In “Give Small-Business Owners False Hope Again!“, we gently suggested that while it’s unquestionably a good thing that small-business owners in America are feeling upbeat about the future, it’s important that everyone at least consider the possibility that the economic sugar high from late-cycle fiscal stimulus is just that: a sugar high.
Populists employ short-term, often slapdash “fixes” in the interest of perpetuating the idea that they’ve “succeeded” in restoring something that’s been “lost” to a people. In America’s case, what’s been “lost” is U.S. industrial “greatness” and the “fix” is a combination of aggressive, pro-cyclical stimulus and tariffs.
The stimulus is not just ill-timed, it’s also ill-conceived to the extent you think deficit-funded tax cuts for corporations and the wealthy at a time when corporations and the wealthy were already doing pretty well, is a fool’s errand.
For the purposes of this brief post, though, let’s set aside the myriad normative concerns around mortgaging the country’s future in the interest of making the rich richer and turbocharging an economy that was already steaming along, and focus on a simple concept: U.S. fiscal policy has created an interesting dynamic for equity investors.
The tax cuts have manifested themselves in a buyback binge and have also helped corporates report record profits. The former (the buybacks) serves as a powerful technical for the market, while the latter (record profits) bolsters the fundamental argument for staying long U.S. stocks.
At the same time, the effects of Trump’s fiscal policies are likely to prove ephemeral. You don’t have to be an incorrigible pessimist to believe that. Inherent in the word “stimulus” is the notion that what you’re doing is designed to produce quick results. Obviously, you’re going to try and design policies that also create a sustainable positive impulse (nobody comes out and admits to being deliberately myopic), but that doesn’t usually work out. This time isn’t likely to break with precedent in that regard.
So that’s a rather odd juxtaposition, isn’t it? U.S. equity investors are staring at two of the most overtly bullish catalysts imaginable (record buybacks and record corporate profits), but paradoxically, those two normally unequivocal buy signals may in reality be the exact opposite of “unequivocal” – that is, they may be a complete mirage.
With that in mind, have a look at this chart from SocGen’s Andrew Lapthorne:
“The chart shows that while reported post-tax net income growth is strong, pre-tax income growth began slowing and peaked a year ago”, Lapthorne writes, in a note dated Monday, before rather dryly noting that “for US equities the tax cut was timely.” He continues:
It is also expensive, with the resultant tax-take implied from the BEA whole economy data dropping to a mere 10%. Companies with higher tax rates performed strongly in the run-up and aftermath of the tax cuts, but have struggled long/short for the last few months. So, the tax effect looks increasingly behind us.
To be sure, Lapthorne has been arguing for what seems like ages that markets will eventually wake up to the reality that is an overleveraged U.S. corporate sector and a market that’s partially propped up on debt-funded buybacks. So far, U.S. stocks haven’t listened to the warning inherent in Andrew’s argument.
But seeing as how that argument is based on, well, based on reality, and seeing as how deficit-funded tax cuts and debt-funded buybacks aren’t generally consistent with reality (where “reality” just means a recognition of common sense concerns for fiscal rectitude and balance sheet discipline), one day, Andrew will be right.
Whether that day comes sooner or later is an open question. So far, the answer is “later”.