Tax Reform Complicates SP 500 Earnings Analysis – Thoughts about 2018 SP 500 EPS

Here was the latest “cash repatriation” math for large-cap Tech in the event of major tax reform passing, and with the Senate passing a bill late Friday night, the probability of real reform becoming law is greatly improved.

Capital gains treatment could also impact the market the next few weeks: here is a Morningstar article by John Rekenthaler that talks about distortions that will result from the change to FIFO capital gains accounting for investors with taxable accounts.

With the Tech sector weaker the last week, was it a function of the semiconductor sector weakness, the potential higher tax on cash repatriation (the last figure I heard was a 10% “repatriation” penalty but that doesn’t mean there is a higher number floating around Congress), or was it a function of selling your ’17 winners to avoid the FIFO cap gains change ?

The Wall Street Journal ran an article early Saturday morning after the Senate bill passed, and in the article was a table comparing the House and Senate bills side-by-side and the 20% expected corporate tax rate stood the test of both Houses of Congress.

The drop from an effective corporate tax rate of 30% – 35% currently, to an expected 20% (maybe why retailers or companies with the majority of revenues in US) will push 2018 EPS estimates up sharply when it happens.

The ultimate question is how much of tax reform is discounted in current US stock market prices ?

With the big rally Thursday after Senator McCain’s comments, maybe far less than we think.

Financial’s had a big week the last 5 days: the XLF was up over 5% on the week, Schwab was up 8% (client’s largest financial weight) and CME broke firmly above its late December, 2007, high of $142.90. Here was this blog’s latest Financial sector update from mid-November ’17. Here is another blog post from early October ’17 beating the drum on Financials.

The Financial sector has narrowed the under=performance gap with the SP 500 considerably the last 30 days.

Thomson Reuters data (by the numbers) dated 12/1/17 

  • Fwd 4-qtr est: $142.49
  • P.E ratio: 18.5(x)
  • PEG ratio: 1.7(x)
  • SP 500 earnings yield: 5.39%
  • Year-over-year growth of fwd estimate: +10.79%, vs last week’s +10.8% 


Analysis / conclusion: Expected 2018 SP 500 earnings growth is already 11% for 2018, but it is unclear just how much of that assumes tax reform. My thought was that we could see $150 from this late October ’17 blog post in 2018, but of the 20% expected corporate tax rate holds, and there is reasonable cash repatriation for large-cap Tech, the high estimate I’ve heard from Wall Street (JP Morgan) is another $12 in EPS could be tacked on to the SP 500.

That means – assuming the JP Morgan Strategist was heard correctly – that $155 – $158 might be the “new normal” for 2018’s SP 500 EPS estimate, versus the current $146, 2018 bottom-up Thomson Reuters estimate today. And again, this assumes very little of tax reform is in 2018 estimates presently.

By the way – and just to repeat to readers – these are opinions and I’m using the weekly blog posts and the SP 500 earnings data simply to force the thought process about SP 500 valuation and expected growth rates.

This could all change in a heart beat with last minute negotiations, deal making, etc.

Here was this blog’s 2017 SP 500 return forecast, written in mid-December ’16.

Not a bad call – and arrived at remarkably easy without complex model creation or dramatic navel gazing. The 2018 forecast will be in two weeks.

Thanks for reading…




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