Earnings could keep momentum going even if Trump's 'massive' tax plan is a letdown

Earnings could keep the momentum going Wednesday, as markets await a much-heralded tax plan from the White House.

There was some trepidation that the plan, touted by President Donald Trump as "massive," could be a letdown after hyped-up expectations. Stocks soared Tuesday and bond yields rose ahead of the tax plan and as it appeared Congress will act on the budget in time to avoid a shutdown of the government later this week.

"I don't think much of the move is related to renewed optimism over the tax plan," said Mark Cabana, head of U.S. short-rate strategy at Bank of America Merrill Lynch. "There's still an expectation that there's a long way to go on this plan.

"We expect to see essentially the outlines of the broad strokes they would like to have, but not too much details," he said. "That leaves a lot of room for negotiation that will be needed between the White House and Congress."

But earnings alone won't carry the market, and if there are a few big misses in the mix, it could trigger profit-taking.

"It will only take disappointment from one or two household names to tip over the apple cart," said Art Hogan, chief market strategist at Wunderlich Securities.

He said the tax plan should be neutral unless it is not received well or there is some new feature the market views as negative.

"It wouldn't take much commentary from the deficit hawks to say it's not passable," said Hogan. "It just feels like after two powerful rallies we're due for a reset."

Donald Trump
Yuri Gripas | Reuters
Donald Trump

Tax man

When Trump unveils his tax plan, it is expected to sound familiar. Early indications suggest it will be much like the plan he introduced during the campaign, with a 15 percent corporate tax rate. There are not expected to be any new revenue-generating schemes, so bond market traders who have been talking about how it could swell the deficit will continue to focus on that.

"Trump is pivoting away from the concept of deficit-neutral tax reform towards deficit-financed tax cuts. Trump is keeping his original plan of a 15 percent corporate tax rate, which is just a marker," wrote Dan Clifton, head of policy research at Strategas. Clifton said Trump may not have specifics on deductions, but he will be clear on lowering the effective corporate tax rate.

Clifton expects, at the end of the day, that the corporate tax rate could fall from 35 percent to somewhere between 23 and 27 percent. The House plan currently proposes a 20 percent rate but includes a controversial Border Adjustment Tax, which would raise $1 trillion in revenues over 10 years. But the White House is not expected to embrace that plan, and traders believe it will rely instead on economic growth generating more tax revenues to pay for the tax cuts.

Krishna Memani, CIO of OppenheimerFunds, said it will take a deficit-widening plan to charge up growth.

"He can have policies that can improve the regulatory environment and cut tax rates, but the likelihood that it will jump-start the economy and get the growth rate to 3 percent ... for that the deficit has to widen. A tax plan where everything is paid for will not do it. ... The trend [growth] rate is 2 percent, and to jump-start that you need some new driver," Memani said.

Powerful punch

Earnings news has been packing a punch, and stocks were firing on all cylinders Tuesday, with big moves up in several big Dow components — Caterpillar, 3M, McDonald's, and Dupont. After the bell, movers included U.S. Steel, down nearly 20 percent on a big miss, and Chipotle, up 6 percent on better earnings.

As of Tuesday morning, S&P 500 companies had beat earnings estimates at a pace of 78 percent. Earnings growth, including actual reports and estimates, was coming in at about 11.4 percent so far, over last year's first quarter, according to Thomson Reuters.

The Nasdaq surged above 6,000 for the first time, and the S&P 500 rose 14 points to 2,388, 7 points shy of its record close. The Dow was up 232, or 1.1 percent, to 20,996.

On Wednesday, Boeing, Procter and Gamble, Pepsico, Anthem, Norfolk Southern, United Technologies, Fiat Chrysler, Daimler, GlaxoSmithKline, Twitter and General Dynamics all report before the bell. Amgen, PayPal, F5 Networks, Fortune Brands and Tractor Supply are among those reporting after the market close.

"Earnings have been pretty good, and given the growth environment, earnings expectations will probably get realized for at least the first half of 2017. There is a bit of risk the U.S. may be rolling over," but that won't be clear for awhile, Oppenheimer's Memani said.

Oil inventories

Oil could be a factor Wednesday, after a surprise jump in oil supply showed up in the American Petroleum Institute inventories report after the closing bell Tuesday. U.S. government data on inventories is reported at 10:30 a.m. ET.

Stock traders have been eyeing oil prices, which have been sliding recently. West Texas Intermediate futures have been trading below $50 per barrel, a key technical area and a psychological level important for shale drillers.

API reported a surprise 900,000 increase in crude inventories in the last week. WTI futures fell slightly, to just below $49.50 per barrel.

But there was a shocking increase in gasoline inventories of 4.4 million barrels, suggesting that gasoline demand remains weak. "I'd say it remains lackluster but refiners are cranking out high volumes of supply," said John Kilduff of Again Capital.

"If we get confirmation of these numbers, we'll have another leg lower," Kilduff said. "This could be another catalyst, particularly if gasoline leads the way down. It's the commodity in the complex that you look to see either supporting them or undermining them."

Platts says analysts expect a drop in crude stocks of 1 million barrels when the Energy Information Administration report is released and a decline in gasoline supply of 1.1 million barrels. Distillates, which include diesel, are expected to fall 1.8 million barrels.

Stock traders have been nervously eyeing crude, but it has not held back the stock market this week.

"For global growth, even if the U.S. slows down, what oil prices are telling you is that emerging market growth may be slowing down," said Memani. "That would be really bad news since that was the driver of the entire trade from the second quarter of 2016."

But he said he expects that oil is in a trading range as long as emerging market growth does not slow down meaningfully.

"I don't think it's correcting," he said. "We'll be fretting about it without panicking."