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This is a headscratcher…

17 March 2019

Nothing hurts more than expecting a cheque yet receiving a bill. Could this be why US data is so perplexing at the moment? Rathbones’ chief investment officer Julian Chillingworth explains.

With the American fourth-quarter earnings season wrapping up, corporate profitability has been fairly resilient. Of course, the real test will be whether companies can continue to improve in 2019.

About 70% of companies beat analysts’ expectations of earnings per share, and 60% posted better-than-forecast sales, according to FactSet. Blended across the index, final-quarter S&P 500 sales were 5.8% higher than a year earlier and earnings were up 13.1%.

But what about the future? Roughly 35% of companies in the headline US equity index have lowered guidance for future profits, while just 5% think they will make more this year than last. Still, more than half of the index have stayed quiet about their prospects.

Concerns about more difficult trading conditions have been hanging over stocks for some time. Late last year, as markets were slumping and investors were panicking, the P/E fell below 14x. It has now bounced back to 16.3x, higher than at any point since global equities began wobbling in October. This uptick in valuations is despite analysts expecting first-quarter earnings to fall 3.2% and remain flat the following quarter.

US economic data were perplexing in February. The number of jobs and wages are growing well, but retail spending absolutely dived in December. The ISM PMI surveys – a mix of emotional data like confidence about the future and hard numbers like upcoming orders – were also simultaneously hot and not. The non-manufacturing ISM jumped much more than expected while the manufacturing measure slumped. A fall in housing starts accelerated, with concrete slabs poured for fewer homes than at any time since 2016.

Many other economic data have started to contradict each other too. For instance, Americans enjoy a booming labour market with decent pay rises, yet more than 7 million of them are at least three months late on their car repayments. That’s the highest number since the global financial crisis. It’s a headscratcher for sure.

The longest government shutdown in history wouldn’t have helped the average Joe’s outlook, for sure.

Tax change affecting millions

Another explanation for a recent spike in sadness – if not a sharp slowdown in spending –could be a small yet overlooked tax change introduced with the Tax Cuts and Jobs Act.

The new regime reduced the amount of income tax taken direct from American payslips (what we call PAYE). In 2017, about three-quarters of all filers received a refund averaging $2,800 because they overpaid tax during the year. Now, the US Treasury expects four million of them won’t get a refund and will instead have top-up bills to pay, despite most of them paying less tax overall.

You could try to explain to these people that this is a good thing: you should always pay your tax later rather than upfront wherever possible. But, as paraplanners, you’ll know that’s not how people work. People who expect a refund but get a bill instead will be incandescent with rage, regardless of mathematical reality. US Congress, meet behavioural finance …

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