As we get set to usher in Q2, the only question anyone truly cares about is this: “does the failure to repeal and replace Obamacare presage trouble ahead with regard to tax reform and fiscal stimulus?”
According to Goldman’s latest, out moments ago, investors fall into two camps with regard to that question. To wit:
This week the market struggled to readjust its expectations for US government policy following the move away from health care reform. Client conversations make clear that investors fall into two camps: The first group worries that the failure to “repeal and replace” the Affordable Care Act is a sign that other items on the policy agenda are less likely to be enacted than they had hoped. Others are encouraged about the shift in focus to tax reform as the new top priority for the administration.
That’s a reflection of something we talked about earlier this week. Namely that some folks are inclined to take a “glass half-full” approach here. In terms of the sell-side, BofAML even went so far as to say that the health care debacle was “the best thing to happen to Trump trades since the inauguration.”
Well, irrespective of which camp you happen to be in, the simple fact of the matter is that trades which would benefit from tax reform and stimulus have been faded – and in some cases faded ‘bigly.’ This is something you need to be acutely aware of and given that, we present the following brief excerpts from the Goldman note cited above.
Investors weigh policy versus growth as the market shifts from political hope to reality
Even more than the modest decline at the market level, performance below the surface highlights a moderation of investor policy optimism. Our basket of S&P 500 stocks with the highest effective tax rates — the most likely beneficiaries of potential tax reform — has unwound all of its sharp post-election gains in the last two months. Similarly, small-caps, which rallied by 16% in the month post-election on hopes of faster growth, lower taxes, and less regulation, have lagged the S&P 500 by 390 basis points this year (+6% vs. +2%). Both the tax basket and small-caps rebounded this week.
Infrastructure beneficiaries have also retreated, but remain above their pre-election levels, and well above levels before both candidates advocated increased spending on the 2016 campaign trail. Despite their 10% decline in the last two months, Construction Materials stocks trade at a 28x forward P/E multiple and remain 20% above their prices one year ago.
Skeptical investors have also withdrawn most of the “deregulation premium” from the share prices of banks stocks and other financials. Hopes for less regulation, which our Banks analysts estimate could boost their 2018 earnings estimates by nearly 20%, lifted share prices more than 10% higher than justified by the rise in Treasury yields. This deregulation premium has collapsed sharply in the last two weeks (Exhibit 2).