Government Shutdown Ends

The government shutdown matters to the economy; I talk it down because the media likes to exaggerate its importance. The good news is it looks like it will end soon as of Monday after it went on for just 3 days. The chart below shows all the government shutdowns since 1976. As you can see, stocks fall 0.6% on average and are negative 55.6% of the time. The one aspect this chart fails to capture is when the market realizes a deal is likely to get done it rallies before the actual deal is agreed upon because the market is forward looking. You can see this shutdown situation play out that way as stocks rallied on Monday, when it looked like a deal was agreed upon, before the shutdown was officially over. This 3 day shutdown was longer than many of the ones listed below. The longest one was in 1995-1996 which lasted 21 days.

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The scariest part about this process is that the short term funding bill, which includes a 6 year extension of CHIP, only lasts until February 8th. We’ll need to discuss this whole debate again in 2 weeks. The key discussion point in this government shutdown was the GOP making a firm agreement that it will take up the DACA legislation after the government re-opens. Because the Democrats were willing to take the GOP leadership’s word, a deal was made. Essentially, the can was kicked down the road again. The issue is the can barely budged. You would think it would be easier to fund the government when the economy is growing quickly, but it still looks difficult. The ability for the government to remain open after February 8th comes down to if a DACA solution can be agreed upon. The President could be a hindrance to this process because he appears to take a harder line on immigration than the Congressional GOP members. However, he technically has no say in the process, so his opinion might not matter.

Citigroup Hit With A Major Onetime Tax Cost

The Q1 earnings results from FactSet show Citigroup had a big impact on the aggregate results, so let’s review its quarterly report before diving into them. Citigroup had a good quarter as its adjusted earnings were $1.28 per share which beat estimates of $1.19. Revenues were $17.3 billion which met estimates. Revenues for consumer banking were up 6%. Revenues were down 1% in the investment and corporate banking business. Credit losses increased 11%.

It’s interesting to see how the tax cut effects every company differently. For example, American Express cut its buyback while the $15.6 billion buyback announced last year by Citigroup remains on track. American Express stock has been falling ever since that quarterly announcement as its stock is down 2.16% in the past 2 days. Citigroup stock is up 1.83% since it reported earnings on Tuesday making it one of the few financials we’ve looked at which has been up right after reporting earnings. Citigroup took a $22 billion non-cash charge because of the tax cut. $19 billion was from a recalculation of the value of its tax assets and $3 billion was from repatriating foreign earnings. That’s a giant amount of money as it’s more than the company’s revenues for the quarter and the equivalent of the total market cap of a mid-cap firm. The $18.3 billion loss ($-7.15 in EPS) in Q4 had a major effect on FactSet’s calculation of S&P 500 earnings.

Q4 Earnings Have Been Hurt By Financials

As you can see, the S&P 500 Q4 earnings growth has fallen from 10% in January to -0.2% today. Without the Citigroup loss, the S&P 500’s earnings growth would have been 7.9%. As I mentioned, many of the financials also reported one-time charges because of the tax law. Without the financial sector, earnings growth would be 11.2%.

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The chart below shows the change in dollar level earnings in each sector from January 12th to January 19th. As you can see, most sectors have barely seen any change, while the financials saw a $29.2 billion decline. The problem with ignoring the effect of financials and just looking at all the other sectors is there’s not much information available yet. Don’t assume this was a great quarter because there haven’t been many non-financials which have reported yet. That will change this week. Up until last week, 29.85% of financials reported results. With the financials, 10.3% of S&P 500 firms reported earnings. Without the financials only 6.3% of firms reported results.

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2018 and 2019 Earnings Estimates

We’re at an unusual stage for valuation metrics because the trailing 12 month EPS multiple is going to be inflated by the tax charges and the 2018 forward multiple is going to be suppressed by the tax cut. Clearly, the net effect on long term earnings is to the upside, but the charges in 2017, make the future results look better than they are. If a company decided to make all its costs for next year occur in 2017, you wouldn’t value stocks based on the 2018 earnings without the costs. Therefore, the true earnings multiple is somewhere in between the trailing and the forward multiple.

The S&P Dow Jones report on S&P 500 earnings showed as reported Q4 earnings are expected to be down 14.7% because of the tax cut charges. The operating estimates without the charges are down 0.7% year to date. The year to date operating earnings estimates for 2018 and 2019 are up 3.3% and 4.0% respectively. This goes along with the FactSet bottom up estimates seen below. 2018 earnings are expected to be $151.55. 2019 earnings estimates are at $167.36. This means the 2018 PE multiple is 18.63. The 10 year average forward 12 month PE multiple is 14.2; even with all this growth from the tax cut, stocks aren’t cheap. The Shiller PE, which doesn’t have the tax cut baked in at all, has a 34.18 multiple which is 10.01 points off the all-time high.

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