"Last week, after making new highs, the NASDAQ “reversed” to the downside. It bounced from there, but yesterday’s action was horrific, for having opened sharply, violently, surprisingly higher, by the day’s end the NASDAQ was sharply, violently, surprisingly weaker and it was so even as the Dow finished higher on the day, albeit materially below its peak. This morning, as we write, the Dow futures are higher but the NASDAQ is weaker… again!" - Dennis Gartman
As we discussed in our overnight wrap, FANG stocks have tumbled 5.6% in last 5 sessions...
... while overnight the MSCI World Tech index just suffered its biggest four-day drop since Brexit, as contagion from the tech-rout spread across the globe.
What started and accelerated this plunge?
The retreat in tech stocks is being attributed to speculation those firms will benefit least from the tax changes, as existing breaks designed to encourage innovation arguably did just that. Turning that around, it implies that those sectors that will benefit most are some of the U.S.’s least dynamic, which in turn undermines the arguments for stronger growth and set a cap on the "growth narrative" and unlimite P/E expansion for tech stocks.
Bloomberg explained further, writing overnight that "in a shift now under scrutiny by corporate tax officials and lawmakers alike, Senate tax-writers made an unexpected decision to keep the existing 20 percent alternative minimum tax for corporations -- a move that imperils GOP promises of business growth and more hiring, tax lawyers and lobbyists said."
Keeping the provision -- which had been set for repeal in an earlier version of the bill -- was “a very unpleasant surprise,” wrote Caroline L. Harris, chief tax counsel for the U.S. Chamber of Commerce, in an article titled “The Alternative Minimum Tax Bombshell.” The chamber and other groups are calling for repealing the AMT.
As Bloomberg adds, Under current law, the corporate AMT serves as a kind of insurance policy designed to prevent companies from using various breaks to pay too little tax. But because the Senate bill would also cut the regular corporate income tax rate to the same 20 percent level, the AMT would hit virtually every U.S. company, according to experts.
“The fact is, almost everyone who’s a corporate taxpayer is going to be an AMT taxpayer” under the bill, said Bret Wells, a tax law professor at the University of Houston.
As a consequence, planned tax breaks in the Senate bill related to intellectual property and to spending on new equipment -- along with the existing research and development tax credit -- would lose their effect.
As a result, Technology firms and utilities might be hardest hit by retaining a 20 percent AMT in the tax legislation, the key factor that appeared to weigh on the stock market Monday.
As Credit Suisse analyst, and tech cheeleader, Jonathan Golub confirms in a report this morning, "TECH+ is our favorite sector given its strong fundamentals. However, as investor attention has shifted to the impact of proposed tax reform, TECH+ has become a source of funds driven by two factors: (1) generally unfavorable tax changes for the group and (2) overweight positioning within the Hedge Fund community."
That said, one doesn't even have to focus on the "bombshell" AMT provision: as Golub explains, companies with primarily domestic end-markets tend to pay more in taxes. "As a result, groups such as Retail, Transports, Business Services, and Telecom should outperform as investors begin to discount tax relief. This should come at the expense of TECH+, Pharma & Biotech, and Autos, which are disadvantaged by proposed changes." This is shown in the first chart below.
Tech's low effective tax rate suggests there is little benefit from tax reform, and in fact upside growth may be capped, even as the sector trades at the second highest forward PE of all market groups, as shown in the next chart.
And while it remains to be seen how much further the coordinated selloff can push tech names, there is some good news: the tech forward PE multiple is far more reasonable than, say, the dot com days, when tech hit 45x fwd.
As such a crash in the Nasdaq is unlikely, although considering record hedge fund leverage, and that tech names have become the biggest hedge fund hotel in history (as shown below), one never knows.