The market was a bit soft in the open, potentially because a tax bill that would allow companies to claim tax refunds by looking back four years (instead of two, currently) seemed to be dead. The significance of that bill is that, companies that had profits and paid taxes over the past four years would be in a position to ask from the IRS to pay back to them those cash tax payments in order to offset current losses.
This practice currently applies with a two-year look-back. So, if a business had pre-tax earnings of $100 for the past two years and paid a cumulative $40 in taxes, but has $100 in losses this year, it can ask for that $40 back. If losses this year exceed the earnings in the past two years, then the company will have to offset future earnings. For example, if losses are $200 instead of $100, the company would receive the $40, and then it would not pay taxes until it has made up another $100 in pre-tax profits.
The look-back feature is important because companies get an upfront payment instead of having to wait for future earnings to materialize, in which case the value of the tax benefit is discounted because of the time-value of money. With the extension to a four-year look-back, companies could receive even more money at once.
However, the main sell-off trigger appears to have been a disappointing new home sales report. The annualized rate of new home sales was expected to come in at 430-450K, but instead was only 402K, which is 7.8% lower from the year-ago rate. This is a step back for the housing market, which is why the reaction was particularly abrupt in stocks of homebuilders and banks.
The higher-levered homebuilders (e.g., HOV and BZH) are down 10-12% today vs. 5-8% for the less credit-sensitive names; the more credit-sensitive banks were down 5-6% vs. 3-4% for the rest. Overall, there was a significant rotation away from risk in the market. Concerns around a V-shaped recoveries set back in and basic materials, energy, and financials sold off the most.
The disappointing new-home sales number comes back-to-back with a poor reading in the consumer confidence index yesterday at 47.7 vs. consensus estimates of 51-55. The major concerns in the consumer confidence index were primarily related to poor outlook for employment.
On the other hand, consumer confidence is where it was only a few months ago and substantially higher than early 2009. Also, new-home sales are easily explained by the uncertainty around the extension of the $8,000 tax credit for first-time homebuyers. It is fairly certain that the credit will be extended, but there will probably need to be a new bill passed, so homebuyers would rather wait for the details to come out before they make a major commitment.
The numbers make sense and we should probably expect a reversal in the unexpectedly strong numbers in the Case-Shiller home price index for October. Nevertheless, the government is still pouring money in the system and the declines may be temporary. Of course, the whole government plan of throwing money to the problem is not a solution at all and the economy can have a big correction when the government realizes that it cannot prop up the entire system by itself, but the market could reverse the recent correction in the meantime.
Disclosure: No positions