Weekly Update: 10.4.17

Quick Update on Tax Plan and Technology Stocks


Dear << Test First Name >>,

When you rush a tax reform plan out a 2am Saturday morning there are going to be some booboos. 

Taking C-corp marginal tax rate to 20% and leaving corporate AMT at 20% (which is only paid by 1% of nearly 6 million C-Corp returns the IRS reports) defeats the whole friggin purpose of the new 20% corporate tax rate.

BUT...while the tax reform euphoria had the Dow open 300 points higher...technology indexes and semiconductor stocks (with a few exceptions) got hit again and clearly used as a source of funds again to the Tax Reform Beneficiary Trade.

Here is the analysis I have read on the subject from Bloomberg

One of the last-minute, late-night changes Senate Republicans made to their tax-overhaul plan may mean higher taxes for corporations, including technology firms, than the bill’s drafters intended, experts say.

As amended, the Senate tax bill would preserve the existing 20 percent corporate alternative minimum tax, a levy designed to stymie companies’ tax avoidance that applies to fewer than 1 percent of U.S. companies under current law.

But under the Senate plan, retaining the AMT could prevent companies from making use of planned tax breaks related to intellectual property, to spending on new equipment and to research and development. The AMT may fall hardest on technology and utilities companies -- though the snag would apply broadly, experts say.

Play Video

House and Senate Work on Compromise Tax Bill

Bloomberg’s Toluse Olorunnipa reports on the House and Senate working on compromise tax legislation.

(Source: Bloomberg)

“The fact is, almost everyone who’s a corporate taxpayer would now be an AMT taxpayer” under the bill, said Bret Wells, a tax law professor at the University of Houston.

Shares of technology companies dropped Monday. An index of technology companies on the S&P 500 fell around 2 percent. The Nasdaq 100 Tech Index fell 1.8 percent.

Already, the U.S. Chamber of Commerce is seeking the AMT’s repeal -- as the Senate bill would have done before Saturday’s changes. Seeing the provision retained in the legislation was “a very unpleasant surprise,” wrote Caroline L. Harris, the organization’s chief tax counsel.

“Repeal of the AMT has long been one of the policy pillars for pro-growth tax reform,” Harris wrote in an article on a chamber website.

‘Drafting Error’

Under existing rules, every corporation must calculate its tax bill according to both the regular corporate income tax and the AMT, and pay whichever’s higher. With the corporate AMT at 20 percent and the current corporate rate at 35 percent, most companies have ended up paying tax calculated at the higher regular corporate rate.

A simple “drafting error” most likely left the AMT in the Senate bill at 20 percent -- even though the overall corporate rate would be reduced -- said Jennifer McCloskey, director of government affairs at the Information Technology Industry Council, a group that represents tech companies including Google, Oracle and Amazon.

Key Point: Congress should repeal the AMT completely or cut it to a level proportionate to the new 20 percent corporate tax rate, she said.

“What member of Congress would say, ‘you know what would get my vote on tax reform? You need to undermine the most popular part of the tax code, the R&D tax credit,”’ McCloskey said Monday in an interview. Addressing the AMT will be one of her group’s “top priorities” going forward, she said.

‘Work as Intended’

Julia Lawless, a spokeswoman for the tax-writing Senate Finance Committee, said lawmakers would work to make sure that tax breaks -- like the Research and Development tax credit -- “work as intended.”

“The goal of this bill is to ensure American job creators can successfully compete around the globe,” Lawless said.

House and Senate leaders this week will begin working on a compromise between their differing versions of tax legislation -- with the goal of delivering agreed-upon legislation to President Donald Trump before the end of this year. One key difference will be the corporate AMT -- which would be repealed under the bill that the House approved last month.

The levy is designed to prevent companies from using deductions, making it essentially a flat rate that can’t be substantially lowered. Without the AMT, companies could use various deductions proposed in the Senate bill -- including provisions for intellectual property and for research and development -- to winnow their tax bills. But because of the way the AMT is calculated, it would snare virtually every company under the bill, according to tax experts.

‘Foreign-Derived’ Income

In other words, a company’s tax bill that’s based on a 20 percent AMT, which doesn’t allow many deductions, would always be higher than the same company’s bill at the regular 20 percent corporate rate -- which would allow various deductions that would lower the ultimate bill.

Such deductions would include a measure designed to induce companies that rely on intellectual property to house it in the U.S., instead of with overseas units. Situating such intangible property offshore with subsidiaries in low-tax jurisdictions -- and then paying those subsidiaries for its use -- has been a key tax-cutting strategy for many such companies.

The Senate bill seeks to address that strategy by setting up a special, discounted tax rate of 12.5 percent for “foreign-derived” income related to IP -- provision that experts say could prompt more companies to hold such property in the U.S.

Leaving the corporate AMT in place would effectively put that lower rate off-limits, though. The provision doesn’t jibe with several other planned deductions or tax breaks, suggesting that the AMT is bound to be reworked by House and Senate negotiators as they meet in a so-called conference committee to fashion a compromise.

Retaining the corporate AMT would also affect companies’ ability to use full and immediate write offs for capital spending on plants and equipment -- which the legislation’s backers have billed as one of its main pro-growth provisions. That deduction would be available for five years -- and then, under the Senate bill, it would phase out in later years to lower levels. Taking such deductions isn’t possible under the current corporate AMT rules, which apply far more restrictive limits on depreciation.

Because the AMT “doesn’t seem to work with some core elements of the overall tax reform package, it can’t survive conference in its current form,” said Michael Mundaca, the co-leader of the Ernst & Young Americas Tax Center.

Only 10,222 corporations filed returns for 2013 showing that they owed the corporate AMT, according to the latest Internal Revenue Service data. That’s less than 0.2 percent of the 5,887,804 corporate returns filed that year."

Action to Take: As this reality strikes the algo trading world, one should expect a snap back in tech in general and our fast growing low p/e stocks.

BUT...Micron Q3 earnings come out Dec 19---which I again expect to beat current expectations because of the strength in NAND pricing and 3D NAND memory in particular. The $billion question is WHERE IS THE SUPPORT ON THE STREET for Micron and memory pricing for 2018? 

Answer is Micron is in its 30-day quiet period before Dec 19 earnings...so its vulnerable. The stock is WAY over sold but as you know it just ripped 60% HIGHER after its last melt-down in August...so Tax Reform bill or not the stock needed a breather and to consolidate itself anyway...but not 20%!!!

Micron and memory related stocks in general have sort of been a game of chicken with DRAM/NAND pricing. Apple's new X phone build peaks in March or April according to the industry...that will keep demand/bid on memory strong (but Apple has of course locked in what ever pricing with Samsung and Micron long ago.) 

Action to Take: We are going to wind down our Memory related stocks here but not into panic selling UNLESS MU can't hold its 100-day moving average and re-take its 50-day. ALL that takes before Dec 19 is positive Wall Street or industry reports/updates AND he promise from the Senate/House conference committee combining the two passed bills to iron out this corporate AMT mistake. 

Here is the Micron chart--we have been in No Man's Land with MU as recently as the  August tech wreck..and then shot up from $28 to $50. Now we have corrected 22%--in 5 trading days. How much of this is rotation to the Tax Reform Beneficiary Trade (TRBT) is unknowable but as I warned in the November newsletter sincei 2018 is shaping up to be the TRBT winners market, we will be rotating ourselves. I can stand a few days under 50-day/100 day price averages since most of us have cost basis of $8-$12 from the original buy recommendation.  


BOTTOMLINE: #1 We will let the market action take us OUT of LRCX MU ALCS AMSL if they do not return to support quickly.
#2 In general we are going to reduce semiconductor exposure and use some long term call options to "rent" exposure with 90% LESS capital
#3 We are adding TRBT positions as one way or another the GOP has clearly decided as predicted to NOT commit political hari kari and the GOP Senators ex-Corker are "in-it-to-win-it"

Action to Take: SELL Ambarella (AMBA)--the 20% boost from their paltry earnings call did not warrant such a move--TAKE YOUR PROFIT and let's buy our first TRBT stock...

BUY MORL Under $17.60 Our old friend MORL the 2x leveraged mortgageREIT ETF. MREITS are C-corporations not pass-throughs and have paid 35% C-Corp taxes on their retained earnings. They will get a bump in distributable cash and that means a bump is MORL's 21% yield. Our forecast is $18.50-$20 target and 22% average yield in 2018 or >30% total return. Personally if you don't use the income I'd reinvest the diviends in new shares; yes the short term rates are going up but the Mortgage REIT industry has that risk hedged out (i.e., they have long term fixed short term borrowing costs). 


That's it from our winter home in beautiful Reno/Tahoe where it's a lot quieter than NYC and we can take a step back and see the fast changing world in slo-motion.

PS: Shopify (SHOP) Options came back to key support today...again on the "sell tech" insanity. IF we don't get a quick relief rally here we will take profits on remaining 60% options contracts ASAP. for total profit of @55-$60k in total!


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Updates/AlertsTobin Smith