Shortly after the Tax Cut/Reform bill was passed by Congress, I did some analysis discussing the various myths of how those “tax cuts,” since they were primarily focused on corporations, would actually turn out.

Well, just two months into 2018, we already have some answers.

Myth 1:Tax cuts will lead to a huge ramp-up in earnings.

The problem with the idea that tax cuts will result in a huge increase in bottom-line earnings, is that estimates got way ahead of reality.

For example, in October of 2017, the estimates for REPORTED earnings for Q4, 2017 and Q1, 2018 were $116.50 and $119.76 respectively. As of February 15th, the numbers are $106.84 and $112.61 or a difference of -$9.66 and -7.15 respectively. 

First, while asset prices have surged to record highs, reported earnings estimates through Q3-2018 have already been ratcheted back to a level only slightly above where 2017 was expected to end in 2016. As shown by the red horizontal bars – estimates through Q3 are at the same level they were in January, 2017.  (Of course, “hope springs eternal that Q4 of this year will see one of the sharpest ramps in earnings in S&P history.) 

Wall Street ALWAYS over-estimates earnings and by about 33% on average. That overestimation provides a significant amount of headroom for Wall Street to be disappointed by year end, particularly once you factor in the “effective” tax rate that most companies actually pay.

But even if we give Wall Street the benefit of the doubt and assume their predictions will be correct for the first time in human history, stock prices have already priced in twice the rate of EPS growth.

It is quite likely that once again Wall Street is extrapolating the last few quarters of earnings growth ad infinitum and providing even more fodder for the market rally. It is also quite likely Wall Street will be proven wrong on earnings as so often has occurred in the past.