corporations have also announced $159 billion in share buybacks. Analysts expect that figure to rise to $800 billion by the end of the year. That would be a 10 percent increase over last year.
Between buyback and dividend increases, roughly 23 percent of the $1.5 trillion in tax cuts have already been spoken for. Remember too, that these dividends and buybacks go directly into the pockets of the wealthy, who are already enjoying outsized benefits from the tax cuts.
It just proves a point, that we Americans are not as dumb as we look. We know a bad deal when we see one and for most of us, this dog won't run.
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The Independent Investor: The Facebook Fallacy
After a grueling two-day inquisition before both houses of Congress, Mark Zuckerberg, the founder of Facebook, has left the building. The question is how much did anyone really learn about the privacy issues of this social media behemoth?
As most readers are aware, the present controversy erupted when it was revealed that a Trump-campaign related firm, Cambridge Analytica, harvested personal data from millions of Facebook users. It spawned a huge controversy over privacy, cybersecurity and Big Data companies in general.
I watched as much of the hearings as I could stomach. What was clear to me was most of our so-called legislators had no idea how Facebook works. While some were obviously coached by their aides, even the answers to their questions drew blank or embarrassed stares. How they expect to regulate something they don't understand is beyond me, but then again, I guess it happens all the time.
It could be any one of us up there grappling to understand an entity that has become so entangled in our everyday lives. The truth is only a handful of Americans truly "get" what Facebook is even though they have been upfront with us since the get-go.
So, let's start by asking a simple question — how does Facebook make money? And yes, Joe, Facebook is a for-profit company. In one word, the answer is advertising. How much is that worth? At last count, the company is capitalized at roughly $543 billion. Clearly, Facebook is not some kumbaya, social network where everything is free no matter how touchy-feely it may look.
Helping two billion people worldwide "connect" is an admirable accomplishment from a social point of view, but it is also a darn good revenue generator. Let's be clear, Mark Zuckerberg has never said it wasn't. He has reminded everyone countless times that "building a mission and building a business go hand in hand."
Selling ads has generated over $39 billion for the company. So, what makes advertisers flock to Facebook when they could just as easily spend their money on tv or radio ads? One word: the product.
"What product?" you may ask.
That's easy. You're the product — along with all the countless billions of bytes that represent the information you have so generously spewed out over years and years of posting personal information about yourself and everyone in your universe. How much of that information you want to share with the world and advertisers is completely up to you.
Through the years, the thousands and thousands of Facebook employees have given you almost every option they could think of to "opt out" of sharing that information. Instead, if you are like me, we blithely pump out more and more personal information to the outside world without a care of how or who is using it. That is until the bad guys start to take advantage of our stupidity.
Suddenly, when that happens, we all feel betrayed by the very entity that tries to protect us when the fact is, in my opinion, that we all have been too lazy to read the material, examine and control who we are sending information to, and doing all that is required to use this social network in a rational way.
We are like the guy who uses 1-2-3-4 as his password on all his accounts. He is then hacked and subsequently sues the company for not providing enough password protection.
You may even admit to the worth of my argument but still insist that you would fulfill your obligations if the safeguards weren't so complex and difficult to use. That's like saying I would practice gun safety if I could figure out which end the bullet came out. The meaning here is you have no business using social media if you don't understand its ramifications to you, your family, and your friends.
No matter how much social media companies try to protect us, who can protect us from ourselves? If you post photos of walking your dog day in, day out at a specific, isolated location, and then someone mugs you there, can you guess why?
The point is that we are Facebook's product. It has always been the case. Yes, we are a lucrative product to them, but it is we who determine what we want to give away. So far, most users have been willing to give away the farm. Are you one of them?
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@theMarket: The Trump Trade Bluff
This week, our fearless leader upped the ante on the tariff tiff with China. It went like this: Trump announced his list. China announced theirs. And at the end of the week, the president sees them one better. Aside from the volatility, it is causing in the stock markets, not much besides headlines has been accomplished.
Are you seeing the pattern yet? Think back to Trump's schoolyard diplomacy with Kim Jong-un, the leader of North Korea. First, a furious exchange of tweets and name-calling between the two. That was followed by saber-rattling on both sides. More test missiles. Naval ships steaming toward the Peninsula. The media spent days explaining the "what ifs" while stocks went up and down.
In the end, the two neighborhood bullies now appear willing to play nice and meet at the end of the month. I fully expect our president to come out of the meeting extolling "Fatty the Third" as his newest and dearest best friend.
Now compare that to the tariff turmoil. Tweets, counter tweets, threats, etc. are flying this way and that; but so far, it's all smoke and mirrors. Investors here in the U.S. are still reacting like puppets on a string, but elsewhere governments and stock markets are disengaging from these Trump tactics.
Take Thursday night's announcement. Trump ordered his trade rep, Robert Lighthizer, to "consider" an additional $100 billion in trade tariffs against China. By the time he does all that studying, a few months will have passed. In the meantime, things change and there is no guarantee that any recommendations will ever see the light of day.
However, like the puppets we have become, Thursday night's futures market for the Dow Jones Industrial Average fell by over 500 points. Corresponding drops in our other indexes also occurred. But here is where foreign investors parted ways with our traders. Japan's stock market traded up slightly at first and then dropped by a small amount at the end of the day. Some markets, such as Hong Kong and India, finished higher. By the time we opened for business on Friday morning, the losses in our own averages were pared back by more than half.
Like a dog whose bark is worse than its bite, global investors and governments are beginning to realize that what comes out of the Twitter-in-Chief's mouth (or his Twitter account) is neither policy nor necessarily even the truth. As such, investors would be well advised to ignore his pronouncements. Granted, that's hard to do because the president will go to great lengths to stay in the center of the spotlight, no matter what he needs to say or do to accomplish that goal.
Nonetheless, do not act on his statements. Next week, earnings season begins, and analysts expect good things from Corporate America. Wages continue to gain (2.7 percent on an annual basis), according to the latest non-farm payroll report, although the number of jobs gained (103,000) was 90,000 short of expectations. From a macroeconomic point of view, things look good and are gaining momentum.
As for the markets, I expect volatility will continue. Right now, the S&P 500 Index is caught in a 100-point trading range and will probably not break out of it until the middle of April at the earliest. Cushioning the market somewhat, as I expected, is the tax cut. U.S. dividends increased in the first quarter to a record high. Corporate buy backs are also recording the same kind of gains, as most corporations reward their investors by passing along their tax savings, rather than investing them in jobs or capital spending (as the legislation's authors promised). That makes owning stocks a good bet for the future.
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The Independent Investor: Free Trade Vs. Fair Trade
In today's world, talk of tariffs is part of daily news headlines. Politicians use terms like "free" and "fair" almost interchangeably in discussing trade to justify their position for or against tariffs. Maybe it's time to review the difference between the two concepts.
While they may sound similar, free trade and fair trade are often at opposite ends of the pole. Free trade is a world where the gloves are off. It allows international cut-throat competition where the marketplace can drive the cost of products way below the price where anyone can make any money. Free trade makes things cheaper including the money we earn to produce those goods.
Fair trade, on the other hand, is in the eye of the beholder. What may seem fair to you or me, maybe the opposite from someone else's point of view. That's because fair trade places all kinds of restrictions on producers of goods and services. Overall, fair trade tends to make goods more expensive. That's because it costs more money to guarantee a minimum wage or make sure that a coal mine or steel mill's working conditions are safe.
However, throughout history and into the present day, both concepts are abused quite often. Take our country's attitude toward trade. After World War II, for example, North America was the only continent left standing. Europe, Asia and everywhere in-between had been decimated by warfare. Our allies needed help and free trade seemed to be the best answer to rebuilding the world in the shortest time possible.
It was the age of Japanese transistor radios, cheap autos from Europe, and U.S. industrial and food products that could be purchased with extremely easy terms. America opened its arms to anything the world could export to us. The purpose was to rebuild and increase economic growth worldwide for both the winners and the losers. All we required was an adherence to democracy.
We accepted free trade, while allowing our partners to re-build on the foundation of fair trade. The purpose was to allow agriculture, industrial production, and the consumer to recover in war-torn regions. We deliberately looked the other way as countries like France, Germany or Japan set tariffs on our cheap imports to protect their own struggling dairy or textile businesses.
Over the years, we all got used to this kind of lopsided arrangement. After all, America was the leading economic power in the world by a wide margin. We could afford to carry the world's weight on our shoulders.
Fast forward to today. Yes, we are still No. 1, but China is a close second. Europe over the past 50 years has forged their own powerful economic union and yet some of our trade deals have failed to keep up with these changing economic circumstances. Part of that problem, I believe, has been the U.S. practice over the past several decades of exchanging economic benefits for geopolitical influence.
How many times in the past have we given massive amounts of foreign aid in the form of trade deals, or gone along with outrageous tariffs on American imports just to achieve some dictator's promise to forsake communism or socialism and follow our brand of democracy? Clearly there is, and has been, a long list of unfair trade practices by just about every country in the world, including our own. I do not believe free trade exists in the world today. But recognizing that our steel and aluminum industry may need some relief from some other country's dumping practices is not the end of the world.
It appears to me that the present turmoil in the financial markets simply reflects something new and different and to some, a therefore dangerous turn of events. Because it has been so long since our country has stood up for itself in the trade arena, those invested in the status quo fear any change at all — even if it is to our benefit.
I commend the president for addressing this issue. Could he have found a better way to do it? Sure, but then again, I'm not the person sitting in the hot seat. Getting a better deal at the trade table is long overdue for this country, even if in the short-term, it might upset a few apples in the cart.
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