QE Tightening To End In 2-4 Years

Fed’s QET To End Between 2020 & 2022

The chart below brings light to the timetable I’ve been discussing with regards to the Fed’s balance sheet unwind. I stated that it would be unlikely for the ECB to start an unwind before the next recession because its QE program will end in late 2018 or early 2019. That would mean a tightening would start in 2020 or later. I added to that point by saying I didn’t even think the Fed would finish its unwind before the next recession even though it is starting over a year before the ECB finishes its QE. As you can see from the chart below, the Fed’s balance sheet will be at about $3.5 trillion in June 2019 which will mark the longest expansion in U.S. history. I have no reason to think a recession will come in 2018, but it’s important to recognize that when you say you’re expecting the unwind to go smoothly, you’re saying that this will be the longest expansion by a year or two. The chart below is a bit misleading in the sense that it shows the balance sheet getting back to $500 billion. That is unlikely to happen. The unwind will end between the two grey dotted lines which represent the $2 trillion and $3 trillion marks.

Finally, I also disagree with the second bullet point which says asset prices went up because of QE, so they will go down once the balance sheet shrinks. The balance sheet was higher in the early 1940s and no stock crash occurred after it fell in relation to GDP. This time the Fed will unwind the balance sheet, unlike last time when the balance sheet simply grew slower than the GDP. My point is simply that if you’re expecting a crash because you think QE was the only reason stocks are up, you will be disappointed. It is one of a few factors that effect the markets.

Tax Reform A Popular Topic On Earnings Calls

FactSet compiles stats on the earnings calls in addition to giving aggregate data on S&P 500 earnings. As you can see from the chart below, one of the charts they did was showing how many conference calls mentioned tax reform by this point in the quarter. As you can see, the chatter has increased from the past two quarters, rivaling Q4 2016. Even though this chart reflects the positivity exuding from corporations, the political chatter has shifted from talking about the benefits to talking about the potential pitfalls. The tax reform plan no longer looks like a win for everyone. A consumer company that does a lot of business in states with high income tax rates might see a hit to their business next year. Some companies might not see a big benefit if they are paying a low effective tax rate now. Finally, the companies which either don’t have capital to repatriate or have already borrowed against overseas capital at low rates won’t see a benefit from the repatriation tax holiday.

To support my point that there’s some uncertainty on the matter, Brighthouse Financial said on its call, “With respect to tax reform, we just – we don't know yet. It just came out, we've got to evaluate this. There are going to be proposals in there that are going to change over time as well. So whatever's in the initial draft is going to change. So it's – it would be very difficult to speculate where this is all going to end up.” To be clear, most companies are positive on the concept of tax reform. All companies want to pay less taxes, so at the onset any plan is going to look good to them, but the devil is in the details. Therefore, I think the negative political chatter will shift to corporations after the plan is passed (if it’s passed).

Corporations need to keep an optimistic outlook even if some negatives come along with the plan, to ensure the odds of it getting passed are as high as possible. If I was the CEO of a corporation, I would talk about how tax reform would cause my firm would hire more workers. Then, after it’s passed with some of the negatives in place, I’d blame the negatives for why I couldn’t hire workers. This is partially disingenuous, but it helps tax reform get done and reflects that there are negatives to the plan.

Earnings Look Great

The earnings growth rate improved to 6.1% compared to 5.8% last week and the sales growth rate improved from 5.7% to 5.8%. At the beginning of the quarter, only 3.1% EPS growth and 4.9% revenue growth were expected. The Q4 earnings expectations barely changed. As you can see from the chart below, the EPS expectations for 2017 and 2018 were about flat in the past week and they have been improving in the past few weeks. This usually happens because firms usually beat earnings expectations, but it doesn’t mean it’s not a positive. 74% of firms beat earnings estimates and 66% of firms beat their sales estimates. Both stats are above their 5 year average, meaning this bump to 2017 bottom up blended EPS is higher than usual. The beat amounts were also higher than the 5 year average as the earnings reports were 4.6% better than expected and the sales reports were 1.1% better than expected.


It’s important to get passed the headlines to see how events will affect stocks. Don’t just look at the chart showing the number of firms mentioning tax reform and their positivity about the process. There will be positives and negatives to the tax plan. While some corporations will see major benefits and some will see minor benefits, some consumers will be helped and some will be hurt. The fact that some people will have their disposable income decreased, makes this issue more complicated than calling it a huge win like some corporations claim. The Brighthouse Financial statement is a good mindset to follow. The plan is uncertain until it gets passed.

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