Good News From Washington D.C.

Thursday’s action seems to be unusual because everything that came out of the fiscal policy front was positive, but stocks didn’t move higher. The S&P 500 has closed at almost the same level for a few days. The VIX was below an 11 handle once again, signaling not even a whiff of risk is on the radar. The two reasons stocks may not have rallied is because oil plummeted over 4% causing the S&P 500 energy ETF (XLE) to fall 1.84% and the stock market is already near its all-time high.

Weak oil prices could potentially weaken S&P 500 earnings, but we’re not at that point yet. Energy is expected to make up 4.02% of Q4 2017 S&P 500 earnings. If you bake in a slight miss to expectations, there isn’t much impact if oil bounces around between the mid-$40s and the mid-$50s. Therefore, I’ve been saying oil falling to the $30s and staying there would damper earnings. I remain in the camp that thinks oil will fall to that price. The May 25th OPEC meeting will be the event which decides where oil goes.

As you can see from the chart below, S&P 500 operating earnings are expected to skyrocket in the next twelve months. The most important sector which is expected to drive earnings is technology led by Apple, Facebook, and Microsoft. The information technology sector is expected to make up 25.25% of Q4 2017 S&P 500 earnings. Analysts see a giant leap in earnings. Q1 has delivered on those estimates even with weak GDP growth. While I’m expecting earnings to come in lower than estimates, it’s tough see that catalyzing a decline in stocks since earnings fell in 2015 and stocks didn’t change their trajectory; they just stalled.

Before I get into a review of the fiscal policy news which occurred on Thursday, let’s look at the most interesting chart I’ve seen this year. It shows the number of respondents who gave positive comments about the government’s economic policies without being asked. These people who are giving this unsolicited information are Trump voters. The number of positive reviews on fiscal policy are about triple the amount given during the beginning of the Reagan, Clinton, and Obama administrations. In the past, these early administration surges have dwindled quickly. As a reminder, consumer sentiment doesn’t reflect consumer spending, so I don’t give it credence. I follow it because the market participants do. A decline in sentiment could hurt stocks in the short-run.

House Passes American Healthcare Act

Unsurprisingly the Senate voted to support a spending bill which averted a government shutdown. I was always on the side of not worrying about a shutdown because the 2013 shutdown is still fresh in the minds of lawmakers. 53% of voters blamed Republicans for that shutdown. Therefore, the Republicans were worried about another one. The Democrats were also likely weary that a minority party could be blamed, so they didn’t force one. Oddly, the big sticking point the Democrats had which was the potential elimination of the cost-sharing payments wasn’t in this spending bill. The issue which could have shut the government down was a threat made by the White House which was unrelated to this plan. Ignoring this unorthodox negotiation tactic, the stock market can breathe a sigh of relief until the fall when another showdown will ensue.

The American Healthcare Act with the MacArthur Amendment passed the House of Representatives by the slim margin of 217-213. The MacArthur Amendment made the plan agreeable to fiscal conservatives because it allowed states to waive the requirement of insurance providers to provide cheap healthcare to those with pre-existing conditions. Those who have those health ailments are put into high-risk pools. The latest negotiation added a final nugget to get moderates on board. It added $8 billion in funding to these high-risk pools to counter the claim that they are often underfunded.

Now the plan heads to the Senate where it will face a tougher battle to pass because the GOP only has 52 seats which means it can only afford to lose two. Dean Heller, the vulnerable Senator from Nevada, already poured cold water on the bill saying he wouldn’t vote for it in its current form because he was afraid of people with pre-existing conditions losing coverage. Senator Rob Portman made a similar statement, highlighting his concern about the potential cuts to Medicaid. The good news for those wanting a bill to pass is that the Senate can make changes to it before voting on the plan. My base case projections include the Senate failing before finally coming up with a solution. This will take a few more weeks and probably conclude in the summer.

The market’s reaction was peculiar because the House passing a healthcare plan means tax reform is more likely to pass by the end of the year. As I have stated, the initial plans to get tax reform done by August were too aggressive. However, getting something done by the end of the year is still positive. After the initial failures by the House, the market may be realizing how many hurdles will need to be jumped over to get to the passing of tax reform. To me, tax reform looks like the final hoorah for the earnings cycle.

Conclusion

Earnings expectations are exceedingly high over the next twelve months. The healthcare reform bill passing the house is a step in the right direction towards getting tax cuts passed which will be a tailwind for earnings. I don’t expect a 15% corporate tax rate to pass, but a 20% or 25% rate seems likely. It’s bullish for retailers that Trump seems to have taken the border tax off the table. The biggest temporary win for stocks will be the repatriation tax holiday.

The chart below breaks down the beneficiaries of cutting the corporate tax rate to 20% by sector. The biggest winners are financials and consumer discretionary. While technology is not a big winner from the corporate tax cuts, it does win from the repatriation tax cut.

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