Brighter lines drawn between winners, losers

While benchmarks muddles along, turbulence was rising within individual industries

by BLOOMBERG

NEW YORKTo the naked eye, it was just another up week for stocks. The S&P 500 Index rose seven points, the eighth time in a row it’s been up. Beneath the surface a barrage of headlines on everything from earnings to the US Federal Reserve (Fed) and taxes were drawing brighter lines between winners and losers.

While benchmarks muddled along and broader volatility gauges plumbed to record lows, turbulence was rising within individual industries. Homebuilders and companies with shaky finances dropped as the House tax bill sought a limit on mortgage and interest expense deductions. Meanwhile, Apple joined other tech megacaps in beating estimates, solidifying the industry’s market leadership.

“You have seen homebuilders get whacked and the big tech companies really fire ahead,” said Jeff Lancaster, a principal of San Francisco-based Bingham, Osborn & Scarborough, which oversees more than US$4 billion (RM16.94 billion). “Investors remain attentive to the shift in the regulatory environment and the tax environment.”

Surface calm masked wide divergences in returns during a quarter in which investors have bought companies with the best earnings potential while staying away from those that may be hurt by competition or new policies. The Fed’s plan to raise interest rates has bolstered financial shares and at the same time made high-dividend stocks such as utilities and phone companies less attractive.

Another example: Amazon. com Inc’s stock is rising along with its online presence while retailers such as JC Penney Co nurse mounting losses. Despite concern over megacap valuations, tech shares have jumped the most this quarter among 11 main groups as the industry enjoyed the broadest profit beats.

While the S&P 500 climbed 2.7% since September, the gap between the best and worst performing industry widened to 19 percentage points. It’s the first time since the 2008 financial crisis that such a small move in the index was accompanied by such big industry divergence.

The S&P 500 was virtually flat last Thursday, when US President Donald Trump nominated Jerome Powell to replace Janet Yellen as next Fed chair and the House announced its

bill to lower the corporate tax rate to 20% from 35%. While Powell and the proposed rate were anticipated, investors still found groups to punish.

They dumped homebuilders, sending a S&P index tracking the group down almost 3%, as the mortgage interest deduction for newly purchased homes is set at US$500,000, a departure from the current cap of US$1 million for couples filing jointly.

Stocks with the weakest balance sheets fell the most relative to the market since June 2016 as a provision in the tax bill capping the amount of deductible interest expenses at 30% of a company’s income. A likely repeal of electric vehicle tax credit also weighed on Tesla shares.

While almost all Wall Street strategists expect an earnings lift from the tax cuts, few have factored it into their current estimates yet.

The reduction to 20% would increase S&P 500 profit by 11% in 2018, according to Canaccord Genuity Inc.

“The real hope for investors and the economy, though, is that companies would use any higher retained earnings and freed-up foreign-held cash to reinvest in their businesses,” said Jeffrey Saut, chief investment strategist at St Petersburg, Florida-based Raymond James Financial Inc. — Bloomberg