Outside the Box: Earnings death or taxes

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By Lee Adler

WEST PALM BEACH, Fla. (MarketWatch) — Investors could be in for a nasty surprise if first-quarter corporate federal income-tax collections are any indication.

Either corporate profits fell sharply in the first quarter or else corporations have suddenly become much savvier about offshoring income and avoiding taxes. While they may be getting better at avoiding taxes, it seems unlikely that they’ve suddenly all become such geniuses at it simultaneously. My bet would be that when everybody has reported, aggregate earnings may not meet the inflated analysts’ expectations … or analysts’ inflated expectations either.

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The Treasury Department publishes daily data on tax collections. As of 5 p.m. each weekday it releases the Daily Treasury Statement for the previous day. That’s as close as we can get to a real-time economic barometer short of being at the cash register. It’s definitely useful in gauging whether subsequent corporate earnings reports will meet, beat or miss expectations.

Corporate tax collections and subsequent reported aggregate earnings have correlated well historically, not just in terms of the trend, but even to the extent that the peaks and valleys in tax collections are echoed at lower amplitude in the earnings line.

Corporations pay taxes each quarter based on what they expect their quarterly net income will be. That means that on March 16, one day after most corporations paid their estimated quarterly taxes, we should have had a very good idea of how they were doing for the current quarter. The government collected $36.1 billion in corporate taxes in the first quarter. That’s down 31% from the first quarter of 2010.

Wait a minute, I thought we were in a recovery. Standard and Poor’s estimated that first-quarter earnings on the SP 500 Index
/quotes/comstock/21z!i1:inx
(SPX
1,313,
-11.05,
-0.83%)


 would be up 38% year over year. How can income-tax collections be down?

These two numbers should not be going in opposite directions. One of them is actual, and one of them represents analysts’ estimates. We know that analysts can be wrong. Could they be that wrong?

Admittedly, the two numbers don’t represent the same thing. Earnings are worldwide; federal taxes are only due on income earned in the U.S. But still, these numbers should correlate, and over the past nine years they have usually correlated well. The fact that they are now headed in opposite directions should get our antennae up.

Contrary to popular belief, stock prices trail earnings, not vice versa. And earnings clearly track with tax collections. The last time we saw a big negative divergence between taxes versus earnings and stock prices was in the summer of 2007, when tax collections began to turn down ahead of earnings and stock prices. An upside reversal in tax collections also led the turn to a bull market in 2003. They were late at the 2009 low, but that was because Congress, in its infinite wisdom, granted tax relief to a wide swath of the business world.

The fact that these indications were available in real time, ahead of the earnings reports, gave anyone who was paying attention a nice heads up on the bear market in 2007. The current divergence is significantly bigger than that one.

So is this a case of corporations suffering a big earnings decline in the first quarter or of them suddenly getting better at avoiding taxes? If it’s the former, investors are in for a shock. The market is expecting much higher earnings, which tax collections suggest haven’t materialized.

If it’s the latter, it brings to mind that U.S. corporations have all the rights of individuals but less of the responsibilities, like paying taxes. Since the Supreme Court has ruled that they can secretly spend as much as they want to influence tax policy, it might be good for the U.S. stock market, but it’s bad for the American people. Just something to keep in mind, if in fact earnings report meet expectations.

Having seen this data my bet would be that they miss in a big way. Maybe the market’s reaction to Alcoa Inc.’s
/quotes/comstock/13*!aa/quotes/nls/aa
(AA
16.62,
-1.15,
-6.47%)


 earnings is the first glimmer of recognition of what the tax data have been telling us.
Read “Alcoa sets a somber tone.”


Lee Adler is editor and publisher and of The Wall Street Examiner
.


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/quotes/comstock/13*!aa/quotes/nls/aa

Alcoa Inc (AA)



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