Weekly Chartology: Mind The Russell 2000 Gap

Tyler Durden's picture

This week's key themes presented by Goldman's David Kostin: "The weak fiscal condition of federal, state and local governments, and corporate tax reform dominated our discussions this week with hedge fund and mutual fund portfolio managers. So far, 207 firms in the S&P 500 have reported 4Q results (55% of total cap). 45% of companies reporting have beat consensus earnings estimates by more than one standard deviation (above the historical average of 41%) and 9% have missed estimates (vs. average of 14%). The average EPS surprise has been nearly 10%, above the 4% historical average. Excluding Financials, there are fewer positive surprises (44%) and fewer negative surprises (6%)." For now Kostin is still sticking to his 1,500 forecast: "The S&P 500 rose 1.5% this week. Industrials was the best-performing sector (+3.0%) while Consumer Staples was the worst-performing sector (-0.5%). We expect the S&P 500 to rise to 1500 in 12 months (+15%)." We give this forecast three months max. After all, the path for QE3 must be paved with good intentions. And the kicker: "We expect a  combination of 8% sales growth and 30 bp of net margin expansion to 8.8% will combine to boost EPS by 14% to $96 per share." Ongoing margin expansion as most companies are prewarning about maring collapses... This is beyond painful. 

Full comments:

Corporate taxes, the weak fiscal condition of federal, state and local governments, and 4Q 2010 earnings results dominated our discussions this week with hedge fund and mutual fund portfolio managers.

A report from the Congressional Budget Office (CBO) showing the US federal deficit would be $1.48 trillion in FY 2011, more than $400 billion greater than estimated 12 months ago, prompted a new round of questions from investors about the appropriate yield and risk premium that should be assigned to US bonds and stocks. The decision by Standard & Poor’s to lower the sovereign credit rating of Japan to AA- focused equity investor attention on the tail risk possibility of a credit downgrade of the US. Last week during our 19th annual strategy conferences across Europe, investors raised the same concerns about the unsustainably weak fiscal position of the US and prospects for higher Treasury yields and lower stock prices.

The US is certainly not alone in its budgetary imbalances and sovereign debt issuance requirements. We have noted previously that with $14.0 trillion of debt currently outstanding the US is on track to hit the existing federal debt ceiling of $14.3 trillion by March or April 2011. Under rules adopted by the House of Representatives under Speaker Boehner, separate votes must take place to raise the debt ceiling and to pass the actual budget.

With many Republican representatives coming to Washington, DC on the Tea Party austerity platform, the media attention surrounding raising the ceiling will be significant. We expect the debt ceiling ultimately will be raised.

Investment implications: (1) we do not view a spike in US interest rates and falling equity prices as the most probable path for financial markets. Many recent US economic indicators have exhibited strength including consumer confidence, new home sales, durable goods orders, and GDP.  However, a dip in the home price index and mortgage applications suggest intermediate term weakness. Goldman Sachs Economics forecasts 10-year US Treasury yields will rise by roughly 50 bp to 3.75% at year-end 2011 and another 50 bp next year to reach 4.25% at year-end 2012.

(2) We forecast S&P 500 will rise roughly 17% to reach 1500 at year-end 2011. We expect a combination of 8% sales growth and 30 bp of net margin expansion to 8.8% will combine to boost EPS by 14% to $96 per share.

(3) Volatility is likely to spike as debt outstanding approaches the ceiling,
repeating a pattern from 1995 when the government last experienced a temporary shut-down of non-essential government services when a budget compromise could not be reached.

President Obama’s “State of the Union” speech mentioned eliminating tax loopholes and using the savings to lower the US corporate tax rate. Unfortunately, no specific proposal was made and details matter when the tax code is concerned.

The current statutory marginal US corporate tax rate equals 35%. Including state taxes lifts the total marginal tax rate to 39%. President Obama argued that cutting the federal corporate tax rate would position the US closer to many other countries and make domestic firms more competitive with overseas counterparts, spurring new orders, capital spending, new hiring and leading to faster domestic economic growth. Exhibit 1 highlights that the US statutory corporate income tax rate (federal and state) ranks well above most other countries.

The argument that the US needs to reduce its existing corporate tax rate to more closely align itself with other nations seems similar to the mercantilist tendencies exhibited last year as countries essentially competed to devalue their currencies in a bid to boost competitiveness of their export industries.  In the case of taxes, each country (or state) wants to make the business environment more hospitable than its neighbors to spur job creation.

However, very few firms actually pay taxes at the statutory rate. For example, the median effective tax rate for the firms in the S&P 500 equals 32% (see Exhibit 3). The map in Exhibit 4 indicates each state’s combined federal and state corporate tax rate. States with adjusted tax rates of 35% have no corporate income taxes.

From an investor perspective it remains unclear whether lowering the statutory US tax rate and closing certain tax loopholes will actually have an impact on profits, and hence valuation of the market. In fact, changing the tax code may not even result in any additional revenue to the federal government given effective rates are so far below the statutory rate.

The top 10 and bottom 10 stocks in the S&P 500, ranked by the trailing five year average effective tax rates, appear in Exhibit 2. For example, Chevron (CVX) and Exxon Mobil (XOM) paid taxes at an average rate of 43% and 42%, respectively, over the past five years. Meanwhile, Altera (ALTR) and Waters (WAT) paid taxes at an average rate of just 13% and 15%, respectively. As noted above, future effective tax rates will be critically dependant on the specifics of any legislation.

Below is the tax-related chart showing how Obama continues to be full of hot air:

And the one chart that confirms that in the hot air department, Goldman is close behind: S&P margins...

Presenting the sell-side groupthink: 1 Month earnings revision sentiment by sector. Go long consumer staples and avoid industrials like the plague.

Aggregate S&P metrics: the one key one - FCF yield at 6%.

Time for a drubbing in the Russell 200: and yes, the RUT is now down 1% for the year.

And as a reminder, a week ago we pointed out the Russell 2000 stocks with the highest beta. Those who believe the market is due for some normalcy, should go balls to walls short these names (as a basket).

Full Kostin presentation:


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Xibalba's picture
Saturday, January 29, 2011

Is Something Serious Up at Treasury?

On Sunday, Treasury Secretary Geithner will have dinner at Treasury with former secretaries of the Treasury.

What's up with this? There was no indication on the weekly Treasury schedule, put out just a day ago, that this dinner was planned. Very unusual.

On top of that, the Treasury put this notice out at 9:00PM on a Saturday night. Sure looks like a rushed meeting to me.


Motorhead's picture

I guess they won't be eating gold for dinner, hehe.

asdasmos's picture

No, but they will garnish their food with salt, pepper and of course, Dollar confetti.

Sam Clemons's picture

While reading this, I can actually feel the rainbows being shot up my ass.




dizzyfingers's picture

You are a fount of pithiness! xoxo

slewie the pi-rat's picture


rainbows, indeed, Sam!

that's when i realized i had

a) wet my pants laughing, plus,

b) i'd fallen face down, and couldn't get up, AND

c) the sun had come out.

i sure hope the porridge isn't too warm for goldilocks!

and that the bears don't come home while she's resting and rip off her head and shit down her neck, just because they're so envious of her beautiful hair, of course.

but this is a lot of bull for an apprentice cat herder to handle.

cat #1:  gov't train(s) careening off the rails.

ans.#1: trust us; doesn't matter, these 500 are headquartered in the caribbean, like the FED.

cat #2:  accounting reports?  what accounting standards?

ans.#2: trust us;  if any discrepancies develop, during some future audit, we'll get back to you ASAP.

cat #3: adjusted for inflation?

ans.#3: trust us; there IS no inflation above what we know to be acceptable (1-2%).

cat # 4: what have the insiders been up to with these stocks?

ans.#4: trust us, they may have taken some money off the table, but that's just because they needed to buy forklifts and airplanes to move to paraguay, next month, as planned since 2008.

cat #5: what is the downside risk to investing here?

ans.#5: trust us; with QE, the danger is to be in a defensive position, and miss this move to 1500!

disclaimer: i have been so wrong, so many times, that if you believe one thing i say, ever,

you might turn into a cat and be a little hard2herd, yourself!

RobotTrader's picture

Note the volume surge off the lows.

I'll probably be buying this on Monday.  Note that I refuse to play the "Double Whammy" or "Triple Whammy" ETF's because virtually action junkie will be piling in and out those the next few months, causing all kinds of price distortions.

I only play the straight ETFs.

Second firm close over the 21-day.  That's a pretty good signal

Everyman's picture

Robo, do you think this will be an extended down for 1-4 months, or quick marketwide drop with your analysis of the charts?

What is the VIX indicator you use or do you use it for this type of call?

slewie the pi-rat's picture


I only play the straight ETFs.


i'm speechless.

Sudden Debt's picture

Anybody picked up on the news that China is going the build the biggest city on earth?

The Bohai Economic Rim will be turned into 1 city and will be the cream in city planning, state of the art communication systems, state of the art transport systems....

  • Nine current cities melded to make single 'megalopolis'
  • New city will be 26 times size of Greater London
  • 150 infrastructure improvements: energy, water, telecommunications
  • 3,100 miles of railway to be laid to connect the cities
  • Read more: http://www.dailymail.co.uk/news/article-1350483/Largest-city-world-China-build-metropolis-twice-size-Wales.html#ixzz1CXHYwVhC






    Lndmvr's picture

    Then round up the americans, ship em over in the empty superships, Give em a job at $2/ hour, ship 300 million chinese to the US to dig up gold?

    dizzyfingers's picture

    Didn't I just see something about China's empty cities?

    And China's shortage of water?

    And some problem with with expansion of deserts?

    Will the new one be named Las Vegas East?

    Tic tock's picture

    Equities are based on one thing, that golem at the FRBNY doing what it does, rain or shine, printing money...if you want to do something right, best to do it yourself, eh.

    Grand Supercycle's picture

    Just updated my S&P 500 Financial Index chart.


    raya123's picture

    Correct on the S&P, but dead wrong on gold and gold stocks, which just bounced off the bottom and is now trading inversely to the euro and will do so for the next several months.

    Bill Lumbergh's picture

    I concur with the poster above that gold and silver should do well in the long-run despite pull-backs along the way.  Similar to other K-Wave Winters equities will decline while the real price of gold and mining shares should end higher.  I never understood why so many forecasters were either outright deflation or inflation and not allowing for precious metals to do well regardless.

    ZeroPower's picture

    Basically Kostin's team suggests long financials, tech, energy.

    Underweight in cons staples and health care.


    Also, 1500 SPX eoy is a decent target - assuming we have a slight (and justified) correction for the next week(s) that means a LOT of choppiness in 2011.

    centerline's picture


    Corporate leaders really smoking the good stuff? Or maybe they do in fact see the train wreck coming and are preparing accordingly. Of course preparations would mean squeezing every ounce of blood possible from the organization to boost margins and stock prices, so they can flip options and cash out as quickly as possible. What would that look like? Well, I would think it would look like hiring freezes, reduced benefits, outsourcing, slashed cap-ex budgets, M&A instead of organic growth/expansion, lots of insider selling into a background of rising equity prices, etc.

    RobotTrader's picture

    Good market wrap by Gary Kaltbaum.

    He says major top already in place, with foreign markets already in "private bear markets".


    ZeroPower's picture

    How many times since 09 have there been people calling tops? May '10, November..

    These are all intermediate-term hiccups.

    To pack up and close shop (i.e short) here would be just want the bulls want - they are still in control until the trend says otherwise.

    ArkansasAngie's picture

    (2) We forecast S&P 500 will rise roughly 17% to reach 1500 at year-end 2011.

    Repeat after me ... there is no inflation.

    What a complete crock of odoriferous material



    Caviar Emptor's picture

    How virtuous cycles turn viscious:

    -Too much print, print, print can come back an bite you in the ass. It worked in the past when the dollar was stronger, when price imbalances with the developing world were wider and wen there hadn't been so much depletion of natural resources. A Goldilocks economy was possible where it was possible to export inflation to the under-developed world in return for cheap imports made with cheap labor and cheap resources. Now the tipping point has been reached where more liquidity simply has far less of an impact on consumer buying power but raises the cost of remaining natural resources and the cost of once cheap labor as under-developed economies become  developING. Simple. Goldilocks is beginning to squawk about her porridge. 

    -Building an import-dependent economy to keep domestic wage inflation at bay might make Goldilocks happy at first, but long term the gutted domestic productive economy can no longer sustain itself. Trade balance (minus bogus Treasury debt purchases by foreign CBs) becomes a joke. Competing nations get handed their bargaining chips. And worst of all, domestic consumers can no longer afford the price structure of middle class existence. 

    There are more such cycles that once the Fed sorcerers marveled at that have tunred on their own creators. 

    snowball777's picture

    They should either start labeling this shit as comedy or draw up charges for fraud.

    Rogerwilco's picture

    Just keep telling yourself that deficit spending at 10% of GDP and ZIRP can go on forever. Win the future, together we thrive, we are the people we have been waiting for, the chocolate ration has been increased 25%.


    Robslob's picture

    The outside world always feels the effects before we do...maybe something wicked this way comes...worse, we deserve it.

    Dig in for 2 years...the end will be near when the big boys cannibalize themselves...

    ThirdCoastSurfer's picture

    " A full month into the Hollywood calendar, ticket sales are down 24% from last year, while attendance has sunk 25% from the same time a year ago, according to Hollywood.com."