I’m about to take you with me on a trip back in time, to some of the most magical years of my life. Fear not, this story has a direct bearing on you and your money in the present.
The Dire Straits’ self-titled debut album was a revelation for me in high school There’s not a “throwaway” song in the lot, and it became the first album that I literally wore out. I listened to that vinyl album so much that the grooves wore down and one line on “Sultans of Swing” (And Harry doesn’t mind…) would play over and over until I bumped the stylus forward.
The high energy hit songs “Sultans of Swing” and “Down to the Waterline” are breathtaking. But there’s a more reflective and mellow song on that album that has won my heart. Here’s the story…
Two years after graduating from college, in front of a secluded park bench in central London, I knelt down on one knee (I’m a traditionalist at heart) and asked my girlfriend of six years to marry me.
The woman who is now my lovely and talented wife said, “Yes”.
Weeks later, I realized – quite by coincidence – that a passage from the song “Wild West End” on that first Dire Straits album was a perfect narration of that engagement night.
Before that fateful moment at the park bench, we had enjoyed the play Figaro in the West End, London’s predominant theater district. And in the West End, the main thoroughfare is Shaftesbury Avenue.
That’s about all the background you need to see why these song lyrics still bring a thrill to my soul every time I hear them:
I saw you walking out – Shaftesbury Avenue
Excuse me for talking, I wanna’ marry you
This is the seventh heaven street to me
Don’t you seem so proud
You’re just another angel – in the crowd
And I’m walking in the wild West End
Walking with your wild best friend
When I heard that song play weeks after our engagement moment, my jaw dropped. I called my fiancee and excitedly told her about my musical epiphany.
And then I did the (almost) impossible – I wore out a CD version of the same album I had listened to so much in high school.
Why this musical walk down memory lane? Because much like my old Dire Straits album, I’m about to sound like a broken record – the market narrative is STILL driving almost every twitch in the stock market…
And that sets us up for repeated profits, too…
It’s All About the Market Narrative
The strong push up in the markets has everything to do with the market narrative. That’s the overarching theme that is the most prevalent driver of the long-term stock price trend.
I know – broken record. I hear you saying, “D.R. – you’ve talked to us about the market narrative so many times…”
I do it for one reason:
If we have a clear understanding of the market narrative, we can make money and plenty of it.
Since early November of 2016, the Trump Growth Narrative has been the prevailing market driver. The three legs of this growth narrative are still – and have been since our original discussions – reduced taxes, regulatory reform, and infrastructure spending.
And right now, the most important driver out of this three-legged stool is the recently passed tax reform. I believe that the effects of tax reform have no yet been fully priced in by the markets. Here’s why.
The most basic fundamental analysis of a stock’s value would be that the current price should reflect the net present value of all future cash flows produced by the company.
Given that definition, when cash flow has a step change increase (in this case from reduced tax expense), stock price must, over time, increase to take into account all of the future tax benefits.
And until companies start reporting actual earnings under the new tax regime, we won’t know the all the nuances of the tax benefits.
Because of this uncertainty, the market has not yet fully been able to price in or “discount” the effects of reduced tax expenses.
So what do we do about that?
Let’s look at the three areas of the tax reform that I believe will have the biggest impact on stock prices:
- Companies with most or all of the tax revenue coming from the U.S.
- Companies that require large capital expenditures
- Companies with large cash hoards overseas
Let’s look at these individually, and then zoom in on some companies that I have my eye on in each category.
High Percentage of Tax Revenue from the U.S.
This one is pretty straightforward once you realize that companies by and large get taxed for their sales in the country where the sales are made. Corporate tax rates haven’t changed significantly in other countries. But they sure have in the U.S.
Since the tax reform only effects sales that happen in the U.S., countries who get most or all of their revenue inside this country stand to benefit the most because of the drop of the top tax rate from 35% to 21%.
I was surprised to find 292 stocks out the largest 1000 U.S. stocks have all or almost all of their revenue coming purely from the U.S.
Here are three I’ll be looking to buy on pullbacks:
- Anthem, Inc. (ANTM) is a healthcare stock that provides medical products and managed care plans for all sizes of employees.
- Citizens Financial Group (CFG) is a super-regional bank that we have made 100% options gains on in Stealth Profits Trader. I love the financial sector for the first half of 2018.
- Steel Dynamics, Inc. (STLD) manufactures steel products and has a large ferrous metal recycling business. This business will be helped not only by tax reform but also by the potential of large infrastructure spending.
Capital Spending Becomes an Expense Sooner
How a company gets to expense the cost of property – from real estate to equipment to even software has always been a complex accounting issue.
In somewhat of an oversimplification: If you put in a new piece of manufacturing equipment with an IRS imposed 20-year lifespan, you could only write that expenditure off in equal increments over 20 years.
With the generous early expensing provisions of tax reform, companies that would benefit include:
- Air Lease Corp. (AL) which buys and then leases commercial aircraft
- Southwest (LUV) – an airline with most of its revenue coming from domestic flights
- Autonation (AN) – Country’s largest car dealer network
- J.B Hunt Transportation (JBHT), CSX (CSX) – Transportation companies for truck (JBHT) and rail (CSX)
Bringing the Cash Back Home
Companies with large overseas businesses won’t be07efit as much from the domestic tax breaks, but those that have managed to accumulate cash overseas get a chance to repatriate that cash at a reduced rate from 8 to 15.5%.
The companies will then be able to return it to shareholders through dividends or share buybacks or better yet, invest the low-tax-rate capital in business growth opportunities. While we know Apple (AAPL) has the single largest overseas cash hoard, there are other companies that have as much as a percentage of market cap. Here are three I love:
- NetApp, Inc. (NTAP) – While Apple has 25% of its market capitalization stored as cash overseas, NTAP has a whopping 36% of its market cap overseas. We’ve been long this stock for over two months in Stealth Profits Trader and I’ll look for new trades on pullbacks.
- Cisco (CSCO) – This maker of “plumbing for the Internet” is the only company with a higher percentage of cash relative to market cap than NTAP stored overseas at 37%. This solid long-term earner is a buy on every pullback stock
- Waters Corp (WAT) is a healthcare lab equipment and software maker with 17% of their market cap tucked away as cash overseas. A strong business model makes this an attractive play on any pullback.
The market narrative is a powerful tool to keep us heading in the right direction. And with a strong market mover in tax reform, we have the opportunity to profit on many stocks as they realize the benefits of this growth-oriented tax plan.
That’s a proposal I’d get pretty starry-eyed about, if I were you.
Great trading and God bless you,