Thursday, December 14, 2017

Fueling the Bull Market

As the stock market continues to soar, it is attracting more money into stocks. That’s what usually happens during meltups. I think the market may be in the early stages of a meltup. We will call it a “meltup” if my 2018 year-end target of 3100 for the S&P 500 is reached within the next 3-6 months rather than the next 12-18 months. To some observers, reaching 3100 by the end of next year may appear to be a meltup since it would mean that the S&P 500 would have risen 51.7% over the three years 2016-2018.

Maybe so, but let’s see whether earnings continue to rise rapidly, providing fundamental support for the stock gains so far and in the year ahead. A cut in the corporate tax rate, effective next year, along with continued deregulation should bolster profits. So should a continuation of the global synchronized boom.

Meanwhile, the flow-of-funds case for a meltup is mounting as more hot money pours into equity ETFs. Over the past 12 months through October, equity ETFs attracted a record $375.6 billion of net new money. Admittedly, some of that money might have come out of equity mutual funds, which had net outflows of $51.7 billion over this same period. Collectively, equity mutual funds and ETFs had net inflows of $323.9 billion, the best such pace since September 2014.

So far, the exuberance for stocks reflected in equity fund inflows is supported by the exuberance of industry analysts about the outlook for S&P 500 revenues and earnings. The weekly “squiggles” data for revenues and earnings show that industry analysts are turning increasingly bullish on the outlook for S&P 500 earnings. They are projecting earnings gains of 10.9% this year, 11.4% next year, and 10.1% in 2019. Presumably, these numbers don’t fully reflect the likely big positive impact of a cut in the corporate tax rate next year.

If that happens before the end of this year, analysts may wait until Q4 earnings calls during January to get some guidance from company managements on how tax reform will impact their earnings estimates on balance. These calls are likely to be relatively bullish, driving stock prices higher early next year. Forward earnings is up to a record $145.06 per share, 13.2% above the four-quarter-trailing sum through Q3.

Thursday, December 7, 2017

Proprietors’ Income Matters

Almost always ignored in discussions of corporate profits is proprietors’ income, which is included in personal income on a pretax basis. It is up 2.7% y/y and in record-high territory. A comparison with pretax corporate profits shows that proprietors’ income recently has approximated 60% of corporate profits. Here are some definitions from the National Income and Product Accounts:

(1) “Nonfarm proprietors’ income measures the income, before deducting income taxes, of sole proprietorships, partnerships, and other private nonfarm businesses that are organized for profit but that are not classified as corporations. Sole proprietorships are businesses owned by a single individual. Partnerships include most associations of two or more of: individuals, corporations, noncorporate organizations that are organized for profit, or of other private businesses. Other private businesses are made up of tax-exempt cooperatives, including credit unions, mutual insurance companies, and rural utilities providing utility services and farm marketing and purchasing services.”

(2) “Unincorporated businesses … are able to move assets freely between business and personal accounts with little, if any, reporting requirements, and tax liabilities are not separated between unincorporated businesses and their owners. In fact, the income of unincorporated businesses is generally reported on individual income tax returns; while compensation paid to employees is separately reported, the income of the business is not distinguished from the labor of the business owner and therefore reflects the incomes that accrue as a result of the owner’s own labor and entrepreneurship. Similarly, dividend and interest incomes are separately reported but do not distinguish between business and personal receipts.”

(3) “Reflecting the concepts of national economic accounting, nonfarm proprietors’ income in the NIPAs is defined as that arising from current production.”

Obviously, the wellbeing of small unincorporated businesses is an important contributor to the wellbeing of the overall economy. Corporations, partnerships, and sole proprietorships all are likely to increase their payrolls and expand their capacity when their profits are rising. They are likely to retrench when their profits are falling.

We soon should find out whether the Republicans’ tax reform plans include substantial benefits, not only for corporations but for other businesses as well.

Wednesday, November 29, 2017

Corporate Taxes: Facts vs Fiction

In the realm of economics, there are lots of theories. There are also lots of urban legends. Both are often propagated despite lots of facts that question their credibility. Daniel Patrick Moynihan, the former senator from New York, once said, “Everyone is entitled to his own opinion, but not to his own facts.” In today’s world of “fake news,” sorting out fact from fiction is a challenge. In the realm of economics, there’s no shortage of data, which can be very helpful in discerning the difference between information and disinformation.

Which brings me to the subject of the US corporate tax rate, which Republicans are aiming to cut. The widespread view, especially among Republicans, is that the corporate tax rate is too high. They aim to pass a tax reform package before the end of the year that will lower the statutory rate from 35% to 20%. I’m all for tax cuts. However, I’m having a problem with the data:

(1) GDP data. Yesterday’s GDP release for Q3 included corporate pretax and after-tax corporate profits. The data show that corporations paid $472.9 billion in taxes over the past four quarters through Q3. This series has been hovering in record-high territory around $500 billion since Q2-2014.

Dividing this tax series by pretax profits of $2281.4 billion over this same period shows that the effective tax rate has been significantly below the statutory rate since the start of the previous decade. During Q3, it was only 20.7%!

(2) Treasury data. But wait … the plot thickens: Actual corporate tax revenues collected by the IRS have been consistently less than the corporate taxes included in the GDP measure of corporate profits since the start of the former data series in 1972. For example, over the past four quarters through Q3, the Treasury reported collecting $297.0 billion in corporate tax revenues, 37% less than the $472.9 billion shown by the GDP measure, on a comparable basis.

The shocking result is that the effective corporate tax rate based on actual tax collections was only 13.0% during Q3, and has been mostly well below 20.0% since the start of the previous decade.

What gives? I’m not sure, but I am inclined to follow the money, which tends to support the story told by the IRS data. If so, then Congress may be about to cut a tax that doesn’t need cutting. Or else, the congressional plan is actually reform aiming to stop US companies from using overseas tax dodges by giving them a lower statutory rate at home. We may not be able to see the devil in the details of the bill until it is actually enacted.

Wednesday, November 1, 2017

Happy Days for US Consumers

We live in happy times. How can that be given all the unhappy happenings in DC these days? Apparently, we are all tuning out the political static and focusing on what matters most: jobs. While our politicians continue to promise policies that will create more jobs, we are doing just that despite Washington. As a result, consumer confidence is soaring. Consider the following happy developments:

(1) Consumer confidence. Both the Consumer Sentiment Index (CSI) and the Consumer Confidence Index (CCI) jumped in October. I focus on the average of the two, which we call the “Consumer Optimism Index” (COI). During October, the overall COI jumped to 113.3, the highest since December 2000. Its current conditions component rose to 133.8, the highest since March 2001, while its expectations component rose to 99.8, its best reading since January 2004.

(2) Availability of jobs. Among the plethora of series included in the CSI and CCI surveys of consumer confidence, our favorites are the jobs plentiful, jobs hard to get, and jobs available series from the latter source. During October, 36.3% of respondents agreed that jobs are plentiful, the highest reading since June 2001. The jobs-hard-to-get percentage fell to 17.5%, the lowest since August 2001. It tends to be highly correlated with the unemployment rate, and suggests that the jobless rate is still falling.

(3) Wages. In the past, there was a reasonably good correlation between wage inflation and the jobs plentiful series This was so using the yearly percent change in either average hourly earnings or the Employment Cost Index (ECI). The latest data show that average hourly earnings for production and nonsupervisory workers rose 2.5% y/y during September, while wages and salaries in the ECI rose 2.6% during Q3. Both remain surprisingly low given the plentitude of jobs.

So why are consumers so happy? Jobs are plentiful and wages rising faster than prices. The PCED rose 1.6% y/y during September.

Tuesday, October 3, 2017

Message to Buffett: Thanks a Million!

Among the various stock market valuation gauges, Warren Buffett has said he favors the ratio of the value of all stocks traded in the US to nominal GNP, which is nominal GDP plus net income receipts from the rest of the world. The data for the numerator is included in the Fed’s quarterly Financial Accounts of the United States and lags the GNP report, which is available a couple of weeks after the end of a quarter on a preliminary basis. Needless to say, it isn’t exactly timely data.

However, the S&P 500 price-to-forward-revenues ratio (a.k.a. the price-to-sales ratio), which is available weekly, has been tracking Buffett’s ratio very closely. In an interview with Fortune in December 2001, Buffett said: “For me, the message of that chart is this: If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you. If the ratio approaches 200%—as it did in 1999 and a part of 2000—you are playing with fire.” That’s sage advice from the Oracle of Omaha.

Buffett’s ratio rose back to 176% in Q2-2017, nearly matching the Q1-2000 peak of 180, and the weekly measure rose to 198% in mid-September. Yet Buffett chose to ignore all that, predicting that the DJIA will be over 1 million in 100 years. He said that on September 19, 2017, speaking at an event in New York City marking the 100th anniversary of Forbes magazine. Buffett noted that 1,500 different individuals have been featured on Forbes’ list of 400 wealthiest Americans since the start of that tally in 1982. “You don’t see any short sellers” among them, he said, referring to those who expect equity prices will fall. He added, “Being short America has been a loser’s game. I predict to you it will continue to be a loser’s game.” Buffett also said, “Whenever I hear people talk pessimistically about this country, I think they’re out of their mind.”

CNBC reported that Mario Gabelli joked on Twitter about whether Buffett’s normally sunny outlook had darkened given the numbers: “one million in one hundred years ... has Buffett turned bearish?,” Gabelli tweeted. He noted that the roughly 3.9% compound annual growth rate (CAGR) needed to get from where the Dow is today to where Buffett predicts it will be in 2117 would be lower than the 5.5% CAGR from the beginning of the 20th century until now. Let’s have a closer look at the numbers:

(1) I have a monthly series for the DJIA starting December 1920. I can put it on a ratio scale and compare it to alternative compounded annual growth rate (CAGR) lines. During the 1950s to 1970s, the DJIA crawled along between CAGR lines of 4%-5%. During the two bull markets of the 1980s and 1990s, it climbed from a CAGR of about 4% at the August 1982 trough to about 6% at the March 2000 peak. During the 2000s and 2010s, it has been rising around the 6% CAGR trend.

(2) Starting from the last trading day of 2016, when the DJIA was at 19,763, I calculate the following DJIA targets in 2117 in round numbers: 54,000 (1% CAGR), 146,000 (2%), 391,000 (3%), 1,038,000 (4%), and 2,729,000 (5%).

(3) Adjusting for inflation, using the CPI since December 1920, the real DJIA has been rising between the 2%-4% CAGR lines averaging around 3%. Since 2000, it’s been tracking the 3% line quite steadily.

(4) All of the above is based on the long-term annualized return of the DJIA ignoring dividends. Nevertheless, it is interesting that the 3.0% real annualized return from net capital gains isn’t far off the 3.3% average real earnings yield of the S&P 500 since 1952. I derived that yield by subtracting the CPI inflation rate from the S&P 500’s earnings-price ratio.